'We are seeing a perfect storm brewing globally… a slow down is inevitable': Dr Hamid Rashid

Illustration: TBS

The global economy continues to face steep challenges, shaped by the Russian invasion of Ukraine, a cost-of-living crisis caused by persistent and broadening inflation pressures, and the slowdown in China. Our economy is also feeling the crunch.

The Business Standard recently sat down with Economist Dr Hamid Rashid, Head of the Global Economic Monitoring Branch at the United Nations to talk about what led us to the current global economic crisis, what's next and what is the way out of this grave predicament. 

How did we reach this current point of recession-like situation?

We have to go back a little for this answer. 

The global economy experienced a great shock in 2008-9, which has been dubbed the great recession. The recovery from that situation was a very tentative recovery. In the last 10 years, yes the economy emerged from the crisis but one trend was observed, investment did not pick up. Job growth was slower than before the crisis. 

If we fast forward a bit to when Covid-19 hit, the world economy was not doing very good. The biggest challenge presented by Covid was it was a shock to the global economy - simultaneously both on the supply and the demand side. What do we mean by that? On the demand side everyone was under lockdown and travel was completely restricted so no one was buying anything, as a result, the global aggregate demand immediately collapsed. On the supply side, the factories closed down, the shipping lines closed down as well as the airlines so they are two sides of the same equation.

Dr Hamid Rashid. Sketch: TBS

As soon as we got the vaccine, the global economy started to reopen. After the economy reopened there was massive stimulus spending, especially in the United States and Europe. 

A lot of households suddenly had a lot of money on their hands. Immediately after the economy started reopening, demand picked up very quickly but supply did not catch up with demand. Because supply takes time - it takes time to reopen a factory, and it takes time to reopen a restaurant, all the ports were congested, which is why we saw a mismatch between demand and supply. That is the first reason behind inflation. 

The classic definition of inflation is too much money chasing too few goods. Goods supply did not increase, service supply did not increase, but too much money was chasing it. The second-order effect was when inflation started increasing around the beginning of 2021, many economists underestimated the risk; they claimed it was a transitory phenomenon which will soon pass, within 3-6 months, depending on who you ask. 

The US Federal Reserve Board, also known as the Fed, said they did not consider it a big threat. That was a big policy mistake. They thought no policy intervention was necessary. 

Along those lines, they were looking at certain numbers like unemployment. Since unemployment was decreasing, they thought the economy was recovering. But there was a mistake as well, because unemployment numbers are not an accurate picture of the economy anymore. In the US if you don't actively look for work for more than six months, then you are considered out of the labour force. So that is why the unemployment rate also is low as many people are out of the labour force.

Many people who worked two-three jobs before the pandemic do not want to do that anymore. They have some money in hand due to the stimulus and other public sector spending. Their job preference has changed as well. People who were truckers, no longer want to be truckers, which made the inflation even more persistent. The Fed could not anticipate this.

In 2021, the global economy grew very fast. We call this base effect. You lower the base and immediately it bounces back. It is statistical growth, not real growth. In 2022, we expected sustained growth. But my team in the UN, IMF and World Bank all downgraded our growth expectations because we could not anticipate some shocks.

The biggest shock was the war in Ukraine. This is a double whammy. This event disrupted the global supply, especially food and energy. They are a big part of the inflation basket, formally known as the CPI [consumer price index] basket. That is why this inflation is persistent. 

Not only is it persistent, but there are also other effects as well, like dragging down growth.

The US Fed has been rapidly raising interest rates since last March and this increase is destabilising the global economy. The cost of borrowing has gone up tremendously, which will further depress investment and without investment, there will be no growth.

Debt sustainability has also become a major issue because globally almost all debt is denominated in US dollars.

For the convenience of our readers, can you please tell us whether the US benefits from the interest rate hike?

The economic theory behind this is when you raise interest rates, consumer demand falls. Because then you have the choice of postponing consumption. If the interest rate goes up to 5% from 3%, some of the money that you would have spent today, you save it. That cools down the economy and inflation drops.

But in reality that is not happening. 

We are very critical of the Fed's policies. The Fed is in fact contributing to inflation. Because a big part of the inflation is housing cost, it is rising rapidly. 40% of the inflation basket is housing cost: rent and imputed rent. When the interest rate goes up house construction goes down, so the supply of new housing goes down, further increasing rent. To curb inflation they should have taken the necessary steps much earlier. 

Now they are doing too much, too fast. One negative effect of that is the dollar is becoming too strong.

What are the negative effects of the dollar being too strong?

There are many pitfalls. 

When the dollar is too strong vis-a-vis the local currency, and if that country is import-dependent, you are losing the value of the local currency and importing inflation. 

In Bangladesh, a lot of the inflation is imported. Oil is being imported, food grain is being imported. Prices are going up. Because everything is priced in dollars, when we convert it to taka, the price goes up.

Secondly, the fiscal space of governments is decreasing due to inflation. Most governments throughout the world, except for the Gulf countries and oil-exporting countries, have their public debt denominated in dollars. In any country, they get their taxes in local currency but the debt servicing [refers to payments in respect of both principal and interest] happens in foreign currency. 

If a country's currency depreciates 50%, if all other things remain the same, their debt servicing increases by 50%. That is why they have to make spending cuts elsewhere. When you make spending cuts in other areas, it slows down economic growth. The demand remains the same but the supply decreases. 

On a side note, since March 2020, if we see the dollar as an asset class, it has appreciated by 14%. All other assets have declined. The dollar is too strong right now.

Normally, devaluation of your currency might be a good thing if you are an exporting country, as your exports become more competitive. If you have a large import component in your export, then it won't benefit you. By buying raw materials from abroad and re-exporting the ready-made garments, we cannot benefit from it. Countries that have all the raw materials are benefiting from the stronger dollar.

When a country's currency loses its value against the dollar, usually it is a good thing because your export goes up [and] import goes down. But with things with inelastic demand like oil or food grains, it does not apply.

How do you see the coming times? What is the worst that we can expect?

We are seeing a perfect storm brewing globally. On multiple fronts, we are seeing a slowdown is inevitable. Overall global demand will go down. Europe will be badly affected during the winter.

Bangladesh's - most of whose exports go to Europe and North America - export will, most certainly, suffer. Around 80% of our export is RMG, the demand for RMG is very volatile as it is elastic. If I am unemployed, I don't need to buy a new shirt.

In Bangladesh's balance of payment, we will see a negative impact in the short run. Especially in 2023, we will see more contraction meaning that in the GDP equation, net exports are negative - so the higher its absolute value goes, the more the GDP decreases. The way our import cost is increasing, inflation will remain high. So one has to be prepared for the storm.

One thing we are hearing is that there will be worldwide famine in 2023, what are your thoughts on it?

Definitely, worldwide hunger has risen significantly. In famine-stricken regions of the world like Somalia, Eritrea and Yemen, food supply has decreased because the food used to go there from the Russian Federation and Ukraine. And because food prices are increasing rapidly, food shortage in sub-Saharan Africa might be acute. 

There are two additional factors as well. 

The harvest this year, especially in the US, was not optimal. Fertiliser prices have gone up tremendously, especially fertiliser that comes out of Russia and Ukraine, that is affecting production in Africa and South America. Overall, the pressure on food prices will continue to be there. People at the bottom of the income distribution will experience worse malnutrition and hunger. 

What will be Bangladesh's situation?

I wish I had a crystal ball. I don't, but I can see all the risks out there. The main risk is there might be a balance of payment crisis. A balance of payment crisis means we pay the import bills from export income or whatever we have in the reserves, or new borrowing. It is a combination of flows, these flows are decreasing. Import income will decrease, bilateral and multilateral lending will shrink, and we also have to service our debt. 

We also need to think about food security. A sizable portion of our population is still living below the poverty line. Global food prices will seriously affect them. Energy security is also a concern. We are a net energy importer. So electricity rationing would become more vital.

How long will this continue?

As economists, we try to be optimistic. We say 2023 will be the bottom out and 2024 will be the recovery. Personally speaking, global bright spots are very limited. In the interdependent economy, we are seeing almost synchronised slowdowns. 

Europe will be the worst hit in 2023, as Europe goes into recession it will affect China's growth prospects. When China slows down, it affects Africa and Latin America because they are heavily dependent on exporting their minerals to China. All of them are dragging each other down. The global economy is spiralling down. 

So where do we see the recovery coming from? You need an engine for growth. Global engines for growth are the US and China, they account for 50% of global growth. If the US can reduce their inflation by 2023, then we will see recovery coming from the US. Meaning that demand will start picking up, [and] the engine will start again. 

When the US recovers, the US will demand more services and goods from Europe, [and] Europe will then recover. Europe will then demand more services and goods from China. Then China will start recovering and the rest of the world will follow.

So, if the US hadn't increased the interest rate so much for internal reasons even after the war broke out, the situation would not be so bad. So what would be the best policy for Bangladesh in these circumstances?

We are all stuck with dollars one way or another. It's almost the global currency. Now what many central banks are doing, they are having bilateral swap arrangements, these need to be accelerated so you reduce the use of the dollar as much as possible.

Second, even in the dollar market, you can buy dollars. If you have a payment that is due six months from now, you can hedge against that dollar charge fluctuation by buying it in the futures market. You are taking a risk. I need 100 million dollars six months from now but I will buy it today. If the dollar drops I will lose money, still it's better to have some kind of hedging.

Third, using the Special Drawing Rights of a currency. During Covid, a $650 billion equivalent of  SDR was created. But till now, there has not been much use. What many people don't understand is that SDR is every country's own asset, not IMF's. IMF is the custodian. 

If we have a balance of payment issue, drawing SDR is better. You can go to the IMF, [and] against your quota you can draw some of the SDR. SDR is like any other currency and the central bank can use the SDR to pay other countries. 

SDR is a little complex. It can not be held by private entities, only central banks. We need to increase the use of SDR so that we are not stuck with such a strong dollar for a long time. It is not good for the US in the long term. It is good in the short term. All the capital is flowing back uphill. Wherever the dollar is, it is outflowing from these countries and going back to the US. 

It is an irony when the US rate goes up, all the dollar flows out because you have a better return. And somehow the US is always seen as a safe haven. That is the risk for the global economy.

In the capital market, say you have a bond in country XYZ. The interest rate has increased, you sell the Ghana bond, take the money and send it to the US. Because US bonds provide 4% interest. US bonds are considered much safer than Ghana.

Back when the current global economic system was created, the Bretton Woods system, John Meynard Keynes forewarned the US that if you make the dollar the reserve currency, yes, it will get benefits, but ultimately it will have a very unstable global financial system. So he proposed a global currency named Bancor. We sell everything using that currency but we will not depend on one country's currency. But of course, the US rejected the idea.

Keynes even showed why it would not work. Before WWII, the pound was the reserve currency, one of the biggest drawbacks of being a reserve currency is that you have to constantly run a current account deficit. Where did all these dollars come from? It is being supplied by Americans themselves. By running a trade deficit, they are supplying dollars to the rest of the world. This is also a big risk for a reserve currency. But the overall benefit is greater than the risks.