While lower energy prices would imply smaller current account and fiscal surpluses, Qatar would continue to have substantial financial resources to implement its ambitious investment programme, says QNB
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A significant decline in commodity prices in recent weeks coupled with a worsening economic outlook and major corrections in equity markets could result in a “great deflation” or a vicious circle of price/asset deflation around the world, a new report has warned.
QNB, in its report, yesterday said the risk of such a scenario occurring was rising as crude oil prices tumbled last week and major equity markets witnessed a significant correction.
“If these trends continue and unless governments around the world stimulate domestic demand through additional government spending, a ‘great deflation’ is likely to occur and significantly worsen the already weak outlook for the global economy”.
But QNB said that Qatar was likely to remain well-insulated in the event the “great deflation” hits the global economy.
While lower energy prices would imply smaller current account and fiscal surpluses,Qatar would continue to have substantial financial resources to implement its ambitious investment programme, leading to double-digit non-hydrocarbon growth and keeping inflation firmly in positive territory.
Deflation is defined as a generalised decline in prices. It generally leads to slower economic activity as consumption and investment decisions are delayed (household and corporations wait for lower future prices) and an increasing number of borrowers default on their loans as the value of their collateral falls below the loan value.
If price deflation is associated with a generalised decline in asset prices, the impact of deflation can be devastating as price and asset deflation feed into a vicious circle of lower income, investment and consumption.
The “great deflation” of the 1870s in the UK and the US and the “great recession” of the 1930s provide the best historical examples of such a vicious circle.
“We had already warned last August that declining global food prices could increase the risk of global deflation. Since then, energy prices have tumbled, adding to the global deflationary pressures,” according to the latest IMF Commodity Price Indices.
At the same time, equity markets have witnessed significant corrections. In the month to October 15, the US S&P 500 index was down 6.8%, the German DAX index 12% and the Japanese Nikkei index 6.2%. This correction, QNB said, seemed to be driven by investors switching to long-term bonds to fend off the risks of deflation.
As a result, yields on 10-year sovereign bonds have fallen to 2.1%, while in Germany they reached a historic low of less than 0.8% and in Japan they have fallen to less than 0.5%.
On top of this, US house prices rose at their slowest pace in 20 months in July, according to the S&P/Case-Shiller index. UK house prices are also showing signs of cooling off. Clearly, global asset deflation seems to be spreading across different asset classes.
“Global deflation means a lot for the global economy”, QNB pointed out.
First, the eurozone will most likely enter deflation later this year. Declining commodity prices, coupled with flat Q2 economic activity and the large correction in equity prices, will most likely turn the preliminary 0.3% inflation rate registered in September 2014 into negative territory. This may lead the ECB to take additional Quantitative Easing (QE) measures, possibly prompting it to buy sovereign bonds.
Second, the UK and the US inflation rates are likely to slow down further in the fourth quarter.
Third, global trade will be negatively affected by declining commodity prices. This in turn will hit commodity exporting emerging markets, where lower export receipts are likely to add to the ongoing economic slowdown emanating from capital outflows following the US Federal Reserve announcement of QE tapering in May 2013.
Both in the US and now in the eurozone, monetary policy (including QE) has proven somewhat ineffective in avoiding a deflationary environment. Theory suggests that the only real policy tool against deflation is an increase in government spending in order to boost domestic demand that could lead to stabilising the price level.
“However, this would vary by the state of development and the level of indebtedness of each country. The consequence of not acting fast is likely to make the ‘great deflation’ more probable,” QNB said.
