'Recovery may start in 2010, but will take years'

financial crisis

The problems with economies around the world are likely to continue. "The US is clearly in a recession. The next couple of quarters are going to be particularly difficult. The UK also looks to be in a bad state and will see a nasty downturn. The Euro-zone will also be contracting next year and so will Japan. This will be quite a prolonged adjustment. We are likely to see a contraction through 2009 and a recovery in 2010 will be kind of modest," says Robert Ward, director global forecasting, Economist Intelligence Unit, in an interview to Vivek Kaul. Excerpts:

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The last time we met you said "sub-prime is yesterday's news". So, what is today's news?

The today's news is car loans, credit cards, auto loans, prime loans, mid-prime loans, hedge funds etc. It has become a system-wide problem.

When you say auto loans, credit cards, prime loans etc. do you mean borrowers have stopped repaying these loans as well?

Absolutely. The entire thing is completely linked. So the problems are spilling over. In the case of prime borrowers, they are now finding themselves in negative equity (i e, falling house prices mean that their loans are worth more than their homes), making them highly vulnerable to shocks such as unemployment, thus feeding rising defaults. Unsecured borrowing is seeing similar trends. This is likely to worsen as the labour market continues to weaken.

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I have been reading that banks and financial institutions are unwilling to rework mortgages. Why is that?

I don't think they are in a position not to foreclose the loans. If estimates are to be believed, nearly 80% of the loans were financed through securitisation rather than just through deposits held with the banks. This means that, with the wholesale markets still closed, banks are simply not able to raise funds through the capital markets. Hence they don't have the funds to feed the mortgage market.

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Do you feel that a temporary freeze on foreclosures could avoid an even more severe financial crisis?

Talking about going for a temporary freeze, yes things like foreclose forgiveness will help in the short-term with the downturn becoming more manageable, but they will only end up delaying the recovery by confusing signals about when the market really has reached bottom � which it must as a precondition of a sustainable recovery. They won't solve the deeper problem. The system needs to be cleaned up, for the recovery to start.

Do you see the US and other western economies getting into a recession? If yes, how long do you see the recession lasting?

The US is clearly in a recession. The next couple of quarters are going to be particularly difficult. Private consumption has driven much of the US growth over the last few years.

And that is clearly in the doldrums. The UK also looks in a particularly bad state and will see a nasty downturn. This is primarily because of the over-reliance on financial services to drive growth as well as the housing bubble bursting. The Euro-zone will also be contracting next year and so will Japan. This will be quite a prolonged adjustment. We are likely to see a contraction through 2009 and a recovery in 2010 will be kind of modest.

How difficult is it for companies to raise finance for new projects as well as to get working capital finance?

It has become very difficult for companies to get any loans. If you have got cash, you're okay. And this applies to India as well which, despite having a relatively conservative banking system has also seen a severe liquidity squeeze of late. And more than that most companies have put expansion plans on hold.

Do you see foreign investors' money coming back to countries such as India and China anytime soon?

There is no doubt that a lot of these emerging markets are oversold. Even when things do calm down, it doesn't mean they will be anywhere near where they were same time last year. I think 2009 will be a particularly bad year for the stock markets in emerging markets. Year 2010 is likely to see some amount of stabilisation, but any noticeable recovery at the earliest will start only in 2011. The recovery is likely to take years rather than months, as some experts seem to suggest.

Has the credit default swaps (CDS) market started to unravel?

Not as such. They are a big cloud over the financial sector. So far, the CDS market has been all right. The governments are also trying to do something about that.

A lot of experts are now blaming Alan Greenspan and the low-interest rate regime that he run in the aftermath of the dotcom bubble burst for fuelling the entire credit crisis. Isn't this more a benefit of hindsight?

Yes. They do that with the benefit of hindsight. It's sort of a complicated issue and it's too early to blame one particular person for it.

Also how much do you think are China and other Asian nations responsible for fuelling the credit crisis because of the fact that they were more than happy to buy the US Treasury at low-interest rates?

Yes they are. China has over $2 trillion of foreign reserves. This is clear evidence that while the US saves too little, China is saving too much. And a lot of it is used up to buy securities issued by the US government, which ensured that interest rates continued to be low and which in turn provided the liquidity to fuel the US consumption boom.

A lasting solution is needed to make things a little more balanced not least getting the Chinese to move the economy away from exports and towards boosting private consumption. One way of doing this would be social security reform in order to make Chinese consumers feel more secure about their future.

Do you feel that the $700 billion US rescue plan would be enough? Economist Nouriel Roubini now estimates that the losses would amount to $3 trillion in all.

He has been very prescient in this whole episode. Having said that, $700 billion is not going to be enough, even though it's a lot of money � there is little evidence that the housing market has reached bottom yet and as I said earlier the labour market and the broader real economy are now weakening. All this will ensure that assets will continue to turn bad over the coming year, further raising the cost of the final cleanup. It can go up to $2 trillion or even $3 trillion as Roubini has been saying.

Sovereign wealth funds have been sitting on a lot of cash. Do you see them coming to the rescue of the US financial system. Or are they likely to stay away?

Again it's a very complicated issue. Yes there are some bargains to be had. But, they have been progressing with a lot of care because some of the investments they made last year have turned bad. There are other issues also. They don't want to hold shares in an institution, which might be nationalised.

So right now I see them working cautiously going forward because the situation is so unclear.

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Do you see dollar's reign as the international reserve currency gradually coming to an end?

Emerging markets have built up a huge store of the US dollar reserves in recent years and certainly it will be prudent to diversify into other currencies in the future. But it's not in anyone's interest to move away suddenly from the dollar, not least because this can trigger another severe bout of the US dollar volatility that will severely reduce the value of these reserves.

However, over a period of 20-30 years the pre-eminent position of the US dollar will change, reflecting in part the continued rising importance of emerging markets such as China.

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