Global insights: rising India, slowing China and the role of sustainability
Paul Gruenwald, New York-based chief economist at S&P Global, shared his global insights at the KangaNews New Zealand Debt Capital Market Summit in Auckland in September – taking in regional and global economies, US dollar strength and economic trajectory, and the growing influence of sustainability on economics.
Given we are in New Zealand, it seems appropriate to ask how you think global economic trends will affect local outcomes.
New Zealand is a very small and very open economy. Therefore, it gets knocked around by global trends and it has to be flexible in response. The Reserve Bank of New Zealand is sometimes accused of being a little hyperactive, but it has to adjust to external shocks that have a bigger impact on the economy.
Competition is a significant factor to consider here. Inward capital flows and immigration sound like small numbers but are actually quite enormous when put into relative terms. The exchange rate is also very sensitive to these shocks – it is a lot to get blown around. The central bank, therefore, focuses its efforts on being very resilient and very flexible.
New Zealand is in a good place in the sense of its relatively low carbon footprint, very competitive exports and great quality of life. Auckland always shows up on lists of the top places to live globally. But a small economy can always be overwhelmed by developments outside its borders. This is the reality most small countries struggle with, but New Zealand seems to be quite good at dealing with it.
China is once again a major global market risk focus – as always seems to be the case when there are no other proximate risk events. Why should we be specifically worried about China right now?
First of all, it is no surprise that China is slowing. It is easier to grow fast when an economy is catching up. But obviously China was not going to grow at 7-10 per cent forever. As the economy becomes richer, and converges with the West, slower growth is inevitable.
What is different this time is that concern about the sustainability of debt levels in China, and some of the associated risks, now looks like it is materialising – particularly in the property sector. There is a negative confidence loop in which developers are paying foreign bondholders, so far, but their local creditors – the state banks – are lowering interest payments and stretching maturities. It is a case of ‘extend and pretend’.
Households are worried about their investments – properties – being completed and local governments are worried about revenue from land sales. As a result, a system that has delivered for so long is now under some stress, which is pulling down growth.
The question for us is whether the strategy of the banks cutting the developers some slack will work or whether there is a more fundamental problem that involves a bunch of bad debt in the financial system that needs to be cleaned up and resolved. We do not know.
What we can say is that the initial response to the US savings and loan crisis in the 1980s and early 1990s was to extend and pretend, and this didn’t work. It was eventually tackled the old-fashioned way. In China’s case, the scale of the problem and the risks around it are uncertain, but property developer debt needs to be dealt with. Plan A is to extend, but we will see what happens.
What are the chances are that the Chinese government delivers a big stimulus?
Probably low. Back in 2009, China saved the world with a vast stimulus package. It was very well timed and very successful on multiple fronts. But China has a lot more debt these days so I think the Chinese authorities are a bit reluctant to throw even more debt into the economy. They want to make sure these companies’ debt issues are resolved.
I also think they have become more comfortable with slower growth. When I was working in Asia, the Chinese authorities would announce growth targets that they would almost always overperform. Now they are saying stability is important and the growth target is approximate. There is a lot more talk about self-sufficiency and the need to rely less on the rest of the world. I suspect this calculus is not as stringent as before and China can tolerate a period of slower growth.
The other issue to consider is how China can continue to grow fast given its population and labour force are shrinking and it is overinvested. The only source of growth left is productivity: China must continue to move up the value chain.
Because the engine of growth at this point must be productivity, and we know from the data that productivity does not come from state enterprises but from the non-state sector, there is a big question about whether productivity growth is compatible with the state playing a bigger role in some of the main companies in China.
Japan has remained a major trading partner for Australia and New Zealand despite experiencing its own transition from growth engine to a largely stagnant – but larger – economy. Are there grounds to think the ‘Japanification’ of China might not have a significant negative impact on Australia or New Zealand?
It is a bit too early to make the ‘Japanification’ call. Japan is obviously a far more advanced economy and already at the frontier of productivity, which means there is no more catching up to do.
I believe China has some catching up to do. It is not in a death trap, where its GDP is going to stagnate like Japan. But China’s 3-4 per cent growth story, versus its 5-8 story in recent years, moves the needle for countries, like New Zealand and Australia, that are very closely linked to China through the trade channel.
“What is different this time is that the concern about the sustainability of debt levels in China, and some of the associated risks, now looks like it is materialising – particularly in the property sector. There is a negative confidence loop.”
Could India replace China as a growth story?
S&P wrote a paper a couple of months ago for the G20 in India where we argued that the growth baton has passed to India from China. Part of this is due to China’s success. Another part is that it seems to be the moment where all the stars are aligning for India.
In reality, India is still quite small compared with China – its economy could be one-third to one-quarter of the size. Therefore, even when China’s growth is slowing to 3-4 per cent it contributes more to global growth than India growing at 7 per cent.
There is also a big question about India’s ascent. This is because Japan, the Asian Tigers and China all developed via manufacturing. The same argument can be made for Eastern Europe around Germany. India is not really part of any global supply chains or global manufacturing hubs, nor is it a major commodity-exporting country like Australia or Canada. To become a prosperous country, India must rely heavily on services.
Is there a path for a country to become prosperous that is very services dependent and not really part of any of the global supply chains? Possibly – but it has not been witnessed before.
Regardless, as India grows it will need infrastructure and to build up its capital stock. There is a role for Australia and New Zealand. Australia could export iron ore – but perhaps not coal, as this is out of fashion. Meanwhile, New Zealand offers high-end consumer goods and food. Over time, the relative weights of China and India could switch. I think this will happen, actually – but it is slow-moving.
“To become a prosperous country, India must rely heavily on services. Is there a path for a country to become prosperous that is very services dependent and not really part of any of the global supply chains? Possibly – but it has not been witnessed before.”
There seems to be greater faith in the US economic trajectory, though some commentators still believe the idea of the US avoiding recession is a little like the ‘transitory inflation’ story – wishful thinking, in other words. How comfortable are you with the soft landing narrative?
US resilience has certainly been surprising. If you said to me a year ago that the Fed [US Federal Reserve] was going to go with 500 basis points of hikes by September 2023, I would say the odds of a recession are pretty high. But this has not happened yet.
The Fed’s work is almost done. It may need to do one more rate increase, but it has nearly done enough to bring inflation – eventually – down to its target. But the US economy is still running a bit hot, with inflation too high and unemployment too low. However, it can get down to a sustainable path – the question is whether this happens gradually or with a recession. Which of these two scenarios prevails really turns on the labour market.
A combination of good employment growth, good wage growth and firms doing a little of what is known as labour hoarding suggests we can have a protracted soft landing slowdown rather than a recession. We are very aware that this has not happened very often in recent history – it has not happened in the US since the mid-1990s. But I think the conditions are there.
On the other hand, if the bottom falls out of the labour market, all bets are off. So far, the big surprise has been the resilience of the labour market. If this carries through over the next year or two – which is the timeline for the slowdown – we will get a relatively soft landing.
We are in a tricky period now, where there is uncertainty around whether the Fed has done enough. However, it is clear that the Fed is extremely wary about this, particularly after it took a hit to its credibility with other central banks by getting out of the blocks too slowly. We still believe that, on the balance of probabilities, the most likely result is a soft landing.
“We are thinking about growth, and funding growth in a way that is sustainable. Natural capital is not a separate thing we can put on the side or in chapter 15 of a textbook. It is front and centre.”
The US dollar has appreciated significantly of late. How sticky is this and what will be the impact on Australia and New Zealand?
The US Treasury secretary in the 1970s, John Connally, famously said – while the rest of the world was complaining about the strength of the US dollar – “it’s our currency but your problem”. It doesn’t really have a large impact within the US, other than that US exporters might worry about competitiveness.
With regard to currency forecasting, these periods of US dollar strength tend to be multiyear events, and we would be somewhere in the middle of one now.
Two things are driving the strength of the US dollar. One is interest rate differentials. If the Fed funds rate is generally higher than the rest of the world, in relative terms, the US will be more attractive. The second is growth differentials. If the US grows faster than its competitors, this will tend to pull in capital and raise the currency as well.
Both are pointing positive for the US right now. Therefore, it looks like US dollar strength is going to be with us for a while, which gets to your question: what does this mean for the rest of the world?
A stronger US dollar tends to suck capital away from emerging markets, and some developed ones, toward the US. It will have an impact on deficit countries like New Zealand. It makes New Zealand and Australia’s exports very competitive. But the capital flow and the debt side are where the problems arise.
How has the growing importance of environmental, social and governance (ESG) inputs, and the growth of sustainable finance, influenced your thinking?
My team and I are certainly paying more attention to sustainability. Economists typically think about growth as central to an economy. We never paid attention to what we call environmental and natural capital.
There is a great UK study called The Economics of Biodiversity: The Dasgupta Review. The author studied and has written about development economics for decades. We cannot just say growth is about accumulating physical capital anymore. Natural capital is important as well. It is not something to accumulate, it is something to preserve.
My team and I have been doing some work on green growth, based on the fundamental question of whether we can grow in the traditional way while maintaining natural capital or the environment. I am writing my second paper on this right now and we are working with S&P’s new Sustainable1 division on the subject.
We are thinking about growth, and funding growth in a way that is sustainable. Natural capital is not a separate thing we can put on the side or in chapter 15 of a textbook. It is front and centre. It has assumed its place now, to the extent that when we start to talk about how economies grow, it is immediately a sustainability discussion.
In my conversations with economists, I ask: what percentage of your time do you spend on sustainability issues? A lot say about one-quarter to one-third of their time. Mine is perhaps a little less, but it is certainly still a lot.
Going back to earlier questions, we now assume the growth of countries such as India, Indonesia and China has to be done in a sustainable way. When the Europeans started, followed by the Americans and the Japanese, sustainability was not being discussed – and, at the equivalent point in their growth, their carbon footprints were extremely high. We are now wagging the finger at the next generation, which seems a bit unfair.
The point is that this is not just a technical matter. There is a generational equity issue that asks whether the ones who developed and did well first ought to compensate the others.
While we are getting our heads around this, we are struggling to properly measure the ‘greenness’ of bonds and we are trying to ensure the carbon credit market makes sense, among other things. Like finance, economics is trying to develop a consistent framework that everyone agrees on. It is very foundational. Everybody has had their “aha” moment over the past few years and it is really exciting to be working on sustainability issues as well as traditional macro.