If a crisis looms, blinkers do not help

A lack of consensus on the remedy does not mean that the diagnosis is wrong. Mongolia at the moment is carried away by increasing revenue and glowing projections, and, in addition to their general refusal to take the people into confidence, election- mode politicians cannot afford to even hint that things could go wrong, for reasons over which the country has no control. Several quotes from hard-boiled analysts and dispassionate observers, included in the section “Parts of speech” elsewhere in this issue, confirm that events and decisions elsewhere could very well dampen the present exuberant optimism overflowing nationwide. (I had thought of calling it gung-ho, but desisted as that word comes from the Chinese ‘gonghe’ and so may not go down well in Mongolia.)

The global economy is on the cusp of another crisis. A brief summary of two recent speeches by two persons eminently qualified – if only because of the offices they hold -- to prognosticate and pontificate confirms this.   They are International Monetary Fund Managing Director Christine Lagarde and World Bank President Robert Zoellick. Urging advanced countries to take bold, coordinated action to break a vicious cycle of weak growth and high debt that threatens the global economy and has been worsened by dysfunctional politics, the IMF chief said in Washington that the world economy had entered a dangerous new phase with global growth slowing as advanced economies struggled with an “anemic and bumpy recovery”.

On the other hand, emerging economies faced overheating pressures with inflation rising, strong credit growth and expanding current account deficits.  Ms. Lagarde said timid growth and weak public balance sheets in developed nations were feeding negatively on each other, fueling a crisis of confidence and restraining demand, investment and employment.  “This vicious cycle is gaining momentum and, frankly, it has been exacerbated by policy indecision and political dysfunction,” she said.

On his part, the World Bank President said the world had entered a “new economic danger zone” and “Unless Europe, Japan, and the United states face up to their responsibilities they will drag down not only themselves, but the global economy. They have procrastinated for too long on taking the difficult decisions, narrowing what choices are now left to a painful few.” Zoellick said European countries were resisting difficult truths about their common responsibilities, Japan had held off on needed economic and social reforms, and political differences in the United States were overshadowing efforts to cut record budget deficits. “The time for muddling through is over. If we do not get ahead of events; if we do not adapt to change; if we do not rise above short-term political tactics or recognize that with power comes responsibility, then we will drift in dangerous currents.”

Do note how both are harping on how action, or lack of it, somewhere can damage economies elsewhere. These two speeches were followed by the  International Monetary Fund releasing its latest assessment of the global economy, which, too, says financial instability, exacerbated by poor policymaking, has worsened considerably and threatened growth, and that the chance of a serious slowdown in the world economy, with growth falling below 2 per cent, has doubled from earlier in the year.

 The report said growth in emerging markets had held up well but it also warned that continued expansion in the emerging markets was endangered by a combination of increasing risk aversion among investors, weaker export demand from the rich world and capacity constraints in some economies which have been in danger of seriously overheating. If demand in China indeed falls, that can significantly alter the contours of Mongolian optimism.
In an updated economic outlook released just before the IMF report, the Asian Development Bank also said Asia’s emerging economies will grow robustly into 2012, although troubles in the developed economies will clip their momentum. The resilience of the region, which has led the world since the 2008/09 global financial crisis, means policymakers cannot relax in the fight against inflation even as global growth concerns overtake price pressures as the dominant economic risk.

Despite global woes, growth will remain healthy across the region, the ADB said. Developing Asia -- made up of 45 countries in Central Asia, East Asia, South Asia, Southeast Asia and the Pacific -- is expected to grow 7.5 per cent in 2011 and 2012.  Before being too excited about this, remember that this is down from April forecasts of 7.8 and 7.7 percent respectively, and growth of 9.0 percent in 2010. Changyong Rhee, the ADB’s chief economist, has also warned that the world’s ability to rebound from something akin to the 2008/09 financial crisis is now much diminished. 

Inflation across the region was forecast at 5.8 percent this year, compared with the April projection of 5.3 percent, while the outlook for 2012 was unchanged at 4.6 percent. “If commodity prices resume their climb and the current weakness in the global recovery turns out to be temporary, regional central banks will have to speed up the process of monetary tightening, especially where inflation is already high,” the ADB said.

Allowing some exchange rate appreciation could help contain inflation by lowering import prices, and that could be combined with temporary capital controls designed to curb unwanted hot money flows which have been preventing some policymakers from raising rates in the inflation fight.  “With real interest rates having turned negative in several countries, more monetary tightening is necessary to control inflation both over the next 2 years and the medium term, when the global economy will regain momentum,” the ADB said.

I have not tried to paint a doomsday scenario, but I do believe that a sense of misplaced security – whether one is lulled deliberately or misled unwillingly – does not bode well. Mongolia should certainly hope for the best but should also be prepared for, if not the worst, at least something several notches below the optimum.  Not all eggs hatch, and if they are all in the same basket of minerals export the risk rises. It would be prudent for Mongolia to tarry a while before counting the tally.

The IMF’s prescription for Mongolia

An IMF mission was in Mongolia last month, to hold Post-Program Monitoring discussions. It noted the “remarkable turnaround” the Mongolian economy has made, so much so that the IMF has decided to withdraw its resident representative in the country.
Even as it expressed faith in Mongolia’s bright economic future, a statement by the mission said there were, in the near term, “substantial risks to the economic outlook”. First, the economy is overheating. Inflation is already high and likely to rise further. Second, this heightened domestic risks of macroeconomic instability come at a time when the global economic outlook is worsening. The IMF strongly urged the Government to “restrain fiscal spending and tighten monetary policy”.
The mission expressed “significant concern” that the Development Bank could be “used as a means to circumvent the fiscal stability law or as a vehicle for off-budget government spending”. This will add to fiscal risks and reduce fiscal transparency.