ECONOMIC ENIRONMENT FOR BUSINESS REPORT
TO COME OUT OF THIS SLOWDOWN, EMERGING ECONOMIES SHOULD CONSUME
MORE AND SAVE LESS AND VICE-VERSA WITH DEVELOPED
COUNTRIES.Submitted on: 13th June, 09 Prepared By:Aditya Agarwal
Kashif Ziad Kiranpal Singh Mayank Sharma Priyanka Nagpal Saumya
Sinha Section F7
ContentsIntroduction....................................................................................3
The 1980s 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
IntroductionPeople 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 1980s and 199091 recessions. Lets observe the policy mix taken
by the economies like US and Europeans at such situation.
The 1980s Recession and RecoveryEconomic policies in the united
states in the early 1980s, departed radically from the policies of
the previous two decades. First, tight monetary policy was
implemented at the end of 1979 to fight an inflation rate and then,
in 1981, an expansionary fiscal policy was put in place of tax cuts
and increased defense spending. In 1973, the US and rest of the
world were hit by first oil shock, in which the oil exporting
countries more than doubled the price of3
oil. This led to rising inflation which was extremely unpopular.
In October 1979, the Fed acted, turning monetary policy in a highly
restrictive direction. The monetary squeeze was tightening in the
first half of 1980, at which point the economy went into a mini
recession. The reason for the sharp decline on the activity was
tight money because inflation was still above 10% and money stock
was growing at only 5.1% in 1981, the real money supply was
falling. With a policy mix of easy fiscal and tight monetary
policies, it was found out a rise in interest rate was expected.
With investment subsidies increased, investment increased with
interest rates. This the fiscal expansion of 1984 and 1985 pushed
the recovery of the economy forward.
The Recession of 1990 91The policy mix in early 1980s featured
highly expansionary fiscal policy and tight money. The tight money
succeeded in reducing the inflation of late 1970s and very early
1980s, at the expense of serious recession. Expansionary fiscal
policies then drove a recovery during which the real interest rates
increased sharply. By middle of 1990 it was clear that the economy
was heading for the recession. The price of oil jumped and for a
time the Fed was faced with the quandary of deciding whether to
keep monetary policy tight while holding interest rates up, in
order to fight inflation, or pursue an expansionary policy in order
to fight the recession. The fiscal policy was immobilized because
the budget deficit was already large and was expected to rise and
thus no one was enthusiastic about increasing it. From end of 1990,
Fed began to cut interest rates aggressively and the economy showed
signs of recovery in second quarter of 1991 but faltered in fourth
quarter.4
Thus, Fed cut the interest rate very sharply at the end of 1991.
In retrospect, this was sufficient to ward off a recession.
The Recession of 2008 onwardsThe Credit Crisis began in August
2007, when interbank lending markets in the US, UK and Europe began
to seize up. These markets had rarely received much public
attention, and it was not immediately obvious why this should have
happened. But loans on interbank markets, from overnight to several
months, were not just important in keeping the flow of credit
circulating amongst banks, and hence amongst almost all economic
agents in a market system, they were made without collateral being
necessary, and were increasingly important to the banking model
developing across market economies. That model relied to an
increasing extent on wholesale markets for supplies of capital,
rather than on the deposits of individuals or companies. At the
same time the degree of leveraging on capital was also increasing.
So with larger supplies of credit and greater leveraging higher
profits were possible. As were higher risks, as banks sought out
increasing rates of return to satisfy their shareholders and those
of their employees whose wages and bonuses were linked to levels of
business or profits. But the increasing levels of risk seemed
manageable by the device of securitisation, which appeared to allow
the securitising bank to simultaneously sell on the risk and
replenish its capital. When a rapidly deflating housing market
bubble in the USA exposed weaknesses in this banking model, and
similar bubbles in Ireland, the UK, Australia and Spain also began
deflating, doubts about the location and value of securitised
assets led eventually to an evaporation of trust between first
banks, and then other financial and non-financial companies.5
By the autumn of 2008 the lack of trust in the financial sector
was sufficiently great to almost completely seize up credit flows
and threaten the stability of the world financial system. The
financial system was in effect broken, and by October 2008 a
coordinated action by large numbers of central banks and countries
was needed to stabilise it. This involved giving widespread
promises of state protection to depositors, large injections of
capital to banks, vast liquidity supplies to gummedup financial
market and increasing guarantees for all sorts of short term bond
issues. Most recently the Crisis moved into the realm of sovereign
default, as countries such Hungary and Ukraine struggle to
refinance foreign currency loans, bringing in international
agencies such as the IMF and the World Bank to provide assistance.
At the same time the Credit Crisis has spawned an international
economic downturn, and in some cases recession, the depth and
severity of which cannot at the moment be estimated. All of these
responses have public finance consequences tax revenues and
expenditures and risk and uncertainty consequences that are still
growing and evolving.
Theoretical InsightTheoretical 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
indicators6
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. But7
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 History About Japanese RecessionIn the
decades following World War II, Japan implemented stringent tariffs
and policies to encourage people to save their income. With more
money in banks, loans and credit became easier to obtain, and with
Japan running large trade surpluses, the yen appreciated against
foreign currencies. This allowed local companies to invest in
capital resources much more easily than their competitors overseas,
which reduced the price of Japanesemade goods and widened the trade
surplus further. And, with the yen appreciating, financial assets
became very lucrative. With so much money readily available for
investment, speculation was inevitable, particularly in the Tokyo
Stock Exchange and the real estate market. The Nikkei stock index
hit its all-time high on December 29, 1989 when it reached an
intra-day high of 38,957.44 before closing at 38,915.87.
Additionally, banks granted increasingly risky loans. With the
economy driven by its high rates of reinvestment, this crash hit
particularly hard. Investments were increasingly directed out of
the country, and manufacturing firms lost some degree of their
technological edge. As Japanese products became less competitive
overseas, the low consumption rate began to bear on the economy,
causing a deflationary spiral. The Japanese Central Bank set
interest rates at approximately zero. When that failed to stop
deflation some economists, such as Paul Krugman, and some Japanese
politicians, advocated inflation targeting.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.
Economic Policy & Fiscal Policy Global financial markets
remain fraught with instability The U.S. financial crisis, which
was initially triggered in 2007 by defaults among subprime mortgage
borrowers and the resulting accumulation of bad loans, continued
deteriorating to the point where it had caused an acute credit
crunch following the failure of Lehman Brothers in 2008. With a
number of financial institutions across the world exposed to
derivatives based on such soured assets, the U.S.-initiated
financial crisis quickly spread to other countries. While Japanese
financial institutions are not immune to the crisis, their European
counterparts have felt a much greater impact. The extreme tension
in the financial markets has caused a global credit crunch, a
flight to quality10
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.11
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 00.25%. 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 shortterm 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, in13
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 to14
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 economic15
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
Japanese16
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. In January 2009
exports went down at a rate of 45.7 percent compared to January
2008. This resulted in an unprecedented amount of trade deficit.
Output of factories in Japan has also gone down in January 2009 by
a record 10 percent. Rate of unemployment in Japan reached a record
figure in terms of last four years. This surely calls for an
unfailing economic policy in Japan so that present weaknesses can
be weeded out. In final quarter of 2008 gross domestic product of
Japan went down at a rate of 12.7 percent for that particular
fiscal. An economic policy at Japan is presently a need of hour if
domestic demand in Japan is to be revived. Economists have opined
that consumer demand in domestic markets would be on wane as a
result of economic uncertainty. Exports of Japan, which are among
its major sources of revenue,17
would be on a downward curve as well since economies of other
countries would be recovering from aftereffects of global financial
recession. As per economists, makers of Japan economic policies
need to look at after effects of imposing constraints on financing
opportunities. As part of their Japan economic policy major
opposition parties in Japan are trying to introduce financial
stimulus packages that so that effects of recession could be
allayed to a certain extent. Democrats, major opposition party in
Japan, have announced that they would be providing an economic
stimulus of $587.3 billion. This amount would be spent for a period
of four years and would be looking to spruce up Japans economy. At
present every Japan economic policy is geared towards addressing
imbalances across various sectors of Japanese economy.
National BudgetIn 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 BritainThe first official confirmation that
the UK is in recession came on Friday after figures from the Office
for National Statistics showed gross domestic product fell 1.5pc in
the final quarter of 2008. That followed a 0.6pc contraction in the
third quarter and two quarters of contraction means we're are
technically in recession is here. The number was significantly
worse than the 1.2pc expected by economists, and is the biggest
three-month GDP fall since the second quarter of 1980 when it
shrank by 1.8pc. That means U.K. is already in a recession deeper
than that of the early 1990s, when the most the economy shrank in a
single quarter was 1.2pc. How long this recession stays, and
whether it overtakes the 1980s in terms of depth, is less certain.
The news that they are a nation in recession will come as no
surprise, but it will do nothing to quash the uncertainty that is
feeding economic decline. Commenting on the figures, Stephen
Gifford, Grant Thornton's chief economist, said: "The sheer fall in
GDP is staggering. Financial meltdown has probably been averted but
the economy has now entered a recession which is sure to be as bad
as the early 80s." There are mixed views on how severe the
recession will be, and the goal-posts seem to be shifting on a
weekly basis as retailers21
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 prospectsDespite his revised forecast, Mr Darling has
taken a more optimistic view of the UK economy than many
independent forecasts. He is expecting the UK economy to recover to
a growth rate of 1.5% to 2% by 2010, and to return to its normal
growth rate of 2.75% in subsequent years. "Because of the
wide-ranging22
measures I am announcing today, and the many strengths of the
British economy, I am confident that the slowdown will be shallower
and shorter than would have been the case," Mr Darling said. But
other forecasts suggest that the economic recovery will not begin
until well into 2010, and that the economy could shrink by as much
as 2% next year. If the world economic recovery is indeed delayed,
then even the grim budget forecasts made by the chancellor could be
too optimistic. Some economists argue that if Mr Darling's stimulus
is not enough to turn around the economy, he will need a further
stimulus package in the Budget. "The economy still faces powerful
contractionary forces in the shape of widespread recession abroad,
and at home falling house prices and stock markets, blunted
monetary policy as banks constrain lending and rock-bottom business
and consumer confidence," says Andrew Smith, chief economist at
KPMG. "If this package fails to kick-start the economy, further
expansionary measures can be expected in next year's budget
proper."
Fiscal squeezeThe 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
the23
plan to bring the public finances back into balance by 2015. But
it will not be enough on its own.
Tax risesThe 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 Overview of Vietnams Economy Vietnams
economy has been bogged down in difficulties since early this year
Many economic sectors are slowing down Causing production stagnancy
Economic growth has slowed from 8.8% last year to 6.5% in the third
quarter of this year The markets consumption power has declined
since the start of the year. According to Nielson Global Online
Consumer Survey, a global ealding company, showing that Vietnams
confidence declined nine points to 97 points during last four
months. In 2009, the gov expects the growth to be from 6.0 to 6.5%
Due to ramping inflation The main causes were rigid monetary
policies and public investment ineffectiveness
Status of Vietnams Economy
Vietnam's economy grew by 8.5% last year, but the target for
this year and next has been scaled back to about 6.5% as the
economy has been battered by a widening trade deficit and
double-digit inflation.
According to IMF, Vietnam's economic growth will drop to five
per cent next year while the government grapples with25
a large current-account deficit and weak banking and corporate
sectors. Vietnam has announced a stimulus plan worth more than $1
billion to avoid recession as the global economic crisis bites into
its export-led economy Prime Minister Nguyen Tan Dung approved a
number of measures to boost production, investment and consumer
spending at a monthly cabinet meeting Tuesday Dung said the
stimulus would fund public works projects, including a large
irrigation canal in the northern Red River delta, and help finance
rice storage depots for about one million tons of grain in major
farming areas.
A package of measures applied to combat the economic slowdown
and cushion the impact of the global financial crisis Measures
outlined by PM at a gov meeting last week included: Revving up
stagnant domestic production and exports Fuelling weakening
consumption power, Applying flexible monetary and financial
policies Ensuring social security, Care for the poor and speeding
up administrative reforms
Actions Taken by MoF & Central Bank Draw up proposals on tax
cuts,26
Tax exemption Delay of tax levies for enterprises Further rate
cuts and assistance Funds
Corporate Income tax cut Bringing the corporate income tax dwon
from 18 to 25% Cutting corporate income tax by 30% for small &
medium sized enterprises Postponing the implementation of the
personal income Tax Law to July 2009 Reducing the basic interest
rate from 11 to 10% . The Governments report, presented by Standing
Deputy Prime Minister Nguyen Sinh Hung at the opening day of the
fifth session of the 12th National Assembly which began on May 20,
2009 outlined main developments of the economy in the first months,
and worked out key solutions to preventing an economic slowdown,
setting it a leading target in the upcoming time. The report, under
the theme Actively preventing economic slowdown, stabilizing the
macro economy, maintaining reasonable and sustainable economic
growth, ensuring social welfare, provides vivid figures which are
evidence of the efficiency of the policies issued by the Party and
State, and the efforts of all levels, sectors, enterprises and the
whole people.
Positive changes27
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 peoples 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 Vietnams economy. Our difficulties
remaining are large, the Deputy Prime Minister said. We cannot be
optimistic with results achieved over the past several months.
Key management28
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 peoples 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.
Some main targets adjustedTo implement well key tasks, the
Government asked the NA to prioritize the four main issues.
Firstly, the NA was suggested to decide that the urgent and key
task for the 2009 socio-economic development plan was to mobilize
all efforts to prevent an economic slowdown, maintain the
sustainable and reasonable economic growth, keep the stability of
the macro economy, prevent inflation, ensure social welfare,
national defence and security, maintain political stability and
social order, in which, preventing an economic slowdown should be
considered the leading prioritized task. Secondly, the Government
suggested that the NA should adjust GDP growth target for 2009 from
6.5% to 5%. Thirdly, it proposed the issuing of an additional VND
20 trillion in Governmental bonds, the amendment of some tax
policies, under29
the jurisdiction of the NA, and some other policies regarding
construction investment and bidding. Fourthly, based on targets and
basic policies, the Government suggested the NA entrust the NA
Standing Committee and the Government in actively and flexibly
operating the policies and solutions.
Future Landscape of Vietnams EconomyOfficials from international
agencies including the World Bank, EuroCham, AmCham, AusChamall
agreed that Vietnam is facing the toughest-ever challenges and
worsening business outlook. Vietnam has faced the toughest-ever
challenges such as high inflation, hefty trade deficit,
fluctuations in forex rates and the slumping stock market, Martin
Rama, the World Banks Country Director in Vietnam told the Vietnam
Business Forum held Dec 1 on threshold of the Consultative Groups
of Donors Meeting. Speaking about the global gloomy outlook, Thomas
ODore, chairman of the American Chamber of Commerce (AmCham) said
Vietnams economy will be facing with similar problems as exports,
which account for more than half of its GDP value, are declining
due to shrinking purchasing power in the U.S., EU and Japan.
Vietnam should boost productivity and cut production costs, and the
government of Vietnam should create favorable conditions for
exporters to borrow loans with appropriate interest rates, Alain
Cany, chairman of EuroCham proposed. Officials at the VBF proposed
the government of Vietnam further boost reforms in infrastructure
developments, intellectual property rights, courts30
systems, efficiency of the public administration and
high-quality human resources.
Case Study 4 United States of AmericaThe United States housing
market correction (a possible consequence of United States housing
bubbles) and subprime mortgage crisis has significantly contributed
to a recession. Apart from that US faced major crisis because
of
Rising oil prices at $100 a barrel31
Global Inflation
High unemployment rates A declining dollar value
All this slowed down the growth of the economy and as the GDP
growth rate fell to 2%, recession set in. The 2008/2009 recession
is seeing private consumption fall for the first time in nearly 20
years. This indicates the depth and severity of the current
recession. With consumer confidence so low, recovery will take a
long time. Consumers in the U.S. have been hard hit by the current
recession, with the value of their houses dropping and their
pension savings decimated on the stock market. Not only have
consumers watched their wealth being eroded they are now fearing
for their jobs as unemployment rises. U.S. employers shed 63,000
jobs in February 2008, the most in five years. Former Federal
Reserve chairman Alan Greenspan said on April 6, 2008 that "There
is more than a 50 percent chance the United States could go into
recession." On October 1, the Bureau of Economic Analysis reported
that an additional 156,000 jobs had been lost in September. On
April 29, 2008, nine US states were declared by Moody's to be in a
recession. In November 2008 Employers eliminated 533,000 jobs, the
largest single month loss in 34 years. For 2008, an estimated 2.6
million U.S. jobs were eliminated. The unemployment rate of US grew
to 8.5 percent in March 2009, and there have been 5.1 million job
losses till March 2009 since the recession began in December 2007.
That is about five million more people unemployed compared to just
a year ago. This has become largest annual jump in the number of
unemployed persons since the 1940s. Although the US Economy grew in
the first quarter by 1%, by June 2008 some analysts stated that due
to a protracted credit crisis and "rampant inflation in commodities
such as oil, food and steel", the country was nonetheless in a
recession. The third32
quarter of 2008 brought on a GDP retraction of 0.5% the biggest
decline since 2001. The 6.4% decline in spending during Q3 on
non-durable goods, like clothing and food, was the largest since
1950. A Nov 17, 2008 report from the Federal Reserve Bank of
Philadelphia based on the survey of 51 forecasters, suggested that
the recession started in April 2008 and will last 14 months. They
project real GDP declining at an annual rate of 2.9% in the fourth
quarter and 1.1% in the first quarter of 2009. These forecasts
represent significant downward revisions from the forecasts of
three months ago. A December 1, 2008, report from the National
Bureau of Economic Research stated that the U.S. has been in a
recession since December 2007 (when economic activity peaked),
based on a number of measures including job losses, declines in
personal income, and declines in real GDP. Recent economy slowdown
as we all know started in U.S. last year in October & initially
it was concentrated on U.S. economy only but as expected & as
experts forecasted that it is going to affect whole world & it
did. So now let`s examine some facts & figure related. The US
Economy has seen an unprecedented growth over the last decade,
which accelerated to over 4% per year over the last four years. The
year 2000 saw this growth at an all-time high of 5.1% a figure that
is staggering in enormity when one considers that a 1% growth in
the US economy is comparable to an 8% growth in the Chinese
Economy. Further, 33% of the global growth is linked either
directly or indirectly to the US economy. With this in mind, it was
a common belief that the American honeymoon would never end. It was
the Industrial Revolution all over again - with increasing
productivity levels, happy days were here to stay. This growth
however, had - and continues to have - a flip side - serious33
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
markets34
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, as38
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 exportdependent
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 and39
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 NASDAQs 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 last40
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
been41
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 could42
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 thineven 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 bean issue which43
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 industryand above
all in hightech investmentmeans 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 producthave 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 slows44
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 the45
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 hitech
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
Asiaspecific 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. The46
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'.
Case Study 5 India Impact on India of SlowdownA slowdown in the
US economy is bad news for India because: Indian companies have
major outsourcing deals from the US India's exports to the US have
also grown substantially over the years.
Indian companies with big tickets deals in the US are seeing
their profit margins shrinking.
Anatomy of the economic depression in India Share Market
More people have sold the shares in the Indian share market than
they bought in the recent weeks. This has added to the fall of
sensex to lower points.
Foreign investors have pulled out from stock markets leading to
heavy losses in stocks and mutual funds Stock broking houses are
laying-off people Because of such uncertainty many people have
started saving money in banks rather than investing47
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
down48
Steel plants are cutting production Hospitality and airlines are
hit by poor demand
On this issue Mr. Manmohan Singh suggested A coordinated fiscal
stimulus by countries that are in a position to do so would help to
mitigate the severity and duration of the recession It would also
send a strong signal to investors around the world. Resort to
fiscal stimulus may be viewed as risky in some situations, but if
we are indeed on the brink of the worst downturn since the Great
Depression (of the 1930s), the risk may be worth taking.
Corrective Steps to Check Recession RBI needs to neutralise the
outflow of FII money by unwinding the market stabilisation
securities that it had used to sterilise the inflows when they
happened. This will mean drawing down the dollar reserves which is
important at this hour. In the IT sector, there should be
correction in salary offerings rather than job cutting Public
should spend wisely and save more
Taxes including excise duty and custom duty should be reduced to
lighten the adverse effect of economic crunch on various
industries49
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
Opportunities in India due to recession US recession may be a
boon for Indian offshore software companies The impact of recession
is higher to small and medium sized (SMEs) enterprises whose bottom
lines get squeezed due to lack of spending by consumers SMEs in the
US are under severe pressure to increase profitability and business
margins to survive. This will force them to outsource and even have
M&A arrangements with Indian firms. India is going to be a
great beneficiary of this trend which will minimize the impact of
the US recession on Indian industry By March 2008, India had
received SME outsourcing deals worth $7 billion from the US as
against $6.2 billion in the previous year50
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.
Indias growth is based essentially on investing its own savings,
and so is relatively insulated from global finance and fashions.
Indias 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 demand51
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. Ecommerce 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, its 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 Indias
economy, any resilience there will provide a big cushion for the
downturn.
53
ConclusionThe global economy is in a tough spot, caught between
sharply slowing demand in many advanced economies and rising
inflation everywhere, notably in emerging and developing economies.
Global growth is expected to decelerate significantly in the second
half of 2008, before recovering gradually in 2009. At the same
time, rising energy and commodity prices have boosted inflationary
pressure, particularly in emerging and developing economies.
Against this background, the top priority for policymakers is to
head off rising inflationary pressure, while keeping sight of risks
to growth. In many emerging economies, tighter monetary policy and
greater fiscal restraint are required, combined in some cases with
more flexible exchange rate management. In the major advanced
economies, the case for monetary tightening is less compelling,
given that inflation expectations and labor costs are projected to
remain well anchored while growth weakens noticeably, but
inflationary pressures need to be monitored carefully. Now
countries needed to put their energies into restoring credit flows
since economic stimulus plans would otherwise struggle to
work.Monetary policy "should be capable of taking more into account
... the accumulation of risks that it had left a bit to one side
before." If governments adopted the right policy mix and stimulus
programmes were accompanied by the restoration of a functioning
financial system, it was possible for the world economy to begin
its recovery early next year.
54
BibliographyBooks 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/
StimulusII_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-govtannounces-package-to-boost-economy.htm
55