Published November 4, 2008

Govts act to breathe life into economies

Reflation takes centre stage; Seoul joins bandwagon with S$16.4b package

By CONRAD TAN

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(SINGAPORE) Central banks and governments worldwide are slashing interest rates and pumping billions of dollars into their economies to boost faltering growth. Reflation is the name of the game.

The desperate hope is that a combination of lower borrowing costs, direct government spending and tax breaks will spur business investment, create jobs and encourage people to spend, at a time when the world's biggest economies appear to be sliding into recession.

Yesterday, South Korea said it would spend 14 trillion won (S$16.4 billion) on infrastructure development and tax benefits next year to stimulate economic activity.

Just last week, the country's central bank cut its benchmark interest rate to 4.25 per cent from 5 per cent - the biggest-ever reduction - in a bid to spur growth.

Australia is expected to cut rates by half a percentage point to 5.5 per cent today, after official data yesterday showed that retail sales and house prices there are falling faster than expected. Central banks in the UK and euro zone - two of the biggest economies in the world - are also expected to deliver unprecedented interest-rate cuts on Thursday.

The Bank of England is facing strident calls to slash its benchmark rate by a full percentage point to 3.5 per cent, although economists are expecting a more cautious reduction of half a percentage point. Mervyn King, its governor, warned on Oct 22 that the UK - the second-largest economy in Europe after Germany - is 'likely' to be sliding into recession.

The European Central Bank, which sets interest rates for the 15 euro-zone economies - is expected to cut rates by half a percentage point to 3.25 per cent.

Fear of deflation - a destructive spiral of falling consumer prices and shrinking income for businesses, leading to fewer jobs and a moribund economy - has rallied support for steep interest-rate cuts in major economies such as the US and UK.

That marks a complete reversal from just a few months ago, when soaring inflation was a big worry - a sign of how quickly and drastically the global economic outlook has deteriorated.

Last Wednesday, the US Federal Reserve lowered its main interest-rate target to just one per cent - the lowest since 2004 - and signalled that it could cut rates even further. The same day, China's central bank also cut its key lending rate.

But Kevin Scully, who heads independent research firm NetResearch Asia here, said governments in the United States and elsewhere would have to resort to aggressive fiscal measures to revive floundering economies.

With credit markets still malfunctioning and banks tightening their lending activity, 'monetary policy is useless - even if they cut rates to zero, nothing will happen', he said.

In his testimony to US lawmakers on Oct 20, Fed chairman Ben Bernanke said that a fiscal package would be 'appropriate', with the US economy 'likely to be weak for several quarters, and with some risk of a protracted slowdown'.

At an emergency meeting last Saturday, the Reserve Bank of India, the country's central bank, cut interest rates and reduced the amount of money that commercial banks have to hold in reserve at the central bank for every dollar they lend, to free up more money for loans to businesses and households.

Last Thursday, Hong Kong and Taiwan also cut rates, following the move by the Fed, and Japan announced a massive five trillion yen (S$75 billion) stimulus plan of public spending and tax breaks.

The next day, the Bank of Japan eased its already low benchmark rate to 0.3 per cent, from 0.5 per cent.

In normal times, cutting interest rates helps to reduce borrowing costs, encouraging businesses to invest in expansion and people to spend, creating more jobs and fuelling economic growth.

But with some of the largest banks struggling to stay afloat, healthy ones reluctant to lend, and businesses and individuals cutting back on their borrowing, economists say that the latest round of interest-rate cuts is likely to be far less effective than usual in revitalising economic growth.

Instead, governments are hoping that boosting public spending on infrastructure projects such as roads and utilities will create jobs in sectors such as construction, while tax breaks and cash handouts for businesses and individuals will encourage them to spend more on goods and services, keeping companies in business.