A slowdown in global demand is underway; Pricing risks could be next, but monetary conditions can remain tight
Neelkanth Mishra | Last Updated at September 07 2022 23:49 IST
This appeared in the Business Standard on September 8, 2022 (link)
This is supposed to be the busiest season for containerships ferrying goods from Asia to the US, as retailers stock up, first for the “back-to-school” shopping, and then for the upcoming holiday season. However, freight rates have been falling, and on routes like Shanghai-Los Angeles, they have halved from their 52-week highs. Given that shipping capacity has not yet expanded meaningfully (that should start over the next year), this implies very weak freight demand.
As important is the sharp fall in lead times. On key routes from China to the US, these have fallen from 83 days to 63 days over six months, and appear headed to the normal 40- to 45-day range in the next few months. Easing of global supply-chain pressures is a positive development, but for a few quarters, it could intensify the order weakness for Asian exporters by prompting de-stocking.
The “inter-arrival period” is the most important variable for firms calculating how much inventory to keep. For example, if the truck/ship comes once a week, there should be enough inventory to meet at least a week of sales. As shipping lead times doubled, supply-chains would have at least doubled the inventory they hold, which becomes unnecessary once lead times normalise.
Recall that the global goods demand is already well below trend due to weakness in China and Europe. Europe’s trade balance in the June quarter was nearly 5 per cent of gross domestic product (GDP), worse than the pre-Covid average, and goods imports are likely to weaken meaningfully going forward, due to either a weak euro, or higher interest rates. Tessellatum readers would recall that China’s retail sales are now two-thirds as large as that of the US (even though much lower on a per capita basis), and even before Covid-driven lockdowns disrupted sales and weakened consumer sentiment, growth had been slowing visibly.
Analysts are cutting growth forecasts for various end-markets. For example, the industry consensus for annual sales of personal computers is now below 300 million, and falling. From a pre-Covid level of around 260 million units, sales had picked up to more than 340 million units. Similarly, estimates for annual global smartphone shipments are now a quarter below the levels at the start of 2022.
A downward lash of the supply-chain bullwhip is likely to trigger the next leg of the correction — weaker prices. Lower factory utilisation forces firms to jostle for market share with price discounts. For metals like copper and aluminium that trade on exchanges with active futures markets, prices have already corrected meaningfully. Prices have been falling even in the high-technology commodity segments like display panels and memory chips. The next leg could be in segments where prices fall with a lag. For example, recent news reports point to some semiconductor foundries offering 10 to 20 per cent price discounts; supply in this sector had been extremely tight just a few months back.
Supply disruptions, like in Europe due to the energy crunch and in China due to lockdowns (though this has had limited impact thus far), may be too small to offset the fall in apparent demand.
Can these price declines allow a quick reversal of the direction of monetary policy from aggressive tightening to some form of easing? For a few quarters at least, that appears unlikely.
In the US, services are more than 60 per cent of the consumption basket, and demand for them, which is still running below the pre-Covid trend, should continue to rise for a while. In the last few months, the services share of inflation in the US has picked up, as wage growth remains elevated. One can debate the level of unemployment necessary for wage growth to normalise, and whether that would require a US recession, but it is difficult to see monetary easing occurring for at least another year.
That means tight monetary conditions globally, transmitted, not least through a stronger US dollar (USD), which would force non-US central banks to maintain a tighter policy than otherwise warranted just to keep their exchange rate stable. Most currencies have depreciated meaningfully against the US dollar this year, whose strength is a sign of risk-aversion among global asset holders.
Thus, for a few quarters, US policy spill-overs may be negative on both fiscal and monetary fronts for Asia and most emerging markets: Fiscal tightening hurts goods demand, and together with de-stocking triggers weaker prices; and tight monetary conditions that preclude any policy boost to local demand. This is over and above the energy-market disruptions caused by the Russia-Ukraine conflict and instability in the Chinese real-estate market.
Most economic trends tend to have self-correcting attributes. Falling prices, for example, can help boost demand for goods. Tight monetary conditions can eventually force inflation down. Weak currencies are a form of monetary easing, and conversely, a strong USD is a form of monetary tightening, implying that interest rates may not need to rise as much as earlier anticipated if the USD continues to strengthen.
While equity markets (especially in India), appear to want to look through this period of weakness, the above adjustments play out over several quarters if not years. In the interim, the global economy runs the risk of accidents — vulnerabilities exposed only when growth has weakened. It could take the form of an economy’s external account becoming unstable, sovereign debt coming under stress, or some large firms or a sector facing debt defaults. The growth in goods exports between 2019 and 2021 for several medium-sized economies was 6 to 15 per cent of GDP — its reversal is unlikely to be painless.
Equally importantly, given the current geopolitical context, the policy coordination one saw between major economies and economic blocs in recent decades may only revive if there is a crisis. A crisis provides cover for policymakers to take decisions that political realities would otherwise prevent.
For Indian policymakers, this means a prolonged period of weak capital inflows and a wide balance-of-payments deficit. The investment cycle in India, which has seen a heartening pick-up in ordering in the last few quarters, is also at risk. Evidence of excess capacity globally could push out the need for new capacity in India, not just due to the weakening of prospects for exports, but also due to the rising threat of imports. The only relief could be from lower energy prices, but supply reduction could forestall that.