Effect of Western Recession on Indian Economy

8/3/2019 Effect of Western Recession on Indian Economy

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Effect on Western Recession on Indian Economy

Introduction

Business cycle:-Business cycle (or trade cycle) refers to the fluctuation in economic activitythat occur in a more or less regular time sequence in all capitalist societies (or market

economy. Business cycles are usually measured by considering the growth rate of real grossdomestic product. Despite being termed cycles, these fluctuations in economic activity do not

follow a mechanical or predictable periodic pattern.

The business cycle starts from a trough (lower point) and passes through a recovery phase

followed by a period of expansion (upper turning point) and prosperity. After the peak point

is reached there is a declining phase of recession followed by a depression. Again the

business cycle continues similarly with ups and downs.

The four phases of business cycles are shown in the following diagram :-

1. Prosperity Phase

When there is an expansion of output, income, employment, prices and profits, there is also arise in the standard of living. This period is termed as Prosperity phase. The features of prosperity are :-

1. High level of output and trade.2. High level of effective demand.3. High level of income and employment.4. Rising interest rates.

5. Inflation.6. Large expansion of bank credit.7. Overall business optimism.8. A high level of MEC (Marginal efficiency of capital) and investment.

Due to full employment of resources, the level of production is Maximum and there is a risein GNP (Gross National Product). Due to a high level ofeconomic activity, it causes a rise in

prices and profits. There is an u pswing in the economic activity and economy reachesits Peak. This is also called as a Boom Period.


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2. Recession Phase

The turning point from prosperity to depression is ter med as Recession Phase.

During a recession period, the economic activities slow down. When demand

starts falling, the overproduction and future investment plans are also given up.

There is a steady decline in the output, income, employment, prices and profits.The businessmen lose confidence and become pessimistic (Negative). It reduces

investment. The banks and the people try to get greater liquidity, so credit also

contracts. Expansion of business stops, stock market falls. Orders are cancelled

and people start losing their jobs. The increase in unemployment causes a sharp

decline in income and aggregate demand. Generally, recession lasts for a short

period.

3. Depression Phase

When there is a continuous decrease of output, income, employment, prices

and profits, there is a fall in the standard of living and d epression sets in.

The features of depression are :-

Fall in volume of output and trade.

Fall in income and rise in unemployment.

Decline in consumption and demand.

Fall in interest rate.

Deflation.

Contraction of bank credit.

Overall business pessimism.

Fall in MEC (Marginal efficiency of capital) and investment.

In depression, there is under-utilization of resources and fall in GNP (Gross

National Product). The aggregate economic activity is at the lowest, causing

a decline in prices and profits until the economy reaches i ts Trough (low

point).

4. Recovery PhaseThe turning point from depression to expansion is termed as Recovery orRevival Phase.

During the period of revival or recovery, there are expansions and rise in economic activities.When demand starts rising, production increases and this causes an increase in investment.

There is a steady rise in output, income, employment, prices and profits. The businessmengain confidence and become optimistic (Positive). This increases investments. The

stimulation of investment brings about the revival or recovery of the economy. The banks


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expand credit, business expansion takes place and stock markets are activated. There is anincrease in employment, production, income and aggregate demand, prices and profits startrising, and business expands. Revival slowly emerges into prosperity, and the business cycleis repeated.

Thus we see that, during the expansionary or prosperity phase, there is inflation and duringthe contraction or depression phase, there is a deflation.

What is a recession?

A recession is a decline in a country's gross domestic product (GDP) growth for two or moreconsecutive quarters of a year. A recession is also preceded by several quarters of slowingdown.

Past recessionsThe US economy has suffered 10 recessions since the end of World War II. The GreatDepression in the United was an economic slowdown, from 1930 to 1939. It was a decade ofhigh unemployment, low profits, low prices of goods, and high poverty.

The US saw a recession during 1982-83 due to a tight monetary policy to control inflationand sharp correction to overproduction of the previous decade. This was followed by Black

Monday in October 1987,when a stock market was collapse.Unemployment goes to 10.8%

in November 1982, the highest level ofunemployment in any recession. It was above

10% for 10 months. 1990-1991 Recession- This recession was eight months (July 1990 toMarch 1991). It was caused by the Savings and Loan Crisis in 1989.The US saw one of its

biggest recessions in 2001.

It was caused by the Y2K scare, which created aboom and subsequent bust in Internetbusinesses. From March to November 2001, employment dropped by almost 1.7 millions.

The dot-com burst hit the US economy and many developing countries as well. The economyalso suffered after the 9/11 attacks.

Unemployment reached 5.7% during the recession, but rose even further to 6% inJune 2003.

Indicators of Recession

It's the question on every media talking head's lips, and every investor's mind. Discussions

involving the "R" word are practically inevitable when the economy faces a popped bubble. While

the question lacks a definitive answer, certain signs do signal that we're headed into a downturn.

As a rule of thumb, a Recession involves at least two consecutive quarters of negative real GDP.

According to FXStreet.com, the National Bureau of Economic Research (NBER), the official

judge of when recessions begin and end, has broadened its characterization to consider four

indicators:


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y Slower consumer spending

The collapse of overvalued assets of any form -- such as housing -- can trigger a

recession. As consumers watch the values of their inflated assets evaporate, they're less

likely (or able) to spend money, because they don't feelwealthy. Thus, watching

consumer spending habits can be a great warning sign

y Inverted yield curve

Unlike a normal yield curve, which suggests that interest rates will rise in the future,

aninverted curve indicates that investors believe rates will drop in the future, since the

yield curve parallels interest rates set by the Fed. Expected declines in interest rates

demonstrate investors' confidence that the Fed will continue to lower rates to stimulate a

deteriorating economy.

y Rising unemployment

Watching the weekly unemployment claim reports is quite important. If people lose their

jobs, they won't be able to spend money, leading to suffering businesses and a chain of

further problems. And when companies release workers, it suggests that business is

slowing or expected to slow, and that not as many employees are needed or are

affordable.

y Inflationary pressure

When price hikes for goods such as food, gas, and clothing begin to rise faster than

wages, it becomes more difficult for consumers to maintain their spending habits, causing

business growth to slow. Plus, these escalating prices increase the cost of

inputs, thinning margins and profitability at many food establishments .

y Not an exact science

The definition of a recession can vary widely. There are many ways for investors to study

the health of the economy; the examples above are simply four of the most prominent

ones. Ultimately, a recession occurs when our economy is in a slump, pieces of the

economy are flowing in the wrong direction, and people fear for our nation's financial

well-being.

Luckily, long-term investors aren't too concerned about recessions, since they offer shares of many

robust companies at great prices. Still, it's important to understand when our economy faces a

challenging atmosphere. Following these signs can give Foolish investors a good idea of our

current spot in the economic cycle.


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General causes of Recession

1) Discretionary Fiscal Policy: Fiscal policy is changes in the taxing and spending of thefederal government for purposes of expanding or contracting the level of aggregate demand.In a recession, an expansionary fiscal policy involves lowering taxes and increasinggovernment spending. In an overheated expansion, a fiscal policy requires higher taxes and

reduced spending. A recession requires deficit spending and an overheated expansionrequires a budget surplus.

The first way this can be done is through the federal budget process. However, this processtakes so long -- 12 to 18 months -- that it is difficult to match discretionary fiscal policy withthe business cycle.

2) Automatic Stabilizers: A second type of fiscal policy is built into the structure of federaltaxes and spending. This is referred to as "nondiscretionary fiscal policy" or more commonlyas "automatic stabilizers". The progressive income tax (the major source of federal revenue)and the welfare system both act to increase aggregate demand in recessions, and to decreaseaggregate demand in overheated expansions. These automatic changes in spending and taxes

will generate a deficit in recessions and a surplus in overheated expansions.

Monetary Policy:

Monetary policy is the process by which the monetary authority of a country controls thesu pply of money, often targeting a rate of interest for the purpose of promoting economicgrowth and stability.Monetary policy is under the control of the Federal Reserve System (ourcentral bank) and is completely discretionary. It is the changes in interest rates and moneysupply to expand or contract aggregate demand. In a recession, the Federal System will lowerinterest rates and increase the money supply. In an overheated expansion, the Federal Systemwill raise interest rates and decrease the money supply.

These decisions are made by the Federal Open Market Committee (FOMC) which meetsevery six to seven weeks. The policy changes can be done immediately, although the impacton aggregate demand can take several months.

Impact of an American Recession on India

Indian companies have major outsourcing deals from the US. India's exports to theUS have also grown substantially over the years. The India economy is likely to lose

between 1 to 2 percentage points in GDP growth in the next fiscal year. Indiancompanies with big tickets deals in the US would see their profit margins shrinking.

The worries for exporters will grow as rupee strengthens further against the dollar.But experts note that the long-term prospects for India are stable. A weak dollar could

bring more foreign money to Indian markets. Oil may get cheaper brining downinflation. A recession could bring down oil prices to $70.

The whole of Asia would be hit by a recession as it depends on the USeconomy. Even though domestic demand and diversification of trade in the Asian


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region will partly counter any drop in the US demand, one simply can't escape adownturn in the world's largest economy. The US economy accounts for 30 per centof the world's GDP.

Says SudipBandyopadhyay, director and CEO, Reliance Money: "In the globalised world,complete decoupling is impossible. But India may remain relatively less affected by adverse

global events." In fact, many small and medium companies have already started developingtrade ties with China and European countries to ward off big losses.

The only silver lining is that the recession will happen slowly, probably in six months or so.

As of now, IT and IT-enabled sector will be the worst hit as 75 per cent of its reven ues comefrom the US. Services, textiles, jewelry, handicrafts and leather segments will suffer losses

because of their trade link. Certain sections of commodities could face sharp impact due tothe volatile nature of these sectors.

LokendraTomar, senior vice-president, Integreon, a BPO firm, says the US recession is likelyto have a dual impact on the outsourcing industry. Appreciating ru pee along with poor

performance of US companies (law firms, investment banks and media houses) will affect thebottom line of the oursourcing industry. Small BPOs, which are operating at a net margin of7-8 per cent, will find it difficult to survive.

According to Dharmakirti Joshi, director and principal economist of CRISIL, along andsevere recession will seriously affect the portfolio and fixed investment flows. Corporateswill also suffer from volatility in foreign exchange rates. The export sector will have todevise new strategies to enhance productivity.

Effect of recession on :

Indian StockMarkets: - The festival season in India was seldom so gloomy for the share

market. Investor wealth worth Rs. 250, 000 crore (1 crore = 10 million) was wiped out on thebourses on a single day. At the first sign of stock market crash and FII funds stampede, theUnited Progressive Alliance (UPA) Government has once again permitted P-notes(participatory notes) paving the way for enhanced speculation.

Trade:-The trade deficit is reaching alarming proportions. If exports are growing, imports aregrowing even more. But for some reasons if the remittances dry up and FIIs funds take flight,it will be a repetition of 1991 after a few years if forex reserves get depleted and trade deficitskeep increasing at the present rate. High forex reserves were becoming a burden. As most ofthese funds were in dollars, the government had parked most of them in US treasury bonds orinvested them in securities and bonds in foreign banks. With the meltdown and consequent

poor returns following rate reduction, these treasury investments have taken a beating.

Indian banks:-Indian banks are safe, reassured Reserve Bank of India (RBI). Indian banks'exposure to international markets is relatively small at 6 percent of their total assets. In theyears to come, as the new investment projects go under one after the other and investors andinsurance companies and hedge funds go under trading in credit default swaps and all suchdevices. ICICI, the symbol of new breed ofunscrupulous financial manipulators, is alreadyin doldrums.


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Employment:-Due to the recession , India was badly affected and many of the peoplebecame jobless and also lost their job opportunities. Effect of U.S recession also led Indian

BPO and IT industries.

Conclusion

Effect of Western Recession on Indian Economy

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