In between the possibilities of a full-scale war leading to a recession and a risk-free scenario, there is possibility of limited contained conflicts via proxy wars which will lead to global growth slowdown, says Nouriel Roubini, Chairman, Roubini Macro Associate, in an exclusive interview with Ajaya Sharma of ETNOW.

Just about 48 hours ago, the global financial markets were on tenterhooks about the Iran-US situation after General Qesim Soleimani’s assassination and the retaliation from Iran. But markets were quite pleasantly surprised by the way it has dialed down. Do you think this is over? Has the risk gone for now?
I do not think the risk is gone. The markets are seriously under pricing these particular geopolitical risks. Markets are essentially assuming that maybe after this attack by Iran on the US base, not much else is going to happen. We are going to go back to the previous status quo. That is the most positive scenario. An extreme scenario, of course, will be of a full-scale war. Maybe that is unlikely because neither Iran nor the United States and Trump want a full-scale war but in between those two scenarios, there is going to be a series of confrontations between the US and Iran — directly or indirectly — using some of the local proxies. Iran could unleash proxies in Iraq, in Syria, even against Israel. There could be other attacks against US assets in bases either in the regions or terrorist attacks in the rest of the world; cyber attacks and there could be a confrontation even within the Gulf . That would also constraint production and export of oil. That is a middle scenario of not a full scale war but not normalcy either. My worry is that oil prices are going to go well above $70 per barrel, closer to $80 per barrel.

Of course, if there was a full scale war, it could be above $100 per barrel but even in that mild scenario in which the escalation is short of a full scale war, there will be a negative shock to the global economy. There will be higher oil prices. The business and investor sentiment would be down. There will be a correction in global equity markets. Global growth will slow down further though not lead to a recession. There will be a recession only if there is a full-scale war and if oil is above $100 per barrel. But there could be a growth slowdown compared to what the markets are expecting right now.

If you are seeing that the Middle East will continue to simmer and not cool down, what implications would that have on emerging markets like India? We are hugely dependent on crude oil. As the US is a net exporter of oil now, crude price shooting up will perhaps work in their favour. Some people say that the way these tensions have come up right ahead of the American elections, it is like a pattern is playing out. What are your thoughts on that?
Well of course a rise in oil prices has a positive impact on net oil exporters and a negative on net oil importers. The United States so far is not yet a net exporter. Maybe, it is becoming energy independent but there are many countries that are important and are net oil importers – China, India, Turkey, Korea among the Emerging Market economies and also Japan, most of Europe and most of the other advanced economies.

So if oil prices were to go from current levels to $80 per barrel, that is a negative growth impact on the global economy because the marginal propensity to spend of the oil exporters is lower than the marginal propensity spend of the oil importers and even within the United States. while the producers of gas and oil will have a windfall in terms of their profits, users of oils — both consumers and households — are going to be hurt by having higher gasoline and utility prices.

Other industries that are heavy users of oil are going to be hurt as well. So the distributional effects of higher oil prices would slow down growth even in the United States because the the producers of oil and gas are not going to spend much more while the consumers are going to be hurt and spend less. So even within the US. it is a net negative.

. There will be a recession only if there is a full-scale war and if oil is above $100 per barrel. But there could be a growth slowdown compared to what the markets are expecting right now.

-Nouriel Roubini

Before the Iran issue came up, global markets including India were rallying and cheering that US and China are coming to terms with the phase I of the trade deal. Do you think that is positive and incremental or is it just kicking the can down the road? That it is a temporary truce and may resurface later on because the race for global domination continues between US and China?
You are absolutely right that market rallied strongly especially in the latter part of last year for three sets of reasons. One, the expectation of a phase I deal between the US and China. Two, expectation of a soft Brexit and of course both the Federal Reserve, the European Central Bank and many other central banks even in emerging market like in India cut policy rates and that was a boost for liquidity also led to rally in assets.

My view about US and China is that first of all the deal is really a skinny deal. It is a mediocre deal because essentially new tariffs have not been imposed and much of the existing tariffs have not been rolled back in exchange of the Chinese buying more American farm products. It is really a mediocre deal and it could even unravel over time.

But the point that you referred to — the strategic rivalry between the US and China — a rising power facing an existing power leading to what geopolitical experts call disruption is going to continue. For the medium term, rivalry will be over who is going to dominate technology — be it AI, 5G, biotech, electric vehicles, autonomous vehicles, biotech engineering. So, this rivalry is going to be in the area of technology, information, knowledge, trade, investment, FDI restrictions and also in the currency area. This was also encompass restrictions on mobility of labour, scholars, students and so on.

We are in the middle of a strategic rivalry that is going to build up over time and that is like a negative supply shock to the global economy because from four decades of globalisation integration, we are now going towards deglobalisation, decoupling with investment in China, fragmentation of the global economy and balkanisation of the global supply chains. The technology war is spilling over to services. That is a big trend which will have a negative impact on growth potential throughout the world.

That is perhaps the reason why global manufacturing facilities are working way below their optimum utilisation levels and slowdown is gripping the world. How do you see the role of global central banks in propping up economies?
In the middle of last year, there were large concerns in the market that an escalating US-China trade war or a hard Brexit could lead to global recession. What saved both the real economy and also asset prices was the quite aggressive action by the Fed which cut rates three times. The ECB went back to quantitative easing and cut policy rates followed by other smaller central banks in Europe and of course, the central bank of China, RBI in India and many other emerging markets. That helped the markets. But let us realise that at least in advanced economies, we are running out of policy bullets.

ECB is already at minus 50. How much more negative can they go? They are already doing quantitative easing and buying both government assets and private assets. The Bank of Japan is even more in aggressive accommodative stance by not only doing quantitative easing but going with negative policy rates by targeting the zero 10-year government bond yields. Even the Fed rate right now is down to 1.5% and therefore if a growth shock were to occur, they can go to zero and they can go back to forward guidance and quantitative easing. But the impact of those policies is going to be less significant because you do not have much policy headroom. We are in a world in which there are potential downside risks to the global economy. Some negative shocks do occur and central banks are lethally running out of policy bullets.

You earned the reputation of being called Dr Doom because of your accurate prediction of 2008 financial crisis and the repercussions which happened. You are now making a case for mild recession or prolonged global growth slowdown. How do you see emerging markets pan out in this light? India is a large emerging market. What repercussions do you see for this side of the world?
My baseline for this year is not a global recession yet. I think global recession could occur if the confrontation between the US and Iran escalates to a full-scale war. That would lead the oil prices above $100 per barrel and that is not my baseline. My baseline is of a limited contained conflict but even in that baseline, I would say what is going to happen is oil prices would go towards $80 per barrel if not above that.

It is going to have a negative impact on the global economy and growth because there are lots of net oil importers. Of course, slowdown of growth in the US, in Europe and Japan is going to hurt the overall Emerging Markets that are exporting either commodities or goods for advanced economies. Within the EMs, there are some that are net oil importers like India, China, Korea and Turkey.

It is true that a small number of EMs in the Gulf and a couple of other countries exporting oil might be benefitting from that, but overall, the largest Emerging Markets are in a more fragile situation, specifically in the case of India. As an economy, where growth recently slowed down having oil prices going up to $80/ barrel and more has a negative impact on trade balance and fiscal position of the government. It would have a negative impact on the growth rate of the economy.

But at the same time would you not see this as a silver lining for economies which are more domestic centric like India? They will be relatively shielded if we are moving towards de-globalisation, fragmentation, more protectionist policies by various world premiers. Do you think more inward looking economies like India will relatively outperform?
At the margin you could argue that economies that are less open are going to be less negatively affected than those that are more open. But one of the problems that India has faced and which also explains part of its recent economic slowdown is that India has not been as open on the trade and investment front. Opening up the economy to a wide range of interaction with the global economy, will be part of a strategy that would lead to an increasing potential growth of India. It is true that a country like India might be sheltered compared to a larger open economy like China or some of the smaller open economies in Asia and other parts of the world when there is a major global shock, but India needs opening up because that is going to be beneficial for potential growth.

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