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Awaiting the lift-off from austerity rollback

There is a belated recognition that stimulus needs to get back to centre stage

Image Credit: Hugo Sanchez/©Gulf News
Gulf News

During 2015, it became apparent that hyperactive monetary policy was starting to lose its effectiveness in stimulating economic growth. And, barring asset prices, had failed to ignite GDP growth.

As interest rates in country after country started to turn negative, even the International Monetary Find (IMF), a long-time proponent of budget cuts, started to urge governments to spend more. This trend accelerated in 2016 and after the US elections, bond yields have snapped higher on exactly such expectations bearing fruit.

Prospects of higher spending — coupled with money flows and greater banking disclosure laws on account of FATCA (Foreign Account Tax Compliance Act) — have already initiated a reallocation of capital towards infrastructure-based assets. This inflection point, if perpetuated, raises the possibility of enhanced global GDP growth as emphasis continues to shift towards government spending as a way of stimulating domestic consumption.

As debt levels in the US and Europe ballooned post-2008, the only impact that was visible was in the levels of asset prices as households and businesses mostly kept to the sidelines in terms of domestic consumption. Despite debt levels almost tripling, the level of debt servicing in the US remains virtually the same as it did in 2007.

At the same time, given repeated warnings from the IMF, tax rates ratcheted higher, discouraging capital formation leading to growth rates that are 40 per cent lower than they were in the 1990s. Since 2008, the entire ecosystem of economics has been dominated by the growth versus austerity debate, one that spilled over into the Gulf region as oil prices moved dramatically lower in late 2014.

What this debate failed to acknowledge was the positive stimulus it created, perhaps for the first time since 2007, for the consumer. It has only been in 2016 that this impact has been acknowledged by international economic agencies, thereby paving the way for an expansionary fiscal policy to gain consensus as the silver bullet.

To be sure, this stance implies higher borrowing rates (markets have already begun to reflect this). However, any econometric analysis indicates that this impact will be gradual, as underlying core inflation remains low.

As prospects of fiscal stimuli increase, coupled with lower tax rates, capital formation both at the household and the corporate level increases, with the CBO projecting that an increase in spending of 10 per cent will imply a stimulus impact of $2.9 trillion over the next 10 years in the US alone.

In other words, a fiscal multiplier of greater than 3 to 1.

Stronger fiscal spending would in particular aid building commodity materials, as an increased emphasis on infrastructure spending would stimulate demand, even as the broader markets would likely remain mixed, given their already elevated levels.

Dubai was perhaps the first in the region to increase domestic spending in 2016, even as the debate for growth versus austerity continued to swing in favour of the latter as countries pruned spending on the back of lower oil prices.

That pendulum seems to be now swinging the other way, as growth dynamics seem to be finally taking a precedence and being implemented concurrently with a continuing regime of removing subsidies.

With its emphasis on infrastructure spending in 2017 (up 27 per cent on a year-on-year basis), Dubai continues to lead the way in creating a first-class destination to facilitate trade, investment and growth. These variables will continue to reflect in asset prices as earnings rise with the velocity of money increases.

Focus will shift towards increasing efficiency and effectiveness of the PPP (public-private partnership) model as the private sector increases participation in the infrastructure sector. While headwinds remain in the form of a strong dollar and current crude oil price levels, history suggests that in the past this has not had the impact on growth that analysts fear.

Perhaps the primary reason for this has been that in the late 1990s (the last time when oil prices fell dramatically in response to the Asian crisis), debt levels were much lower, allowing for economies to pursue an expansionary fiscal policy without eliciting warnings from the IMF.

This time around, the IMF has been far more hawkish in its stance to curb budget deficits, a stance that it only reversed in the last few months as evidence mounted that fiscal policy remains the only tool to enhance growth dynamics. This shift will have interesting implications for asset prices (likely accelerate a recovery already underway) and growth alike in the year ahead.

— The writer is managing director of Global Capital Partners.