Beruflich Dokumente
Kultur Dokumente
BUSINESS REPORT
Submitted on:
13th June, 09
Prepared By:
Aditya Agarwal
Kashif Ziad
Kiranpal Singh
Mayank Sharma
Priyanka Nagpal
Saumya Sinha
Section F7
Contents
Introduction....................................................................................3
The 1980’s Recession and Recovery...........................................3
The Recession of 1990 – 91.........................................................4
The Recession of 2008 onwards..................................................4
Theoretical Insight..........................................................................6
Case Study 1 – Japan......................................................................8
Case Study 2 – Great Britain........................................................18
Case Study 3 – Vietnam...............................................................22
Case Study 4 – United States of America.....................................28
Case Study 5 – India.....................................................................40
Conclusion....................................................................................46
Bibliography.................................................................................47
2
Introduction
People in industrialized nations are far wealthier than people
living in less developed countries. But still these wealthier nations
suffer most during the slowdown period. There was boom in 2007
and then the slowdown started showing its presence prominently
in the year 2008. Before economies could take it seriously, there
was recession. This is what explained by Business Cycle which
says everything which goes up is bound to come down. All these
activities are studied under macroeconomics which is concerned
with the behavior of economy as a whole. This is not the first time
world economies are facing slowdown, there has been 5
recessions in the last 30 years around the globe which includes
the most remembered “Great Depression”. Inflation, Employment
Cuts, Price hike, low demand etc is all characteristics of slowing
down of the economy. The main problem faced by the countries is
not nuclear threat but high inflation rates.
Before starting with the current slowdown of the world
economies, lets have a look at the scenarios of 1980’s and 1990-
91 recessions. Lets observe the policy mix taken by the
economies like US and Europeans at such situation.
4
Thus, Fed cut the interest rate very sharply at the end of 1991. In
retrospect, this was sufficient to ward off a recession.
Theoretical Insight
Theoretical insight about the recession and how to tackle
recession can be given by the help of macroeconomic studies.
But before that we should pay attention to what is meant by
recession?
“In economics, a recession is a general slowdown in economic
activity over a sustained period of time, or a business cycle
contraction. During recessions, many macroeconomic indicators
6
vary in a similar way. Production as measured by Gross Domestic
Product (GDP), employment, investment spending, capacity
utilization, household incomes and business profits all fall during
recessions.”
To come out of this slowdown different economies adopt different
policies mainly under the heads of Fiscal Policy and Monetary
Policy.
Tight Monetary policy affects the economy, first, by affecting the
interest rates and then by affecting the aggregate demand. An
increase in the money supply reduces the interest rate, increases
investment spending and aggregate demand and thus, increases
equilibrium output.
Loose Fiscal policy is implemented by increasing government
spending, cutting taxes etc. A cut in taxes will increases the
consumption of the public and thus increase in demand.
There are again two extreme cases in the operation of monetary
policy and fiscal policy.
First is the Classical Case where the demand for real balances is
independent of the interest rate, monetary policy is highly
effective and any kind of fiscal policy will be ineffective and thus
there will be crowding out of private spending by government.
Second is the case where there is Liquidity Trap, i.e., public is
willing to hold any amount of real balances at the going interest
rates, thus, monetary policy is highly ineffective but fiscal policy
is effective.
In all cases, the main concern of tightening the monetary policy
and easy fiscal policy is to increases consumption and increases
demand in the economy. Thus, consume more and save less. But
7
in developed countries like Japan saving is encouraged to come
out of the slowdown.
But just by implementing these policies will not help in getting
the desired results. A key component is there which plays an
important role for the success of any policy. This key component
is “Multiplier”.
Multiplier Effect is explained as the changes in the real variables
due to the changes in the exogenous variables. If the multiplier is
greater than 1 , then it indicates that any increases the in
government spending will result in greater change in the
aggregate demand and any decrease in the interest rates will
result in much less money supply. In such economies where
multiplier is greater than 1, expansionary fiscal policies will be
effective and can give very good results and vice versa.
In the current scenario, many economies under economic
slowdowns are implementing a policy mix of monetary and fiscal
measures. Reduction in interest rates, introducing stimulus
packages in different sectors, cutting tax rates and increasing
government spending in buying bonds etc are all measures taken
up by different emerging as well as developed economy to
survive in this recession period.
These measures and how developing economies follow “consume
more and save less” strategy and developed economies follow
“consume less and save more” strategy will be explained further
by the case studies of different countries and steps taken by
them.
8
Case Study 1 – Japan
9
The easily obtainable credit that had helped create and engorge
the real estate bubble continued to be a problem for several
years to come, and as late as 1997, banks were still making loans
that had a low probability of being repaid. Loan Officers and
Investment staff had a hard time finding anything to invest in
that would return a profit. They would sometimes resort to
depositing their block of investment cash, as ordinary deposits, in
a competing bank, which would bring howls of complaint from
that bank's Loan Officers and Investment staff. Correcting the
credit problem became even more difficult as the government
began to subsidize failing banks and businesses, creating many
so-called "zombie businesses". Eventually a carry trade
developed in which money was borrowed from Japan, invested for
returns elsewhere and then the Japanese were paid back, with a
nice profit for the trader.
10
among global investors, and a huge plunge in asset prices. Thus,
global financial markets remain fraught with great instability.
In the United States, the financial crisis has dragged down prices
of subprime-related securitized products, mortgage loans, and
commercial real estate. Not only has this resulted in greater
burdens on financial institutions by increasing the amount of
nonperforming assets to be disposed of, it has also substantially
reduced the value of household assets. Indeed, stocks and real
property held by American households lost 10% of their value in
one year, and the effects of this have rippled throughout the real
economy and caused a steep drop in consumer demand. In the
wake of the sharp decline in consumption, many American
companies have decided to forego or postpone capital
investment projects, and the nation's employment situation has
deteriorated significantly. But the impact is not limited to the U.S.
Many other countries that have been dependent on the
continuous growth of U.S. consumer demand are now suffering
from a big drop in exports to the U.S.
In many countries, shrinking domestic demand and falling asset
prices, both direct results of the credit crunch, have been
compounded by falling external demand caused by the drastic
downturn in the U.S. economy. The combination of these events
has depressed consumption, driven companies to cut back on
production, and begun to have a serious impact on the
employment situation. And that is an outline of the financial crisis
and subsequent economic recession experienced by the world in
2008. But, as the ongoing parade of bad news continues to
spread across the world in a chain reaction, it serves as a
renewed reminder of just how tightly countries are integrated
with each other in both international finance and trade.
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➢ Comparison between Japan and the U.S. in terms of policy
response
The U.S. government has been both quick and bold in its policy
response to the crisis. In addition to providing $700 billion in
public funds for financial institutions to facilitate the disposal of
bad assets, the government has also made emergency bridge
loans available for the three biggest U.S. automobile
manufacturers to help them stave off imminent bankruptcy.
Furthermore, the incoming administration of President-elect
Barack Obama has already laid out plans for large-scale fiscal
expenditures. Meanwhile, in December 2008, the U.S. Federal
Reserve effectively adopted a zero interest rate policy by
lowering its target for the benchmark federal funds rate to 0-
0.25%. The Federal Reserve also announced its decision to
purchase agency debt and mortgage-backed securities, thus
embarking on a quantitative easing of monetary policy.
Although poor in comparison to the bold and rapid steps taken by
U.S. officials, Japanese policymakers are also moving in the same
direction as their U.S. counterparts by easing monetary policy
and pursuing expansionary fiscal policy. The Japanese
government committed to ¥1.8 trillion and ¥4.8 trillion of
expenditures to the first and second supplementary budgets,
respectively, for fiscal 2008 (April 2008 through March 2009). At
the same time, the government decided to re-launch its
emergency share purchase plan with a maximum of ¥20 trillion -
compared to the previous ceiling of ¥2 trillion - set aside for
purchasing shares held by banks. The plan was designed to
prevent financial uncertainty, alleviate the credit crunch, and
increase the amount of public funds available for injections into
banks.
12
For fiscal 2009, the Cabinet has approved a record budget
amount that calls for more than ¥88 trillion in general account
expenditures. Meanwhile, the Bank of Japan lowered the target of
the benchmark uncollateralized overnight call rate from 0.3% to
0.1%. In addition, the central bank decided to proceed with
quantitative easing measures such as increasing its outright
purchases of long-term Japanese government bonds (JGBs) and
commercial paper (CP) from financial institutions.
All these measures taken by the Japanese fiscal and monetary
authorities before the end of 2008 are emergency plans in nature,
designed to put the brakes on the steep downward slide in asset
prices and prevent the economy from receding further. As short-
term measures they are definitely needed, but they do not come
without non-negligible side effects.
In its fiscal policy, the government relies on debt to finance its
aggressive spending plans, which has led to an increase in
government bond issuance to about ¥33 trillion in both fiscal
years 2008 (after the second supplementary budget) and 2009.
The expansionary fiscal measures come with serious side effects,
namely an acutely deteriorating primary balance. Japan's primary
deficit more than doubled from ¥5.2 trillion in the initial budget
for fiscal 2008 to ¥13 trillion in fiscal 2009, with the ratio of
government debt outstanding to gross domestic product (GDP)
reaching 114%.
In its monetary policy, the central bank has begun shouldering
some of the credit risks of private-sector companies, but since
returning to an ultra-low interest rate policy it is once again left
with virtually no room to maneuver in money market operations.
Obviously, the government cannot afford to continue today's
expansionary fiscal and monetary policies forever. However, in
13
spite of the extraordinary fiscal and monetary steps implemented
or proposed to date, it is hard to expect the credit crunch will
subside and the Japanese economy will emerge from recession in
the coming fiscal year.
➢ Reversing slowing GDP and combating surging
unemployment are top priorities
The current state of the world economy, where recent declines in
energy, resource, and asset prices are occurring simultaneously
with the deepening of the recession, can be defined as the
beginning of a deflationary spiral caused by the credit crunch and
declining demand. It will be a long time before the world
economy recovers from the crash of both financial asset values
and real property prices. And it will take even longer for the
recovery of depressed demand, i.e., consumption and capital
investments. Last year the U.S. economy slipped into negative
growth and its unemployment rate has been rising sharply. For
the Japanese economy, the government is now forecasting zero
growth for fiscal 2009. Meanwhile, BRICs, which had recorded
high growth for years, have also begun making significant
downward revisions to their 2009 growth forecasts.
Unfortunately, as far as this year is concerned, the gloomy
outlook will not be too far off the mark. How soon countries can
stem sharply declining GDP growth and bring down high
unemployment are shaping up to be the biggest challenges in
2009.
Japanese fiscal and monetary authorities have little room to take
additional measures. As a result of steering into expansionary
policy, by the time the government finalized its budget bill for
fiscal 2009 it had already destined itself to running a large fiscal
deficit, which may cause profound negative effects for years to
14
come. Furthermore, even if the situation further deteriorates in
2009, it will be impossible to bring about a sustainable economic
recovery simply by continuing the expansionary policy of the past
several months. In the not-so-distant future, the time will come
for the government to leave things to the market. However,
overcoming today's unprecedented difficulties and transforming
the Japanese economy into one capable of bringing long-term
prosperity to the people are much more demanding than what
can be achieved by small government and market functions. In
this context, the government still has many cards that need to be
played.
As many people may remember, World War II is what finally put
an end to the Great Depression, which had begun in 1929. If the
depression engulfing the world economy today is worse than the
Great Depression, the way out definitely involves a drastic
transformation of social and economic structures. That is, in order
to find an exit from the worldwide depression, radical changes
must take place in the structures of demand, production, fiscal
discipline, and financial rules across the world. And such changes
must come with innovation-driven "creative destruction" of social
structure.
➢ A new social infrastructure is needed
In the formulation of further policy measures to respond to the
economic shocks stemming from the ongoing crisis, the Japanese
government needs to develop and incorporate a long-term vision
for drastically changing the nation's economic structure. Such a
vision must be constructed on the basis of innovation and new
rulemaking. If the government irresponsibly continues vast fiscal
expenditures on infrastructure construction and other
conventional public works projects for the sake of economic
15
stimulus, taxpayers will be forced to bear the costs for many
years to come. Obviously, this will not lead to economic recovery.
To the contrary, it would increase people's anxiety about growing
future tax burdens and could conceivably delay the recovery.
Fiscal expenditures of this kind cannot provide any foundation for
inducing innovation. Instead, the government needs to
(1) promote innovation by creating a social infrastructure and
systems capable of overcoming challenges posed by climate and
other environmental changes
(2) establish a financially sustainable social security system that
can reliably address health and welfare needs arising from the
nation's rapidly aging population and decreasing birthrate
(3) accumulate internationally competitive human resources by
allocating intensive capital resources to the area of human
resource development; and
(4) work to develop global market rules that ensure the proper
evaluation and management of risks related to new financial
instruments such as the subprime and nonrecourse loans that
triggered the current financial crisis.
These proposed measures are fundamentally different from the
short-term, emergency measures formulated and/or implemented
in rapid succession during 2008. The most critical pending policy
issue for overcoming the oncoming depression is the creation of a
new social infrastructure capable of sustaining economic growth
over a long period of time.
No optimism is warranted regarding the possibility that the
Japanese economy will bottom out in 2009. However, if this year
marks the beginning of structural innovation, the recovery will
definitely start earlier than it would have otherwise. The Japanese
16
economy is not big enough to lead the recovery of the global
economy, and neither does it have the capacity to bear such a
burden. Yet by spearheading innovation and structural changes in
its economy and society, Japan will be able to send out an
effective message - and thus make a great contribution - to
rebuilding the integrated world economy.
Many a Japan economic policy has been adopted by Bank of
Japan in view of effects global financial recession are having on
its economy. These Japan economic policies had been adopted in
last phase of 2008.
Tadao Noda, who is a board member with Bank of Japan, has
reiterated that an effective economic policy of Japan needs to be
hit upon pretty quickly as Japanese economy is at present in a
very bad state.
National Budget
In the postwar period, the government's fiscal policy centers on
the formulation of the national budget, which is the responsibility
of the Ministry of Finance. The ministry's Budget Bureau prepares
expenditure budgets for each fiscal year based on the requests
from government ministries and affiliated agencies. The
ministry's Tax Bureau is responsible for adjusting the tax
schedules and estimating revenues. The ministry also issues
government bonds, controls government borrowing, and
administers the Fiscal Investment and Loan Program, which is
sometimes referred to as the "second budget."
18
Three types of budgets are prepared for review by the National
Diet each year. The general account budget includes most of the
basic expenditures for current government operations. Special
account budgets, of which there are about forty, are designed for
special government programs or institutions where close
accounting of revenues and expenditures is essential: for public
enterprises, state pension funds, and public works projects
financed from special taxes. Finally, there are the budgets for the
major affiliated agencies, including public service corporations,
loan and finance institutions, and the special public banks.
Although these budgets are usually approved before the start of
each fiscal year, they are usually revised with supplemental
budgets in the fall. Local jurisdiction budgets depend heavily on
transfers from the central government.
Government fixed investments in infrastructure and loans to
public and private enterprises are about 15 % of GNP. Loans from
the Fiscal Investment and Loan Program, which are outside the
general budget and funded primarily from postal savings,
represent more than 20 % of the general account budget, but
their total effect on economic investment is not completely
accounted for in the national income statistics. Government
spending, representing about 15 % of GNP in 1991, was low
compared with that in other developed economies. Taxes
provided 84.7 % of revenues in 1993. Income taxes are
graduated and progressive. The principal structural feature of the
tax system is the tremendous elasticity of the individual income
tax. Because inheritance and property taxes are low, there is a
slowly increasing concentration of wealth in the upper tax
brackets. In 1989 the government introduced a major tax reform,
including a 3 % consumer tax. This tax has been raised to 5 % by
now.
19
After the breakdown of the economic bubble in the early 1990s
the country's monetary policy has become a major reform issue.
US economists have called for a reduction in Japan's public
spending, especially on infrastructure projects, to reduce the
budget deficit. To force a reduction of the loan program, partially
financed through postal savings, then-Prime Minister Junichiro
Koizumi aimed to push forward postal privatization. The postal
deposits, by far the largest deposits of any bank in the world,
would help strengthening the private banking sector instead.
20
Case Study 2 – Great Britain
21
go to the wall, company profits plunge, unemployment rises, and
the housing market stands stubbornly still.
Ultimately a crisis that began in the US banking sector and is
characterised by a credit squeeze has filtered through to the
broader UK economy, which contracted 1% between September
and November, the National Institute of Economic and Social
Research (NIESR) has estimated.
This fall followed after a 0.8% drop in the three months to the end
of October, said the think tank.
Indicating that the rate of output decline is "accelerating", the
NIESR now expects a fall of more than 1% in the last three
months of the year. Official data showed that the economy shrank
0.5% from July to September. But it will not be until January that
the Office for National Statistics reports on the final quarter's
GDP. If it reports a decline for the three months to December,
then the UK will be in officially in recession under the generally
accepted definition of two consecutive quarters of decline.
The NIESR says it has a good track record in forecasting GDP
growth in advance of the official figures.
Economic prospects
Fiscal squeeze
The government is also planning a sharp cut in the rate of growth
in public spending over the next few years. Public spending is
now expected to grow by just 1.2% per year, less than the growth
rate of the economy as a whole, and a sharp decrease from the
1.8% previously planned. This compares to an annual growth in
public spending of around 3% under the previous Labour
government. In addition, the government has pencilled in £5bn in
efficiency savings by 2011. This spending slowdown is part of the
23
plan to bring the public finances back into balance by 2015. But it
will not be enough on its own.
Tax rises
The government is also going to implement a very large shift in
the tax burden in years to come. Compared to tax giveaways of
£19bn this year, the government is expecting to raise taxes by
£20bn in four years' time. The largest slice of tax increases will
come from the 0.5% increase in National Insurance contributions,
which will raise £4.7bn. Taxes on the rich, including the 45%
higher rate and restrictions on personal allowances, will add £2bn
in tax revenues. And, if growth is slower than predicted, there
may have to be other tax increases in the pipeline.
24
Case Study 3 – Vietnam
Positive changes
27
According to the report, the country has realized three basic
targets of the 2008 plan, including curbing inflation and
stabilizing the macro economy, continuing to maintain economic
growth and ensure social welfare.
The Government assesses that in the first months of 2009,
despite many difficulties, the economy has seen positive
development and shows signs of recovering from the most
difficult period. “The situation has created conditions and the
ability to achieve better results in the upcoming time,” the report
said.
The positive change in the first quarter was shown in industrial
production increasing by 2.1%, and GDP increasing by 3.1%
compared to the same period last year. The first quarter also saw
the registration of 15,000 new enterprises, a year-on-year
increase of some 22%.
“The Government has strictly followed the situation, promptly
asked for advice from the Politburo, the Party Central Committee
and the National Assembly Standing Committee, in order to issue
synchronous policies and solutions to realize the 2009 targets,
and focusing on drastic measures to bring the economy out of
crisis and better people’s lives,” Deputy Prime Minister Nguyen
Sinh Hung said.
However, the Government noted that the global economic and
financial crisis was still continuing in complexity, and affecting
Vietnam’s economy. “Our difficulties remaining are large,” the
Deputy Prime Minister said. “We cannot be optimistic with results
achieved over the past several months.”
Key management
28
The Government announced five key management directions to
prevent economic slowdown, maintain growth, and ensure social
welfare. They focus on efficiently realizing stimulus and
consumption packages, preventing economic slowdown, restoring
reasonable growth; increasing production and business,
expanding the domestic market and developing the export
market; shifting the tightening financial and monetary policies to
active, cautious and flexible financial and monetary policies, in
order to stimulate the growth and prevent inflation.
The Government will also remain concerned about people’s lives,
with an increase in job creation and poverty reduction; and
followed with manageable situations that will create a consensus
among society to successfully realize the 2009 targets.
30
systems, efficiency of the public administration and high-quality
human resources.
33
imbalances are present in the US economy, indicated by the
following factors. A huge current account deficit at US $500billion
- over 5% of the GDP. So far, the current account imbalance,
which has been quite high over the last 4-5 years, has mainly
been sustained by capital inflows from Euroland to the US.
European investors had great confidence in the ability of
American companies to earn greater profits in the future by way
of increases in productivity allegedly taking place in the US
Economy. How much of this perceived productivity increase is
true of all or most of corporate America and not just IT firms is,
however, debatable; extremely high Private Sector borrowing;
gross over-valuation of the asset market and· the fact that the
American consumer, leveraging on notional wealth, is borrowing
more and more, to spend, resulting in a national dis-saving.
Consumption expenditure far outstrips disposable income. It has
been argued that domestic consumption was buoyant on the
basis of strong equity markets and although some of these have
also been corrected more recently, the risks are a currency
collapse or something going wrong in the equity market, thus
rendering the whole system vulnerable.
Of disturbing significance is the fact that each of the above
mentioned factors of imbalance has preceded other recessions of
the past. In fact, the situation today is a close replication of 1998.
Then, the Federal Reserve reduced the interest rates by 75 basis
points, thereby reviving the markets. With dot coms and software
successes waiting to happen, a huge boom took place and
consumption spending came back with a bang. 1998 was a
classic example of the 'markets driving the economy' syndrome,
which continues to be the norm.
What remains to be seen is whether the gamble will pay off this
time around. The soft landing will be brilliant for global markets
34
and for global economies. On the other hand, however, if Alan
Greenspan, Chairman, Federal Reserve, is not able to revive the
market with interest rate cuts, the current account deficit will
further increase, leading to investors shying off potentially "risky"
US assets. All of this can only result in much larger dis-equilibrium
- and subsequently, a much larger recession, therefore, than what
we are seeing today. It is, however, too early to predict the final
outcome. The current probability of soft vs a hard landing is 2:1.
One can also take heart in the fact that a global recession, which
would be the result of a hard landing of the US Economy, has not
happened in the last 50 years - not even during the 1973 oil
crisis. The most likely possibility, therefore, is a growth recession
or reduction. The after effects will be manifold with over 33% of
global growth linked either directly or indirectly to the US
economy, there is a disproportionate global dependence on the
US Economy. Turmoil in the US, in turn, therefore, causes a
substantial ripple effect on a number of global economies.
So now after having a closer look on U.S. economy we examine
we examine its effects on other parts of globe. ASIA Japan would
be the worst hit, so to say. Before the Euro, everything moved in
linear correlation to the US Dollar. If the US Dollar strengthened,
the deutsche Mark weakened, as did the yen. This time, however,
a fundamental change was witnessed - the Euro strengthened
and the Yen weakened. The Yen, which has come down by 12% in
the last 4 months, seems to be the only currency taking a beating
despite the slowdown in the US economy. The Japanese have
tried everything in the book to revive and stimulate the economy
to its previous glory but to no avail. The Nikkei, which used to be
40,000 at one time, is about 13,000-15,000 now. Further, retail
sales in Japan have been coming down for a straight 44 months.
Japanese exporters talking down their currency has not helped.
35
The biggest irony is that corporate Japan is doing well but this has
not reflected anywhere in stock market prices, which are once
again down to levels where a number of banks are facing capital
inadequacy problems. If exports to the US decline as a result of
the slowdown and Japan continues with a weak Yen policy, it will
result in some more and graver imbalances. All banks have huge
equity portfolios and anytime the market goes up a little, they
start dumping these and the market comes down. The worrisome
factor is that the banks are now all unsure about investing money
in Japan.
On the other hand, Japanese corporates have huge holdings in
the west, but prefer to leave most of their earnings in US Dollars
and the Euro. Toyota, for example, has just decided to do so with
US$ 26 billion of their earnings. The logic really is that since most
Japanese companies remit their profits to Japan in March, they
would end up remitting more Yen in the current scenario. If more
and more companies begin to do this, the Yen would weaken even
more.Other Asian economies, like Malaysia, Taiwan (where chip
manufacturing companies are already running lower at 85%
capacity), Hong Kong and Singapore would feel the ripple effect
far more than others. In other parts of the world, Canada, Mexico
and Brazil are most certainly way more vulnerable than any other
countries.
EUROLAND Sunnier days are ahead as far as the Euro is
concerned as all factors determining the Euro - interest
differentials, oil prices and relative productivities are favourable
to the currency. A 10-year Euro bond today yields about 4.65% as
compared to 5.15% by a 10-year US Treasury bond. This spread is
going to narrow down a bit further with further expected cuts.
36
The falling oil prices, lower-than-expected productivity levels of
American companies and the fact that oil producing and oil
revenue earning countries have invested in US dollar
denominated assets traditionally and will continue to do so, are
all factors that are Euro positive. According to the experts a base
will be formed around the Euro at 92-93, where it will see a brief
honeymoon. It is, however, too early to predict where it will go
thereafter. What remains clear, however, is that if the US
economy does not revive, more money will flow into Euroland or
else, the Euro will continue to gravitate around these levels.
So these are the after effects of U.S. slowdown on Asia & Europe
the other two most important parts of the world now we can shift
our attention to our own country the India. INDIA It is far too
presumptuous to think that India is going to be hugely and
adversely affected by the US economy slowdown. At 0.6%, India's
share of the global trade is too tiny for this. At the same time,
however, one must always bear in mind the far-reaching impact
of globalisation, which has, in turn, led to the interdependence of
economies, particularly where the US is concerned. 25% of India's
IT exports, for example, are to the US. The value of the Rupee,
however, as far as interest rates are concerned, would depend on
fund flow and valuation dynamics and the Reserve Bank of India's
policy towards this. In the end count, the Rupee still moves the
way the Central Bank wants it to - we are still a closed economy
to that extent. And the RBI tracks currencies other than the US
Dollar - the Euro, Yen, RMB, as also a few other competitor
currencies, whilst deciding the fate of the Rupee.
The wild cards, in this entire play of currency management is the
weakness of the Yen and the RMB. Any significant weakening in
either of these currencies could very well have a domino effect
across the entire region, including India and the Indian currency,
37
the Rupee. The RMB is closely linked to the US dollar - the latter's
fortunes really determine what the RMB will do. The dollar
weakening against the Euro and other currencies is a huge
breather as far as Chinese exports are concerned. If, however,
the dollar starts appreciating, then the Chinese will want to
kickstart their economy through a possible RMB devaluation. It is
critical to remember, therefore, that despite the over Rs 3,000
crore of investments that came into the Indian market in the first
20 days of January, 2001, (partly, some feel, because of a certain
perceived under-valuation of the Indian markets and the not so
high 'risk', and partly because interest rates have been cut in the
US), there is always a possibility of something going wrong
externally that could affect the Rupee. In the end count: A
decrease in exports as a result of the US Economy slowdown will
be certainly negative from the Indian standpoint but the decrease
in oil prices (from a peak of $35 a barrel to $20-$22) will be
positive for the Indian Rupee and the funds flow, given the US
interest rate cuts, would be positive.
However, the FDI track record will continue to be shoddy, so the
effect would be neutral. The amazing growth of frontline IT
companies at 55-60% is a thing of the past. The global slowdown
will definitely affect these companies. What inevitably needs to
change is to shift our exports focus from being US-centric to
newer markets. The Reserve Bank, however, is far more
concerned with the slowdown in growth rather than inflation,
which will be counter-balanced by the lower oil import bill. Its
focus will, therefore, be on re-igniting the 'feel-good' factor in
order to stimulate consumer spending patterns as a function of
their aggregate net worth rather than disposable income.
Measures to this effect must be set in motion at the earliest, as
38
2001 is the only year when any fundamental policy changes can
be made. 2002 will be too close to the general elections.
So now we examine why U.S. slowdown is affecting us with
reasons: Firstly the United States is India's largest trade partner,
source of foreign direct investment and external job opportunities
for the Indian middle class. Any slowing of the US economy is
likely to hurt India more today than at any time in the past. The
fact is that the US is not only India's largest trade partner, but
that India has the highest trade surplus with the US and any
slowdown in Indian exports to the US is likely to have a larger
impact on the trade deficit than a slowdown in trade with
European Union or developing Asia. India's trade with the EU and
non-Opec developing Asia, our other two major trade partners, is
more or less balanced with exports to these markets equal to
imports from them. Our huge trade deficit with Opec countries is
largely balanced by the trade surplus we enjoy with the United
States. Recently published data shows that India's trade surplus
with the US has actually increased since India's exports to the US
have continued to grow, while its imports from the US have
declined. Indian exports to the US have been mainly in the area
of consumer durables and these have grown, with the recent
growth of the US economy. Thus, while in the first quarter of
2000-01, Indian exports to the US went up by 26 per cent,
imports from it were down by 18 per cent. This trade data does
not include software exports. The software segment is another
main area of concern. The US has emerged as the biggest market
for Indian software exports. A slowdown of the US economy will
hurt the "new economy" in India since it is still largely export-
dependent and has not yet found a domestic market large
enough to offset any loss in the external market. But analysts and
software CEOs argue that in a slowing economy, jobs are cut and
39
companies invest in automation, so that the demand for software
services and for IT products is likely to increase as the economy
slows down.
Also, many US firms may offload work to lower-cost countries like
India, especially in the area of data-processing and office
management work, and that this is likely to increase the demand
for new economy services in India rather than hurt them. On the
negative side is the concern that firms tend to put on hold
expansion plans and investment in new projects when there is a
fear of a generalised slow down. This is likely to hurt demand for
Indian IT services and products. The final outcome may be a
combination of both factors. But one must realise that most of
the companies who service the lower rung areas of maintenance
etc., will not really stand to loose. They may face a squeeze on
their margins but the business will continue.
Another area which will be impacted, will be the capital markets.
Today the world markets dance to NASDAQ’s tune. Dr Huang, who
has spend 20 years in US and Taiwan, China, to develop and
implement a method to track accurately daily financial markets,
said at an investment forum early last year that NASDAQ was
overheated, would face a correction upto 2800-3000 and the
Dow, he stated, would be back to 9600. and global markets would
follow US for 20 % correction. His logic was that there is never a
bull market before economic softlanding. The bulls must take 20
% or more correction and consolidation reflecting economic
slowdown impact on consumer demand and corporate earning
decline. Bull markets, according to him, exist under expanding
monetary policy. Expectations of higher profits resulted in an
unbelievable rally in the equity markets over the last five years.
NASDAQ, the technology stock heavy index, rallied from the start
of 1995 and increased by a whooping 5.8 times till March last
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year. Capital market rally resulted in the `wealth effect', which
further fueled the economy. Americans saw their investments in
equity markets growing dramatically in value.
However with this wealth effect wearing off and the risk
consciousness rising, we will see a lower deployment of funds to
the world equity markets, which are also in a slump at the
moment. For the Indian markets, the impact is two fold - firstly,
lower funds coming into the market through the FII route and
secondly, companies who had planned NASDAQ listings etc. have
had to put their plans on hold and this will delay their funds
inflow as well as growth plans. So, we in India, will definitely need
to be prepared for some fall out on the slowdown in the US
economy and fine tune our corporate and export strategies as the
picture develops. So here comes the real picture lets now move
our focus to reports published by IMF about this situation last
year when the International Monetary Fund issued its half-yearly
report, the world, in the words of one its leading officials,
appeared to be a much “safer place.” Growth was continuing in
the United States, the European economy was expanding, East
Asia was recovering from the crisis of 1997-98 and there were
even signs that a Japanese “recovery” might finally get under
way.
The picture presented in the latest World Economic Outlook
released is very different. Apart from cutting the world growth
forecast by 1 percentage point, the main feature of the report is
the uncertainty over the future course of the global economy and
the warnings that, notwithstanding the hopes that the situation
could quickly turn around, it could also worsen quite rapidly. In his
press conference releasing the report, IMF director of research
Michael Mussa pointed out that last September in Prague world
growth for 2001 was predicted to be 4.2 percent. This has been
41
revised down to 3.2 percent. It is clear, he said, that “global
growth is slowing more than was anticipated, or is desirable.”
“For the United States, which has been the mainstay of global
expansion in the past decade, growth this year is forecast to be
only 1.5 percent, down from almost 5 percent last year and from
an earlier forecast of over 3 percent for this year.” The projection
for the year 2002 has been reduced to 2.5 percent, at least one
percentage point below the estimated potential growth rate for
the US economy. In the euro-zone, the IMF estimates the growth
rate will be 2.4 percent, a full percentage below what it forecast
last September. Mussa said the situation in Japan was “even more
worrying” with growth for this year forecast to be barely over 0.5
percent and growth for next year expected to reach only 1.5
percent. Asia will be hit by the slowdown in North America and
Japan and by the global downturn in telecommunications and
high technology with estimates for growth coming in at between
1 and 3 percentage points less than six months ago. Mussa,
however, did not confine his remarks to the details of the report
but delivered a stinging rebuke to the European Central Bank and
its refusal to cut interest rates, following rate cuts in the US and
Japan. After noting that the euro area was not contributing
sufficiently to world economic demand, Mussa continued: “In a
period when general economic slowdown is the main problem
and when inflation is not likely to be a continuing threat, the euro
area, the second largest economic area in the world, needs to
become part of the solution rather than part of the problem of
slowing down world growth.”
Mussa took the opportunity to deliver another broadside when
taking questions from journalists on the briefing. Asked to
comment on whether calls on the ECB to cut interest rates by the
managing director of the IMF and the US treasury secretary could
42
be regarded as “interference” Mussa replied: “Here in the IMF we
don't call that interference. We call it surveillance. And it is
mandated by the Articles of Agreement.” Global recession In
delivering its pronouncements, and particularly in setting out
policy prescriptions for countries that are considered not to have
measured up, the IMF strives to create the impression that it is
fully in command of the situation, with a deep understanding of
the processes taking place in the global economy. But it seems
the impression is starting to wear a little thin—even among
financial journalists who can usually be relied upon to echo its
analysis without asking too many questions. As one journalist
pointedly commented: “Mr Mussa, it seems that yourself and Wall
Street and every economist has been caught by surprise by this
slowdown. In the last WEO you said the prospects were the best
in a decade. Now you say we'll avoid recession. Given the
situation is so fluid, how can you be so certain that we won't
actually dip into a US recession and possibly a global recession?”
Mussa replied that there was “no certainty in this business” and
offered the reassurance that policy in most countries, which had
policy flexibility, had been adjusted “promptly and reasonably
aggressively to the threat that things might be even somewhat
worse than we have allowed for in the baseline.” The WEO report
itself claims there is a “reasonable prospect that the slowdown
will be short-lived” but warns that “the outlook remains subject to
considerable uncertainty and a deeper and more prolonged
downturn is clearly possible.”
So far, it notes, the effects of the global slowdown have been
most visible in countries which have close trade ties with the US,
including Canada, Mexico, and East Asia. The outlook for the rest
of the year “will depend on how deep and prolonged the
slowdown in the United States proves to be”—an issue which
43
“remains subject to considerable uncertainty.” The WEO says its
baseline scenario is that the US economy will pick up in the
second half of the year, growth will remain strong in Europe,
while recovery in the Japanese economy will resume in 2002. But
it adds that while this scenario is “plausible” it is far from
“assured” and the “risks of a less favourable outcome are clearly
significant.” One of those risks, it states, is that the “virtuous
‘new economy' circle of rising productivity, rising stock prices,
increased access to funding, and rising technology investment
that contributed to the strong growth in the 1990s could go into
reverse.” Even this is a somewhat optimistic assessment, given
that most observers of the US economy have concluded that,
whatever the immediate outcome of the present downturn,
overcapacity in all sections of industry—and above all in high-
tech investment—means that there is no prospect of the boom of
the latter 1990s returning. The report notes that if the slowdown
does prove to be deeper and more prolonged than anticipated
“this would pose several interlinked risks for the global outlook
that would significantly increase the chance of a more
synchronised and self-reinforcing downturn developing.”
Among those risks is the possibility that what the report calls
“apparent misalignments among the major currencies” could
“unwind in a disorderly fashion.” It points out that current
account deficits of the size presently experienced by the US—
more than $430 billion, equivalent to around 4.5 percent of gross
domestic product—have not been sustained for long and that
“adjustment is generally accompanied by a significant
depreciation [of the currency].” If there were increased economic
growth in Europe and Japan, then it would be possible to reduce
the US imbalances in a “relatively manageable and nondisruptive
fashion.” “However, in an environment where US growth slows
44
sharply, the portfolio and investment flows that have been
directly financing the US current account deficit could adjust
more abruptly.” In other words, there could be a rapid movement
of capital out of the US and a sharp fall in the value of the dollar.
“This would heighten the risk of a more rapid and disorderly
adjustment, possibly accompanied by financial market turbulence
in both mature and emerging markets. Large swings in exchange
rates could also limit the room for policy manoeuvre.” That is to
say, according to the IMF's latest forecasts, there could arise a
situation in which the US dollar starts to fall and financial markets
are hit by a crisis, under conditions of a deepening slump. The
fact that such a possibility is even being canvassed is a measure
of how far and how fast the world economic situation has moved
in the past six months. So here IMF also clearly specifies the
picture of global slowdown. Lets move to the perception of IMF
about Indian economy.
The US consumer price index inflation is expected to fall to a rate
of 2.4 per cent by end-2001. Both producer and consumer prices
continue to decline in Japan, where consumer prices have fallen
at a rate of 0.6 per cent (annual rate) and a similar decline is
expected for the year as a whole. The decline in asset prices, in
particular, the real estate prices, has generated new gaps in the
adequacy of collateral for bank debts. The decline in growth of
the global economy has been caused by a combination of global
and country-specific factors. One universal cause has been the
persistent rise in the energy prices during 1999-2000. Another
key factor to the reduction in growth has been the sharp and
sudden downturn in hi-tech investment in the second half of
2000. This weakened growth, notably in the US and Europe, while
brutally reducing the export performance of many Asian
countries. This pervasive setback has contributed to the
45
weakness of manufacturing sector in virtually every industrial
country and driven many Asian economies, including Singapore,
into recession. Particular mention must be made of the rise and
fall of demand for hi-tech equipment. In the US, the output of hi-
tech equipment accelerated at an annual growth rate to 70 per
cent in early 2000, before collapsing. The crisis worsened
because not only was demand falling but the unit price
equipment in the hi- tech sector also collapsed. US investment
spending was sharply reduced, particularly on hi-tech equipment.
The unexpected decline in the demand for hi-tech investment
goods undermined stock prices, reversing the earlier surge in the
value of new economy stocks. One other factor responsible for
straining the earlier growth and subsequent slowdown in the US
has been the tightening of monetary policy. While the tightened
monetary policy did help control inflation, it also contributed to
subsequent economic slowdown.
Both US and Japanese policy-makers have made it clear that they
are prepared to accept a weak yen if that is the result of market
reactions. The devaluation of the yen will not be without impact
on other currencies. It is quite possible that China may react with
the devaluation of yuan, which may well force the various Asia-
specific countries to follow suit. This will have serious
repercussions on the world economy. Incidentally, the fact that oil
prices will remain high indicates further fiscal tightening for the
Government. The oil pool deficit will grow higher. Unpleasant
decisions, which will have serious political repercussions, cannot
be delayed. The sooner they are taken, however, the better it will
be for fiscal health. The Finance Minister and the Prime Minister
have yet another difficult challenge to meet. The decline in the
world's major economies has its repercussions, unpleasant ones,
on India's economy, in particular on its export prospects. The
46
Government has to take note of this trend and be ready to handle
the adverse consequences of a continuing global economic
slowdown. It cannot be `business as usual'.
47
➢ IT and Real Estate Sector
• The key challenges faced by the industry now are inflation
and the psychological impact of the US crisis, leading the
companies to hit the panic button.
• Bonuses, perks, lavish parties, and many other benefits
are missing as companies look to cut cost.
• India's IT export growth is also slowing down
• One of the casualties this time are real estate, where
building projects are half-done all over the country and in
this tight liquidity situation developers find it difficult to
raise finances.
➢ Layoffs and Unemployment
• Hundreds of workers have lost jobs in diamond jewellery,
textiles and leather industry.
• Companies in IT industry have stopped hiring and
projected lower manpower need.
• Firms attached to the capital market are laying off people
and large companies are putting their future expansion
plans on hold.
➢ Industrial sector
• Government and other private companies are reluctant in
starting new ventures and starting new projects.
• Projects that are halfway to completion, or companies
that are stuck with cash flow issues on businesses that
are yet to reach break even, will run out of cash.
• Car, bike & truck sales down
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• Steel plants are cutting production
• Hospitality and airlines are hit by poor demand
49
• In real estate the builders should drop prices, so as to bring
buyers back into the market.
• Also, the government should try and improve liquidity, while
CRR and SLR must be cut further
• Indian Companies have to adopt a multi-pronged strategy,
which includes diversification of the export markets,
improving internal efficiencies to maintain cost
competitiveness in a tight export market situation
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A Ray Of Hope
Experts see a ray of hope in the fiscal stimulus I package of Rs
10,000 crore which is expected to boost demand for the capital
goods sector and the infrastructure industries which primarily
include power, cement, coal, crude oil and petroleum.
India’s growth is based essentially on investing its own savings,
and so is relatively insulated from global finance and fashions.
India’s savings rate has shot up from 23.5% in 2001-02 to 37.4%
today, a phenomenal achievement.
High savings constitute a structural change that is here to stay.
This will suffice to finance an investment rate of at least 36% of
GDP. So, given that output in India rises at roughly a quarter the
rate of investment, a realistic GDP growth of 9% should be
sustainable.
If the world economy recovers in the next six months, a 7%
growth looks feasible. This will mean little deceleration from the
current year and hence, little additional pain. This scenario
depends on a resumption of global growth early in the next fiscal
year.
Assocham President, S. Jindal hopes that money will flow into the
system to support the projects that have been put on hold.
The Prime Minster who holds the Finance portfolio also, is
confident that the country will be able to maintain the growth
rate around 8 percent in the current fiscal. The most pessimistic
estimates put it at 7 percent.
It is important now is that the industry and other sectors of
economy respond to government initiatives in full measure and
pass on the benefit of price cuts to the consumers. They need to
realize that in the current global crisis when international demand
51
is shrinking, it is only the domestic demand that can keep the
business going.
Fortunately, India with its 1.1 billion population has a huge
potential of keeping demand afloat. All they need is the
purchasing power which the Government is trying to do by
pumping in funds into the system.
A silver lining has been the consistently falling inflation rate
which has now come down to around 6 percent. With the fall in
petrol and diesel prices, the general price line is bound to fall
further as petrol prices constitute an important ingredient of
transport costs. We may thus witness a more comfortable
inflation rate much too soon.
Industry sector has welcomed the measures though it expects
more to defuse the situation. FICCI described the measures as “a
good start in the right direction”.
While a number of banks have already announced lower lending
and deposit rates with effect from January 1, 2009, a further
softening in interest rates seem to be in the offing.
FICCI secretary general Amit Mitra said: “The steps should
hopefully give big boost to the slowing economy,” adding that he
expected “business confidence would be restored”.
The bond market quickly reacted to the rate cuts. The yield on
the bond dropped to 5.07%, from the previous close of 5.29%.
Industry is hoping that its lending costs, too, will drop.
Interest rates are expected to come down further with a lag as
banks will first align their deposit rates.
52
The funding of the purchase of buses under JNNURM would help
increase capacity utilization. This is crucial at a time when plant
shutdowns and temp layoffs are becoming routine.
The business environment of the future will be intensely
competitive. Countries will want their own interests to be
safeguarded. As tariffs tumble, non-tariff barriers will be
adopted. New consumer demands and expectations coupled with
new techniques in the market will add a new dimension. E-
commerce will unleash new possibilities. This will demand a new
mindset to eliminate wastes, delays, and avoidable transaction
costs. Effective entrepreneur-friendly institutional support will
need to be extended by the Government, business and umbrella
organisations.
Experts, who earlier predicted easing of trade credit by December
2008, are now hoping that it would be achieved by June 2009.
The world economy continued to contract at a near-record pace in
December 2008, but the rate of contraction has slowed.
There was a marked improvement in the services sector, with the
Global Services Purchasing Managers Index (PMI) at 40 in
December, well above the 36.1 level it plummeted to in
November 2008.
India does not have a PMI for the services sector yet, but looking
at the global pattern, it’s very likely that in India too the rate of
contraction of services will be less than that of the manufacturing
sector. And since services account for 60% of India’s economy,
any resilience there will provide a big cushion for the downturn.
53
Conclusion
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Bibliography
Books
• Dornbusch and Fisher – Macro Economics
Web Links
• http://crisistalk.worldbank.org/2009
• http://economictimes.indiatimes.com/archive.cmswww.scrib
d.com
• www.wikipedia.com
• www.livemint.com
• http://economictimes.indiatimes.com/articleshow/3928470.c
ms
• http://economictimes.indiatimes.com/News/Economy/Policy/
Stimulus-
II_India_Inc_gets_more_room_to_grow/articleshow/3929013.c
ms
• http://economictimes.indiatimes.com/articleshow/3929007.c
ms
• http://economictimes.indiatimes.com/articleshow/3929043.c
ms
• http://www.rediff.com/money/2008/dec/07bcrisis-govt-
announces-package-to-boost-economy.htm
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