Co-ordinated and quick action was crucial

 

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By Paul Betts
Published: October 14 2008 02:09 | Last updated: October 14 2008 02:09
Copyright The Financial Times Limited 2008

No one knows whether the European plans unveiled on Monday to help resolve the global financial crisis will be enough to stop the world from sliding into recession – or even worse. But what we do know is that it was absolutely crucial that action was co-ordinated and quickly.

There have been too many political gaffes in recent weeks that have had the world business community on tenterhooks. Already, there were clear signs that companies had been pulling back on investment plans – such as Michelin shelving a new $700m (€516m, £402m) Mexican factory – while they waited for governments to act.

But now that the government efforts to salvage the European banking system have been approved, the question is: Can business ride out the remaining storms in the market place?

The global economy was set for a slowdown even before last week’s stock market meltdown. Against International Monetary Fund estimates of global growth a year ago of 4.8 per cent for 2008, its latest forecast is for the world economy to grow by 3.9 per cent this year. And growth is expected to slow down even more sharply next year to about 3.0 per cent. Life was thus going to be pretty tough anyway.

The fact that the banking system had virtually stopped lending had made life even more difficult, especially for smaller companies that rely on their monthly cash flow management to stay afloat. By lubricating interbank lending, it should now become easier for these companies to access the finance to continue to do their day-to-day business.

And by decisive action to restore confidence in the system, governments may have averted the worst outcome: a complete evaporation of consumer confidence feeding an irrational market panic.

When no one spends then no one buys and the economy ultimately comes to a halt. You do not need to be an economic genius to work out the consequences: the classic vicious circle of rising unemployment, falling consumer spending, bankruptcies and business restructurings, leading to higher unemployment and even lower confidence. And for governments, this inevitably translates into higher deficits.

But the plan, business leaders warn, is not going to stop borrowing costs rising – quite the reverse. Governments are going to have to borrow heavily to finance their new obligations and this will inevitably force longer-term rates higher. And high borrowing costs when demand is slowing down is no recipe for success. Banks will undoubtedly tighten conditions for lending, notwithstanding their new government guarantees.

Companies themselves are also likely to hold back on capital spending until they see what the repercussions are on the real economy, and that hardly creates growth.

But it is not all doom and gloom. For example, the French economic institute Coe-Rexecode believes the adjustment in the US property market, where the crisis all began, is more advanced than people think. Second, oil prices are falling. And third, official interest rates will have to fall even though borrowing costs will remain under pressure.

This should all help a gradual return to growth by 2010. Wishful thinking perhaps, but any other option may be too grim to contemplate, especially on a day when the stock markets are celebrating a rare display of European and global unity.