An incipient economic recovery, colorfully described as green shoots, is said to be a precursor of better times for the US and the World Economy. This notion has been countered by an equally colorful skeptical riposte “yellow weeds”. In an environment of risk aversion, skyrocketing fiscal deficits, stalled negotiations over the Doha Round, the imminent prospect of increasing tax rates, massive unfunded liabilities of health care and retirement acting as a drag on the economy aggravated by a log jam over the future policy for health and social security, the chances of growth recovering to its trend rate of 3% in the USA are near zero. The more likely prospect is that of of a double-digit recession. A temporary boost from Government spending will be followed by another recession as the economy is weighed down by higher debt service payments.
The one reason for optimism is the recovery in emerging markets. Till September 2008, the recession in the USA was relatively mild. A devalued dollar helped to drive exports overseas especially to emerging markets. The torrid growth in exports was brought to an abrupt halt following the collapse of Lehman Brothers. While the banks were saved from a domino effect, the financial crisis spiraled out of control as trade credit to emerging markets shrank. Concurrently, capital overseas sought refuge in the USA which raised the value of the dollar and rendered exports non-competitive.
As credit markets stabilize, the cost of credit is steadily falling from its astronomical levels and its availability is increasing. Concurrently, overseas investors are increasingly skeptical of USA as a safe haven and want to diversify their currency portfolio. As growth prospects in emerging markets improve, capital is beginning to flow out of the USA. The dollar’s value is steadily falling.
A survey by the International Chamber of Commerce in March 2009 revealed the extent of the damage to the trade credit market. 47% of the 122 banks in 59 countries surveyed by ICC reported lower volume of letters of trade credit and 43% in the value of the letter of credit transactions in the last quarter of 2008. Over 40% of the respondents reported higher fees they have to pay for Commercial Letters of Credit, Standbys and Guarantees. At the same time, the cost of trade credit increased dramatically. According to a survey by the IMF, the cost of export credit insurance was 19 basis points more than cost in the last quarter of 2008 compared to 8 basis points increase over the year ending October 2008. Similarly, the cost of stand-by Letter of Credit increased by 25 to 300 basis points over LIBOR and in some cases 600 basis points. The higher costs of credit squeeze the tiny margins that Asian exporters earn on the goods they supply in developed markets.
A correction in the abnormal situation in credit markets could well restore export activity from Asian countries to levels correlated with the current levels of economic activity even if it has been lowered by the recession. While economic activity in the USA declined by about 5% in the first quarter of 2009, the corresponding reduction in export growth was 22%. In emerging countries like India, the growth was a positive 6% while exports declined by 24%. The World Bank estimated that 85% of the decline in trade was due to fall in international demand and the rest due to shortage of credit of the order of $300 billion. In the case of USA, there is an additional impact of an almost 40% increase in the value of the dollar as overseas investors sought a safe haven.
The trade credit market is showing some early signs of recovery. Central Banks in India, Russia, Brazil and China have stepped in to improve supply as have multilateral institutions like the IFC and Asian Development Bank. The cost of trade credit is still high with a 400 basis points spread over LIBOR. However, the LIBOR spread itself is down 400 basis points from its peak. Concurrently, the value of the dollar has declined 10% against the Euro, 23% against the Australian dollar and 20% against the Brazilian real.
US economic recovery will be driven by growth in the rest of the world till structural problems in the domestic economy are resolved. Lower costs of trade credit and devaluation of the dollar will arrest the dramatic decline in growth but the US economy will continue to sputter at around zero growth.