The crux of the game Pokémon is fairly simple: stronger monsters win. Such was also the diktat from central bankers and world leaders a year earlier: stronger economies do better. Conversely, weaker economies (those saddled with elevated debt) needed a push for fiscal austerity to bolster public accounts. About 12 months later amid a backdrop of still anemic world expansion, it appears that austerity is no longer trendy, and that fiscal expansion is a better anodyne for the current environment.
Before Brexit, there was Grexit. Last year, markets fretted that without a bailout from the International Monetary Fund and the European Central Bank, Greece would have to abandon the euro currency and return to the drachma. After a Greek referendum failed, an agreement was reached and crisis averted. But the message for struggling countries was that they could not continue spending more than they earned. By the fall of that year, the US economy seemed confident it could handle interest rate normalisation and world growth prospects became optimistic. However, as growth began to ebb, major political parties utilised the slowdown as indicative of failed policies. Frustration begets populism, and by the summer of 2016, the United Kingdom voted to leave the European Union.
During the Chengdu G20 meeting in July, the first major gathering following Brexit, global leaders met amid lingering challenges over protectionism rhetoric. They repeated pledges from earlier meetings, but appeared to have greater acceptance towards expanding fiscal measures as part of using "all policy tools" in order to generate "inclusive growth."
Though echoed by central banks' earlier warnings about the ineffectiveness of ultra-loose monetary policies, fiscal contribution adds incrementally to global growth, in our view. Similar to excessively loose monetary policies, effectiveness wanes as real rates move close or below zero because debt profiles remain high. The same concept would apply to liberal fiscal policies, as public spending would only increase credit and expose economic vulnerabilities.
But expansionary fiscal policies would likely do better in economies where debt is not only low, but supported by healthy balance of payments. These characteristics are more evident in Emerging Asian economies, particularly Asean and India, which are also less vulnerable in a slowdown in global trade due to higher growth contribution from domestic markets. Asean's and India's investment to GDP ratio of 29 per cent and 33 per cent, respectively, are lower relative to that of Emerging Asia of 38 per cent. While the G7's investment spending is only 20 per cent of the total economy, gross general government debt is 120 per cent of GDP, compared to Emerging Asia's 48 per cent.
Markets may not only provide premiums to economies where expansionary fiscal measures are more effective, but may prolong those premiums if the availability of capital is funded less with debt and more from net trade gains that generates a healthy balance of payments. Thus, having a current account surplus matters as Emerging Asia's positive current account balance provides funding source, while the G7's negative account would either rely on debt or weaken the currency. Emerging Asia is also a beneficiary of positive real rates, which places less depreciating pressure on the currency to build a trade advantage.
The idea of raising debt may become more popular as world economic growth remains below trend following the global financial crisis. At this juncture, structural reforms have become less popular as they do little to spur near term growth. However, we believe that a pickup in fiscal spending would be more effective in Emerging Asia, where infrastructure spending and public investments have not only commenced but followed periods where local governments have improved the investment landscape by reforming tax laws and fostering greater foreign competition. Without structural reform and political will, believing that expansionary fiscal policies alone can fix the current economic environment only works in augmented reality.
Assistant Fund Manager - Asia
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