With China undertaking a once-in-a-generation shift from investment-led growth to consumption-led growth and with Europe too ambling about with little growth, the world economy is expected to be in 'limbo land' for at least a year, says noted economist Sanjeev Sanyal of Deutsche Bank.

With China undertaking a once-in-a-generation shift from investment-led growth to consumption-led growth and with Europe too ambling about with little growth, the world economy is expected to be in 'limbo land' for at least a year, says noted economist Sanjeev Sanyal of Deutsche Bank. In an interview with CNBC-TV18, Sanyal said the recent developments in China are likely to cause an outflow of capital, which will then slosh around the world waiting to be picked up by some other large economy. "What is now needed required is someone like the US to step up and provide demand of last resort," he told CNBC-TV18's Latha Venkatesh and Sonia Shenoy, adding that the Indian economy was too small to soak up capital. Sanyal was commenting after China's flash PMI fell to a six-and-a-half-year low, as output at its factories fall and as it tries to boost domestic consumption through means such as fiscal stimulus. "China has a high savings rate but the fall in its saving rate will not be enough [to spur consumption] to counter fall in investment demand," he said.

Below is the transcript of the interview on CNBC-TV18.

Sonia: Once again weak data coming in from China, do you think things have gotten from bad to worse and what is the expectation hereon?

A: You need to be very careful about how we interpret this data. There is no doubt that China's economy is slowing but extrapolating that into saying that China is having emerging market crisis type situation is perhaps also not right. China's growth is slowing, it will slow past below 7 percent this year but this is not a cyclical downturn. This is a structural shift away from China's investment driven growth model and this will happen over several years. The country has enormous external and internal resources to smoothen this. So this is a structural shift and we need to interpret it in that context.

Latha: What we would like to know is therefore will the manufacturing numbers continue to contract, ultimately that has a bearing on China's trading partners on the amount of cheap steel and tyres it sends abroad and on commodity prices in general, so should we see this purchasing managers' index (PMI) tick going from 47 to even lower for the time being?

A: PMI is not an index. So in that sense, the tick may or may not go down. Even if it remains at this level, it suggests slowdown so that is not the right way to think about it. But more broadly yes, with every year, you will see China growing little bit slower than it did in the previous year and yes, it does mean that you will see somewhat weaker demand out of China for various commodities than had been maybe extrapolated in the past. As I keep pointing out, this is part of China's transition from being the world's factory to becoming the world's investor, which means that as it slows down, it will also simultaneously keep pushing out huge amounts of capital to the rest of the world -- which is a point I have been making for quite some time now -- will keep the cost of capital globally cheap for a long time to come.

Latha: At the moment we are less worried about the capital, we are worried about the cheap steel that they are pushing out. We just spoke to steel company executive who was deeply worried about the amount of Chinese steel dumping that he is forced to face on Indian shores, is there any respite to that or that continues?

A: I think China's own demand for many of these commodities, including steel will be soft for some time and even if it picks up, I think given the amount of capacities, there will be a significant amount of overcapacity for some foreseeable future. So ultimately, as far as the world is concerned, what you will need to see this excess capital that I talked about being absorbed somewhere else in the world in order to generate growth and demand and investment that will suck up this excess steel and frankly in the end it will have to be the US.

Sonia: So far we have seen a lot of stimulus coming from the Chinese government itself but do you expect some more to flow through and do you think that could alleviate some of the stress that it is facing in terms of slow growth?

A: I think what you are seeing in China is a smoothening out of a structural slowdown and this is not the case that these easing measures are going to cause a return to the old days of growth. At most you will see a smoothening down this downward trajectory. As I keep pointing out, this is not going to be hard landing but at the same time, this is not going to be a cyclical upturn either and instead, a significant proportion of this stimulus that you are talking about will leak abroad in some form and become capital outflow.

Latha: The Chinese government indicated, the premier indicated that they are going to expand the fiscal stimulus from 7 percent to 10 percent at the world economic forum. Will this make a difference and we will start to see China consuming other things -- they have seen a steep fall even in their car consumption, one can see it in the Tata Motors numbers, should we start to see Chinese consumption improve and alleviate many people who are selling consumer goods to China?

A: You may see some smoothening out, even some recovery. But let us be very clear, what is going on is a long-term structural shift in a country where the work force is already shrinking by the end of this decade. And it is a very high savings country where the savings rate may decline as a result of higher consumption. But fact of the matter is the savings rate is not going to fall fast enough to keep up with declines in the investment rate and therefore you will have this slackness in demand for a long time.

Sonia: Do you have a view on what is happening in the other part of the world that is with the European economy because yesterday and today or rather in the past two days we have seen quite a bit of a sell off in European equities, there is this whole Volkswagen problem which is ballooning as well but is it only one or two companies specific issue or do you think over there too there could be some slowdown worries?

A: Obviously these are specific company issues which I cannot comment about but the fact is the European economies aren’t gathering a lot of momentum. Many of the exports out of Germany or capital goods exports have also been affected by this slowdown in China. The real issue for us is who in the world is going to absorb this excess capital and we would be grateful if the Europeans don’t add to the problem by trying to export their way out of this. So I think the best we can expect out of Europe is that they don’t add to the problem and at least absorb their own savings to keep the system going and they are certainly not in a position to absorb China's excess.

Latha: Today we got some comments from Ruchir Sharma of Morgan Stanley, his point is that Asia is now in a trade recession with everybody's exports falling and total quantum of trade falling, global manufacturing growth he says, incremental growth has come to a standstill and he calls this signs of global economy being close to a recession, would you agree with that?

A: I wouldn’t like to comment on somebody else's views. I would say that it is the case that the world economy is not gathering pace -- that includes the industrial economy. And unless some large economy somewhere in the world begins to take this excess capital and begins to put it to some good use, presumably into large scale investments, you will be even one year from now remaining in this limbo land where there is large amount of capital sloshing around -- occasionally causing bubbles -- but the economy not getting going. Now, this is the context in which you have to realise that the US economy is critical. India may or may not gather steam but it is too small. The US is the only other genuinely large economy that can take this excess capital and deploy it.  There are lots of good things you can do [with that capital] in the US. Anybody who has been to US will know that there are many positive things you can invest into in the US but it requires a political will to get on with it. So it is again coming down to the old problem of requiring the US to provide the demand of last resort.