OPINION : Economics – Local economy well cushioned

Economic forecasters’ crystal balls were muddied more than usual early in September by turmoil in global financial markets. The turmoil had been triggered by losses in the American sub-prime mortgage market resulting from rising numbers of home foreclosures and persistent housing slump. Global markets were unsettled as concerns were raised about prospects of an economic slowdown in the world’s biggest economy.
Dark clouds of doubt make forecasting difficult, but don’t deter economists.
The OECD lowered its growth forecasts for the US and eurozone economies and warned that world prospects were “clearly less buoyant” because of financial market instability. The Paris-based organisation announced its pessimistic outlook while updating previous half-yearly forecasts, but acknowledged the full impact of the American housing crisis and related problems in financial markets could not yet be measured. Chief OECD economist Jean-Philippe Cotis hinted that further revisions were probable.
The IMF similarly was scaling back its projections for economic growth in the United States and Europe. “There will be some downward revision to our growth projection, more so next year than this year,” said Masood Ahmed, spokesman for the International Monetary Fund. “We can already say that the downward revisions are likely to be the largest for the US but we will also see some impact in the euro area.”
He did not reveal how much the IMF expected to trim its growth estimates, but said fresh assumptions would likely be released in mid-October ahead of the IMF and World Bank annual meetings. Even so, he said IMF economists “envisage relatively strong global growth performance continuing”.
In this country, Treasury noted early in September that the pace of real economic growth seemed to have slowed since the start of the year, “and downside risks have risen because of recent volatility in global financial markets”.
The reduced appetite for financial risk had already resulted in sharp drop in the exchange rate. lower dollar (and continued high interest rates) could reorientate growth towards exports and away from domestic demand.
But investor sentiment was “fragile” and volatility high – the New Zealand dollar traded daily in $0.01 to $0.02 ranges in the first week of September, and the Treasury was not ruling out renewed turmoil.
While the main economic impact from such turmoil was likely to be felt in the US, the Treasury portended, some “small” impacts were likely in other markets. Among the possible impacts in this country was downward pressure on prices for commodities and in overall demand for New Zealand exports.
The economy nevertheless could be cushioned by fall in the dollar, and macroeconomic settings (interest rates and strong fiscal position) gave room for movement if needed. Moreover, impacts from similar events in the past, such as the terrorist attacks in 2001, had not been as large as initially expected.
“Indeed, the ‘lower dollar/higher interest rates’ mix from recent events could reorientate growth towards exports and away from domestic demand,” the Treasury enthused. “Such reorientation would accentuate slowing in domestic demand that appears to have started before the recent turmoil took place.”
For the business sector, some company valuations could come under pressure from tighter credit conditions and higher financing costs, and higher uncertainty could discourage some business investment. Investors may be more reluctant to take up higher risk investments in New Zealand, which could constrain some investment activities. “Some finance companies are particularly vulnerable to this shift in investor sentiment, as has been manifested in recent financial company collapses,” the Treasury said.
Within days of the publication of the Treasury report, spate of finance company failures had been reported. These sparked flurry of demands for government authorities to do something – for the Reserve Bank to act as lender of last resort to “good” finance companies to boost investor confidence, for example. But Westpac economists Brendan O’Donovan and Dominick Stephens, in paper sent to clients and the media, put things in perspective. Recent company failures did not amount to significant risk to either the financial system or the wider economy, they noted. The impact should mostly be limited to short-term hit to general confidence, but this would quickly be swept aside by the goodies flowing into the economy from the dairy boom.
Their estimates showed the amount New Zealanders had invested with finance companies ranged from about $9 billion (Reserve Bank data) to about $12 billion (industry figures). The amount of deposits affected by the finance-company failures reported at the time they published their paper had climbed to $1.2 billion, at least 10 percent of the sector total.
But investors would not lose the lot, “so actual losses will be more like $0.5 billion – mild hiccup on the stock exchange”.

Bob Edlin is regular contributor to Management.

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