The changing spotlight in the global economy

With all the attention on Dubai this December and then on Greece now, the focus has shifted to countries and their debt and deficit levels. Six-seven months ago, this was not a major source of concern as economies around the globe were ‘allowed’ by economists/ analysts/ observers to dilute fiscal policy to drive growth. Now, you have ‘government solvency’ back into the wider discussion on economic stability. In a week, both Portugal and Spain have been forced to unveil spending cuts in order to calm the markets while broader plans are being devised in these and other ‘fiscally ill’ countries in the Eurozone (like Italy and Ireland) to tackle rising deficits and bring down debt levels.

For me, sharp market reaction to fiscal health of countries is a bit disturbing cause then it brings into focus some (other) important economies in the world with very high levels of debt – namely Japan, the US and the UK. With fiscal health always a matter of concern for some emerging economies also, disproportionate reaction from markets would serve to force central bankers/ fiscal authorities to rein in loose policy across the globe much sooner than might be necessary. Though improving fiscal health and reducing the overall debt burden of the economy serves to improve economic health and hence growth in the long-term, what I fear is the over-reaction component of the market. It is not as if the market was not aware of Spain, Ireland and Portugal. It is what the Greece trigger has done to them is important. And hence the caution against market panic rendering huge ‘insolvency’ pressures on economies that are either recovering slowly or on the path to recovery. This could pour cold water on a yet nascent global recovery (please ignore IMF figures – they manage to revise it always!!!!)

The caution notwithstanding, the beauty of the market mechanism is that through pressures on prices (be it bonds, CDS, equities), countries who have avoided making tough structural reforms on government budgets, economic competitiveness and data transparency have been forced to take notice. So, in Greece where it has been pointed out that about 1/3^rd of taxable revenues go untaxed you have tough talk on increasing efficiency of the tax mechanism even as the government has vowed to reduce the size (both in value and volume) of the public sector. The same is true for other countries as well. If they do not, at one time or the other, the market will punish - which sometimes could be very harsh (read Lehmann and AIG).

I hope His Excellency Makhtoum is listening!