Receding Fortunes

Are we headed for a worldwide economic downturn?

By Kim Natacha

Economics Today

The world economy and market systems have been shaken in the last few months and several organizations have adjusted their growth projection for countries and for the world.

In an age of increasingly integrated economies, the 2007 US “subprime” crisis has been the snowball that has transformed into an avalanche, which threatens to submerge the world through financial crisis, plunging stock markets, runaway inflation and global recession.

Cambodia, like other countries, is not spared and its economic growth for 2008 has been revised downward to take into account this economic deflagration.

The country’s growth rate was 10.1 percent in 2007, according to the Ministry of Planning’s National Institute of Statistics. Early this year, analysts expected the economy to fare less well but still to remain strong with an 8-percent growth rate.

In early April, projections for the Cambodian economy were adjusted. The World Bank predicted a growth of 7.5 percent. And a report from the United Nations Economic and Social Commission for Asia and Pacific (UNESCAP) put the figure at 7 percent. The International Monetary Fund (IMF) put forward the same estimate.

The UNESCAP report warned against the dependence of the economy on its garment industry and exports, which explained the economic impact—a view that is generally shared by analysts.

“Cambodia’s main exports are garments and the majority of them are exported to the US and the European Union,” noted John Nelmes, Cambodia resident representative for the IMF. “So a slowing of consumption in those countries will result in less demand for clothes and thus of exports. That’s the main reason why we project a slowdown of the economy,” he explained.

After several years of exceptional growth, the Cambodian economy slowed down as a delayed result of the housing crisis in the US, which riddled the world with serious financial, inflationary and economic repercussions.

From a Domestic Sector Crisis to a World Crisis

The current world economic turbulences are rooted in the housing bubble that began in the US in 2001 and burst in 2005. The effects of the housing crisis were exacerbated by the subprime mortgage practice, according to analysts.

What seemed to be a crisis limited to a specific domestic industry would rapidly lead to more dire turbulences. A serious financial crisis started in August 2007 as investors discovered securities backed by subprime mortgages in the portfolios of banks and hedge funds around the world.

With hindsight, “the financial market that erupted in August 2007 has developed into the largest financial shock since the Great Depression,” stated the IMF in its latest World Economic Outlook report.

A “credit crunch”– a severe decline in the supply of credit– followed, threatening investments and economic growth in the US. The American central bank, the Federal Reserve which is commonly known as the Fed took almost immediate action. Between August and November last year, the Fed cut its interest rate several times and injected dozens of billions of dollars to respond to the banks’ liquidity crisis.

While such moves were welcomed with relief by the banks and investors—stock indices went up almost immediately after the announcements— the prospects of inflation dramatically increased with such large sums injected into the market.

According to economists, inflation is related to broad money growth. The more money that is in circulation in an economy for a constant supply of goods, the higher their prices, explained John Nelmes.

A weak dollar, conflicts in the Middle East, surging energy demand in China and India, and investor panic led to the soaring prices of crude oil. In a matter of months, the price of a barrel of petroleum hit record highs from US$90 in late 2007 to more than US$120 in April.

Global inflation and financial turbulences eroded investors’ confidence and consumer spending worldwide, sparking a sudden recession in the US, which possible could occur worldwide.

World Economy’s Future Looks Bleak

The question in the US now is to know whether the US is heading for an economic recession in 2008. The answer is mixed. A recession is technically a period in which the economic growth rate is negative— or in other words the economy shrinks—for two quarters in a row, explained John Nelmes.

However figures from the US Bureau of Economic Statistics (BEA) show a growth rate of 0.6 percent in January-March 2008 and the same growth in October-December 2007.

Even though there is still debate on this question in the media, John Nelmes confirmed that “the US will experience a mild recession in 2008.” The drastic slowdown in the first quarter of this year will probably result in an annual growth rate of 0.5 percent. Last year the US economy grew by an honorable 2.2 percent.

Because of its trade links with the rest of the world and the financial turmoil, the US economy will pull other countries’ growth down, resulting in a global slowdown or even a growth recession.

“A global growth recession would translate into a growth rate of 3 percent at most,” noted John Nelmes. The IMF projects that world output will grow 3.7 percent in 2008.

Expectations that the Asian economy would be able to “decouple or delink” from the US economic crisis have begun to vanish as the Chinese and Indian economies are feeling the blow of expensive energy and food. And so is Cambodia, which will significantly slow down the pace of its economic growth.

Cambodian Economy Remains Strong and so does Inflation

By all standards, the Cambodian economy will remain robust in 2008, at around 7 percent. Although the country’s exports may suffer—especially garment exports—other sectors are expected to remain healthy. “The tourism, construction and agriculture sectors are still performing well,” said John Nelmes adding that their growth will compensate for other declining industries.

“There is no signs whatsoever of a recession in Cambodia,” he asserted.

However, Cambodia’s exceptional growth in the last few years resulted in high domestic demand which exceeds the country’s capacity to supply it, John Nelmes explained.

While there is little worry about the economy, the most serious woes for consumers and private companies are the rising prices of goods and rising costs of production.

The price of rice—Cambodia’s staple food—has hit record highs and caused a panic among consumers, who rushed to stock rice and buy Government stocks. There seems to be little national authorities could do as domestic inflation is driven by international prices “We import inflation,” noted Hang Chuon Naron, Ministry of Economy and Finance Secretary of State, at a forum on inflation in early May.

Still several government measures are being taken to cope with inflation, such as raising the banks’ reserves requirements in an effort to limit the supply of money.

But the monetary policy measure is disputed by the private sector, especially banks, which are concerned that it will impact investment and economic growth.

“Banks haven’t lent enough to the private sector,” In Channy, president and CEO of Acleda Bank, told the Cambodia Daily on May 6. More investment, job creation and economic growth would be more desirable, he insisted.

According to economists, there is also a trade-off to be made between strong economic growth and reasonable, affordable prices. How long can high inflation last in Cambodia? In the near term, inflation will remain high, according to John Nelmes.

But monetary and fiscal policies aim at cooling down the economy and domestic demand. “Through prudent fiscal policy and raising banks’ reserves, we let some steam off the economy,” John Nelmes explained. “And if international oil and food prices stabilize, I think we could see some easing in inflation later this year. But we have to keep in mind that the projection is highly conditional on what is going on in the world economy,” he concluded.


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