Beware the risk of a stagflation world

In the third quarter of this year, the world economy and investment climate began to deteriorate after strong momentum in the first half. Gross domestic product growth in many countries peaked in the second quarter, while purchasing managers' indices, especially in developed countries, fell, with the Chinese index falling below the break-even level of 50 amid a renewed lockdown.

In strong-growth economies such as the United States and China, recent figures have been disappointing, including job data in the US and retail sales in China. We expect the momentum to continue to slow in the fourth quarter.

Meanwhile, inflationary pressure as a result of price increases in several commodities has become evident in numerous developed countries. In the US, consumer price inflation in August eased from July but was still uncomfortably high, while producer price inflation is at a historical high, as the difference between the two rates widens.

In China, the evidence is more severe, with manufacturing inflation skyrocketing but consumer inflation remaining low, suggesting a squeeze in producers’ margins. This is a signal of stagflation — the cost of production is trending upward while demand is pressured by negative factors such as the Delta variant and tightened economic policy.

The result of the US Federal Open Market Committee (FOMC) meeting on Wednesday confirms our view. Data released after the meeting shows Federal Reserve policymakers expect slower GDP growth this year, to 5.9% from 7% expected in June.

At the same time, the Fed projects inflation to speed up, with the core personal consumption expenditure (PCE) index, the Fed’s favoured gauge, expected to average 4.2% this year, up from an earlier projection of 3%. The forecast for 2022 was nudged up a bit to 2.2% from 2.1%. Consequently, the committee hinted it was ready to start reversing its pandemic stimulus programmes this year and could raise interest rates next year.

CHINA CRACKS DOWN

On the fiscal front, the US government is proposing a tax increase on those with higher incomes. In China, meanwhile, tighter regulation of financial institutions has affected risky business groups, especially real estate.

Exhibit A is the China Evergrande debacle: China’s second-biggest real estate business is now at risk of defaulting on more than two-thirds of its $300 billion in outstanding debt. This reflects a government to limit borrowing by developers and rule changes that are part of that wider campaign against indebtedness.

The Chinese government is also tightening its grip on other businesses such as fintech, ride-hailing, online gaming and tutorial schools. The proclamation of a new policy goal of “common prosperity”, which seeks to spread wealth more evenly to all by taxing the rich and big business and increasing social support for the rest, will hurt the Chinese economic and investment picture in the medium term, though it will be good for society in the long run.

The latest Thai economic data showed some improvement after the number of new Covid infections began to trend down to between 13,000 and 15,000 per day, while vaccinations continue to grow by more than 500,000 per day. In response, the authorities have relaxed lockdown measures in the dark-red provinces.

However, economic data in July signalled a significant deterioration, especially in domestic consumption. Hence, we maintain our economic growth projection at about 1% this year, down from the 2% previously expected, taking into account the current slow pace of reopening.

Although the short-term economic trend is beginning to look better, we still believe recovery will be very slow as a result of the authorities not making significant changes in economic policy. The governor of the Bank of Thailand has suggested that the Ministry of Finance borrow an additional one trillion baht to remedy the “income hole” caused by the loss of labour income of about 1.3 trillion baht since last year — and this may reach 2.6 trillion baht next year.

ROOM TO BORROW

We agree with the governor, since we view that current fiscal measures (about 100 billion baht) are relatively small compared to earlier ones. With public debt at 8.8 trillion baht (56% of GDP), our view is that there is still room for borrowing.

We believe that if the government boosts spending by an additional 1 trillion baht, it would help cover over the income hole and provide a GDP growth upside of approximately 1.4%. However, we also believe monetary policy can be of additional help, since there is room for an interest rate cut while inflation is not a risk. The most recent Monetary Policy Committee (MPC) meeting on Aug 4, in which some members voted for a rate cut, indicates that some members take the same view.

At the same time, we believe the policy rate will be left unchanged for the rest of the year since most MPC members believe fiscal measures — including a special loan facility, asset warehousing scheme and other measures by specialised financial institutions — would be more effective than a further reduction in the policy rate, which is already low.

Nonetheless, we believe the economy will remain under pressure from various headwinds including global policy tightening and further risks, including the impact of the Delta variant, US domestic political risk, Chinese austerity policies and various geopolitical factors. Investors should therefore consider adjusting their strategies by being more cautious.

Stagflation fear is making a comeback. Investors, please prepare.


Piyasak Manason is senior vice-president and head of the wealth research department at SCB Securities, email piyasak.manason@scb.co.th

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