Deja Vu For The Global Economy?

Roadblocks to reform mean the worldwide financial crisis won't go away anytime soon

The scenario has become depressingly familiar. Emerging-market nations, their economies crippled by debt, start to spin out of control--currencies plunge, stock markets crash, foreign investors flee. That triggers sell-offs in bourses around the world and pushes up interest rates on all sorts of borrowing. Then, the International Monetary Fund and other financial institutions of the industrialized nations swing into action, stitching together loan packages and dictating reform plans to stop the panic. Investors, figuring the worst is finally over, plunge back into emerging markets--only to run into a wall of reality.

Is the cycle restarting now? In the past few weeks, reminders that the global economy is still in perilous shape came in rapid succession. Brazil's legislature rejected part of an austerity plan tied to a $41.5 billion IMF deal designed to prevent a meltdown. In Moscow, leaders launched a desperate bid to avert a default on foreign bonds that would send its already shattered economy deeper into the abyss. In Caracas, the election of a populist president raised fears that teetering Venezuela may be the next IMF basket case. In their wake, stock markets from the U.S.--where new highs had been set--to Asia and Europe staged prudent retreats.

On Dec. 1, Boeing Co. reminded Americans that, despite the continuing strength of the U.S. economy, they are not immune to Asian contagion. Facing a slew of canceled orders from Asian carriers, Boeing says it will face weak earnings growth for the next five years and will lay off more workers as a result.

Suddenly, it's clear how little has really changed in the nations battered by the global maelstrom. The easing of monetary policy in the West and reform in Japan did quell global financial panic and eased worry that the entire world will slide into recession next year. With luck, many economists believe, most emerging markets should be ready to grow again in 2000.

But first, there's 1999. The global economy is still balancing precariously on the edge, and another shock could easily push it over. There is no way around the fact that cleaning up the finances of Japan, South Korea, Russia, Brazil, and other crisis countries will be a long, tortuous, and expensive process. What's more, new roadblocks from local politicians, companies, and bureaucrats will inevitably arise. If the U.S. sputters, warns Zurich Group global economic strategist David D. Hale, "next year has the risk of being the worst for the world economy since World War II."

The global environment won't make recovery easy either. Prices for oil, copper, and other commodities--as a group already down 23% since May, 1997--are likely to keep dropping in early 1999. Meanwhile, the aftershocks of the Asian and Russian collapses still crimp credit to most developing nations, hurting their ability to roll over hundreds of billions in foreign-currency debts and export their way back to health.

ANOTHER SHOCK? True, the severe liquidity squeeze of September and October has eased for emerging markets. "But only prime borrowers are getting any money," notes Uri Dadush, the World Bank's chief economist for developing nations, "and only at spreads that are two or three times higher than they were." Indeed, even in the U.S. spreads between Treasuries and high-risk bonds have recently crept back near their levels at the height of the liquidity scare. Five-year Treasury bonds sold three months ago now trade at 10 basis points higher than the most recent issues, another sign of tight liquidity.

If capital flows are severely squeezed for a year, Dadush warns, emerging markets could suffer another shock as big as last year's Asian debacle, which erased $150 billion in consumption and hammered America's manufacturing sector. "There is room for no complacency at all," he says.

That makes the outlook for the coming year grim. Enormous swathes of the world--36 countries in all, according to the World Bank--are already in recession. Latin America should finish 1998 with regional growth of just 2.4%, and may contract by 0.8% next year, predicts J.P. Morgan. Brazil's economy may shrink by 4.3%. Venezuela is also on the edge, facing a $5 billion budget shortfall next year, a currency that may be overvalued by 40%, and still-dropping oil prices. Yet President-elect Hugo Chavez has talked about hiking wages and agricultural subsidies and halting privatization of state-owned industries.

In Europe, many analysts expect Britain to slide into recession, while Germany is now projected to grow a mere 1.7% as exports to Asia drop. Then there is Japan, which is poised to enter its third year of recession after an estimated 2.5% contraction in 1998. Tokyo's lavish public spending program is not expected to greatly boost consumer spending, and many analysts doubt that its $500 billion bank- recapitalization scheme will resolve Japan's debt crisis.

About all the U.S. and Europe can do is cut interest rates again. But the Fed and the new European Central Bank will be reluctant to do that unless their own economies start slowing--which would be bad news for everyone.

So in reality, the world's policymakers can only hope that the crisis countries stick to reforms--and pray that nothing else goes wrong. If developments in Brazil and Russia are a harbinger, 1999 will be another year of living nervously.

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