Trying to assess the current situation and further growth prospects of the US economy, the first important fact to see is the US economic recovery pattern. Thus changing numbers suggest that the US economy is heading towards a recession but its impact on emerging economies like India is yet awaited, writes Ambreen Arif
Assessing the US economy's prospects, the most important thing first to take into account is that what has happened over the last few years is not the garden-variety business cycle. It is a grossly overly indebted and unbalanced bubble economy, in which borrowing and indebtedness have gone to unprecedented extremes in chasing price inflation. And a bubble economy needs rising asset prices to keep it going. Once the prices of those assets which have lubricated the decisive assets – let alone fall – the whole process stops and reverses with vengeance, because the formerly ample liquidity and wealth creation go into reverse.
Shock waves of the problems in US economy are being felt in the global stock market as the world’s largest economy threatens to get into a recession. The sub-prime crisis has taken a hit of about $ 130 billion dollars. Biggest banks in the world have reported the largest losses in their history. Besides the sub-prime crisis, funding of the war in Iraq and Afghanistan, record high oil prices and increased prices of food items are adding to problems with the US economy.
However, the true weight on consumer sentiment now seems to be economic data itself. Signs that unemployment is rising, the service sector contracted for the first time in nearly four years and general growth cooled sharply through the end of 2007 have all weighed on American’s outlook for the economy’s health and their own financial condition. Though Treasury secretary Paulson and Fed Chairman Bernanke recently predicted that US would avoid a recession in 2008, the market has not been struck with the same confidence. And, since the consumer is the last leg of positive growth, the stakes are that much higher. On the other hand, with the dollar thoroughly battered and officials still forecasting a rebound in growth; a drop in confidence could accelerate a dollar drop.
Though no one likes or wants a recession, almost everyone appears reconciled to one in the United States. Meanwhile, politicians continue to downplay any fears of global repercussions, citing decoupling of the United States and other economies as a buffering factor. But what is the reality for countries like India?
It would be naïve to imagine that a recession in the United States would have no impact on India. The United States accounts for one-fourth of the world GDP and any significant slowdown is bound to have reverberations elsewhere. On the other hand, interdependencies between the US economy and emerging economies like India and China has reduced considerably over the last two decades. Thus, the effect may not be as drastic as would have been the case in the 1980s.
Even so, fears of a US recession led to panic in the Indian stock market. And it saw a meltdown with a mind-boggling US$450 billion in market capitalization being vaporized.
History might hold a clue here. The last time the bubble burst (2001–2002), the DJIA went down by 23%, while the Indian Index fell by 15%. But much has happened between then and now. The Indian economy has shown a robust and consistent growth trajectory and the projection for 2008 is 9%. Indian exports to the United States account for just over 3% of GDP. India has a healthy trade surplus with the United States. In other words, the effects of this recession on India may be quite distinct from those of the past.
However in terms of specific sectors, the IT Enabled Services sector may be hit since a majority of Indian IT firms derive 75% or more of their revenues from the United States. If Fortune 500 companies slash their IT budgets, Indian firms could be adversely affected. Same is the case with manufacturing sector which has to ramp up scale economies and improve productivity and operational efficiency, thus lowering prices, if it wishes to offset the loss of revenue and subsequent loss of jobs from a possible US recession.
In summary, at the macro-level, a recession in the US may bring down GDP growth but not by much. At the micro-level, specific sectors could be affected. Innovation now may prove to be the engine for growth when the next boom occurs.
For US firms, who have long looked at China as a better investment destination, this may be a good time to look at India as well. After all, 350 million people with purchasing power cannot be ignored. This is not a sales pitch for India but only a gentle suggestion to US corporations.
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