Rewind. The consequences of easy money

There has been a massive misallocation of capital, thanks to the easy money policies that were followed by central bankers after the 2008 global financial crisis. Cheap money distorts the cost of capital, thus lowering the benchmark for rates of return sought for it and capital being over-allocated in some sectors.

Between 1994 and 2014, whilst global GDP grew at a compounded annual rate of 5.3 per cent, to $78 trillion, global debt grew (and from a higher base, hence there is no base effect) at a CAGR of 9 per cent, to $225 trillion. This figure excludes derivative exposure which, if added, takes global debt to over $600 trillion. Far too much money has been created by printing presses, and has gone into building over-capacities and under-utilised assets.

For example, there are 65 million unsold apartments in China, lying vacant. Also, in Japan, real estate prices are falling because too many apartments are lying vacant .

This investment in real estate led to an economic boom in China which led to a global boom, as China sucked in nearly half the world’s supply of commodities.

Mineral-rich countries built up mine capacity to feed the Chinese demand, using the cheap money available. Since 2005, capex in mining has gone up 420 per cent even as capex in manufacture has fallen by 30 per cent

As Chinese demand for commodities fades, prices of most commodities have halved. The excess mining capacity in Australia and in the US is being sold at a pittance, entailing big losses for those who invested in them.

To cater to the construction boom (which ultimately led to a glut of unsold apartments), China built up its steel making capacity, increasing capacity by 60 per cent in the past five years, to 1.16 billion tonnes, which is half the world’s capacity. It produced 820 million tonnes in 2014, of which 747 million tonnes were domestically consumed. The rest of the steel is dumped in global markets, creating losses for steel manufacturers in other countries.

Along with other commodities, the price of crude oil has also fallen off the cliff. This is the result of both the technological prowess of the US to extract oil/gas from tight shale rock formations, and the consequent retaliation by Saudi Arabia to dump crude oil in order to break shale oil/gas producers’ backs.

Capex in the oil and gas sector is also down 20 per cent .

Oil exporting countries, which were net exporters of capital when crude prices were high, have now become net importers of capital, as they have to borrow to meet their social commitments. Many will cut social spending and introduce/raise taxes. Sovereign wealth funds of these oil producing nations would also be net sellers in global equity and debt markets, in order to meet the resource gap.

India, which imports 80 per cent of its crude oil requirement, has benefited from the sharp drop in crude prices.

It ought, however, to prepare for a levelling off, perhaps even rising, oil price. Falling crude prices have also taken a toll on ONGC, India’s largest oil and gas exploration company.

There are excess capacities built up in many industries. There would be a restructuring of these assets, with each rise in US interest rates, debt becomes comparatively more attractive than equity, which would lead to selling pressure by foreign investors. This is being countered by increasingly confident domestic investors pumping in money and believing in the India story.

Consumptive growth has not kicked in. So, though the India story remains a good one, thanks to domestic consumption and saving, the global scene would be choppy.

The writer is India Head, Euromoney Conferences

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