COVER STORY • 1

GInterview with Udith Sikand, Senior Emerging Markets Analyst, Gavekal Research Ltd.

lobal Investment Analyst Provides
Views on the Prospects for a New
Economic Society with Covid-19

By Japan SPOTLIGHT

Gavekal is one of the world’s leading independent providers of global investment research, advising ona select range of funds and offering software solutions to the financial community. Their analyses areaimed at the business community and are thus practical rather than academic. We would do well to listen
to business-oriented views as well as academic views at this crucial moment for the global economy.
Udith Sikand is senior emerging markets analyst at Gavekal and he provided us with an interesting
perspective on emerging markets and developing economies (EMDEs) under the pandemic in thefollowing interview conducted by email.
(Interviewed on Sept. 2, 2020 by email in answer to our questionnaire)

Perception of the Current
Global Recession
JS: The short-term implication of theCovid-19 pandemic is that there willbe the deepest and mostsynchronized global recession
since World War II. Do you agree?

Economic Prospects for
Advanced Nations &Emerging Markets
JS: What are your estimates for GDP

growth rates in advanced nations,EMDEs, and the world in 2020 and2021?

Sikand: Without a doubt, the global recession
Sikand: At Gavekal, we generally resist thecaused by the coronavirus pandemic is likely
temptation to undertake forecasts – after all,to be the severest since 1945-46. There is
if anyone could forecast anything,arguably no precedent for the speed at which
communism would work! The IMF’s
economic activity has collapsed as a result ofprojections (https://www.imf.org/en/
the quarantines and lockdowns imposed toPublications/WEO/Issues/2020/06/24/
deal with the public health crisis. The WorldWEOUpdateJune2020) are a useful starting
Bank’s Global Economic Prospects report
point to map out the likely trajectory of global
Udith Sikand
pithily summed it up: “Covid-19 is the mostgrowth over the next two years. And even if
adverse peacetime shock to the global economy in a century.”
the actual growth rates prove to be significantly off the mark, I would
The good news is that global economic growth is likely to bounce
generally agree with the broad point about the swing in growth rates
back strongly as restrictions are steadily lifted and thein advanced economies (AEs) being stronger than in EMDEs forunprecedented monetary and fiscal stimulus measures kick in.
three reasons. Firstly, policymakers in AEs have generally adopted far
However, it is important to recognize that the rebound in global
more aggressive and direct easing measures than their EMDE
growth rates in the near term will largely occur for mechanicalcounterparts. Secondly, the latter’s resource constraints along withreasons (i.e. a low base effect). Moreover, there are considerable
the presence of large informal sectors means that stimulus in EMDEs
uncertainties including (but not limited to) the epidemiology of thewill have a hard time reaching where it is most needed. Lastly,virus, the effectiveness of vaccines currently under development andEMDEs are generally far more dependent on external demand as an
the efficacy of containment or suppression strategies that could
engine of growth and although EM export volumes may recovercontinue to weigh on any recovery in the short term.
quickly on the back of large stimulus packages in AEs, demand isunlikely to be strong enough to generate higher export prices forEMDEs.

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https://www.jef.or.jp/journal/

COVER STORY 1

JS: What about the long-term prospects for EMDEs,

the OECD nations and the world economy? Withlarge losses, do you think in any region there will be
no return to pre-Covid trends?

Sikand: Even before the pandemic hit, the long-term prospects forthe global economy were looking increasingly grim. On the onehand, the most pressing policy issue for AEs was how to overcome
secular stagnation. On the other hand, EMDEs which have accounted
for more than two-thirds of global growth in recent years were also
grappling with the inevitable slowing of its biggest engine – China.
The pandemic and the extraordinary policy responses it has
generated means a lot of the headwinds to global growth have either
been upended (e.g. Europe has seemingly shed its penchant for
fiscal austerity and embraced debt mutualization) or exacerbated(e.g. the disruption to global supply chains centered around China in
the early stages of the pandemic will likely intensify efforts todecouple the world’s two largest economies). How the balance of
these competing forces stack up and the consequent implications
that has for growth in various parts of the global economy may not
be clear for quite some time.
However, for the developing world, particularly the world’s poorest
economies, there is a significant risk that the economic and financial
shock has caused permanent damage to their economies. For AEs
and even some of the larger EMDEs, raising financial resources todeal with the economic fallout of the pandemic has not proven to bea challenge as central banks have stepped in forcefully to help
markets clear. But this is not an option available to the poorer
countries that have underdeveloped financial markets and in manycases large amounts of debt already owed to foreign creditors.
A number of multilateral debt relief programs (by the G20 and theParis Club among others) have been announced and emergency
funding is being made available by the IMF and other multilateralagencies at breakneck speed. But without the participation of private
sector creditors in debt relief programs and each emergency funding
program being dealt with on a case-by-case basis, it is unlikely thatthese current efforts will be sufficient in terms of speed or size tomeet the funding needs of EMDEs to get through the pandemic,
estimated by the IMF at nearly US$2.5 trillion.
JS: Will the long-term implications for Covid-19 be

weaker potential output, investment andproductivity?

Sikand: Recency bias makes it hard to see just how the seemingly
inexorable trend towards weaker investment and lower productivity
that has characterized the global economy for the better part of thelast decade could be altered. Indeed, the fallout from the Covid-19
pandemic seems to suggest that a lot of the underlying trends arelikely to get even more firmly entrenched.
However, it is worth recalling that in 1982, at the peak of aworldwide inflation crisis and a global depression caused by 20%
interest rates, it was unimaginable that inflation was about to bepermanently defeated and that interest rates would fall even to single
digits, never mind to the zero and negative levels taken for granted
today. Thus, it would be silly to dismiss the possibility that the new
global macroeconomic environment characterized by enormous
fiscal stimulus that is supported by unlimited monetary expansion
could work just as predicted in most mainstream economics
textbooks. In other words, Keynesian policies that embrace
expansionary demand management could work to boost private
sector consumption and investment without generating runaway
inflation, echoing the period after World War II until the late 1960s
that could be described as the “Keynesian golden age”.
Of course, this is not to suggest that Keynesian policies are asufficient condition to generate rapid growth, for higher investment
does not always generate productivity improvements. Still, it is worth
contemplating three reasons to be optimistic about the structural andtechnological drivers of growth in the years ahead. Firstly, a global
transformation of energy and transport systems is almost certain as
fossil fuels and internal combustion engines are sought to bereplaced by renewable energy. Secondly, there is almost certainly
going to be an upsurge of investment in technology, science andhigher education in China as it seeks to overcome the squeeze being
put on its technology firms by the US. Lastly, a revival of economic
growth in Europe is now a distinct possibility as a result of thetransformation of European Union fiscal politics caused by the Covid
crisis.

Concern About Financial Systems in EMDEs
JS: How do you assess the prospect of a financial

crisis in EMDEs, as a significant increase ingovernment debt for an expansionary fiscal policy todeal with the recession due to the pandemic could
destabilize the financial system in those countries?

Sikand: Historically, bouts of “capital flight” have almost always
forced policymakers in EMDEs into a pro-cyclical tightening ofmonetary and fiscal policy in order to stabilize currencies and avoid aspiral of higher inflation and a rising cost of capital with a long lag
before these tightening policy moves are unwound. This time, rather
than hiking interest rates to stem currency falls and thwart inflation,
EMDEs have slashed rates and prepared the way for quantitative
Japan SPOTLIGHT • November / December 2020

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COVER STORY 1

easing policies that can “monetize” debt issued to fund fiscalexpansions. As a child of the Washington Consensus, I must admitthat I was caught flat-footed by this development as past experiencesuggested that EMDEs would have to deploy capital controls if theywanted such policy flexibility.
One explanation for the equanimity of markets to thesedevelopments is that EMDE policymakers have justified their actions
on the basis that they are market-smoothing operations rather thanstimulus measures. The fact that EMDEs are conducting asset
purchases when they still have scope to ease rates – and have done
so in small quantities – certainly supports this notion.
Ben Bernanke has argued that Quantitative Easing (QE) works by(i) cutting the supply of long duration assets to reduce their yields(“portfolio balance effect”), and (ii) showing policymakers’ intent tokeep interest rates low for a long period (the “signaling effect”). As
such, the efficacy of QE can be judged by a yield curve that bothshifts downwards and flattens. Yet most EMDEs doing QE today haveseen their yield curves steepen, probably because investors wanthigher term premiums to compensate for institutional deficiencies
and higher expected inflation.
To be fair, it is early days and QE-toting EMDEs may eventually see
flatter yield curves, as intended. But if this does not happen it ispossible – and indeed likely – that formerly cautious EMDE central
banks will shed their inhibitions and ramp up purchases, lest theircredibility with investors be doubted. It is true that larger EMDE
economies today borrow much more in their own currencies than in
the 1980s and 1990s – periods characterized by waves of defaults
among EMDEs. But the significant presence of foreign institutions inlocal currency bond markets means they remain vulnerable to capitalflight should external liquidity conditions change, or confidence inEMDEs to execute such policies suddenly reverse.
JS: To avoid a financial crisis and enhance

productivity in the long run, will structural reforms toreignite growth and improve debt and investment
transparency be important for EMDEs in particular?

Sikand: The standard policy prescription given to EMDEs is toundertake structural reforms that would allow them to emulate theso-called East Asian development model that has been usedsuccessfully in Japan, South Korea, Taiwan and most recently inChina. However, that model has not proven to be universallyadaptable even within Asia itself – Thailand and Malaysia are two
prominent examples of economies where the early gains frompursuing an export-oriented economic development strategy could
not be sustained. Moreover, the East Asian development model, atleast in its initial stages, has historically required substantial
6 Japan SPOTLIGHT • November / December 2020

government interventions such as financial repression, capital
controls and the mollycoddling of “national champions”. These
interventions were coupled with considerable opacity in theoperations of the broader financial system in order to allow thesocialization of the high initial costs of setting up large-scale
manufacturing units capable of producing export-quality goods andthe enabling infrastructure.
Striking a balance between the generalized demand for greater
political and economic freedoms vis-à-vis the desire to maintain
political and economic control in order to achieve the long-term
development goals is a function of each individual country’s unique
circumstances – the manufacturing exporters of Central and Eastern
Europe face a very different set of challenges as compared to thecommodity exporters of Latin America. In this context, it is also
important to recognize that policymakers in EMDEs today are facedwith Hobson’s choice – either they risk the wrath of the market andseek to jumpstart growth using risky policy tools like deeply negative
real rates and QE, or they risk the ire of electorates whose economic
suffering is exacerbated by the inadequacy of offsetting stimulus
measures. The path chosen by various EMDEs, both in the near term
as well as the long run, will be just as much a function of theireconomic circumstances as it is of their political pressures.
JS: What are the major policy issues in East Asia andthe Pacific in promoting structural reforms?

Sikand: East Asian economies have achieved considerable economic
success by implementing policies that prioritize exports. This
strategy is reflected in the substantial current account surpluses
across most of Asia that have, in turn, facilitated the accumulation oflarge stockpiles of foreign assets which are used effectively to tide
them over external shocks. However, one corollary to these “excesssavings” is that domestic demand, specifically consumption, hasbeen inhibited. Meanwhile, the desire to diversify risks and generate
returns has meant that this large and growing pool of Asian savings
has helped stoke asset price inflation both at home and abroad.
There is no universal template to solve Asia’s problem of excess
savings. South Korea and Taiwan could certainly afford to run larger
budget deficits to invest in expanding social safety nets, thus
reducing the need for high savings among their populace. But thesame cannot be said for Japan which already has the highest public
debt-to-GDP ratio in the world and a private sector that continues togenerate substantial savings simply because there are few profitable
investment opportunities in an economy where the population isshrinking.
Even China that has been running “augmented” fiscal deficits
worth 8-10% of GDP for several years now has failed to achieve theCOVER STORY 1

necessary rebalancing away from an investment-led growth model
towards consumption-led growth. Perhaps in recognition of thisfailure in past policy, President Xi Jinping’s recently proposed “dualcirculation” model seeks to continue to build out China’s export
prowess while also providing greater policy support for production
facilities that cater to domestic consumption.
However, the crux of the issue is that reorienting China (andindeed the rest of Asia’s export-focused economies) towards
boosting the domestic consumption share of GDP requires a large
shift in the distribution of income, and perhaps even wealth, towards
those with a higher propensity to consume. That transition can bedifficult to achieve as evidenced by the continued dominance ofJapanese zaibatsu and Korean chaebol in their respective economies
and is arguably going to be even trickier in China where the state
itself exerts control over vast amounts of wealth.

Global Fiscal Policy Coordination to Reduce
Risk of Disruption
JS: What do you think about global fiscal policy

coordination, such as a Tobin tax on speculative
exchange market transactions by all nations for
reduction of fiscal deficits, to enhance fiscal stimulus
in all nations to cope with the pandemic crisis?

Sikand: Given the long gestation periods involved in globallycoordinated policy actions, it is unlikely that a global Tobin tax will beimplemented anytime soon. One example of the difficulties incoordinating policy at a global level can be seen in the OECD’s G20
Base Erosion and Profit Shifting Project that was set up to tackle tax
avoidance by multinational corporations – an agreement that wasexpected this year, eight years after the project was announced, is
now likely to be delayed further because of the pandemic andrenewed disagreements among members. Of course, individual
countries could go ahead and impose such a tax unilaterally but pastexperience of countries (notably Brazil) unilaterally imposing suchtaxes has shown that the direct and indirect costs associated withimposing a Tobin tax generally outweigh the benefits.

The “End of Shareholder Capitalism”?
JS: Do you think in the post-pandemic age, we will see

an end to “shareholder capitalism”, as businesses
will need to take care of a wide range of stakeholders
such as the employees, local communities, and soforth?

Sikand: In the aftermath of the Global Financial Crisis, one major
obstacle to a constructive policy response had been the ideology ofmarket fundamentalism. Since the early 1980s, politics has been
dominated by the dogma that markets are always right andgovernment economic intervention is almost always wrong. This
doctrine took hold in response to the inflationary crisis of the 1970s.
Powerful political interests motivated the revolution in economic
thinking of the 1970s. The supposedly scientific evidence thatgovernment economic intervention is almost always counterproductive legitimized an enormous shift in the distribution ofwealth, from industrial workers to the owners and managers offinancial capital, and of power, from organized labor to businessinterests.
The dominant ideology of government non-intervention naturally
intensifies resistance to change among the winners fromglobalization and technology, and creates overwhelming problems insequencing economic reforms. To be successful, monetary, fiscal
and structural policies need to be implemented together, in a logicaland mutually reinforcing sequence.
If market fundamentalism blocks expansionary macroeconomic
policies and prevents redistributive taxation or public spending,populist resistance to trade, labor deregulation and pension reform isbound to intensify. Conversely, if populist opposition makes
structural reforms impossible, this encourages conservative
resistance to expansionary macroeconomics.
But suppose that the “progressive” economics of full employment
and redistribution could be combined with the “conservative”
economics of labor reform and trade liberalization. Bothmacroeconomic and structural policies would then be easier tojustify politically – and much more likely to succeed. The Covid-19
crisis, and the policy responses it has engendered, looks like it may
mark the start of precisely such a confluence of styles inmacroeconomic management which is then likely to be combinedwith and reinforced by a boom in long-term investment driven byenergy transformation, European integration and China’s need fortechnological self-reliance. None of these things is certain but hopesof a structurally stronger world economy will become increasingly
credible unless there is evidence to the contrary and provided
expansionary macroeconomic policies persist.
(The interviewee would like to acknowledge the expertise of hiscolleagues at Gavekal which has informed some of his responses.)Written by Naoyuki Haraoka, editor-in-chief of Japan SPOTLIGHT & executive
managing director of Japan Economic Foundation (JEF).

Japan SPOTLIGHT • November / December 20207