Why V-shaped recovery not good

by Manas Chakravarty and Mobis Philipose – Mint

Thanks to the recent stock market rally, some economists have started predicting a V-shaped recovery.

Here’s what HSBC economist Robert Prior-Wandesforde has written in a recent note: “We are increasingly confident in our V-Shaped recovery view for the Asian region as a whole. As we see it, the initial improvement, now under way, largely reflects the end of the Lehman-related panic, while the biggest effects of the various policy easing measures should come through around the turn of the year according to our Asian growth model. Having seen a series of multi-decade record falls in many real economic indicators, we wouldn’t be surprised to see some showing multi-decade record jumps over coming months.” A Citigroup Inc. research note on Singapore, a country tightly linked to the revival of foreign trade, asks, “Could we be heading for a V-shaped GDP (gross domestic product) recovery?”

But as a Citigroup note on Asia ex-Japan points out: “The combination of IBES or Institutional Brokers’ Estimate System forecasts for 2009E and 2010E and actual results for 2008 would imply this to be the 2nd shortest and 2nd shallowest earnings recessions since 1975.”

In other words, a V-shaped recovery would mean there has been hardly any impact from the global financial crisis, that all the talk about the loss of liquidity arising out of global deleveraging was tripe, that all those academic studies that predicted a long hard recession were mistaken and that things will soon be back to business as usual.

The International Monetary Fund (IMF), however, is sticking to its guns. In a recent speech, Takatoshi Kato, deputy managing director of IMF, emphasized that the road to recovery will be long and protracted. For emerging markets, he predicted, “Overall, net private flows to emerging markets, which peaked at 5% of GDP in 2007, will turn negative in 2009. Portfolio outflows will continue as investors face margin calls, high redemptions, and alternative government-guaranteed investment opportunities in mature markets. Foreign direct investments flows are expected to remain subdued in the present environment of scarce financing.” He said that over the medium term, deleveraging is likely to weigh heavily on credit creation and capital flows.

Kato’s warning is timely and underlines the fact that much of the improvement in the economy seen in recent times in the advanced countries is merely a bottoming out process. In the emerging markets, the recovery has been based on government spending and on mandated lending in China.

What’s more, it’s possible that weak growth may actually be good for the markets, because a recovering economy will start to absorb some of the “excess liquidity” sloshing around.

Moreover, central banks too will start worrying about inflationary pressures once the economy starts to revive. As Morgan Stanley economists Manoj Pradhan and Joachim Fels point out, “Further growth in excess liquidity appears likely in the foreseeable future as central banks are far from done with quantitative easing, and we deem a V-shaped economic recovery to be unlikely.”

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