Here comes a sinking feeling

By BRIAN FALLOW

It's a good wind that blows nobody any ill.

The collapse of Saddam Hussein's regime has removed some of the uncertainty overhanging the world economy: would it be a prolonged conflict? Would there be another oil shock?

But the lifting of that shadow has turned investors' attention back to the underlying state of the world economy and it does not look too good.

In particular, the gaping external deficit the United States is running, around half a trillion dollars a year, is likely to mean a weaker US dollar, making life more difficult for New Zealand exporters.

Since the middle of last year economists' forecasts for growth this year in the US, Europe and Australia have been cut and cut and cut again.

The International Monetary Fund joined in last week. It has cut its forecast for world growth this year to 3.2 per cent, 0.5 percentage points less than it expected six months ago, and a barely perceptible improvement on last year's lacklustre result of 3 per cent. It has also cut its forecast for world trade growth by nearly a third.

On a more encouraging note, the IMF said "a relatively rapid resolution of the uncertainties surrounding the situation in Iraq could provide a larger boost to global activity from the second half of 2003 than currently assumed, both through a stronger pick-up in confidence and through lower oil prices [as their recent fall attests]".

Because of the weakness of both Europe and Japan, recovery continues to depend heavily on the US, the IMF said. And that worries it because the US current account deficit is around 5 per cent of GDP.

When New Zealand runs deficits of that order no one much cares; when the US does, it is a serious imbalance in the global economy.

History suggests reducing that deficit is likely to mean slower US growth.

"With few signs that this would be offset by stronger growth in the euro area and Japan, this could have significant global consequences," the IMF said. It also poses a risk of a "disorderly adjustment" - a rapid fall in the value of the US dollar and a corresponding steep appreciation of other currencies.

Such a scenario would be grim for New Zealand exporters, who have had to contend in the past year with the steepest rise in the exchange rate since the kiwi dollar floated in 1985.

The dollar's appreciation has devoured the recovery in export commodity prices since the middle of last year.

In New Zealand dollar terms export commodity prices have fallen 25 per cent from their peak two years ago, when in world price terms they are only 4 per cent lower than they were then.

Much of that decline has yet to flow through via lower farm incomes to the rest of the economy.

Exporting manufacturers have had to contend with a 12 per cent appreciation over the past year in the exchange rate with their main export market, Australia.

Meanwhile, a lack of rain threatens to cut farm output and carries the risk of electricity shortages this winter as well. Some electricity-intensive industries have already cut production.

Then there is the Sars virus, sending ripples of fear out from southern China. Until the odds of surviving an attack improve from the present 25-to-one, the potential effects on the economy, should it take hold here, are incalculable.

Its effects are already being felt by a global airline industry already on the ropes. More than one in four inbound tourists comes from Asia. Southeast Asia takes about 15 per cent of New Zealand's exports.

Weak world growth, a rising exchange rate, drought, power shortages and the Sars virus - with such a list of problems, actual or potential, it may be surprising that economic forecasters are still expecting the economy to grow 2 or 2.5 per cent in the year ahead.

Partly it is because the economy began the year with a lot of momentum. It had expanded 4.4 per cent over last year. Even with a decidedly uphill road ahead, that sort of momentum takes some time to decay.

But there are clear signs of a slowdown. Excluding one-off factors, core retail sales have been flat for the past three months.

Although still at buoyant levels, house sales and building consents look to have peaked late last year.

The Institute of Economic Research's March survey of business opinion found firms' expectations of domestic trading activity below their long-term average, consistent with growth slowing this year. They also reported a softening in new orders, export expectations, hiring and investment intentions.

But the net inflow of migrants, which has been an important source of buoyancy in the economy, and the housing market in particular, over the past year, continues unabated. It boosted the population by 41,600 or more than 1 per cent in the year ended March, up from 25,000 the year before.

This week's March inflation figures strengthened expectations in money market dealing rooms that the Reserve Bank will start to cut interest rates in June.

Not only did inflation in the "tradables"sector (exposed to international prices) decline, as one would expect in an environment of weak world inflation and a rising exchange rate, so did non-tradables inflation, whose annual rate fell from 3.9 per cent in December to 3.4 per cent.

Tradables inflation should fall again this quarter as the sharp fall in international crude oil prices, since the outbreak of war in Iraq was declared, feeds through to prices at the pump.

It's an ill wind that blows no one any good.