Vijay Kumar Gaba

The tremendous economic growth achieved by Japan in the post-WWII era is popularly known as “The Japanese Economic Miracle”. It was in fact nothing less than a miracle – a country totally devastated by war rose from ashes to become one of the largest economies in the world. Japan recorded a high rate of economic growth during 1950-1975. The growth was primarily led by strong capital accumulation, strategic initiatives to expand trade share in global markets, concentration on technology development & innovation, and development of a strong high-quality ethical workforce.

Supported by benign monetary policy, easy credit, and profligate fiscal policies, by the end of the 1970s, Japan had become a powerhouse of technology and finance. The 1980s however witnessed unprecedented heating of the Japanese economy. Asset prices ballooned to unsustainable levels. The Bank of Japan, in its wisdom, decided not to tighten the monetary policy to control the surging asset prices. Low rates and a stronger JPY, led to a prolonged phase of low growth and low inflation. Worsening demography, due to a variety of reasons, further exacerbated the deflationary pressures in the economy. 1990-2020 witnessed Japan struggling with low inflation and low growth. The Global Financial Crisis and Covid-19 pandemic made things only worse.

The present state of the Japanese economy has become a generic reference for economies struggling with low growth, low inflation, low rates, and high debt for a prolonged period; and is referred to as “The Japanification of Economy” in the popular economic lexicon.

Post the Global Financial Crisis (GFC) in 2008-09, the fears of Japanification of several global economies increased. Unprecedented monetary easing in the wake of Covid-19 further enhanced the risk of a prolonged phase of low growth in several developed and developing countries.

In the past couple of years, we have witnessed a strong spike in inflationary pressures across the globe. Initially, it was believed that this episode of inflation is mostly a consequence of supply-chain issues, which broke down badly due to the pandemic; hence it would be transitory. However, later it emerged that it may be more structural than transitory.

The quantitative easing in the wake of the GFC did not cause consumer inflation, because money printed during 2009-2011 was mostly given to banks, which did not lend much of it to consumers. The velocity of money remained very poor; thus the actual money supply did not increase materially. But during Covid-19, a large chunk of new money flowed into the hands of consumers increasing demand at a time when supply was seriously constrained. High inflation was a natural consequence. Erratic weather conditions globally and a war between Russia and Ukraine (major suppliers of energy and food to Europe in particular) added further to the food and energy inflation.

In the past fifteen months, the central bankers globally have tightened the money supply and efforts have been made to add production capacities to meet incremental demand. It seems for now inflation has been controlled; though the inflationary expectations remain high as it is commonly believed that slower growth and financial crisis (that looks imminent) would force central bankers to open the liquidity taps again – sooner than later.

Nonetheless, for now, Japanification of the US and Europe has not happened as inflation remains high, rates have been hiked and recession has been avoided.

On the other hand, the conditions in China eerily resemble the conditions in Japan during the early 1990s. After two decades of massive growth led by huge investments in technology, infrastructure, and manufacturing capacities, the Chinese economy is feeling the fatigue. The population is aging and employment conditions are worsening. The growth rate is consistently declining. The real estate market is in a bubble-like situation, with several defaults and a huge inventory. China is the only major economy, besides Japan, that has not cut rates in the past decade. Inflation continues to remain low. The financial institutions are weakening and fiscal support to consumers and the financial system remains high.

The risk of the Japanification of the Chinese Economy is real and material. Considering that China has been a major driver of global growth in the past couple of decades, a Japanified China cannot be good news for the world as a whole. However, on the positive side, it may be an excellent opportunity for India that may get favorable conditions for growth – what Japan got in two decades post WWII and China got after its admission into WTO.

In a world where almost every central banker is struggling to contain inflation and tightening monetary policy, the People’s Bank of China (PoBC) seems to be facing a different set of problems and hence adopting a divergent policy approach. PoBC has actually cut the key loan prime rate (LPR) twice in 2022.

It is pertinent to note that the Chinese economic growth has been on the decline ever since the global financial crisis. The pandemic has slowed the growth even further. The latest growth data suggests that the Chinese economy is growing less than 5% this year, its lowest growth rate in at least three decades. Some part of the growth decline could be attributed to the zero tolerance policy towards Covid and stringent lockdown; but it is important to keep the declining trend since 2010 in mind.

Considering that China has been one of the key growth drivers of the global economy; declining Chinese economy is a matter of concern for all.

Besides, China has been one of the primary (i) financiers of the deficit budgets run profligately by many western economies; (ii) investor for the development projects undertaken by the Middle-East and Central Asian and African emerging economies; (iii) exporter of deflation through low rates, taxes and wages to the world; and (iv) absorber of the carbon emission for many developed and developing countries which chose to offshore their polluting manufacturing to the Chinese shores. Obviously, a weaker Chinese economy is a major concern for a large part of the world.

In the Evergrande episode (read here) we saw how much the global markets are sensitive to a financial crisis in China. In principle, the western democracies may not like the authoritative political regime of China, but the global investors’ confidence in the Chinese markets is mostly driven by this very regime; as it lends confidence to the investors that any crisis will be contained almost instantaneously. As President Xi Jinping gets ready to be elected for a record third term later this year, it would be important to see how he keeps alive the faith of global investors, who have not made money in Chinese markets for almost a decade now.

In recent days the following three global trends have evoked much interest amongst market participants:

1.    The production, consumption and import of commodities in China have increased materially.

2.    The USD weakness is persisting. The China letting CNY appreciate against USD is noteworthy.

3.    BP in its yearly outlook virtually declared "peak oil" demand, stating that the oil demand growth may not be seen through 2050.

These three trends are important in my view as these could materially influence the markets in short term.

For past two decades, China has been a major driver of the commodities' demand and hence prices in the global market. The slowdown in Chinese economy in past 5years has led to correction in commodity prices, impacting a large number of commodity driven economies like Australia, Canada, OPEC countries, Brazil etc. This is cited as one of the reasons of sustained deflationary pressure on US, Japan and EU economies. The central bankers in these economies have been able to unabashedly print money to support their fiscal profligacy as the inflation has not been a concern.

As per the latest reports that trend might be about to change. As per a recent ING Bank research report, "Domestic demand is driving China's economic growth. Retail sales returned to positive growth. And new-infra and traditional infrastructure investments increased, which matched the growth in these items in industrial production. But external circulation may remain a challenge to growth." The reports further highlights that "China’s new-infra plan and traditional infrastructure projects in transportation have led overall investment spending. Fixed asset investment (FAI) shrank only -0.3%YoY YTD in August from - 1.6%YoY YTD in July. The "computer, telecommunication" category, which represents new-infra investment plans, grew 11.7%YoY YTD, which results in part from China’s push towards self-reliance in technology. Rail transportation investment also grew 6.4%YoY YTD.

These growth numbers are high compared to the headline growth rates, which means these are the engine of investment growth in China currently."

The Chinese monetary authorities recently allowed CNY to appreciate below 6.8/USD level. This could be seen as a reconciliatory gesture by Chinese authorities to the global community. China has allowed CNY to weaken even above 7/USD level in the trade and currency war with USA and Japan. The international relations of China have worsened materially after the outbreak of COVID-19 pandemic. This reversal of CNY could be seen as first, though small, sign of China wilting under global pressure. This could be comforting news for the global markets.

British Petroleum's (BP) annual outlook fo energy market is respected world over. Last year, BP forecasted demand for fossil fuels could peak by 2030. However, in 2020 outlook, BP has made a major shift in its assessment. As per the energy major, peak demand for oil may have already happened. The report implies that global crude demand may never again surpasses 2019’s average of around 100 million B/D. A natural corollary to this is that that 2019 could also mark the peak of carbon emissions from energy use.

This may potentially change many things - global trade balance, sustainability investments, geopolitics, cost of doing manufacturing, etc. Arab world countries making conciliatory moves towards Israel may, for example, be just one of the effects of this. BP announcing major investment plans with RIL in renewable energy sector to support electric mobility is another.