Will India sneeze when US catches cold?
Posted by hidayathfund on October 28, 2008
The adage “what goes up, must come down,” becomes true in the case of recession that follows vibrant economic activities that make people think would continue forever. By standard definition recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters in a year.
Many economists, however, differ to believe this definition since they feel it excludes factors such as unemployment rate and consumer spending that affect the economy.
The signs of an economic slowdown include:
·Decreased consumer spending
·Decrease in manufacturing yield
·Dip in personal income
·A wildly fluctuating stock market
Why it happens
Consumer demand is usually high in a growing economy. To meet this increased demand, producers optimize available resources, including labor. The greater demand for labor brings more wages to people.
More wages increase consumer confidence, which lead to higher consumer spending. Investors invest in stocks on rising consumer demand, resulting in a bullish market.
However, the economy will not keep expanding indefinitely; it will contract for a while. A period of contraction is known as a recession. When a severe recession lasts longer, it is called a depression.
According to the International Monetary Fund, (IMF) global recessions occur over a cycle lasting eight and 10 years.
What causes recession? Many aspects could affect the economy. For example, to satiate the growing consumer demand, manufacturers may tend to overproduce.
Another reason could be layoffs and rising unemployment. Insecure jobs or a slackened job market tightens consumers’ purse strings, affecting the real estate market, which will in turn lead to a dip in investments. These along with other factors take the economy to a recessionary situation.
The current situation in the US was triggered by defaults on sub-prime home mortgages. Sub-prime is a high-risk debt offered to people with poor credit worthiness or unstable incomes.
Major banks saw red after people failed to repay loans. The huge number of foreclosures shook the US economy. This, coupled with the rising oil prices at over $100 a barrel, slowed down the economy.
Open markets, and increasing globalization and economic global connectedness now mean that the ramifications of the recession in the US could be felt in the rest of the world.
Effect on India
The IMF has predicted that the US would experience a ‘mild recession’ in 2008, from which it will slightly recover in 2009. The IMF has estimated the impact of global financial turmoil following US sub-prime crisis at US$1 trillion.
A slowdown in the US could increase the risk of a global chain reaction triggered by decline in consumer spending by Americans.
The US sources a lot of its products and manufacturing from other economies. A decrease in US’ demand would mean fewer manufacturing orders for these countries.
The American population, which accounts for about five per cent in the world, consumes almost 25 per cent of the world’s resources, either as raw materials or as finished products.
Compared to the developed nations, the impact of the US recession would be lesser in emerging economies like India and China, IMF said.
Thanks to offshoring, India had registered better economic growth during the earlier US recession that followed the terror attack on the US in 2001.
American billionaire investor George Soros also felt that India would not be affected much by the current recession.
“China, India and some oil-producing countries are experiencing dynamic developments, which may not be significantly disrupted by the financial crisis and a recession in the United States,” he says in his latest book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means.
The Indian economic growth is likely to slip to 7.9 percent in 2008 from 9.2 percent in 2007. In 2009, the Indian economy would expand at a slightly higher rate of 8 per cent, the IMF’s World Economic Outlook said.
However, Stephen Roach, chairman, Morgan Stanley Asia, said India would be affected: “If the US goes into recession, you are going to feel it in Asia, you are going to feel it in India.”
It is still early to tell which course the Indian economic would take a few quarters down the road.