The fear of a recession looms over the United States. And as the cliche goes, whenever the US sneezes, the world catches a cold. This is evident from the way the Indian markets crashed taking a cue from a probable recession in the US and a global economic slowdown.
Weakening of the American economy is bad news, not just for India, but for the rest of the world too.
A recession is a decline in a country's gross domestic product (GDP) growth for two or more consecutive quarters of a year. A recession is also preceded by several quarters of slowing down.
What causes it?
An economy which grows over a period of time tends to slow down the growth as a part of the normal economic cycle. An economy typically expands for 6-10 years and tends to go into a recession for about six months to 2 years.
A recession normally takes place when consumers lose confidence in the growth of the economy and spend less.
This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment.
Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment.
Stock markets & recession
The economy and the stock market are closely related. The stock markets reflect the buoyancy of the economy. In the US, a recession is yet to be declared by the Bureau of Economic Analysis, but investors are a worried lot. The Indian stock markets also crashed due to a slowdown in the US economy.
The Sensex crashed by nearly 13 per cent in just two trading sessions in January. The markets bounced back after the US Fed cut interest rates. However, stock prices are now at a low ebb in India with little cheer coming to investors.
Current crisis in the US
The defaults on sub-prime mortgages (homeloan defaults) have led to a major crisis in the US. Sub-prime is a high risk debt offered to people with poor credit worthiness or unstable incomes. Major banks have landed in trouble after people could not pay back loans (See: Subprime pain: Who lost how much)
The housing market soared on the back of easy availability of loans. The realty sector boomed but could not sustain the momentum for long, and it collapsed under the gargantuan weight of crippling loan defaults. Foreclosures spread like wildfire putting the US economy on shaky ground. This, coupled with rising oil prices at $100 a barrel, slowed down the growth of the economy.
How to fight recession
Tax cuts are the first step that a government fighting recessionary trends or a full-fledged recession proposes to do. In the current case, the Bush government has proposed a $150-billion bailout package in tax cuts.
The government also hikes its spending to create more jobs and boost the manufacturing and services sectors and to prop up the economy. The government also takes steps to help the private sector come out of the crisis.
Past recessions
The US economy has suffered 10 recessions since the end of World War II. The Great Depression in the United was an economic slowdown, from 1930 to 1939. It was a decade of high unemployment, low profits, low prices of goods, and high poverty.
The trade market was brought to a standstill, which consequently affected the world markets in the 1930s. Industries that suffered the most included agriculture, mining, and logging.
In 1937, the American economy unexpectedly fell, lasting through most of 1938. Production declined sharply, as did profits and employment. Unemployment jumped from 14.3 per cent in 1937 to 19.0 per cent in 1938.
The US saw a recession during 1982-83 due to a tight monetary policy to control inflation and sharp correction to overproduction of the previous decade. This was followed by Black Monday in October 1987, when a stock market collapse saw the Dow Jones Industrial Average plunge by 22.6 per cent affecting the lives of millions of Americans.
The early 1990s saw a collapse of junk bonds and a financial crisis.
The US saw one of its biggest recessions in 2001, ending ten years of growth, the longest expansion on record.
From March to November 2001, employment dropped by almost 1.7 million. In the 1990-91 recession, the GDP fell 1.5 per cent from its peak in the second quarter of 1990. The 2001 recession saw a 0.6 per cent decline from the peak in the fourth quarter of 2000.
The dot-com burst hit the US economy and many developing countries as well. The economy also suffered after the 9/11 attacks. In 2001, investors' wealth dwindled as technology stock prices crashed.
Impact of a US recession on India
A slowdown in the US economy is bad news for India.
Indian companies have major outsourcing deals from the US. India's exports to the US have also grown substantially over the years. The India economy is likely to lose between 1 to 2 percentage points in GDP growth in the next fiscal year. Indian companies with big tickets deals in the US would see their profit margins shrinking.
The worries for exporters will grow as rupee strengthens further against the dollar. But experts note that the long-term prospects for India are stable. A weak dollar could bring more foreign money to Indian markets. Oil may get cheaper brining down inflation. A recession could bring down oil prices to $70.
Between January 2001 and December 2002, the Dow Jones Industrial Average went down by 22.7 per cent, while the Sensex fell by 14.6 per cent. If the fall from the record highs reached is taken, the DJIA was down 30 per cent in December 2002 from the highs it hit in January 2000. In contrast, the Sensex was down 45 per cent.
The whole of Asia would be hit by a recession as it depends on the US economy. Asia is yet to totally decouple itself (or be independent) from the rest of the world, say experts.
'Risk of a US recession high, India to be hit'
Stephen S Roach, chairman of Morgan Stanley Asia, warned that Asia and India will be hit hard due to a likely recession in the US in 2008, saying "if US sneezes, Asia will catch a cold." Predicting a significant correction in emerging market equities, which would also not spare the fast rising Indian stock markets, Roach, who is regarded as one of the Wall Street's most influential economists, said he did not believe in the global de-coupling theories. "The risk of a recession in the US in 2008 is high and rising. If the US goes into recession, you are going to feel it in Asia, you are going to feel it in India," he said. He, however, agreed that India may be little bit less export-dominated compared with other typical Asian economies. The share of exports in China's GDP is as high as 36.6 per cent. Exports to the US alone are as high as 21 per cent. Same for Japan, the share of exports to US is 22.5 per cent. For Korea, the share of exports to GDP is 36.7 per cent, and US share at 13.3 per cent. He said Eastern Asia and China would be the biggest victims of a US recession. He added the subprime crisis in the US would serve as a wake up call for central banks around the world. "I think there could be a significant correction in emerging market equities that certainly could hit the Indian stock market quite hard," he said.
Roach was in Mumbai to speak on the subject 'Subprime: Canary in a coal mine?' at a lecture organised by Asia Society India Centre.
Roach, who was until recently Morgan Stanley's chief economist in charge of the firm's global team of economists, said Asia as a region, and developing Asia in particular, remains very much an export-led region.
