Description
current recession in detail and recessions of the previous three decades in brief. The project gives a brief overview of the other post-war recessions. It outlines the fiscal and monetary policy response to current recession and its future effects on various sectors in India. It also looks at theories of why recessions occur.
Current Recession How long? How deep?
Director’s Project
Submitted by: Dhanashree Wankhade 2008A15 Dimple Bhat 2008A16 Deepthi Arumalla 2008A37 Mayuri Mathur 2008 A46
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THE CURRENT ECONOMIC RECESSION: HOW LONG, HOW DEEP, AND HOW DIFFERENT FROM THE PAST Abstract:After the Second World War, the world has seen 11 recessions till date. Of these 11 recessions there have been two major recessions excluding the current crisis. The project attempts to examine the current recession in detail and recessions of the previous three decades in brief. The project gives a brief overview of the other post-war recessions. It outlines the fiscal and monetary policy response to current recession and its future effects on various sectors in India. It also looks at theories of why recessions occur. At the end of the project we have tried to estimate the next recession and predicted it to happen in 2016.
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Table of Contents RECESSION .............................................................................................................................................. 5 THEORIES RELATED TO RECESSION ......................................................................................................... 5 KEYNESIAN THEORY- ........................................................................................................................... 5 BUSINESS CYCLE THEORY .................................................................................................................... 6 EFFICIENCY WAGE ARGUMENT........................................................................................................... 6 HISTORY OF RECESSIONS ........................................................................................................................ 7 Conclusions ......................................................................................................................................... 9 CURRENT SITUATION OF RECESSION ................................................................................................... 10 MONETARY POLICY ........................................................................................................................... 10 Overview ....................................................................................................................................... 15 Fiscal Policy for the ensuing financial year ................................................................................... 17 Tax Policy....................................................................................................................................... 17 Contingent and other Liabilities .................................................................................................... 19 Government Borrowings, Lending and Investments .................................................................... 20 Initiatives in Public Expenditure Management ............................................................................. 21 Policy evaluation ........................................................................................................................... 22 FUTURE EFFECTS OF CURRENT CONTRACTION ON VARIOUS SECTORS OF INDIA................................ 28 INDIAN STOCKS ................................................................................................................................. 28 Economy........................................................................................................................................ 28 The case of Indian equities ........................................................................................................... 29 The way ahead .................................................................................................................................. 29 BANKING ........................................................................................................................................... 30 AUTO ................................................................................................................................................. 31 TEXTILE .............................................................................................................................................. 32 REALTY .............................................................................................................................................. 32 ENERGY ............................................................................................................................................. 33 INSURANCE ....................................................................................................................................... 34 MANUFACTURING............................................................................................................................. 34 REASONS BEHIND A TYPICAL RECESSION ............................................................................................. 35 CHARACTERISTICS OF A TYPICAL RECESSION........................................................................................ 36 PREDICTING NEXT RECESSION USING ARIMA MODELS .................................................... 36 ARIMA MODEL .................................................................................................................................. 36
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RECESSION
A recession is a contraction phase of the business cycle. It is defined as a significant decline in economic activity spread across the country, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.
THEORIES RELATED TO RECESSION
There are three ways to explain a recession.
KEYNESIAN THEORYThe foremost of the views can be attributed to John Maynard Keynes. Better known as the animal spirit hypothesis, this theory says consumers behave like animals. They suddenly become optimistic or pessimistic about their future, leading to a fall in effective demand. Effective demand implies what the consumer intends to buy. A fall in effective demand will lead to a fall in demand, thus contributing to an economic downturn. For instance, any consumer feeling less secure about his future (jobs or otherwise) might want to delay purchasing a car. When this happens across the economy, it will affect the car industry. The car industry, witnessing a fall in demand, will want to hire fewer factor inputs (labour or capital) leading to unemployment in the labour market and a reduced rate of interest in the capital market. A low rate of return in the capital market means fewer incentives for the consumer to lend savings for investment. Again, unemployment means lower earnings for consumers. So both processes become self-fulfilling, resulting in the persistence of recession. Here, poor economic fundamentals do not lead to an economic downturn. It is the psychological behaviour of households or firms that cause the recession. This theory is well documented by real world data. Latest economic reports confirm that the recession in the US is mainly because of consumer pessimism. They reined in spending, which accounts for two-thirds of the US economy. When their confidence fell to a four-quarter low, so did their spending.
J.M. Keynes has used three psychological propensities in formulating his theory of business cycle. They are: Propensity to consume, propensity to save and the marginal efficiency of capital. He also introduced the concept of multiplier in order to show the effect to increase in total income due to increase in investment. Keynes is of the view that upswing of business cycle is caused by a rise in the marginal efficiency of capital. If there is a fall in AD then according to Keynesian analysis there will be a fall in Real GDP. The effect on Real GDP depends upon the slope of the AS curve if the economy is close to full capacity lower AD would only cause a
small fall in Real GDP. AD is composed of C+I+G+X-M, therefore a fall in any of these components could cause a recession. For example, if the MPC increased interest rates sharply this would cause the cost of borrowing to increase and make saving more attractive. This would have the effect of reducing consumer spending. AD could also fall due to deflationary fiscal policy, for example higher taxes and lower government spending would also cause a fall in AD. If there was a fall in AD the multiplier effect may magnify the initial fall in AD, for example if there was a fall in output, workers would be made unemployed. These workers would then spend less causing a secondary fall in AD. This would make the fall in Real GDP greater
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BUSINESS CYCLE THEORY
The second view involves the business cycle theorists. Other things being equal, above average rates of Total Factor Productivity growth (because of technological innovation) generate higher rates of growth in real (inflation adjusted) wages because workers are compensated for producing more goods and services. Higher wages result in increased household income, leading to lower consumption and savings. An example of positive externalities is the development and widespread use of Internet. As individual firms continue to increase their use of the Internet, they induce improvements in the distribution, utilisation and management of information across the economy. Thus, a negative technology shock (such as September 11) will lead to fall in the real wage rate. Extending the argument further, this will lead to fall in demand and, hence, to recession. Thus, one the reason for the economic recession in the US is because of the terrorist attack. The September 11 attack accounted for loss of all —human, physical and financial — capital. Labour productivity fell as the existing labourers had lower capital to work with. This theory is well documented. The neo-Keynesian group leads the other major school of thought. It attributes price and wage stickiness for recession. In a recession, price and wages do not adjust quickly — these variables do not fall at a rate concurrent to recession. Thus, the effect of recession is more widespread and prolonged. One reason that prices do not adjust immediately to clear markets is because adjusting price is costly. To change prices, a firm may need to send out a new catalogue to customers, distribute new price lists to sales staff, or for restaurants, print new menus. These costs, better known as menu costs, cause firms to adjust price intermittently rather than cautiously. Price stickiness may also result from coordination failures among firms. For example, in a recession, if one firm reduces price and other firms do not, there may be no way for the first firm to recoup its loss in revenue resulting from a lower price. As a result no individual firm would like to whittle down price even when it has information about recession. Like price, wage stickiness also prolongs the recession effect. Wage stickiness is mainly because of labour unions. Union leaders guarantee that wages do not fall a critical minimum level even in a recession. More so, as wage contracts are signed at the beginning of each year. Wages are inflexible in the short run.
EFFICIENCY WAGE ARGUMENT
The other reason can be explained through the efficiency wage argument. According to this theory, higher wages make workers more productive. The influence of wages on worker efficiency may explain the failure of firms to cut wages despite excess labour. Though a wage reduction would lower a firm's wage bill, it would also lead to a drop in worker productivity and profits. Consequently, wage stickiness persists and the recession continues. These three schools of thoughts agree on the fact that increase in capital spending is necessary for bringing the economy out of recession. Capital spending by increasing aggregate demand encourages firms to invest more and, hence, increase employment. Positive technology shocks also increase labour productivity and, hence, returns to labour. Technology, by increasing labour productivity, plays a critical role in explaining long run growth. In the short run, it is always possible to get in more output simply by increasing inputs. However, in the long run, growth tapers off as some inputs (especially human and physical capital) become scarce, calling for some technological breakthrough. Much of the spectacular growth in the US was because of the increase in productivity growth.The US Federal Reserve, on its part, is trying to revive the 6
economy by keeping the interest rate low. A low interest rate encourages investments in physical and human capital. While the former is important in buttressing aggregate demand, the latter is important for providing a technological breakthrough.
HISTORY OF RECESSIONS
The Union Recession: (February 1945 - October 1945) ? ? ? ? ?
Duration: 9 months Magnitude GDP Decline: 11 Unemployment Rate: 1.9% Reasons and Causes: The tail-end of World War II, the beginning of demobilization of military forces and the slow transition to civilian production marked this period. War production had virtually ceased and veterans were just beginning to re-enter the workforce. It was also known as the "Union Recession" as unions were beginning to reassert themselves. Minimum wages were on the rise and credit was tight.
The Post-War Recession: (November 1948 - October 1949) ? ? ? ? ?
Duration: 11 months Magnitude GDP Decline: 1.1 Unemployment Rate: 5.9% Reasons and Causes: As returning veterans returned to the workforce in large numbers to compete for jobs with existing civilian workers who had entered the workforce during the war, unemployment began to rise. The government's response was minimal as it was much more worried about inflation than unemployment at that time.
The Post-Korean War Recession: (July 1953 - May 1954) ? ? ? ? ?
Duration: 10 months Magnitude: GDP decline: 2.2 Unemployment Rate: 2.9% (lowest rate since WWII) Reasons and causes: After an inflationary period that followed the Korean War, more dollars were directed at national security. The Federal Reserve tightened monetary policy to curb inflation in 1952. The dramatic change in interest rates caused increased pessimism about the economy and decreased aggregate demand.
The Eisenhower Recession: (August 1957 - April 1958) ? ? ? ? ?
Duration: 8 months Magnitude: GDP Decline: 3.3% Unemployment Rate: 6.2% Reasons and Causes: The government tightened monetary policy to years prior to the recession to curb inflation, but prices continued to rise in the U.S. through 1959. The sharp world-wide recession and the strong U.S. dollar contributed to a foreign trade deficit. (For another view on trade deficits read, In Praise of Trade Deficits.) 7
The "Rolling Adjustment" Recession: (April 1960 - February 1961) ? ? ? ? ?
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Duration: 10 months Magnitude: GDP Decline: 2.4 Unemployment Rate: 6.9% Reasons and Causes: This recession was also known as the "rolling adjustment" for many major U.S.industries, including the automotive industry. Americans shifted to buying compact and often foreign-made cars and industry drew down inventories. Gross national product (GNP) and product demand declined. The Nixon Recession: (December 1969 - November 1970) Duration: 11 months Magnitude: GDP Decline: 0.8 Unemployment Rate: 5.5% Reasons and Causes: Increasing inflation caused the government to employ a very restrictive monetary policy. The structure of government expenditures added to the contraction in economic activity.
The Oil Crisis Recession: (November 1973 - March 1975) ? ? ? ? ?
Duration: 16 months Magnitude: GDP Decline: 3.6 Unemployment Rate: 8.8% Reasons and Causes: This long, deep recession was brought on by the quadrupling of oil prices and high government spending on the Vietnam War. This led to "stagflation" and high unemployment. Unemployment finally reached 9% in May of 1975. (For more on this see, Stagflation, 1970s Style.)
The Energy Crisis Recession: (January 1980 - July 1980) ? ? ? ? ?
Duration: 6 months Magnitude: GDP decline: 1.1% Unemployment Rate: 7.8% Reasons and Causes: Inflation had reached 13.5% and the Federal Reserve raised interest rates and slowed money supply growth, which slowed the economy and caused unemployment to rise. Energy prices and supply were put at risk causing a confidence crisis as well as inflation.
The Iran/Energy Crisis Recession: (July 1981 - November 1982) ? ? ? ?
Duration: 16 months. Magnitude: GDP decline: 3.6% Unemployment Rate: 10.8%
Reasons and Causes: This long and deep recession was caused by the regime change in Iran; the world's second largest producer of oil at the time, the country came to regard the U.S. as a supporter of its ousted regime. The "New" Iran exported oil at inconsistent intervals and at lower volumes, forcing prices higher. The U.S. government enforced a tighter monetary policy to 8
control rampant inflation, which had been carried over from the previous two oil and energy crises. The prime rate reached 21.5% in 1982.
The Gulf War Recession: (July 1990 - March 1991) ? ? ? ? ?
Duration: 8 months Magnitude: GDP Decline: 1.5 Unemployment Rate: 6.8% Reasons and causes: Iraq invaded Kuwait. This resulted in a spike in the price of oil in 1990, which caused manufacturing trade sales to decline. This was combined with the impact of manufacturing being moving offshore as the provisions of North American Free Trade Agreement (NAFTA) kicked in. The leveraged buyout of United Airlines triggered a stock market crash.
The 9/11 Recession: (March 2001 - November 2001) ? ? ? ? ?
Duration: 8 months Magnitude GDP Decline: 0.3 Unemployment Rate: 5.5% Reasons and Causes: The collapse of the dotcom bubble, the 9/11 attacks and a series of accounting scandals at major U.S. corporations contributed to this relatively mild contraction of the U.S. economy. In the next few months, GDP recovered to its former level. (For more information, read Crashes: The Dotcom Crash.)
Conclusions
For one, oil price, demand and supply sensitivity appear to be consistent and frequent historical precursors to U.S. recessions. A spike in oil prices has preceded nine out of 10 post-WWII recessions. This highlights that while global integration of economies allows for more effective cooperative efforts between governments to prevent or mitigate future recessions, the integration itself ties the world economies more closely together, making them more susceptible to problems outside their borders. Better government safeguards should soften the effects of recessions as long as regulations are in place and enforced; better communications technology and sales & inventory tracking allows businesses and governments to have better transparency on a real time basis so that corrective actions are made to forestall the accumulation of factors and indicators contributing to or signaling a recession. More recent recessions, such as the housing bubble, the resulting credit crisis and the subsequent government bailouts are examples of excesses not properly or competently regulated by the patchwork of government regulation of financial institutions. (For another perspective on credit crisis, see The Bright Side of The Credit Crisis.) Contraction and expansion cycles of moderate amplitude are part of the economic system. World events, energy crises, wars and government intervention in markets can affect economies both positively and negatively, and will continue to do so in the future. Expansions have historically exceeded previous highs in economic growth trends if capitalist fundamentals applied within regulatory guidelines govern the markets.
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CURRENT SITUATION OF RECESSION
MONETARY POLICY
The Reserve Bank has released the document “Macroeconomic and Monetary Developments Third Quarter Review 2008-09” to serve as a backdrop to the Third Quarter Review of Monetary Policy 2008-09. The highlights of macroeconomic and monetary developments during 2008-09 so far are: Overview The Indian economy, after exhibiting strong growth during the second quarter of 2008-09, has experienced moderation in the wake of the global economic slowdown. Although agricultural outlook remains satisfactory, industrial growth has decelerated sharply and services sector is slowing. The economic slowdown, during the second quarter vis-à-vis the first quarter of 200809, was primarily driven by a moderation of consumption growth and widening of trade deficit, offset partially by an acceleration in investment demand. The balance of payments (BoP) for the first half of 2008-09 reflected a widening of the current account deficit and moderation in capital flows. Net capital inflows reduced sharply and remained volatile during 2008-09 with foreign direct investment inflows showing an increase, while portfolio investments recording a substantial outflow. The growth of non-food credit remained high during 2008-09, so far, albeit with some moderation in recent months. Continued high growth in time deposits enabled the banking system to sustain the credit expansion while the non-banking sources of funds to the commercial sector declined. The total flow of resources from banks and other sources to the commercial sector during 200809, so far, has been somewhat lower than the comparable period of 2007-08. Financial markets in India, which, by and large, remained orderly from April 2008 to midSeptember 2008, witnessed heightened volatility subsequently reflecting the knock-on effects of the disruptions in the international financial markets and the uncertainty that followed. This necessitated the Reserve Bank to undertake a series of measures to inject rupee and foreign exchange liquidity from mid-September 2008 onwards. Liquidity conditions turned around and became comfortable from mid-November 2008. Headline inflation has declined in major economies since July/August 2008. In India, inflation measured as year-on-year variation in the wholesale price index (WPI) has declined sharply since August 2008 and was at 5.6 per cent as of January 10, 2009. On the macroeconomic front, the downside risks for economic growth emanate from global economic slowdown, deterioration in global financial markets and slowing down in domestic demand. On the positive side, factors include expected increase in consumption demand mainly reflecting rise in basic exemption limits and tax slabs, Sixth Pay Commission awards, debt waiver for farmers and pre-election expenditure. The easing of international oil prices and commodity prices may help in softening the inflationary pressure. Output
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According to estimates released by the Central Statistical Organisation (CSO) in November 2008, the real GDP growth was placed at 7.6 per cent during the second quarter of 2008-09 as compared with 9.3 per cent during the corresponding quarter of 2007-08, reflecting deceleration in growth of industry and services. The Ministry of Agriculture has set a target for foodgrains production for 2008-09 at 233.0 million tonnes. According to the First Advance Estimates, the kharif foodgrains production during 2008-09 was placed at 115.3 million tonnes (Fourth Advance Estimates) as compared with that of 121.0 million tonnes during the previous year. The index of industrial production during April-November 2008-09 recorded year-on-year expansion of 3.9 per cent as compared with 9.2 per cent during April-November 2007-08. The manufacturing sector recorded growth of 4.0 per cent during April-November 2008-09 (9.8 per cent during April-November 2007-08) and the electricity sector recorded growth of 2.9 per cent (7.0 per cent during April-November 2007-08). Available information on the leading indicators of services sector activity during April-October 2008-09 indicate some acceleration in growth in respect of several indicators such as railway revenue earning and freight traffic and export cargo handled by civil aviation as compared with the corresponding period of 2007-08. On the other hand, growth decelerated in respect of cargo handled at major ports and other indicators of civil aviation excluding export cargo, commercial vehicles, cement and steel. Aggregate Demand Aggregate demand in the Indian economy is primarily domestically driven, though exports have been gaining progressively higher importance in recent years. The economic slowdown, during the second quarter vis-à-vis the first quarter of 2008-09, was primarily driven by a moderation of consumption growth and widening of trade deficit, offset partially by an acceleration in investment demand. On the other hand, the government consumption expenditure accelerated during the same period. According to the latest information on Central Government finances for 2008-09 (AprilNovember), the revenue deficit and fiscal deficit were placed higher than those in AprilNovember 2007 both in absolute terms and as per cent of budget estimates (BE) primarily on account of higher revenue expenditure. Tax revenue as per cent of BE was lower than a year ago on account of lower growth in income tax, corporation tax and customs duties owing to economic slowdown. Aggregate expenditure as per cent of BE, was higher than a year ago on account of higher revenue expenditure, particularly, subsidies, defence, other economic services, social services and plan grants to States/Union Territories. While expenditure is slated to increase on account of the fiscal stimulus measures undertaken by the Government to address the problem of economic slowdown, growth of tax revenue is likely to decelerate in the coming months of 2008-09 due to moderation in economic activity. The net cash outgo on account of the two supplementary demand for grants is placed at Rs. 1,48,093 crore. This, in turn, will be reflected in the non-attainability of the deficit targets for 2008-09 as envisaged in the Union Budget 2008-09. During 2008-09 (up to January 13, 2009), special bonds amounting to Rs.44,000 crore and Rs.14,000 crore have been issued to oil marketing companies and fertiliser companies, respectively. 11
Sales performance of select non-Government non-financial public limited companies in the private corporate sector during the first two quarters of 2008-09 was impressive; however, profits performance was subdued as compared with 2007-08. Higher increase in expenditure in relation to sales growth was primarily on account of rising input costs, interest expenses and large provisioning towards mark to market (MTM) losses on foreign exchange related transactions which exerted pressure on profits. The External Economy India?s balance of payments position during the first half of 2008-09 (April-September) reflected a widening of trade deficit resulting in large current account deficit, and moderation in capital flows. Merchandise trade deficit recorded a sharp increase during April-November 2008 on account of higher crude oil prices for most of the period and loss of momentum in exports since September 2008. Net surplus under invisibles remained buoyant, led by increase in software exports and private transfers. Net capital inflows reduced sharply and have remained volatile during 2008-09 so far. The large increase in merchandise trade deficit during April-September 2008 led to a significant increase in the current account deficit over its level during April-September 2007. The widening of trade deficit during April-September 2008 could be attributed to higher import payments reflecting high international commodity prices, particularly crude oil prices. The surplus in the capital account moderated during April-September 2008 reflecting increased gross capital outflows on the back of global financial turmoil. While the net inward FDI (net direct investment by foreign investors) remained buoyant reflecting relatively strong fundamentals of the Indian economy and continuing liberalisation measures to attract FDI, net outward FDI (net direct investment by Indian investors abroad) also remained high during April-September 2008. The gross capital inflows were higher on account of higher FDI inflows and NRI deposits during the period. In terms of residual maturity, the revised short-term debt (below one year) comprising sovereign debt, commercial borrowings, NRI deposits, short-term trade credit and others maturing up to March 2009, was estimated at around US $ 85 billion as at end-March 2008. According to the provisional data released by DGCI&S, India?s merchandise exports during April-November 2008 increased by 18.7 per cent while imports recorded a higher growth of 32.5 per cent, largely due to the rise in petroleum, oil and lubricants (POL) imports. The rise in oil imports was primarily due to the elevated international crude oil prices, while the volume of oil imports moderated. Merchandise trade deficit during April-November 2008 widened to US $ 84.4 billion from US $ 53.2 billion a year ago. As of January 16, 2009, foreign exchange reserves at US $ 252.2 billion declined by US $ 57.5 billion over the level at end-March 2008, including changes due to valuation losses. Monetary Conditions Monetary and liquidity aggregates that expanded at a strong pace during the first half of 200809 showed some moderation during the third quarter reflecting the decline in capital flows and consequent foreign exchange intervention by the Reserve Bank. Growth in broad money (M3), year-on-year (y-o-y), was 19.6 per cent (Rs. 7,36,777 crore) on January 2, 2009 lower than 22.6 per cent (Rs. 6,91,768 crore) a year ago. Aggregate deposits of banks, y-o-y, expanded 20.2 per cent (Rs.6,49,152 crore) on January 2, 2009 as compared with 12
24.0 per cent (Rs. 6,21,944 crore) a year ago. The growth in bank credit continued to remain high. Non-food credit by scheduled commercial banks (SCBs) was 23.9 per cent (Rs.5,01,645 crore), y-o-y, as on January 2, 2009 from 22.0 per cent (Rs.3,79,655 crore) a year ago. The intensification of global financial turmoil and its knock-on effect on the domestic financial market, and downturn in headline inflation, necessitated the Reserve Bank to ease its monetary policy since mid-September 2008. Reserve money growth at 6.6 per cent, y-o-y, as on January 16, 2009 was much lower than that of 30.6 per cent a year ago. Adjusted for the first round effect of the changes in CRR, reserve money growth was 18.0 per cent as compared with 21.6 per cent a year ago. Financial Markets The crisis in global financial markets deepened since mid-September 2008, triggered by the collapse of Lehman Brothers followed by the failure of a number of other financial firms across countries. The pressure on financial markets mounted with the credit spreads widening to record levels and equity prices crashing to historic lows leading to widespread volatility across the market spectrum. The turmoil transcended from credit and money markets to the global financial system more broadly. The contagion also spilled over to the emerging markets, which saw broad-based asset price declines amidst depressed levels of risk appetite. Added to this, there was a significant deterioration in the global economic outlook. As a result, authorities in several countries embarked upon an unprecedented wave of policy initiatives to contain systemic risk, arrest the plunge in asset prices and shore up the confidence in the international banking system. While these initiatives did help in restoring some level of stability, the financial market conditions remained far from normal during the period OctoberDecember 2008. Liquidity conditions tightened significantly in India between mid-September and October 2008 emanating from adverse international developments and some domestic factors.Financial markets in India came under pressure since mid-September 2008, reflecting the knock-on effects of the disruptions in the international financial markets. This necessitated the Reserve Bank to undertake a series of measures to inject rupee and foreign exchange liquidity from midSeptember 2008 onwards. Accordingly, money markets in India came under some pressure mirroring the impact of capital outflows and redemption pressures faced by mutual funds and other investors. The pressure on money markets was reflected in call rates breaching the upper bound of Liquidity Adjustment Facility (LAF) corridor but settling back within the corridor by November 2008. Interest rates in the collateralised segments of the money market moved in tandem with but remained below the call rate during the third quarter of 2008-09. In the credit market, lending rates of scheduled commercial banks, which had increased initially, started declining in December 2008. Yields in the government securities market also came to soften during the third quarter 2008-09. In the foreign exchange market, Indian rupee generally depreciated against major currencies. Indian equity markets witnessed downswings quite in line with trends in major international equity markets. The Reserve Bank swiftly initiated a series of measures, which helped to assuage liquidity 13
conditions, while reassuring the market that the Indian banking system continued to be safe and sound, well capitalised and well regulated. Price Situation The accommodative monetary policy, which was pursued by most central banks since September 2008, aimed at mitigating the adverse implications of the recent financial market crisis on economic growth and employment. Headline inflation moderated in major economies since July/August 2008 on account of the marked decline in international energy and commodity prices as well as slowdown in aggregate demand emerging from the persistence of financial market turmoil following the US sub-prime crisis. After remaining at elevated levels for an extended period, global commodity prices declined sharply since the second quarter of 2008-09 led by decline in the prices of crude oil, metals and food. The WTI crude oil prices have eased from its historical high of US $ 145.3 a barrel level on July 3, 2008 to around US $ 42.3 a barrel as on January 22, 2009 reflecting falling demand in the Organisation for Economic Co-operation and Development (OECD) countries as well as some developing countries, notably in Asia, following the economic slowdown. Metal prices eased further during the third quarter of 2008-09, reflecting weak construction demand in OECD countries and some improvement in supply, especially in China. In India inflation, based on the year-on-year changes in wholesale price index (WPI), declined sharply from an intra-year peak of 12.9 per cent on August 2, 2008 to 5.6 per cent as on January 10, 2009. The recent decline in WPI inflation was driven by decline in prices of minerals oil, iron and steel, oilseeds, edible oils, oil cakes, raw cotton. Amongst major groups, primary articles inflation, year-on-year, increased to 11.6 per cent on January 10, 2009 from 4.5 per cent a year ago and (it was 9.7 per cent at end-March 2008). This mainly reflected increase in the prices of food articles, especially of wheat, fruits, milk, and eggs, fish and meat as well as non-food articles such as oilseeds and raw cotton. The fuel group inflation turned negative (-1.3 per cent) as on January 10, 2009 as compared to an intra-year peak of 18.0 per cent on August 2, 2008. This reflected the reduction in the price of petrol by Rs. 5 per litre and diesel by Rs. 2 per litre effective December 6, 2008 as well as decline in the prices of freely priced petroleum products in the range of 30-65 per cent since August 2008. Manufactured products inflation, year-on-year, also moderated to 5.9 per cent on January 10, 2009 as compared with the peak of 11.9 per cent in mid-August 2008 but remained higher than 4.6 per cent a year ago. The year-on-year increase in manufactured products prices was mainly driven by sugar, edible oils/oil cakes, textiles, chemicals, iron and steel and machinery and machine tools. Inflation, based on year-on-year variation in consumer price indices (CPIs), increased further during November/December 2008 mainly due to increase in the prices of food, fuel and services (represented by the „miscellaneous? group). Various measures of consumer price inflation were placed in the range of 10.4-11.1 per cent during November/December 2008 as compared with 7.3-8.8 per cent in June 2008 and 5.1-6.2 per cent in November 2007. Macroeconomic Outlook The various business expectations surveys released recently reflect less than optimistic sentiments prevailing in the economy. The results of Professional Forecasters? Survey 14
conducted by the Reserve Bank in December 2008 also suggested further moderation in economic activity for 2008-09. According to the Reserve Bank?s Industrial Outlook Survey of manufacturing companies in the private sector, the business expectations indices based on assessment for October-December 2008 and on expectations for January-March 2009 declined by 2.6 per cent and 5.9 per cent, respectively, over the corresponding previous quarters. The global economic outlook has deteriorated sharply since September 2008 with several countries, notably the US, the UK, the Euro area and Japan experiencing recession. In India too, there is evidence of a slowing down of economic activity. Unlike in the advanced countries where the contagion of crisis spread from the financial to the real sector, in India the slowdown in the real sector is affecting the financial sector, which in turn, has a second-order impact on the real sector. On the positive side factors include expected increase in consumption demand mainly reflecting rise in basic exemption limits and tax slabs, Sixth Pay Commission awards, debt waiver for farmers and pre-election expenditure. WPI inflation has fallen sharply driven by falling international commodity prices especially those of crude oil, steel and selected food items, although, some contribution has also come from the slowing domestic demand. Going forward, the outlook on international commodity prices indicate further softening of domestic prices.
FISCAL POLICY
The following is the government's fiscal policystrategy statement that the finance minister announced in Parliament. Overview 1. The Union Budget 2008-09 was presented in the backdrop of impressive growth in the Indian economy which clocked about 9 per cent of average growth in the last four years. This striking performance coupled with significant improvement in fiscal indicators, during the FiscalResponsibility and Budget Management (FRBM) Act, 2003 regime definitely put the country on a higher growth trajectory inspiring confidence in the medium to long term prospects of the economy. The process offiscal consolidation during these years has resulted in improvement in fiscal deficit from 5.9 per cent of GDP in 2002-03 to 2.7 per cent of GDP in 2007-08. During the same period, revenue deficit has declined from 4.4 per cent to 1.1 per cent of GDP. In tune with the philosophy of equitable growth, the process of fiscal consolidation was taken forward without constricting the much-required social sector and infrastructure related expenditure. This improvement in the state of public finances was achieved through higher revenue buoyancy, driven by efficient tax administration and improved compliance which is evident from increase in the tax to GDP ratio from 8.8 per cent in 2002-03 to 12.5 per cent in 200708. 2. Riding on the path of fiscal consolidation, the Union Budget 2008-09 was presented with fiscal deficit estimated at 2.5 per cent of GDP and revenue deficit at 1 per cent of GDP. 15
However after the presentation of the Union Budget in February 2008, the world economy was hit by three unprecedented crises -- first, the petroleum price rise; second, rise in prices of other commodities; and third, the breakdown of the financial system. The combined effect of these crises of these orders are bound to affect emerging market economies and India was no exception. The first two crises resulted in serious inflationary pressure in the first half of 2008-09. The focus of the monetary as well as fiscal policy shifted from fuelling growth to containing inflation, which had reached 12.9 per cent in August, 2008. Series of fiscal measures both on tax revenue and expenditure side were undertaken with the objective of easing supply side constraints. These measures were supplemented by monetary initiatives through policy rate changes by the Reserve Bank of India [Get Quote], and contributed to the softening of domestic prices. Headline inflation fell to 4.39 per cent in January, 2009. However, the fiscal measures undertaken through tax concessions and increased expenditure on food, fertiliser and petroleum subsidies along with increased wage bill for implementing the Sixth Central Pay Commission recommendations significantly altered the deficit position of the Government. 3. The global financial crisis in the second half of the financial year which heralded recessionary trends the world over, also impacted the Indian economy causing the focus of fiscal policy to be shifted to providing growth stimulus. The moderation in growth of the economy and the impact of the fiscal measures taken to stimulate growth can be seen reflected in the estimates for gross tax revenue which stand reduced from Rs 6,87,715 crore in B.E.2008-09 to Rs 6,27,949 crore in R.E.2008-09. Additional budgetary resources of Rs.1,50,320 crore provided as part of stimulus package and various committed liabilities of Government including rising subsidy requirement, provision under NREGS, implementation of Central Sixth Pay Commission recommendations and Agriculture Debt Waiver and Debt Relief Scheme for Farmers contributed to the higher fiscal deficit of 6 per cent of GDP in RE 2008-09 as compared to 2.5 per cent of GDP in B.E.2008-09. 4. The Country is facing difficult economic situation, the cause of which is not emanating from within its boundaries. However, left unattended, the impact of this crisis is going to affect us in medium to long term. The Government had two policy options before it. In view of falling buoyancy in tax receipts, the Government could have taken a decision to cut expenditure and thereby live within the estimated deficit for the year. The second option was to increase public expenditure, even with reduced receipts, to stimulate economy by creating demand and maintain the growth trajectory which the country was witnessing in the recent past. The Government took the second option of adopting fiscal measures to increase public expenditure to boost demand and increase investment in infrastructure sector. Ensuring revival of the higher growth of the economy will restore revenue buoyancy in medium term and afford the required fiscal space to revert to the path of fiscal consolidation.
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Fiscal Policy for the ensuing financial year The Interim Budget 2009-2010 is being presented in the backdrop of uncertainties prevailing in the world economy. The impact of this is seen in the moderation of the recent trend in growth of the Indian economy in 2008-09 which at 7.1 per cent still however makes India the second fastest growing economy in the World. The measures taken by Government to counter the effects of the global meltdown on the Indian economy, have resulted in a short fall in revenues and substantial increases in government expenditures, leading to a temporary deviation from the fiscal consolidation path mandated under the FRBM Act during 2008-09 and 2009-2010. The revenue deficit and fiscal deficit for R.E.2008-09 and B.E.2009-2010 are, as a result, higher than the targets set under the FRBM Act and Rules. The grounds due to which this temporary deviation has taken place, are detailed in the Fiscal Policy Overview above and also in the Macro-economic Framework Statement being presented in the Parliament. The fiscalpolicy for the year 2009-2010 will continue to be guided by the objectives of keeping the economy on the higher growth trajectory amidst global slowdown by creating demand through increased public expenditure in identified sectors. However, the medium term objective will be to revert to the path of fiscal consolidation at the earliest, with improvement in the economic situation. Tax Policy Indirect Taxes During the first half of the fiscal year, the global spurt in commodity prices (crude petroleum, food items and metals) led to increases in domestic prices of essential items and industrial inputs, putting a severe inflationary pressure on the economy. Hence, the Government took several measures after the presentation of the Union Budget 2008-09, particularly on the Customs side, to contain the rising inflation, as detailed below:Customs
of food items, a sharp reduction was effected in the import duty rates on various food items such as semi-milled or wholly milled rice (70% to nil) and crude and refined edible oils (from 40%-75% to 20%-27.5%). On 01.04.2008, a further reduction was effected in the import duty rate- on all crude edible oils duty was reduced to nil, and on refined edible oils duty was reduced to 7.5%.
10.5.2008.
petrol and diesel to 2.5% (earlier 7.5%). Customs duty on other petroleum products was reduced from 10% to 5% on 04.06.2008.
inputs for this sector (zinc, ferro-alloys, metcoke) on 29.4.2008. Further, in order to increase the domestic availability and bring about moderation in prices, export duties were imposed on 17
many items in the iron and steel sector @ 15% ad valorem on pig iron, sponge iron, iron and steel scrap, iron or steel pencil ingots, semi finished products and HR coils/sheets, etc.
the prices of raw cotton and augment the domestic supply. Excise
from Rs 6.35 per litre to Rs 5.35 per litre and on unbranded high speed diesel (HSD), excise duty was reduced from Rs 2.6 per litre to Rs 1.6 per litre. In the post-October stage, while the inflationary pressures on the economy were subdued, the global meltdown and resultant slowdown of the Indian economy required review of the existing policy in favour of maintaining the growth momentum and retaining export markets. As such, the following policychanges were effected which would be reviewed in the ensuing financial year in the light of the macroeconomic situation particularly the growth of the manufacturing sector: Excise fiscal stimulus package was implemented. -the board reduction of 4 percentage points in the ad valorem rates of excise duty on non-petroleum items, with a few exceptions. Thus the three major ad valorem rates of Central Excise duty viz. 14%, 12% and 8% have been reduced to 10%, 8% and 4%, respectively.
proportionately. Customs
ty for the benefit of the aviation industry w.e.f. 31.10.2008.
exemptions provided earlier to combat inflation, on iron and steel items, zinc and ferro-alloys, were withdrawn w.e.f. 18.11.2008.
to imports of cement has been withdrawn w.e.f. 2nd January, 2009 to provide a cushion to domestic cement industry and boost demand. In the power sector, customs duty on naphtha used for generation of electricity by electrical generating stations has been fully exempted w.e.f. 2nd January, 2009 till the end of this financial year. Service Tax ers on various taxable services attributable to export of goods has been further extended to include clearing and forwarding agents services.
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services has been enhanced from 2% of FOB value to 10% of FOB value of export goods.
respect of exports. ecified services which are provided to goods transport agency have also been fully exempted from service tax. Direct Taxes 7. Over the last five years, widespread reforms have been ushered in the area of direct taxes. The reform strategy comprises the following elements: -
the tax rates.
deterrence levels. Both these objectives reinforce each other and have promoted voluntary compliance. -engineering business processes in the Income-tax Department through extensive use of information technology, viz., e-filing of returns; issue of refunds through ECS and refund bankers; selection of returns for scrutiny through computers; e-payment of taxes; establishing a Centralized Processing Centre and an effective taxpayer information system. These measures have substantially enhanced the direct tax revenue productivity from 3.81 per cent of GDP in 2003-04 to an estimated 6.35 per cent of GDP in 2008-09. Further, the share of direct taxes in the Central tax revenues is now significantly higher than the share of indirect taxes resulting in a substantial improvement in the equity of the tax system. Therefore, the reform strategy in the medium term is to consolidate the achievements of the past. 8. Since there is no change in the tax base and rates, the prospects of growth in direct tax collection in the ensuing financial year will remain unchanged vis-a-vis the revised estimate for the financial year 2008-09. Contingent and other Liabilities The FRBM Act mandates the Central Government to specify the annual target for assuming contingent liabilities in the form of guarantees. Accordingly the FRBM Rules prescribe a cap of 0.5 per cent of GDP in any financial year on the quantum of guarantees that the Central Government can assume in the particular financial year. The Central Government extends guarantees primarily on loans from multilateral/bilateral agencies, bond issues and other loans raised by various Public Sector Undertakings/Public Sector Financial Institutions. The stock of contingent liabilities in the form of guarantees given by the government has reduced from Rs 1,07,957 crore at the beginning of the FRBM Act regime i.e. 2004-05 to Rs 1,04,872 crore at the end of 2007-08. As a percentage of GDP, it has reduced from 3.4 per cent in 2004-05 to 2.3 per cent in year 2006-07 and further to 2.2 per cent for the year 200708.
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The disclosure statement on outstanding Guarantees as prescribed in the FRBM Rules, 2004 is appended in the Receipts Budget as Annex 3 (iii). Assumption of contingent liability in the form of guarantee by the sovereign helps to leverage private sector participation in areas of national priorities. In the current situation, wherein a large number of infrastructure projects are being cleared for implementation under the Public Private Partnership (PPP) mode, difficulties are being faced in reaching financial closure due to the current uncertainties in the global financial market. Within the given fiscal constraints and with a view to supporting financing of above mentioned PPP projects, the India Infrastructure Financing Company Limited (IIFCL) has been authorized to raise Rs 10,000 crore through Government guaranteed tax free bonds, by the end of 2008-09 and additional Rs 30,000 crore on the same basis as per requirement in the next financial year. The capital so raised will be used by IIFCL to refinance bank lending of longer maturity to eligible infrastructure projects. This initiative of the government is expected to result in leveraging of bank financing to PPP programmes of about Rs one lakh crore. The likely assumption of contingent liability in the form of guarantee for 2008-09, including the above mentioned Rs 10,000 crore for IIFCL, will amount to Rs 36,606 crore which will be 0.67 percentage of GDP during 2008-09, higher than the target of 0.5 per cent of GDP set under the FRBM Rules. This deviation has been necessiated in the larger interest of re-invigorating the economy in the background of the current economic scenario, to stimulate demand and increase investment in infrastructure sector projects. In the medium term while this may not have a potential budgetary impact, the additional demand thus created will help restore the economy to its higher growth path and contribute to higher revenue buoyancy which has shown a slump in the current financial year due to moderation in the growth in economy. Government Borrowings, Lending and Investments 11. The Government policy towards borrowings to finance its deficit continues to remain anchored on the following principles namely (i) greater reliance on domestic borrowings over external debt, (ii) preference for market borrowings over instruments carrying administered interest rates, (iii) elongation of the maturity profile and consolidation of the debt portfolio and (iv) development of a deep and wide market for Government securities to improve liquidity in secondary market. 12. In the first half of the current financial year, the government borrowing was in line with the indicated auction calendar decided upon in consultation with the Reserve Bank of India. However, due to the need to provide the fiscal stimulus to counter the situation created by the effects of the global financial crisis, the borrowing calendar of the government had to be revised in the second half of the current financial year. The gross and net market borrowings (dated securities and 364- day Treasury Bills) of the Central Government during 2008-09 (up to February 9, 2009) amounted to Rs 2,40,167 crore and Rs 1,68,710 crore, respectively. As part of policy to elongate maturity profile, Central Government has been issuing securities with maximum 30--year maturity.
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The weighted average maturity of dated securities issued during 2008-09 (up to February 9, 2009) was 14.45 years which was marginally lower than 14.90 years during the corresponding period of the previous year. The weighted average yield of dated securities issued during 2008-09 (up to February 9, 2009) was 7.91 per cent and was lower than 8.12 per cent during the corresponding period of last year. 13. Consequent to the transition to the FRBM Act mandated environment, recourse to borrowing from RBI under normal circumstances is prohibited. During the year 2008-09 (up to February 7, 2009) the Central Government resorted to ways and means advance to meet the temporary mismatch in receipts and expenditure for 77 days as compared with 91 days a year ago. The daily average utilization of ways and means advance by the Central Government was Rs 7,383 crore as compared with Rs 14,498 crore a year ago. The Central Government also availed of Overdraft (OD) for 24 days up to February 7, 2009. The daily average of OD was Rs.11,233 crore as compared with Rs 6,381 crore a year ago. 14. The outstanding balance under Market Stabilization Scheme (MSS) on 1st April, 2008 was Rs 1,70,554 crore. Notwithstanding fresh issuance of Rs 43,500 crore during 2008-09, the outstanding balance under the MSS declined to Rs 1,05,773 crore mainly reflecting the change in policy and unwinding MSS through buyback of Rs 47,544 crores. This was done in order to ease liquidity in the system in the backgrounds of the additional borrowing plan during the second half of 2008-09 to finance the increased deficit. 15. In order to have prudent management of debt and greater focus on carrying cost as well as meeting secondary market liquidity, the government has set up a Middle Office which in due course will merge with the proposed Debt Management Office. 16. Central Government has stopped playing the role of financial intermediary for State Government for domestic market borrowings and the trends in the current year shows that this transition has been very smooth resulting in reduction in cost for the State Governments while at the same time bringing in a sense of market discipline. 17. Government has set up National Investment Fund (NIF) to which the disinvestment proceeds from Central PSUs are being transferred. This fund is being managed by professional fund managers. The receipts in the Fund are not reckoned as resources for the purpose of financing the fiscal deficit. The income from investments under NIF is used to finance social infrastructure and provide capital to viable public sector enterprises without depleting the corpus of NIF. Initiatives in Public Expenditure Management 18. The focus has shifted from financial outlays to outcomes for ensuring that the budgetary provisions are not merely spent within the financial year but have resulted in intended outcomes. Initiatives have been taken to evenly pace plan expenditure during the year and also to avoid rush of expenditure at the year end which results in poor quality of expenditure. The practice of restricting the expenditure in the month of March to 15 per cent of budget allocation within the fourth quarter ceiling of 33 per cent is being enforced religiously. The quarterly exchequer control based cash and expenditure management system which inter alia involves preparing a Monthly Expenditure Plan (MEP) continues to be followed in select Demands for Grants. The emphasis is on right pacing plan expenditure by ensuring adequate resources for execution of budgeted schemes. At the same time, steps have also been taken in 21
the form of austerity instructions to reduce expenditure in non-priority areas without compromising on operational efficiency. This has resulted in availability of adequate resources from realised receipts for priority schemes. 19. Delays in receipts of utilization certificate are broadly indicative of poor implementation strategy, diversion of funds or delay in utilization of funds for intended purposes. Monitoring of utilization certificates and unspent balances with the implementing authorities is reviewed at the highest level in the Ministry of Finance. Necessary control mechanisms have been put in place with the help of the office of the Controller General of Accounts (CGA) to avoid parking of funds and to track expenditure. 20. A central monitoring, evaluation and accounting system for the 1258 centrally sponsored schemes and central sector schemes of the Government has been instituted under the Central Plan Schemes Monitoring System. All sanctions issued by the Central Ministries under these schemes are now identified with a unique sanction ID that enables the tracking of release as per their accounting and budget heads across the different implementing agencies. This central system is hosted on the e-lekha portal of the CGA. 21. In addition pilots are currently underway in the States of Punjab, Karnataka and Uttarakhand for testing a system for expenditure filing and direct payment to beneficiaries under the schemes. The results of the pilot would form the basis of designing comprehensive IT based Decision Support System and Management Information System for all the centrally sponsored schemes and central sector schemes. This initiative assumes special significance in the light of the significant increase in the social sector spending by the Government. 22. The application software COMPACT has been extended to all civil ministries of the Government and expenditure data is being uploaded on a daily basis by the Pay and Accounts Offices on e-lekha. This is a significant step towards faster and accurate compilation of the accounts for the Government of India and will lead to the development of a core accounting solution. The monthly and annual Finance and Appropriation Accounts are regularly updated on the CGA website: www.cgaindia.gov.in. Policy evaluation 23. The process of fiscal consolidation during the FRBM Act regime has created necessary fiscal space to undertake much needed social sector expenditure and provide for higher infrastructure outlays. The performance up to 2007-08 was heartening. Fiscal deficit was brought down from 4.5 per cent of GDP in 2003-04 to 2.7 per cent in 2007-08. Similarly, revenue deficit was reduced from 3.6 per cent of GDP in 2003-04 to 1.1 per cent in 2007-08. The government was steadfast in following the fiscal consolidation path which is reflected in the deficit estimates of B.E.2008-09. However, subsequent to the global meltdown, there was a compelling need to adjust the fiscal policy to take care of exceptional circumstances through which the economy has been passing. The result of the fiscal measures taken by the Government for containing inflation has been positive as is evident from headline inflation dropping from high of 12.9 per cent in August 2008 to 4.39 per cent in January 2009. Similarly the intervention of the Government has ensured that the economy grows at a healthy rate of 7.1 per cent in a difficult year when most of the developed economies are facing recession. The fiscal consolidation process has to be put on hold temporarily. 22
The process of fiscal consolidation will be back on track once there is an improvement in economic conditions. Economic indicators show onslaught of recession Data for November-January shows steep drops in economic activity. Adrian Filut26 Feb 09 15:35 Export of goods fell by 6.4% in November 2008-January 2009, imports of raw materials fell 11.3%, industrial output fell 0.9%, and trade and services proceeds fell 8.4%, the Central Bureau of Statistics reported today in an onslaught of gloomy economic news that show that the recession has arrived. The slump in export of goods, excluding diamonds, ships, and planes, was an annualized 23.3%, and follows the annualized 22% drop in August-September 2008. Trend figures show that high-tech exports fell by an annualized 0.6% in November-January, after falling by an annualized 15.7% in August-September; mixed high-tech exports fell by an annualized 21.8% in November-January, after falling by an annualized 20.4% in August-September; and mixed low-technology exports fell by an annualized 57.7% in November-January, after falling by an annualized 51% in the preceding three months; but low technology exports rose by an annualized 0.2% in November-January, after rising by an annualized 5.8% in the preceding three months.
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From the above graph, it is evident that the private consumption has drastically gone down from quarter1 of 2009 to quarter 3 of 2009. This reflects that the average Indian consumer is losing confidence to buy and consume. To make up for this loss in the GDP, the government of India, like any other government would do, has increased consumption expenditure and hence helped the nation to maintain the real GDP. The Investments have come down from 10.1 billion dollars in q1 to 5.3 billion dollars, almost a 50% decrease in the investments. All these factors have led to an overall decrease in the real GDP of the country. However, classically recessions have not last longer than 12 -18 months baring few aberrations. Hence, as of now there is very low probability of India getting into recession.
BSE500
8000 7000 6000 5000 4000 3000 2000 1000 0 Jan/08 Feb/08 Apr/08 Jun/08 Jul/08 Sep/08 Oct/08 Dec/08 BSE500
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The returns from the BSE 500 portfolio has been going down continuously from January 2008 to December 2008. This is due to the financial crisis in the US. The reduction in share prices have caused an erosion in the wealth of the share holders. This has contributed ti the decrease in the GDP.
The rupee has been depreciating continuously against dollar and Euro as shown in the above graph. Thus the exports of Diamonds and other precious items have gone down. The GDP has gone down because of this factor also.
GDP GROWTH RATE OF INDIA
12 10 8 6 4 2 0 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 -2 -4 -6 2006 IND
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Real GDP Trend
10 9 8 7 6 5 4 3 2 1 0 Jan/07 Apr/07 Aug/07 Nov/07 Feb/08 Jun/08 Sep/08
Real GDP Trend
Repo rates
9 8 7 6 5 4 3 2 1 0 12/Apr/08 01/Jun/08 21/Jul/08 09/Sep/08 29/Oct/0818/Dec/0806/Feb/0928/Mar/09 Repo rates
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. January 21 and 22 saw a meltdown with a mind-boggling US$450 billion in market capitalization being vaporized. An unprecedented interest cut by the Fed led to a bounce-back on January 23 and at the time of this 26
writing, the benchmark index (BSE) has gained 2.5%, almost in line with Hang-Seng, Nikkei, and Kospi. 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%. 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. Here are some areas worth following: 1. A credit crisis in the United States might lead to a restructuring of asset allocation at pension funds. It has been suggested that CalPERS is likely to shift an additional US$24 billion to its international portfolio. A large portion of this is likely to flow into India and China. If other funds follow suit, a cascading effect can be expected. Along with the already significant dollar funds available, the additional funds could be deployed to create infrastructure--roads, airports, and seaports--and be ready for a rapid takeoff when normalcy is restored. 2. 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--a classic case of having put all eggs in one basket. If Fortune 500 companies slash their IT budgets, Indian firms could be adversely affected. Instead of looking at the scenario as a threat, the sector would do well to focus on product innovation (as opposed to merely providing services). If this is done, India can emerge as a major player in the IT products category as well. 3. The manufacturing sector has to ramp up scale economies, and improve productivity and operational efficiency, thus lowering prices, if it wishes to offset the loss of revenue from a possible US recession. The demand for appliances, consumer electronics, apparel, and a host of products is huge and can be exploited to advantage by adopting appropriate pricing strategies. Although unlikely, a prolonged recession might see the emergence of new regional groupings--India, China, and Korea? 4. The tourism sector could be affected. Now is the time to aggressively promote health tourism. Given the availability of talented professionals, and with a distinct cost advantage, India can be the destination of choice for health tourism. 5. A recession in the United States may see the loss of some jobs in India. The concept of Social Security, that has been absent until now, may gain momentum. 27
6. The Indian Rupee has depreciated in relation to the US dollar. A stronger Rupee would reduce the import bill, and narrow the overall trade deficit. The Indian central bank (Reserve Bank of India) can intervene anytime and cut interest rates, increasing liquidity in the economy, and catalyzing domestic demand. A strong domestic demand would also help in competing globally when the recession is over. 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.
FUTURE EFFECTS OF CURRENT CONTRACTION ON VARIOUS SECTORS OF INDIA
The year 2008, one of the worst years in the world?s economic history, experienced a major global meltdown. This global meltdown led to job lay-offs across the world. According to the Labor Department?s report, the unemployment rolls swelled by 2.2 million, over the last year, to 9.5 million.
INDIAN STOCKS
Markets across the world have entered 2009 with an unprecedented amount of uncertainty, volatility, losses and, above all, fear.The concern of what the New Year will bring in terms of returns from financial assets, especially equities, is paramount on every investor?s mind. To find the answers to how Indian equities will perform in 2009, we should take a look at 2008 and assess why this turmoil started in the first place. The problems started with defaults in the US housing markets, which later spread to the entire financial market. Losses in real estate-related instruments forced institutions to sell assets across the board in all markets to meet liquidity challenges — assets related to real estate became almost illiquid. The problem intensified as some of the institutions were highly leveraged, which resulted in a free fall of prices for most financial assets, including equity. The tight liquidity problem made its way to the real economy — production and consumption started getting affected. The result: a bleak global economic outlook for 2009. Economy As we move into 2009, the baggage of excesses created in the last few years will continue to haunt us. We haven?t yet totally adjusted to the ripple effects of the sub-prime crisis. Also, the ongoing process of de-leveraging will continue to put pressure on all financial assets for some more time. We believe that the global economic condition will worsen before it starts improving. The good thing in this turmoil is unprecedented response from central banks and governments across the world, which helped avoid any kind of systemic failures. Experts believe that timely intervention will make the landing safer and help early recovery.
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The case of Indian equities Indian markets fell in line with global developments and lost in excess of 50 per cent in 2008. The price damage is significant in some sectors. For example, all stocks in the BSE Realty Index have lost in excess of 80 per cent (except Akruti City) since January 2008. The correction has been so severe that with the market cap of DLFin January 2008, you can now buy all the companies, including DLF, in the realty index two times over, and still be left with spare cash. The realty sector is not the only one feeling the pain. Stocks have fallen across the board, and we don?t have a single sectoral index in green. The FMCG Index has shown some resistance, but it, too, has lost close to 13 per cent since the beginning of 2008.
The way ahead
The Indian equity market will continue to track global developments in 2009. In 2008, market participants learned that there?s nothing called decoupling of financial markets. Apart from global events, domestic factors, such as earnings growth, GDP growth, and the general elections — the biggest event of the year — will also play their part. The third quarter results will be disastrous and the fourth quarter results are unlikely to show any great improvement either. We believe that markets in initial stages will be range bound, trying to find a bottom. Recovery will not be sharp as there has been collateral damage in the system. But we expect decent returns from the current levels. At the moment, it is extremely difficult to put figures for sales volume, margins, interest rates, and currency risk for Indian Corporates. This, in turn, is not allowing analysts to calculate profits for the coming quarters. However, some positive developments are not getting counted due to wider negative sentiments in the market. The outlook for 2009, in terms of commodities, is of softer prices. The peak of interest rates is behind us and it should only go down from here. The combination of these two factors means that the earnings outlook is far more optimistic going forward compared to what it is in retrospective terms. Apart from global events and the domestic earnings outlook, which will affect investors? sentiments, the outcome of the general elections will play a major role. If the verdict is fractured, it will be difficult for the government to focus on development as it will end up spending more time on its survival. Analysts believe that the outcome of the assembly elections held in 2008 had a strong message — development. This will encourage the current government to push speedy implementation of projects during its remaining tenure, and this will have a positive impact on the broader economy and the markets. Investors entering the markets at this stage should have at least a 3-year investment horizon. We believe that the worst is not yet over and bad news will continue to flow in for some more time. The first two quarters of 2009 will be crucial for the markets as well as the economy. Markets will start recovering with the first sign of stability in the global economy. However, don?t expect it to bounce back to the January 2008 highs in a hurry. The global risk aversion is likely to continue for some more time, and the excess liquidity, which was there in the system till early 2008, is not available anymore. Also, we will not see the kind of liquidity we saw in last few years. 29
The large government deficits, which the developed markets are creating for bailouts and stimulus packages, will result in a supply of sovereign bonds, which will suck liquidity from the system. The global liquidity situation is not allowing the money to flow into equities and forcing the institutions to sell, either to meet redemption pressure or to generate cash for their own survival. At the same time, individuals and institutions, which have cash, are staying away from the market as they anticipate further corrections and are waiting to buy at lower levels. In such a scenario, stock selection becomes extremely important because now prices will be based on the earnings expectations and not on PE expansions.
BANKING
The Indian banking system is relatively insulated from the factors leading to the turmoil in the global banking industry. Further, the recent tight liquidity in the Indian market is also qualitatively different from the global liquidity crunch, which was caused by a crisis of confidence in banks lending to each other. While the main causes of global stress are less relevant here, Indian banks do face increased challenges due to domestic factors. The banking sector faces profitability pressures due to higher funding costs, mark-to-market requirements on investment portfolios, and asset quality pressures due to a slowing economy.The strong capitalisation of Indian banks is a positive feature in the current environment. The problems of global banks arose mainly due to exposure to sub-prime mortgage lending and investments in complex collateralised debt obligations whose values have seen sharp erosion. Globally, banks have also been affected by the freeze in the inter-bank lending market due to confidence-related issues. On both counts, Indian banks have limited vulnerability. Indian banks? global exposure is relatively small, with international assets at about 6 per cent of the total assets. Even banks with international operations have less than 11 per cent of their total assets outside India. The reported investment exposure of Indian banks to distressed international financial institutions of about USD1 billion is also very small. The mark-to-market losses on this investment portfolio, will, therefore, have only a limited financial impact. Indian banks? dependence on international funding is also low. The reasons for tight liquidity conditions in the Indian market in recent weeks are quite different from the factors driving the global liquidity crisis. Some reasons include large selling by Foreign Institutional Investors (FIIs) and subsequent Reserve Bank of India (RBI) interventions in the foreign currency market, continuing growth in advances, and earlier increases in cash reserve ratio (CRR) to contain inflation. RBI?s recent initiatives, including the reduction in CRR by 150 basis points from October 11, 2008, cancellation of two auctions of government securities, and confidence-building communication, have already begun easing liquidity pressures. The strong capitalisation of Indian banks, with an average Tier I capital adequacy ratio of above 8 per cent, is a positive feature in their credit risk profile. Nevertheless, Indian banks do face challenges in the current Indian economic environment, marked by a slower gross domestic product growth, depressed capital market conditions, and relatively high interest rate regime. The profitability of Indian banks is expected to remain under pressure due to increased cost of borrowing, declining interest spreads, and lower fee income due to slowdown in retail lending. Profit levels are also likely to be impacted by mark-to-market provisions on investment portfolios and considerably lower profit on sale of investments, as compared with previous years. Moreover, those Indian banks considering accessing the capital markets for shoring up capital adequacy may be forced to curtail growth plans, if 30
capital markets remain depressed. While these challenges will play out over the medium term, we expect the majority of Indian banks? ratings to remain unaffected, as they continue to maintain healthy capitalization, enjoy strong system support and benefits of government ownership in the case of public sector banks.
AUTO
India has been relatively unaffected by the direct impact of the economic slowdown; however, the ripple effects are very much here. Despite the government?s sops, auto sales have declined in November by 18%. As demand slows down, auto makers like Tata Motors, Hyundai and Ashok Leyland have cut down production. It is unlikely that sales will rise in December either, forcing carmakers to keep prices low until the time demand picks up. In December, customers generally prefer not to buy vehicles and wait for the new year. The real impact of the tax cut, if any, will be clear in only by the end of January 2009. Most car launches planned for India towards the begining of 2009 have already been quietly pushed forward by „a few months?. Looming over the bleak economy is the potential collapse of America?s Big Three automakers General Motors, Chrysler and Ford. If any of these companies with trancontinental operations go bust, it can spark a chain reaction, pulling down operations in numerous countries, affecting even successful rivals lke Toyota and Honda and leading to millions of jobs losses across borders. It is true that the Indian arms of the troubled three US auto companies have been doing rather well. However, buyers tend to avoid cars which have foreign parents in trouble.This is because they fear a potential disruption in services and warranties if the parent companies go bankrupt. In the US too, General Motors has - so far shied away from filing for restructuring under bankruptcy, since it fears that people will not buy cars from a company under Chapter 11 protection. A bankruptcy at any of the Big Three can, in theory, force consumers to cut out that company?s cars while looking for a new set of wheels. This could be true of consumers in India as well. After much leading and grovelling, the US car CEOs managed to get a $15 billion loan from the US government, which they must repay by March if they fail to come up with a viable restructuring plan during that time. Simply put, they will have to cut thousands of jobs, renegotiate many contracts, abandon several car brands and get their creditors to agre to easier repayment terms. This is not going to be an easy task for the employers nor he employees, but that is the only way these companies will be able to keep their heads above water during these stormy times. And, since the loan is tied to their ability to restructure viably, a potential failure to do so can still drive them to bankruptcy. The auto bakruptcies can create a riple effect across nations. In India, China and Mexico, there are thousands of companies supplying a steady stream of parts - ranging from light bulbs to transmission systems - to the Big Three automakers in the US. With car sales declining in the US, these suppliers are ?already in trouble and a bankruptcy at Detroit can send hundreds of them belly-up across countries, and render additional lakhs of workers jobless. Just last financial year, India exported Rs 14,400 crore worth of components to the US alone.This year, it will be substantially less. There is the fact that in India, the effects of the slowdown are already well visible. The days of quick job-hopping are over, and so are big increments are salary hikes. Unlike the average customer in the US, Indians have always been keen on saving. With uncertainty on the horizon, the Indian customer is saving even more - and as they save more, the less they spend, leading to a further showdown in sales in all industries. It is a vicious circle, with no easy way out. 31
There is a silver lining in all this, though. A restructured US auto industry might turn out to be leaner and meaner. The Japanese companies are more efficient and are working towards even more efficiency, learning the right lessons from the crisis. No one expects the slowdown to last more than an year, though things would be tough in that period for sure. However, anyone who is financially secure and have plans for a car should not think twice. After the tax cut, prices for vehicles are really attractive, and dealers desperate for sales might offer even more discounts.
TEXTILE
The future outlook of the Indian textile industry is predicted to remain gloomy for 2009 due to negative impact of the recession on international markets. Textile exports tumbled nearly 30% and the production contracted 20%-30% since April 2008. If one takes orders placed into account, then the export in the current year dropped even more. As per the available data, orders placed in the third quarter of 2008 by leading exporters slumped 15-20% on an average whereas the sales in domestic market slammed 10-15% on year-on-year basis. The grim outlook for the Indian textile industry for next year is forecasted in the backdrop of forex losses and economic slowdown in the international market. These factors along with lengthening cash cycles and rising working capital requirements have put extensive pressure on the short-term liquidity of the industry. Moreover, the impact of the global financial crisis was inevitable to fall on the Indian economy, resulting in drying up of investments in the country. Manufacturing sector will certainly see the direct impact of the crisis. The Indian textile industry rallied under declining domestic demand and high input costs in the current year. Drop in demand from external markets (like the US and Europe, both absorb nearly 50% of the total production) created panic among manufacturers who have started trimming production in a phased manner. Indian companies have adopted a policy of temporarily discharging workers to deal with menace of the global economic meltdown. Not only this, textile manufacturing units at major hubs like Delhi, Bangalore and Tirupur have been closed, rendering thousands of people jobless. The industry had asked the Ministry of Textiles to continue the interest subvention on credit for packing across value chain. The global financial crisis has made the Indian textile industry to bleed white because it is driven by exports and the present scenario is likely to remain as it is until December 2009. As the effect of recession is higher on developed markets, the demand is expected to remain weak. This will be visible in the financial performance of exporters in the current financial quarter.
REALTY
Rentals plunged and even freebies offered by realtors failed to pep up demand. Reports had it that there are no takers for Mumbai 100cr flats. Profits for most realtors listed in the Bombay Stock Exchange reflect downturn in the sector. BSE Realty index plunged by 25per cent in last one month and 75per cent in last one year. Second quarter results indicated that DLF (once responsible for raising $2bn from the capital market) logged a 4% drop in net profits. Omaxe reported a whopping 87% drop. Realty bubble bust is even impacting hospitality sector as hotel developers have cut down on budgets owing to slow business traffic.
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CBDs markets are likely to face vacancies in 2009, as the first impact of the global recessionary economy is being felt by the financial and other fore-runner organizations. The vacancy may be further fuelled in CBD areas by the consolidation moves of many organizations. We will also see a reversal of the trend witnessed over the last two expansionary decades where large organizations moved from owned to leased assets. Given the drop in prices and availability of choice properties, this will be a good time for surviving organizations to announce their new leadership positions through trophy purchases. Jones Lang LaSalle Meghraj is currently transacting in many such mandates. This CBD vacancy rate, if triggered, can add significant pressure to the upcoming/newly developed premises in upcoming front-office districts such as Lower Parel in Mumbai and Nehru Place in Delhi. While the sentiment in the US and Europe towards outsourcing is positive in the long term, as the corporations there realize its need more than before, the active decision-taking for expansion by BPOs is totally suspended for the moment. We do not expect this to change in the 2009. Hence, the pressure on upcoming and announced projects -especially SEZs - will continue in 2009. In 2009, IT SEZs will also experience further pressure from the fact that the STPI concessions may be extended for another couple of years. While these concessions are important for IT companies? survival during the recession, they will adversely impact SEZ developments. In 2009, the peripheral areas of metros as well as the Tier II/III cities will need to compete with the central or secondary business districts for the same set of talents, thus dissolving the clear segmentation which was emerging and separating various micro-markets over the last couple of expansionary years. Newly developed or announced projects are especially going to suffer and may see continued vacancy in 2009. However, 2009 will also see practices in the real estate business become more organized and professional, as they did in the late „90s and early 2000s with the introduction of FIs, foreign money and the creation of Government-supported large development formats. This time around, a similar professional approach may reach warehousing land acquisitions.
ENERGY
Oil prices are appearing to reflect state of economies. Rising prices between 2003 and 2007 reflected the best economic growth in the recent times. This high economic growth was brought to an end not only by under-pricing of risk, excess liquidity and over-confidence but also by an increasingly unsustainable commodity boom - of which oil was a crucial part. Now, as the world has dropped into recession, oil prices have fallen by around 80% (as we write) from the high of $147/bbl to touch $33/bbl. While shortage of refining capacity was considered as the prime reason for increase of crude prices, now the same refineries are going under due eroding GRMs. For example, the profitability of RIL's new refinery is projected to come under severe pressure. The other elements of energy chain are no better whether it is the collapsed rig markets or delayed construction of new power projects. Rising prices for a long term gestation projects also mean domino effect in terms of delayed decisions by consumers, governments and businesses that have changed the course of demand. Another matter of concern is that Indian economy is also appearing to be cooling down faster than expected. People may cheer fast declining inflation rate but it is also a dangerous indicator towards declining economic activity. All hydrocarbon products consumption took a nose dive of more than 15% from May 2008 to October 2008. Though, the fall in oil prices and economy in general is a great relief to hard-pressed consumers and the fall in oil prices is a sort of de facto tax cut - a stimulus package that does not have to be approved by the Parliament or paid for out of RBI's efforts. Lower prices are forcing energy companies to cut their budgets, hold back on starting some new projects and look for new survival gymnastics by retrenching people and cutting down expansion 33
plans, developing efficient processes and optimising systems. This will make itself felt in a new turn of the cycle after an economic recovery. Probably, every recession contains the seeds of the new economy order. The lower costs will start making sense for a lot of new businesses ideas that would become profitable and thus a whole of new generation of activities would take over. But what would be those activities? The energy policies of the new India, as in other countries, will emphasise greater energy efficiency and renewables. A "green stimulus programme" is already high on the transition agenda. But the worried question around the economy now is: to what degree lower prices will crimp investments in existing and new projects. The answer will not be determined just by energy prices, important as they are. The biggest impact will come from the health of the economy, the nation's fiscal position and the availability of capital and credit. With the impaired credit system, resources for energy capex and opex purposes are likely to be severely constrained. In such circumstances, it is important that a collaborative efforts are made to understand how deep the problem is and what are the best survival strategies. Rather, how can these problems are turned into opportunities for a robust performance in the revived economic future. This one day programme has been designed specifically to seek answers to these questions from the industry veterans, the leading consultants and the players themselves. Probably the new mantra for survival is to synergize and join together.
INSURANCE
Insurance is to provide for a future contingency. As the premium has to come from savings, it gets the last priority after meeting the immediate needs. For this reason insurance requires selling through persuasion. Economic recession and unemployment will adversely affect growth of insurance business and build-up of funds. Insurance like banking is a strong pillar of the economy and needs to be immunized against the ill effects of recession. Otherwise the economy as a whole will suffer.
In life insurance, initial symptoms will be default in payment of premiums followed by surrender of policies in force. For the first time in the last fifty years this is a major threat to the growth of insurance. It can create a crisis of confidence.General insurance will also be affected due to economic slow down and decline in production and consumption.
MANUFACTURING
The global financial malaise has had a significant feed-through effect to India. According to a report inlate October in India's daily Business Standard, the interest rates for project financing operations rose to14% -16% from 9%-11% before the summer. This jeopardises the financial viability of highway projectsworth over US$2bn, which in turn represent approximately 40% of projects that have been approved bythe National Highways Authority. This of course will delay the realisation of the government's ambitionsto fast track highway construction through the National Highway Development Programme, the firstphase - the multi-billion dollar 'Golden Quadrilateral' programme. India's infrastructure sector has registered strong growth in recent years, with 2006 and 2007 witnessing real construction sector growth of 20% and 14% per annum respectively, thanks to strong activity by both private and public sources. This development has been spurred by a virtuous cycle of strong economic growth, rising government revenues and foreign investment, which has begun to pull the under-developed infrastructure sector up by its bootstraps. However, this progress is now threatened by the global financial crisis and economic downturn, which has seen foreign investment 34
flows to the country reverse. Exports are also under pressure, undermining economic growth and government revenues. As such, future funding for infrastructure from both the public sector and the private sector is very much threatened. The government is attempting to find ways to underpin the infrastructure sector, and the economy as awhole. One proposal is for the government to subsidise loans by effectively setting a ceiling lending rateand absorbing the costs of the higher rates. But the government's ability to fund such projects has itslimits, given its own significant (and growing) fiscal constraints. In this context, rating agency Fitch hasexpressed considerable concerns about the outlook for the infrastructure sector, especially given thatmany key projects require imminent refunding. This pending refinancing and debt re-structuring 'couldnot have come at a worse time', according to the rating agency. On the plus side, multilateral support is significant. As reported in December 2008, India was granted anew US$3bn loan from the World Bank for infrastructure spending. For the time being, we have reviseddown our forecast for real growth in India's construction sector to 5.7% in 2009, from a previous forecastof over 10%. We estimate real construction sector growth in 2008 to have been just under 9%, comparedto just over 14% in 2007. For 2010, we currently forecast that real construction sector growth willrebound to 9%. Risks to our forecasts are very much to the downside. Much depends on how prolonged the recession indeveloped markets lasts, and whether the financial crisis will resurface. Our core global scenarioenvisages a recovery in most key markets in 2010, but the outlook is extremely uncertain and thisscenario is by no means guaranteed. Indeed, the US (and other economies) could remain in recession in2010, further starving India of export revenues and capital to finance its infrastructure development, justat a time when major projects are due to be refinanced. As such, there is a particularly severe downsiderisk to our 2010 infrastructure forecasts.
REASONS BEHIND A TYPICAL RECESSION
Recessions have a variety of causes and a wide range of symptoms. 1. Some causes are domestic in origin, stemming from policy mistakes on behalf of the economic authorities. For example, the central bank might allow the money supply to grow too slowly and keep interest rates above the level needed to maintain a steady rate of growth. Higher interest rates have the effect of dampening down spending by both households and businesses and can lead to plant closures and job losses. 2. External shocks can also bring about recession. For example in 1973-74 the large jump in world oil prices caused a sharp rise in cost push inflation and an acceleration in wages. Falling real purchasing power of consumers and a deflationary fiscal and monetary policy from the government sent the economy into reverse. 3. Inflation is another main factor which contributes more towards the situation. The higher the rate of inflation, the smaller the percentage of goods and services that can be purchased with the same amount of money. This may be because of increased production costs, higher energy costs and national debt. When the prices of goods reach their ever higher stage, people tend to cut on overall spending, luxurious spending, restrict them towards basic necessities and thus save more n more. As a result, GDP declines when people begin to cut expenditures in order to cut down costs. This makes the companies to cut their costs as well and they chuck out workers which brings unemployment.
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4. Another one of the important causes of economic recession is falling demand for goods and services. It's not hard to understand that if we produce more than we are consuming, the demand for the excess production just won't be there, and we have a waste of resources. 5. Economic recessions are caused by a decline in GDP growth, which is itself caused by a slowdown in manufacturing orders, falling housing prices and sales, and a drop-off in business investment. The result of this slowdown is falling employment, and rising unemployment, which causes a slowdown in retail sales. This creates a downward spiral in manufacturing and increased layoffs. 6. High interest rates are also a cause of recession. That's because it limits liquidity, or the amount of money available to invest.
CHARACTERISTICS OF A TYPICAL RECESSION
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Declining demand for output leading to higher levels of spare productive capacity Contracting employment / rising unemployment as firms lay-off workers to control their costs (see the chart below) A sharp fall in business confidence & profits A decrease in fixed capital investment spending because there is insufficient demand to justify new capital projects De-stocking and heavy price discounting - this leads to lower inflation Reduced inflationary pressure in the labour market as unemployment rises Falling demand for imports Increased government borrowing
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PREDICTING NEXT RECESSION USING ARIMA MODELS
ARIMA MODEL
In statistics and econometrics, and in particular in time series analysis, an autoregressive integrated moving average (ARIMA) model is a generalisation of an autoregressive moving average or (ARMA) model. These models are fitted to time series data either to better understand the data or to predict future points in the series. They are applied in some cases where data show evidence of nonstationarity, where an initial differencing step (corresponding to the "integrated" part of the model) can be applied to remove the non-stationarity. The model is generally referred to as an ARIMA(p,d,q) model where p, d, and q are integers greater than or equal to zero and refer to the order of the autoregressive, integrated, and moving average parts of the model respectively. Here we have predicted the next recession using these models by taking past 50 years GDP growth rate of USA as input to the model to predict future GDP growth rates till 2021.USA is taken as the past behavior of recessions are predominantly seen by fall in GDP growth rate of USA. Output of ARIMA Model
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Estimates at each iteration Iteration 0 1 2 3 4 5 6 7 SSE 305.672 253.840 216.043 192.445 183.147 182.992 182.991 182.991 0.100 -0.043 -0.186 -0.328 -0.470 -0.488 -0.490 -0.490 Parameters 0.100 0.100 0.100 -0.050 -0.028 -0.017 -0.200 -0.157 -0.135 -0.350 -0.288 -0.255 -0.500 -0.418 -0.376 -0.521 -0.437 -0.394 -0.522 -0.438 -0.395 -0.522 -0.438 -0.395 0.080 0.101 0.116 0.124 0.126 0.123 0.122 0.122
Relative change in each estimate less than 0.0010 Final Estimates of Parameters Type AR 1 AR 2 AR 3 AR 4 Constant Coef -0.4897 -0.5219 -0.4382 -0.3952 0.1224 SE Coef 0.1445 0.1480 0.1485 0.1453 0.3033 T -3.39 -3.53 -2.95 -2.72 0.40 P 0.002 0.001 0.005 0.009 0.689
EQUATION
ifferencing: 1 regular difference Number of observations: Original series 48, after differencing 47 Residuals: SS = 181.545 (backforecasts excluded) MS = 4.323 DF = 42 Modified Box-Pierce (Ljung-Box) Chi-Square statistic Lag Chi-Square DF P-Value 12 12.0 7 0.099 24 28.1 19 0.081 36 34.2 31 0.316 48 * * *
WE HAVE ESTIMATED FUTURE VALUES OF GDP GROWTH RATE OF USA USING ARIMA(4,1,0) MODEL SINCE P-VALUES OF ALL THE COEFFIIENTS HERE ARE LESS THAN 0.05 HENCE SIGNIFICANT FOR THE PREDICTION.BY TAKING DIFFERENCES OF TWO ADJACENT YEARS? GDP GROWTH RATE WE FIND THE ESTIMATED EQUATION TO BE:Y(T)-Y(T-1)=-0.4897*[Y(T-1)-Y(T-2)]-0.5219*[Y(T-2)-Y(T-3)]-.4382*[Y(T-3)-Y(T-4)]0.3952[Y(T-4) -Y(T-5)]+.1224, where Y(T)= GDP GROWTH RATE AT TIME t=T (YEARLY) EXTRAPOLATING THE DATA GDP GROWTH RATES UPTO 2021 ARE:2003 2004 2005 2006 2007 2008 2009 2010 2011 2.5 3.9 3.2 2.9 2.3 1.1 2.53 2.96 2.89 37
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
3.10 3.33 2.99 2.18 2.52 2.86 2.94 2.89 2.71 2.78
GDP GROWTH RATE OF USA WITH PREDICTION TILL 2021
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NEXT RECESSION
6 4 2 0
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Series1
HENCE WE PREDICT THAT THE NEXT RECESSION WILL OCCUR NEARABOUT YEAR 2015.
2021
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doc_456363415.docx
current recession in detail and recessions of the previous three decades in brief. The project gives a brief overview of the other post-war recessions. It outlines the fiscal and monetary policy response to current recession and its future effects on various sectors in India. It also looks at theories of why recessions occur.
Current Recession How long? How deep?
Director’s Project
Submitted by: Dhanashree Wankhade 2008A15 Dimple Bhat 2008A16 Deepthi Arumalla 2008A37 Mayuri Mathur 2008 A46
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THE CURRENT ECONOMIC RECESSION: HOW LONG, HOW DEEP, AND HOW DIFFERENT FROM THE PAST Abstract:After the Second World War, the world has seen 11 recessions till date. Of these 11 recessions there have been two major recessions excluding the current crisis. The project attempts to examine the current recession in detail and recessions of the previous three decades in brief. The project gives a brief overview of the other post-war recessions. It outlines the fiscal and monetary policy response to current recession and its future effects on various sectors in India. It also looks at theories of why recessions occur. At the end of the project we have tried to estimate the next recession and predicted it to happen in 2016.
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Table of Contents RECESSION .............................................................................................................................................. 5 THEORIES RELATED TO RECESSION ......................................................................................................... 5 KEYNESIAN THEORY- ........................................................................................................................... 5 BUSINESS CYCLE THEORY .................................................................................................................... 6 EFFICIENCY WAGE ARGUMENT........................................................................................................... 6 HISTORY OF RECESSIONS ........................................................................................................................ 7 Conclusions ......................................................................................................................................... 9 CURRENT SITUATION OF RECESSION ................................................................................................... 10 MONETARY POLICY ........................................................................................................................... 10 Overview ....................................................................................................................................... 15 Fiscal Policy for the ensuing financial year ................................................................................... 17 Tax Policy....................................................................................................................................... 17 Contingent and other Liabilities .................................................................................................... 19 Government Borrowings, Lending and Investments .................................................................... 20 Initiatives in Public Expenditure Management ............................................................................. 21 Policy evaluation ........................................................................................................................... 22 FUTURE EFFECTS OF CURRENT CONTRACTION ON VARIOUS SECTORS OF INDIA................................ 28 INDIAN STOCKS ................................................................................................................................. 28 Economy........................................................................................................................................ 28 The case of Indian equities ........................................................................................................... 29 The way ahead .................................................................................................................................. 29 BANKING ........................................................................................................................................... 30 AUTO ................................................................................................................................................. 31 TEXTILE .............................................................................................................................................. 32 REALTY .............................................................................................................................................. 32 ENERGY ............................................................................................................................................. 33 INSURANCE ....................................................................................................................................... 34 MANUFACTURING............................................................................................................................. 34 REASONS BEHIND A TYPICAL RECESSION ............................................................................................. 35 CHARACTERISTICS OF A TYPICAL RECESSION........................................................................................ 36 PREDICTING NEXT RECESSION USING ARIMA MODELS .................................................... 36 ARIMA MODEL .................................................................................................................................. 36
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RECESSION
A recession is a contraction phase of the business cycle. It is defined as a significant decline in economic activity spread across the country, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.
THEORIES RELATED TO RECESSION
There are three ways to explain a recession.
KEYNESIAN THEORYThe foremost of the views can be attributed to John Maynard Keynes. Better known as the animal spirit hypothesis, this theory says consumers behave like animals. They suddenly become optimistic or pessimistic about their future, leading to a fall in effective demand. Effective demand implies what the consumer intends to buy. A fall in effective demand will lead to a fall in demand, thus contributing to an economic downturn. For instance, any consumer feeling less secure about his future (jobs or otherwise) might want to delay purchasing a car. When this happens across the economy, it will affect the car industry. The car industry, witnessing a fall in demand, will want to hire fewer factor inputs (labour or capital) leading to unemployment in the labour market and a reduced rate of interest in the capital market. A low rate of return in the capital market means fewer incentives for the consumer to lend savings for investment. Again, unemployment means lower earnings for consumers. So both processes become self-fulfilling, resulting in the persistence of recession. Here, poor economic fundamentals do not lead to an economic downturn. It is the psychological behaviour of households or firms that cause the recession. This theory is well documented by real world data. Latest economic reports confirm that the recession in the US is mainly because of consumer pessimism. They reined in spending, which accounts for two-thirds of the US economy. When their confidence fell to a four-quarter low, so did their spending.
J.M. Keynes has used three psychological propensities in formulating his theory of business cycle. They are: Propensity to consume, propensity to save and the marginal efficiency of capital. He also introduced the concept of multiplier in order to show the effect to increase in total income due to increase in investment. Keynes is of the view that upswing of business cycle is caused by a rise in the marginal efficiency of capital. If there is a fall in AD then according to Keynesian analysis there will be a fall in Real GDP. The effect on Real GDP depends upon the slope of the AS curve if the economy is close to full capacity lower AD would only cause a
small fall in Real GDP. AD is composed of C+I+G+X-M, therefore a fall in any of these components could cause a recession. For example, if the MPC increased interest rates sharply this would cause the cost of borrowing to increase and make saving more attractive. This would have the effect of reducing consumer spending. AD could also fall due to deflationary fiscal policy, for example higher taxes and lower government spending would also cause a fall in AD. If there was a fall in AD the multiplier effect may magnify the initial fall in AD, for example if there was a fall in output, workers would be made unemployed. These workers would then spend less causing a secondary fall in AD. This would make the fall in Real GDP greater
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BUSINESS CYCLE THEORY
The second view involves the business cycle theorists. Other things being equal, above average rates of Total Factor Productivity growth (because of technological innovation) generate higher rates of growth in real (inflation adjusted) wages because workers are compensated for producing more goods and services. Higher wages result in increased household income, leading to lower consumption and savings. An example of positive externalities is the development and widespread use of Internet. As individual firms continue to increase their use of the Internet, they induce improvements in the distribution, utilisation and management of information across the economy. Thus, a negative technology shock (such as September 11) will lead to fall in the real wage rate. Extending the argument further, this will lead to fall in demand and, hence, to recession. Thus, one the reason for the economic recession in the US is because of the terrorist attack. The September 11 attack accounted for loss of all —human, physical and financial — capital. Labour productivity fell as the existing labourers had lower capital to work with. This theory is well documented. The neo-Keynesian group leads the other major school of thought. It attributes price and wage stickiness for recession. In a recession, price and wages do not adjust quickly — these variables do not fall at a rate concurrent to recession. Thus, the effect of recession is more widespread and prolonged. One reason that prices do not adjust immediately to clear markets is because adjusting price is costly. To change prices, a firm may need to send out a new catalogue to customers, distribute new price lists to sales staff, or for restaurants, print new menus. These costs, better known as menu costs, cause firms to adjust price intermittently rather than cautiously. Price stickiness may also result from coordination failures among firms. For example, in a recession, if one firm reduces price and other firms do not, there may be no way for the first firm to recoup its loss in revenue resulting from a lower price. As a result no individual firm would like to whittle down price even when it has information about recession. Like price, wage stickiness also prolongs the recession effect. Wage stickiness is mainly because of labour unions. Union leaders guarantee that wages do not fall a critical minimum level even in a recession. More so, as wage contracts are signed at the beginning of each year. Wages are inflexible in the short run.
EFFICIENCY WAGE ARGUMENT
The other reason can be explained through the efficiency wage argument. According to this theory, higher wages make workers more productive. The influence of wages on worker efficiency may explain the failure of firms to cut wages despite excess labour. Though a wage reduction would lower a firm's wage bill, it would also lead to a drop in worker productivity and profits. Consequently, wage stickiness persists and the recession continues. These three schools of thoughts agree on the fact that increase in capital spending is necessary for bringing the economy out of recession. Capital spending by increasing aggregate demand encourages firms to invest more and, hence, increase employment. Positive technology shocks also increase labour productivity and, hence, returns to labour. Technology, by increasing labour productivity, plays a critical role in explaining long run growth. In the short run, it is always possible to get in more output simply by increasing inputs. However, in the long run, growth tapers off as some inputs (especially human and physical capital) become scarce, calling for some technological breakthrough. Much of the spectacular growth in the US was because of the increase in productivity growth.The US Federal Reserve, on its part, is trying to revive the 6
economy by keeping the interest rate low. A low interest rate encourages investments in physical and human capital. While the former is important in buttressing aggregate demand, the latter is important for providing a technological breakthrough.
HISTORY OF RECESSIONS
The Union Recession: (February 1945 - October 1945) ? ? ? ? ?
Duration: 9 months Magnitude GDP Decline: 11 Unemployment Rate: 1.9% Reasons and Causes: The tail-end of World War II, the beginning of demobilization of military forces and the slow transition to civilian production marked this period. War production had virtually ceased and veterans were just beginning to re-enter the workforce. It was also known as the "Union Recession" as unions were beginning to reassert themselves. Minimum wages were on the rise and credit was tight.
The Post-War Recession: (November 1948 - October 1949) ? ? ? ? ?
Duration: 11 months Magnitude GDP Decline: 1.1 Unemployment Rate: 5.9% Reasons and Causes: As returning veterans returned to the workforce in large numbers to compete for jobs with existing civilian workers who had entered the workforce during the war, unemployment began to rise. The government's response was minimal as it was much more worried about inflation than unemployment at that time.
The Post-Korean War Recession: (July 1953 - May 1954) ? ? ? ? ?
Duration: 10 months Magnitude: GDP decline: 2.2 Unemployment Rate: 2.9% (lowest rate since WWII) Reasons and causes: After an inflationary period that followed the Korean War, more dollars were directed at national security. The Federal Reserve tightened monetary policy to curb inflation in 1952. The dramatic change in interest rates caused increased pessimism about the economy and decreased aggregate demand.
The Eisenhower Recession: (August 1957 - April 1958) ? ? ? ? ?
Duration: 8 months Magnitude: GDP Decline: 3.3% Unemployment Rate: 6.2% Reasons and Causes: The government tightened monetary policy to years prior to the recession to curb inflation, but prices continued to rise in the U.S. through 1959. The sharp world-wide recession and the strong U.S. dollar contributed to a foreign trade deficit. (For another view on trade deficits read, In Praise of Trade Deficits.) 7
The "Rolling Adjustment" Recession: (April 1960 - February 1961) ? ? ? ? ?
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Duration: 10 months Magnitude: GDP Decline: 2.4 Unemployment Rate: 6.9% Reasons and Causes: This recession was also known as the "rolling adjustment" for many major U.S.industries, including the automotive industry. Americans shifted to buying compact and often foreign-made cars and industry drew down inventories. Gross national product (GNP) and product demand declined. The Nixon Recession: (December 1969 - November 1970) Duration: 11 months Magnitude: GDP Decline: 0.8 Unemployment Rate: 5.5% Reasons and Causes: Increasing inflation caused the government to employ a very restrictive monetary policy. The structure of government expenditures added to the contraction in economic activity.
The Oil Crisis Recession: (November 1973 - March 1975) ? ? ? ? ?
Duration: 16 months Magnitude: GDP Decline: 3.6 Unemployment Rate: 8.8% Reasons and Causes: This long, deep recession was brought on by the quadrupling of oil prices and high government spending on the Vietnam War. This led to "stagflation" and high unemployment. Unemployment finally reached 9% in May of 1975. (For more on this see, Stagflation, 1970s Style.)
The Energy Crisis Recession: (January 1980 - July 1980) ? ? ? ? ?
Duration: 6 months Magnitude: GDP decline: 1.1% Unemployment Rate: 7.8% Reasons and Causes: Inflation had reached 13.5% and the Federal Reserve raised interest rates and slowed money supply growth, which slowed the economy and caused unemployment to rise. Energy prices and supply were put at risk causing a confidence crisis as well as inflation.
The Iran/Energy Crisis Recession: (July 1981 - November 1982) ? ? ? ?
Duration: 16 months. Magnitude: GDP decline: 3.6% Unemployment Rate: 10.8%
Reasons and Causes: This long and deep recession was caused by the regime change in Iran; the world's second largest producer of oil at the time, the country came to regard the U.S. as a supporter of its ousted regime. The "New" Iran exported oil at inconsistent intervals and at lower volumes, forcing prices higher. The U.S. government enforced a tighter monetary policy to 8
control rampant inflation, which had been carried over from the previous two oil and energy crises. The prime rate reached 21.5% in 1982.
The Gulf War Recession: (July 1990 - March 1991) ? ? ? ? ?
Duration: 8 months Magnitude: GDP Decline: 1.5 Unemployment Rate: 6.8% Reasons and causes: Iraq invaded Kuwait. This resulted in a spike in the price of oil in 1990, which caused manufacturing trade sales to decline. This was combined with the impact of manufacturing being moving offshore as the provisions of North American Free Trade Agreement (NAFTA) kicked in. The leveraged buyout of United Airlines triggered a stock market crash.
The 9/11 Recession: (March 2001 - November 2001) ? ? ? ? ?
Duration: 8 months Magnitude GDP Decline: 0.3 Unemployment Rate: 5.5% Reasons and Causes: The collapse of the dotcom bubble, the 9/11 attacks and a series of accounting scandals at major U.S. corporations contributed to this relatively mild contraction of the U.S. economy. In the next few months, GDP recovered to its former level. (For more information, read Crashes: The Dotcom Crash.)
Conclusions
For one, oil price, demand and supply sensitivity appear to be consistent and frequent historical precursors to U.S. recessions. A spike in oil prices has preceded nine out of 10 post-WWII recessions. This highlights that while global integration of economies allows for more effective cooperative efforts between governments to prevent or mitigate future recessions, the integration itself ties the world economies more closely together, making them more susceptible to problems outside their borders. Better government safeguards should soften the effects of recessions as long as regulations are in place and enforced; better communications technology and sales & inventory tracking allows businesses and governments to have better transparency on a real time basis so that corrective actions are made to forestall the accumulation of factors and indicators contributing to or signaling a recession. More recent recessions, such as the housing bubble, the resulting credit crisis and the subsequent government bailouts are examples of excesses not properly or competently regulated by the patchwork of government regulation of financial institutions. (For another perspective on credit crisis, see The Bright Side of The Credit Crisis.) Contraction and expansion cycles of moderate amplitude are part of the economic system. World events, energy crises, wars and government intervention in markets can affect economies both positively and negatively, and will continue to do so in the future. Expansions have historically exceeded previous highs in economic growth trends if capitalist fundamentals applied within regulatory guidelines govern the markets.
9
CURRENT SITUATION OF RECESSION
MONETARY POLICY
The Reserve Bank has released the document “Macroeconomic and Monetary Developments Third Quarter Review 2008-09” to serve as a backdrop to the Third Quarter Review of Monetary Policy 2008-09. The highlights of macroeconomic and monetary developments during 2008-09 so far are: Overview The Indian economy, after exhibiting strong growth during the second quarter of 2008-09, has experienced moderation in the wake of the global economic slowdown. Although agricultural outlook remains satisfactory, industrial growth has decelerated sharply and services sector is slowing. The economic slowdown, during the second quarter vis-à-vis the first quarter of 200809, was primarily driven by a moderation of consumption growth and widening of trade deficit, offset partially by an acceleration in investment demand. The balance of payments (BoP) for the first half of 2008-09 reflected a widening of the current account deficit and moderation in capital flows. Net capital inflows reduced sharply and remained volatile during 2008-09 with foreign direct investment inflows showing an increase, while portfolio investments recording a substantial outflow. The growth of non-food credit remained high during 2008-09, so far, albeit with some moderation in recent months. Continued high growth in time deposits enabled the banking system to sustain the credit expansion while the non-banking sources of funds to the commercial sector declined. The total flow of resources from banks and other sources to the commercial sector during 200809, so far, has been somewhat lower than the comparable period of 2007-08. Financial markets in India, which, by and large, remained orderly from April 2008 to midSeptember 2008, witnessed heightened volatility subsequently reflecting the knock-on effects of the disruptions in the international financial markets and the uncertainty that followed. This necessitated the Reserve Bank to undertake a series of measures to inject rupee and foreign exchange liquidity from mid-September 2008 onwards. Liquidity conditions turned around and became comfortable from mid-November 2008. Headline inflation has declined in major economies since July/August 2008. In India, inflation measured as year-on-year variation in the wholesale price index (WPI) has declined sharply since August 2008 and was at 5.6 per cent as of January 10, 2009. On the macroeconomic front, the downside risks for economic growth emanate from global economic slowdown, deterioration in global financial markets and slowing down in domestic demand. On the positive side, factors include expected increase in consumption demand mainly reflecting rise in basic exemption limits and tax slabs, Sixth Pay Commission awards, debt waiver for farmers and pre-election expenditure. The easing of international oil prices and commodity prices may help in softening the inflationary pressure. Output
10
According to estimates released by the Central Statistical Organisation (CSO) in November 2008, the real GDP growth was placed at 7.6 per cent during the second quarter of 2008-09 as compared with 9.3 per cent during the corresponding quarter of 2007-08, reflecting deceleration in growth of industry and services. The Ministry of Agriculture has set a target for foodgrains production for 2008-09 at 233.0 million tonnes. According to the First Advance Estimates, the kharif foodgrains production during 2008-09 was placed at 115.3 million tonnes (Fourth Advance Estimates) as compared with that of 121.0 million tonnes during the previous year. The index of industrial production during April-November 2008-09 recorded year-on-year expansion of 3.9 per cent as compared with 9.2 per cent during April-November 2007-08. The manufacturing sector recorded growth of 4.0 per cent during April-November 2008-09 (9.8 per cent during April-November 2007-08) and the electricity sector recorded growth of 2.9 per cent (7.0 per cent during April-November 2007-08). Available information on the leading indicators of services sector activity during April-October 2008-09 indicate some acceleration in growth in respect of several indicators such as railway revenue earning and freight traffic and export cargo handled by civil aviation as compared with the corresponding period of 2007-08. On the other hand, growth decelerated in respect of cargo handled at major ports and other indicators of civil aviation excluding export cargo, commercial vehicles, cement and steel. Aggregate Demand Aggregate demand in the Indian economy is primarily domestically driven, though exports have been gaining progressively higher importance in recent years. The economic slowdown, during the second quarter vis-à-vis the first quarter of 2008-09, was primarily driven by a moderation of consumption growth and widening of trade deficit, offset partially by an acceleration in investment demand. On the other hand, the government consumption expenditure accelerated during the same period. According to the latest information on Central Government finances for 2008-09 (AprilNovember), the revenue deficit and fiscal deficit were placed higher than those in AprilNovember 2007 both in absolute terms and as per cent of budget estimates (BE) primarily on account of higher revenue expenditure. Tax revenue as per cent of BE was lower than a year ago on account of lower growth in income tax, corporation tax and customs duties owing to economic slowdown. Aggregate expenditure as per cent of BE, was higher than a year ago on account of higher revenue expenditure, particularly, subsidies, defence, other economic services, social services and plan grants to States/Union Territories. While expenditure is slated to increase on account of the fiscal stimulus measures undertaken by the Government to address the problem of economic slowdown, growth of tax revenue is likely to decelerate in the coming months of 2008-09 due to moderation in economic activity. The net cash outgo on account of the two supplementary demand for grants is placed at Rs. 1,48,093 crore. This, in turn, will be reflected in the non-attainability of the deficit targets for 2008-09 as envisaged in the Union Budget 2008-09. During 2008-09 (up to January 13, 2009), special bonds amounting to Rs.44,000 crore and Rs.14,000 crore have been issued to oil marketing companies and fertiliser companies, respectively. 11
Sales performance of select non-Government non-financial public limited companies in the private corporate sector during the first two quarters of 2008-09 was impressive; however, profits performance was subdued as compared with 2007-08. Higher increase in expenditure in relation to sales growth was primarily on account of rising input costs, interest expenses and large provisioning towards mark to market (MTM) losses on foreign exchange related transactions which exerted pressure on profits. The External Economy India?s balance of payments position during the first half of 2008-09 (April-September) reflected a widening of trade deficit resulting in large current account deficit, and moderation in capital flows. Merchandise trade deficit recorded a sharp increase during April-November 2008 on account of higher crude oil prices for most of the period and loss of momentum in exports since September 2008. Net surplus under invisibles remained buoyant, led by increase in software exports and private transfers. Net capital inflows reduced sharply and have remained volatile during 2008-09 so far. The large increase in merchandise trade deficit during April-September 2008 led to a significant increase in the current account deficit over its level during April-September 2007. The widening of trade deficit during April-September 2008 could be attributed to higher import payments reflecting high international commodity prices, particularly crude oil prices. The surplus in the capital account moderated during April-September 2008 reflecting increased gross capital outflows on the back of global financial turmoil. While the net inward FDI (net direct investment by foreign investors) remained buoyant reflecting relatively strong fundamentals of the Indian economy and continuing liberalisation measures to attract FDI, net outward FDI (net direct investment by Indian investors abroad) also remained high during April-September 2008. The gross capital inflows were higher on account of higher FDI inflows and NRI deposits during the period. In terms of residual maturity, the revised short-term debt (below one year) comprising sovereign debt, commercial borrowings, NRI deposits, short-term trade credit and others maturing up to March 2009, was estimated at around US $ 85 billion as at end-March 2008. According to the provisional data released by DGCI&S, India?s merchandise exports during April-November 2008 increased by 18.7 per cent while imports recorded a higher growth of 32.5 per cent, largely due to the rise in petroleum, oil and lubricants (POL) imports. The rise in oil imports was primarily due to the elevated international crude oil prices, while the volume of oil imports moderated. Merchandise trade deficit during April-November 2008 widened to US $ 84.4 billion from US $ 53.2 billion a year ago. As of January 16, 2009, foreign exchange reserves at US $ 252.2 billion declined by US $ 57.5 billion over the level at end-March 2008, including changes due to valuation losses. Monetary Conditions Monetary and liquidity aggregates that expanded at a strong pace during the first half of 200809 showed some moderation during the third quarter reflecting the decline in capital flows and consequent foreign exchange intervention by the Reserve Bank. Growth in broad money (M3), year-on-year (y-o-y), was 19.6 per cent (Rs. 7,36,777 crore) on January 2, 2009 lower than 22.6 per cent (Rs. 6,91,768 crore) a year ago. Aggregate deposits of banks, y-o-y, expanded 20.2 per cent (Rs.6,49,152 crore) on January 2, 2009 as compared with 12
24.0 per cent (Rs. 6,21,944 crore) a year ago. The growth in bank credit continued to remain high. Non-food credit by scheduled commercial banks (SCBs) was 23.9 per cent (Rs.5,01,645 crore), y-o-y, as on January 2, 2009 from 22.0 per cent (Rs.3,79,655 crore) a year ago. The intensification of global financial turmoil and its knock-on effect on the domestic financial market, and downturn in headline inflation, necessitated the Reserve Bank to ease its monetary policy since mid-September 2008. Reserve money growth at 6.6 per cent, y-o-y, as on January 16, 2009 was much lower than that of 30.6 per cent a year ago. Adjusted for the first round effect of the changes in CRR, reserve money growth was 18.0 per cent as compared with 21.6 per cent a year ago. Financial Markets The crisis in global financial markets deepened since mid-September 2008, triggered by the collapse of Lehman Brothers followed by the failure of a number of other financial firms across countries. The pressure on financial markets mounted with the credit spreads widening to record levels and equity prices crashing to historic lows leading to widespread volatility across the market spectrum. The turmoil transcended from credit and money markets to the global financial system more broadly. The contagion also spilled over to the emerging markets, which saw broad-based asset price declines amidst depressed levels of risk appetite. Added to this, there was a significant deterioration in the global economic outlook. As a result, authorities in several countries embarked upon an unprecedented wave of policy initiatives to contain systemic risk, arrest the plunge in asset prices and shore up the confidence in the international banking system. While these initiatives did help in restoring some level of stability, the financial market conditions remained far from normal during the period OctoberDecember 2008. Liquidity conditions tightened significantly in India between mid-September and October 2008 emanating from adverse international developments and some domestic factors.Financial markets in India came under pressure since mid-September 2008, reflecting the knock-on effects of the disruptions in the international financial markets. This necessitated the Reserve Bank to undertake a series of measures to inject rupee and foreign exchange liquidity from midSeptember 2008 onwards. Accordingly, money markets in India came under some pressure mirroring the impact of capital outflows and redemption pressures faced by mutual funds and other investors. The pressure on money markets was reflected in call rates breaching the upper bound of Liquidity Adjustment Facility (LAF) corridor but settling back within the corridor by November 2008. Interest rates in the collateralised segments of the money market moved in tandem with but remained below the call rate during the third quarter of 2008-09. In the credit market, lending rates of scheduled commercial banks, which had increased initially, started declining in December 2008. Yields in the government securities market also came to soften during the third quarter 2008-09. In the foreign exchange market, Indian rupee generally depreciated against major currencies. Indian equity markets witnessed downswings quite in line with trends in major international equity markets. The Reserve Bank swiftly initiated a series of measures, which helped to assuage liquidity 13
conditions, while reassuring the market that the Indian banking system continued to be safe and sound, well capitalised and well regulated. Price Situation The accommodative monetary policy, which was pursued by most central banks since September 2008, aimed at mitigating the adverse implications of the recent financial market crisis on economic growth and employment. Headline inflation moderated in major economies since July/August 2008 on account of the marked decline in international energy and commodity prices as well as slowdown in aggregate demand emerging from the persistence of financial market turmoil following the US sub-prime crisis. After remaining at elevated levels for an extended period, global commodity prices declined sharply since the second quarter of 2008-09 led by decline in the prices of crude oil, metals and food. The WTI crude oil prices have eased from its historical high of US $ 145.3 a barrel level on July 3, 2008 to around US $ 42.3 a barrel as on January 22, 2009 reflecting falling demand in the Organisation for Economic Co-operation and Development (OECD) countries as well as some developing countries, notably in Asia, following the economic slowdown. Metal prices eased further during the third quarter of 2008-09, reflecting weak construction demand in OECD countries and some improvement in supply, especially in China. In India inflation, based on the year-on-year changes in wholesale price index (WPI), declined sharply from an intra-year peak of 12.9 per cent on August 2, 2008 to 5.6 per cent as on January 10, 2009. The recent decline in WPI inflation was driven by decline in prices of minerals oil, iron and steel, oilseeds, edible oils, oil cakes, raw cotton. Amongst major groups, primary articles inflation, year-on-year, increased to 11.6 per cent on January 10, 2009 from 4.5 per cent a year ago and (it was 9.7 per cent at end-March 2008). This mainly reflected increase in the prices of food articles, especially of wheat, fruits, milk, and eggs, fish and meat as well as non-food articles such as oilseeds and raw cotton. The fuel group inflation turned negative (-1.3 per cent) as on January 10, 2009 as compared to an intra-year peak of 18.0 per cent on August 2, 2008. This reflected the reduction in the price of petrol by Rs. 5 per litre and diesel by Rs. 2 per litre effective December 6, 2008 as well as decline in the prices of freely priced petroleum products in the range of 30-65 per cent since August 2008. Manufactured products inflation, year-on-year, also moderated to 5.9 per cent on January 10, 2009 as compared with the peak of 11.9 per cent in mid-August 2008 but remained higher than 4.6 per cent a year ago. The year-on-year increase in manufactured products prices was mainly driven by sugar, edible oils/oil cakes, textiles, chemicals, iron and steel and machinery and machine tools. Inflation, based on year-on-year variation in consumer price indices (CPIs), increased further during November/December 2008 mainly due to increase in the prices of food, fuel and services (represented by the „miscellaneous? group). Various measures of consumer price inflation were placed in the range of 10.4-11.1 per cent during November/December 2008 as compared with 7.3-8.8 per cent in June 2008 and 5.1-6.2 per cent in November 2007. Macroeconomic Outlook The various business expectations surveys released recently reflect less than optimistic sentiments prevailing in the economy. The results of Professional Forecasters? Survey 14
conducted by the Reserve Bank in December 2008 also suggested further moderation in economic activity for 2008-09. According to the Reserve Bank?s Industrial Outlook Survey of manufacturing companies in the private sector, the business expectations indices based on assessment for October-December 2008 and on expectations for January-March 2009 declined by 2.6 per cent and 5.9 per cent, respectively, over the corresponding previous quarters. The global economic outlook has deteriorated sharply since September 2008 with several countries, notably the US, the UK, the Euro area and Japan experiencing recession. In India too, there is evidence of a slowing down of economic activity. Unlike in the advanced countries where the contagion of crisis spread from the financial to the real sector, in India the slowdown in the real sector is affecting the financial sector, which in turn, has a second-order impact on the real sector. On the positive side factors include expected increase in consumption demand mainly reflecting rise in basic exemption limits and tax slabs, Sixth Pay Commission awards, debt waiver for farmers and pre-election expenditure. WPI inflation has fallen sharply driven by falling international commodity prices especially those of crude oil, steel and selected food items, although, some contribution has also come from the slowing domestic demand. Going forward, the outlook on international commodity prices indicate further softening of domestic prices.
FISCAL POLICY
The following is the government's fiscal policystrategy statement that the finance minister announced in Parliament. Overview 1. The Union Budget 2008-09 was presented in the backdrop of impressive growth in the Indian economy which clocked about 9 per cent of average growth in the last four years. This striking performance coupled with significant improvement in fiscal indicators, during the FiscalResponsibility and Budget Management (FRBM) Act, 2003 regime definitely put the country on a higher growth trajectory inspiring confidence in the medium to long term prospects of the economy. The process offiscal consolidation during these years has resulted in improvement in fiscal deficit from 5.9 per cent of GDP in 2002-03 to 2.7 per cent of GDP in 2007-08. During the same period, revenue deficit has declined from 4.4 per cent to 1.1 per cent of GDP. In tune with the philosophy of equitable growth, the process of fiscal consolidation was taken forward without constricting the much-required social sector and infrastructure related expenditure. This improvement in the state of public finances was achieved through higher revenue buoyancy, driven by efficient tax administration and improved compliance which is evident from increase in the tax to GDP ratio from 8.8 per cent in 2002-03 to 12.5 per cent in 200708. 2. Riding on the path of fiscal consolidation, the Union Budget 2008-09 was presented with fiscal deficit estimated at 2.5 per cent of GDP and revenue deficit at 1 per cent of GDP. 15
However after the presentation of the Union Budget in February 2008, the world economy was hit by three unprecedented crises -- first, the petroleum price rise; second, rise in prices of other commodities; and third, the breakdown of the financial system. The combined effect of these crises of these orders are bound to affect emerging market economies and India was no exception. The first two crises resulted in serious inflationary pressure in the first half of 2008-09. The focus of the monetary as well as fiscal policy shifted from fuelling growth to containing inflation, which had reached 12.9 per cent in August, 2008. Series of fiscal measures both on tax revenue and expenditure side were undertaken with the objective of easing supply side constraints. These measures were supplemented by monetary initiatives through policy rate changes by the Reserve Bank of India [Get Quote], and contributed to the softening of domestic prices. Headline inflation fell to 4.39 per cent in January, 2009. However, the fiscal measures undertaken through tax concessions and increased expenditure on food, fertiliser and petroleum subsidies along with increased wage bill for implementing the Sixth Central Pay Commission recommendations significantly altered the deficit position of the Government. 3. The global financial crisis in the second half of the financial year which heralded recessionary trends the world over, also impacted the Indian economy causing the focus of fiscal policy to be shifted to providing growth stimulus. The moderation in growth of the economy and the impact of the fiscal measures taken to stimulate growth can be seen reflected in the estimates for gross tax revenue which stand reduced from Rs 6,87,715 crore in B.E.2008-09 to Rs 6,27,949 crore in R.E.2008-09. Additional budgetary resources of Rs.1,50,320 crore provided as part of stimulus package and various committed liabilities of Government including rising subsidy requirement, provision under NREGS, implementation of Central Sixth Pay Commission recommendations and Agriculture Debt Waiver and Debt Relief Scheme for Farmers contributed to the higher fiscal deficit of 6 per cent of GDP in RE 2008-09 as compared to 2.5 per cent of GDP in B.E.2008-09. 4. The Country is facing difficult economic situation, the cause of which is not emanating from within its boundaries. However, left unattended, the impact of this crisis is going to affect us in medium to long term. The Government had two policy options before it. In view of falling buoyancy in tax receipts, the Government could have taken a decision to cut expenditure and thereby live within the estimated deficit for the year. The second option was to increase public expenditure, even with reduced receipts, to stimulate economy by creating demand and maintain the growth trajectory which the country was witnessing in the recent past. The Government took the second option of adopting fiscal measures to increase public expenditure to boost demand and increase investment in infrastructure sector. Ensuring revival of the higher growth of the economy will restore revenue buoyancy in medium term and afford the required fiscal space to revert to the path of fiscal consolidation.
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Fiscal Policy for the ensuing financial year The Interim Budget 2009-2010 is being presented in the backdrop of uncertainties prevailing in the world economy. The impact of this is seen in the moderation of the recent trend in growth of the Indian economy in 2008-09 which at 7.1 per cent still however makes India the second fastest growing economy in the World. The measures taken by Government to counter the effects of the global meltdown on the Indian economy, have resulted in a short fall in revenues and substantial increases in government expenditures, leading to a temporary deviation from the fiscal consolidation path mandated under the FRBM Act during 2008-09 and 2009-2010. The revenue deficit and fiscal deficit for R.E.2008-09 and B.E.2009-2010 are, as a result, higher than the targets set under the FRBM Act and Rules. The grounds due to which this temporary deviation has taken place, are detailed in the Fiscal Policy Overview above and also in the Macro-economic Framework Statement being presented in the Parliament. The fiscalpolicy for the year 2009-2010 will continue to be guided by the objectives of keeping the economy on the higher growth trajectory amidst global slowdown by creating demand through increased public expenditure in identified sectors. However, the medium term objective will be to revert to the path of fiscal consolidation at the earliest, with improvement in the economic situation. Tax Policy Indirect Taxes During the first half of the fiscal year, the global spurt in commodity prices (crude petroleum, food items and metals) led to increases in domestic prices of essential items and industrial inputs, putting a severe inflationary pressure on the economy. Hence, the Government took several measures after the presentation of the Union Budget 2008-09, particularly on the Customs side, to contain the rising inflation, as detailed below:Customs
of food items, a sharp reduction was effected in the import duty rates on various food items such as semi-milled or wholly milled rice (70% to nil) and crude and refined edible oils (from 40%-75% to 20%-27.5%). On 01.04.2008, a further reduction was effected in the import duty rate- on all crude edible oils duty was reduced to nil, and on refined edible oils duty was reduced to 7.5%.
10.5.2008.
petrol and diesel to 2.5% (earlier 7.5%). Customs duty on other petroleum products was reduced from 10% to 5% on 04.06.2008.
inputs for this sector (zinc, ferro-alloys, metcoke) on 29.4.2008. Further, in order to increase the domestic availability and bring about moderation in prices, export duties were imposed on 17
many items in the iron and steel sector @ 15% ad valorem on pig iron, sponge iron, iron and steel scrap, iron or steel pencil ingots, semi finished products and HR coils/sheets, etc.
the prices of raw cotton and augment the domestic supply. Excise
from Rs 6.35 per litre to Rs 5.35 per litre and on unbranded high speed diesel (HSD), excise duty was reduced from Rs 2.6 per litre to Rs 1.6 per litre. In the post-October stage, while the inflationary pressures on the economy were subdued, the global meltdown and resultant slowdown of the Indian economy required review of the existing policy in favour of maintaining the growth momentum and retaining export markets. As such, the following policychanges were effected which would be reviewed in the ensuing financial year in the light of the macroeconomic situation particularly the growth of the manufacturing sector: Excise fiscal stimulus package was implemented. -the board reduction of 4 percentage points in the ad valorem rates of excise duty on non-petroleum items, with a few exceptions. Thus the three major ad valorem rates of Central Excise duty viz. 14%, 12% and 8% have been reduced to 10%, 8% and 4%, respectively.
proportionately. Customs
ty for the benefit of the aviation industry w.e.f. 31.10.2008.
exemptions provided earlier to combat inflation, on iron and steel items, zinc and ferro-alloys, were withdrawn w.e.f. 18.11.2008.
to imports of cement has been withdrawn w.e.f. 2nd January, 2009 to provide a cushion to domestic cement industry and boost demand. In the power sector, customs duty on naphtha used for generation of electricity by electrical generating stations has been fully exempted w.e.f. 2nd January, 2009 till the end of this financial year. Service Tax ers on various taxable services attributable to export of goods has been further extended to include clearing and forwarding agents services.
18
services has been enhanced from 2% of FOB value to 10% of FOB value of export goods.
respect of exports. ecified services which are provided to goods transport agency have also been fully exempted from service tax. Direct Taxes 7. Over the last five years, widespread reforms have been ushered in the area of direct taxes. The reform strategy comprises the following elements: -
the tax rates.
deterrence levels. Both these objectives reinforce each other and have promoted voluntary compliance. -engineering business processes in the Income-tax Department through extensive use of information technology, viz., e-filing of returns; issue of refunds through ECS and refund bankers; selection of returns for scrutiny through computers; e-payment of taxes; establishing a Centralized Processing Centre and an effective taxpayer information system. These measures have substantially enhanced the direct tax revenue productivity from 3.81 per cent of GDP in 2003-04 to an estimated 6.35 per cent of GDP in 2008-09. Further, the share of direct taxes in the Central tax revenues is now significantly higher than the share of indirect taxes resulting in a substantial improvement in the equity of the tax system. Therefore, the reform strategy in the medium term is to consolidate the achievements of the past. 8. Since there is no change in the tax base and rates, the prospects of growth in direct tax collection in the ensuing financial year will remain unchanged vis-a-vis the revised estimate for the financial year 2008-09. Contingent and other Liabilities The FRBM Act mandates the Central Government to specify the annual target for assuming contingent liabilities in the form of guarantees. Accordingly the FRBM Rules prescribe a cap of 0.5 per cent of GDP in any financial year on the quantum of guarantees that the Central Government can assume in the particular financial year. The Central Government extends guarantees primarily on loans from multilateral/bilateral agencies, bond issues and other loans raised by various Public Sector Undertakings/Public Sector Financial Institutions. The stock of contingent liabilities in the form of guarantees given by the government has reduced from Rs 1,07,957 crore at the beginning of the FRBM Act regime i.e. 2004-05 to Rs 1,04,872 crore at the end of 2007-08. As a percentage of GDP, it has reduced from 3.4 per cent in 2004-05 to 2.3 per cent in year 2006-07 and further to 2.2 per cent for the year 200708.
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The disclosure statement on outstanding Guarantees as prescribed in the FRBM Rules, 2004 is appended in the Receipts Budget as Annex 3 (iii). Assumption of contingent liability in the form of guarantee by the sovereign helps to leverage private sector participation in areas of national priorities. In the current situation, wherein a large number of infrastructure projects are being cleared for implementation under the Public Private Partnership (PPP) mode, difficulties are being faced in reaching financial closure due to the current uncertainties in the global financial market. Within the given fiscal constraints and with a view to supporting financing of above mentioned PPP projects, the India Infrastructure Financing Company Limited (IIFCL) has been authorized to raise Rs 10,000 crore through Government guaranteed tax free bonds, by the end of 2008-09 and additional Rs 30,000 crore on the same basis as per requirement in the next financial year. The capital so raised will be used by IIFCL to refinance bank lending of longer maturity to eligible infrastructure projects. This initiative of the government is expected to result in leveraging of bank financing to PPP programmes of about Rs one lakh crore. The likely assumption of contingent liability in the form of guarantee for 2008-09, including the above mentioned Rs 10,000 crore for IIFCL, will amount to Rs 36,606 crore which will be 0.67 percentage of GDP during 2008-09, higher than the target of 0.5 per cent of GDP set under the FRBM Rules. This deviation has been necessiated in the larger interest of re-invigorating the economy in the background of the current economic scenario, to stimulate demand and increase investment in infrastructure sector projects. In the medium term while this may not have a potential budgetary impact, the additional demand thus created will help restore the economy to its higher growth path and contribute to higher revenue buoyancy which has shown a slump in the current financial year due to moderation in the growth in economy. Government Borrowings, Lending and Investments 11. The Government policy towards borrowings to finance its deficit continues to remain anchored on the following principles namely (i) greater reliance on domestic borrowings over external debt, (ii) preference for market borrowings over instruments carrying administered interest rates, (iii) elongation of the maturity profile and consolidation of the debt portfolio and (iv) development of a deep and wide market for Government securities to improve liquidity in secondary market. 12. In the first half of the current financial year, the government borrowing was in line with the indicated auction calendar decided upon in consultation with the Reserve Bank of India. However, due to the need to provide the fiscal stimulus to counter the situation created by the effects of the global financial crisis, the borrowing calendar of the government had to be revised in the second half of the current financial year. The gross and net market borrowings (dated securities and 364- day Treasury Bills) of the Central Government during 2008-09 (up to February 9, 2009) amounted to Rs 2,40,167 crore and Rs 1,68,710 crore, respectively. As part of policy to elongate maturity profile, Central Government has been issuing securities with maximum 30--year maturity.
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The weighted average maturity of dated securities issued during 2008-09 (up to February 9, 2009) was 14.45 years which was marginally lower than 14.90 years during the corresponding period of the previous year. The weighted average yield of dated securities issued during 2008-09 (up to February 9, 2009) was 7.91 per cent and was lower than 8.12 per cent during the corresponding period of last year. 13. Consequent to the transition to the FRBM Act mandated environment, recourse to borrowing from RBI under normal circumstances is prohibited. During the year 2008-09 (up to February 7, 2009) the Central Government resorted to ways and means advance to meet the temporary mismatch in receipts and expenditure for 77 days as compared with 91 days a year ago. The daily average utilization of ways and means advance by the Central Government was Rs 7,383 crore as compared with Rs 14,498 crore a year ago. The Central Government also availed of Overdraft (OD) for 24 days up to February 7, 2009. The daily average of OD was Rs.11,233 crore as compared with Rs 6,381 crore a year ago. 14. The outstanding balance under Market Stabilization Scheme (MSS) on 1st April, 2008 was Rs 1,70,554 crore. Notwithstanding fresh issuance of Rs 43,500 crore during 2008-09, the outstanding balance under the MSS declined to Rs 1,05,773 crore mainly reflecting the change in policy and unwinding MSS through buyback of Rs 47,544 crores. This was done in order to ease liquidity in the system in the backgrounds of the additional borrowing plan during the second half of 2008-09 to finance the increased deficit. 15. In order to have prudent management of debt and greater focus on carrying cost as well as meeting secondary market liquidity, the government has set up a Middle Office which in due course will merge with the proposed Debt Management Office. 16. Central Government has stopped playing the role of financial intermediary for State Government for domestic market borrowings and the trends in the current year shows that this transition has been very smooth resulting in reduction in cost for the State Governments while at the same time bringing in a sense of market discipline. 17. Government has set up National Investment Fund (NIF) to which the disinvestment proceeds from Central PSUs are being transferred. This fund is being managed by professional fund managers. The receipts in the Fund are not reckoned as resources for the purpose of financing the fiscal deficit. The income from investments under NIF is used to finance social infrastructure and provide capital to viable public sector enterprises without depleting the corpus of NIF. Initiatives in Public Expenditure Management 18. The focus has shifted from financial outlays to outcomes for ensuring that the budgetary provisions are not merely spent within the financial year but have resulted in intended outcomes. Initiatives have been taken to evenly pace plan expenditure during the year and also to avoid rush of expenditure at the year end which results in poor quality of expenditure. The practice of restricting the expenditure in the month of March to 15 per cent of budget allocation within the fourth quarter ceiling of 33 per cent is being enforced religiously. The quarterly exchequer control based cash and expenditure management system which inter alia involves preparing a Monthly Expenditure Plan (MEP) continues to be followed in select Demands for Grants. The emphasis is on right pacing plan expenditure by ensuring adequate resources for execution of budgeted schemes. At the same time, steps have also been taken in 21
the form of austerity instructions to reduce expenditure in non-priority areas without compromising on operational efficiency. This has resulted in availability of adequate resources from realised receipts for priority schemes. 19. Delays in receipts of utilization certificate are broadly indicative of poor implementation strategy, diversion of funds or delay in utilization of funds for intended purposes. Monitoring of utilization certificates and unspent balances with the implementing authorities is reviewed at the highest level in the Ministry of Finance. Necessary control mechanisms have been put in place with the help of the office of the Controller General of Accounts (CGA) to avoid parking of funds and to track expenditure. 20. A central monitoring, evaluation and accounting system for the 1258 centrally sponsored schemes and central sector schemes of the Government has been instituted under the Central Plan Schemes Monitoring System. All sanctions issued by the Central Ministries under these schemes are now identified with a unique sanction ID that enables the tracking of release as per their accounting and budget heads across the different implementing agencies. This central system is hosted on the e-lekha portal of the CGA. 21. In addition pilots are currently underway in the States of Punjab, Karnataka and Uttarakhand for testing a system for expenditure filing and direct payment to beneficiaries under the schemes. The results of the pilot would form the basis of designing comprehensive IT based Decision Support System and Management Information System for all the centrally sponsored schemes and central sector schemes. This initiative assumes special significance in the light of the significant increase in the social sector spending by the Government. 22. The application software COMPACT has been extended to all civil ministries of the Government and expenditure data is being uploaded on a daily basis by the Pay and Accounts Offices on e-lekha. This is a significant step towards faster and accurate compilation of the accounts for the Government of India and will lead to the development of a core accounting solution. The monthly and annual Finance and Appropriation Accounts are regularly updated on the CGA website: www.cgaindia.gov.in. Policy evaluation 23. The process of fiscal consolidation during the FRBM Act regime has created necessary fiscal space to undertake much needed social sector expenditure and provide for higher infrastructure outlays. The performance up to 2007-08 was heartening. Fiscal deficit was brought down from 4.5 per cent of GDP in 2003-04 to 2.7 per cent in 2007-08. Similarly, revenue deficit was reduced from 3.6 per cent of GDP in 2003-04 to 1.1 per cent in 2007-08. The government was steadfast in following the fiscal consolidation path which is reflected in the deficit estimates of B.E.2008-09. However, subsequent to the global meltdown, there was a compelling need to adjust the fiscal policy to take care of exceptional circumstances through which the economy has been passing. The result of the fiscal measures taken by the Government for containing inflation has been positive as is evident from headline inflation dropping from high of 12.9 per cent in August 2008 to 4.39 per cent in January 2009. Similarly the intervention of the Government has ensured that the economy grows at a healthy rate of 7.1 per cent in a difficult year when most of the developed economies are facing recession. The fiscal consolidation process has to be put on hold temporarily. 22
The process of fiscal consolidation will be back on track once there is an improvement in economic conditions. Economic indicators show onslaught of recession Data for November-January shows steep drops in economic activity. Adrian Filut26 Feb 09 15:35 Export of goods fell by 6.4% in November 2008-January 2009, imports of raw materials fell 11.3%, industrial output fell 0.9%, and trade and services proceeds fell 8.4%, the Central Bureau of Statistics reported today in an onslaught of gloomy economic news that show that the recession has arrived. The slump in export of goods, excluding diamonds, ships, and planes, was an annualized 23.3%, and follows the annualized 22% drop in August-September 2008. Trend figures show that high-tech exports fell by an annualized 0.6% in November-January, after falling by an annualized 15.7% in August-September; mixed high-tech exports fell by an annualized 21.8% in November-January, after falling by an annualized 20.4% in August-September; and mixed low-technology exports fell by an annualized 57.7% in November-January, after falling by an annualized 51% in the preceding three months; but low technology exports rose by an annualized 0.2% in November-January, after rising by an annualized 5.8% in the preceding three months.
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From the above graph, it is evident that the private consumption has drastically gone down from quarter1 of 2009 to quarter 3 of 2009. This reflects that the average Indian consumer is losing confidence to buy and consume. To make up for this loss in the GDP, the government of India, like any other government would do, has increased consumption expenditure and hence helped the nation to maintain the real GDP. The Investments have come down from 10.1 billion dollars in q1 to 5.3 billion dollars, almost a 50% decrease in the investments. All these factors have led to an overall decrease in the real GDP of the country. However, classically recessions have not last longer than 12 -18 months baring few aberrations. Hence, as of now there is very low probability of India getting into recession.
BSE500
8000 7000 6000 5000 4000 3000 2000 1000 0 Jan/08 Feb/08 Apr/08 Jun/08 Jul/08 Sep/08 Oct/08 Dec/08 BSE500
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The returns from the BSE 500 portfolio has been going down continuously from January 2008 to December 2008. This is due to the financial crisis in the US. The reduction in share prices have caused an erosion in the wealth of the share holders. This has contributed ti the decrease in the GDP.
The rupee has been depreciating continuously against dollar and Euro as shown in the above graph. Thus the exports of Diamonds and other precious items have gone down. The GDP has gone down because of this factor also.
GDP GROWTH RATE OF INDIA
12 10 8 6 4 2 0 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 -2 -4 -6 2006 IND
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Real GDP Trend
10 9 8 7 6 5 4 3 2 1 0 Jan/07 Apr/07 Aug/07 Nov/07 Feb/08 Jun/08 Sep/08
Real GDP Trend
Repo rates
9 8 7 6 5 4 3 2 1 0 12/Apr/08 01/Jun/08 21/Jul/08 09/Sep/08 29/Oct/0818/Dec/0806/Feb/0928/Mar/09 Repo rates
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. January 21 and 22 saw a meltdown with a mind-boggling US$450 billion in market capitalization being vaporized. An unprecedented interest cut by the Fed led to a bounce-back on January 23 and at the time of this 26
writing, the benchmark index (BSE) has gained 2.5%, almost in line with Hang-Seng, Nikkei, and Kospi. 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%. 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. Here are some areas worth following: 1. A credit crisis in the United States might lead to a restructuring of asset allocation at pension funds. It has been suggested that CalPERS is likely to shift an additional US$24 billion to its international portfolio. A large portion of this is likely to flow into India and China. If other funds follow suit, a cascading effect can be expected. Along with the already significant dollar funds available, the additional funds could be deployed to create infrastructure--roads, airports, and seaports--and be ready for a rapid takeoff when normalcy is restored. 2. 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--a classic case of having put all eggs in one basket. If Fortune 500 companies slash their IT budgets, Indian firms could be adversely affected. Instead of looking at the scenario as a threat, the sector would do well to focus on product innovation (as opposed to merely providing services). If this is done, India can emerge as a major player in the IT products category as well. 3. The manufacturing sector has to ramp up scale economies, and improve productivity and operational efficiency, thus lowering prices, if it wishes to offset the loss of revenue from a possible US recession. The demand for appliances, consumer electronics, apparel, and a host of products is huge and can be exploited to advantage by adopting appropriate pricing strategies. Although unlikely, a prolonged recession might see the emergence of new regional groupings--India, China, and Korea? 4. The tourism sector could be affected. Now is the time to aggressively promote health tourism. Given the availability of talented professionals, and with a distinct cost advantage, India can be the destination of choice for health tourism. 5. A recession in the United States may see the loss of some jobs in India. The concept of Social Security, that has been absent until now, may gain momentum. 27
6. The Indian Rupee has depreciated in relation to the US dollar. A stronger Rupee would reduce the import bill, and narrow the overall trade deficit. The Indian central bank (Reserve Bank of India) can intervene anytime and cut interest rates, increasing liquidity in the economy, and catalyzing domestic demand. A strong domestic demand would also help in competing globally when the recession is over. 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.
FUTURE EFFECTS OF CURRENT CONTRACTION ON VARIOUS SECTORS OF INDIA
The year 2008, one of the worst years in the world?s economic history, experienced a major global meltdown. This global meltdown led to job lay-offs across the world. According to the Labor Department?s report, the unemployment rolls swelled by 2.2 million, over the last year, to 9.5 million.
INDIAN STOCKS
Markets across the world have entered 2009 with an unprecedented amount of uncertainty, volatility, losses and, above all, fear.The concern of what the New Year will bring in terms of returns from financial assets, especially equities, is paramount on every investor?s mind. To find the answers to how Indian equities will perform in 2009, we should take a look at 2008 and assess why this turmoil started in the first place. The problems started with defaults in the US housing markets, which later spread to the entire financial market. Losses in real estate-related instruments forced institutions to sell assets across the board in all markets to meet liquidity challenges — assets related to real estate became almost illiquid. The problem intensified as some of the institutions were highly leveraged, which resulted in a free fall of prices for most financial assets, including equity. The tight liquidity problem made its way to the real economy — production and consumption started getting affected. The result: a bleak global economic outlook for 2009. Economy As we move into 2009, the baggage of excesses created in the last few years will continue to haunt us. We haven?t yet totally adjusted to the ripple effects of the sub-prime crisis. Also, the ongoing process of de-leveraging will continue to put pressure on all financial assets for some more time. We believe that the global economic condition will worsen before it starts improving. The good thing in this turmoil is unprecedented response from central banks and governments across the world, which helped avoid any kind of systemic failures. Experts believe that timely intervention will make the landing safer and help early recovery.
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The case of Indian equities Indian markets fell in line with global developments and lost in excess of 50 per cent in 2008. The price damage is significant in some sectors. For example, all stocks in the BSE Realty Index have lost in excess of 80 per cent (except Akruti City) since January 2008. The correction has been so severe that with the market cap of DLFin January 2008, you can now buy all the companies, including DLF, in the realty index two times over, and still be left with spare cash. The realty sector is not the only one feeling the pain. Stocks have fallen across the board, and we don?t have a single sectoral index in green. The FMCG Index has shown some resistance, but it, too, has lost close to 13 per cent since the beginning of 2008.
The way ahead
The Indian equity market will continue to track global developments in 2009. In 2008, market participants learned that there?s nothing called decoupling of financial markets. Apart from global events, domestic factors, such as earnings growth, GDP growth, and the general elections — the biggest event of the year — will also play their part. The third quarter results will be disastrous and the fourth quarter results are unlikely to show any great improvement either. We believe that markets in initial stages will be range bound, trying to find a bottom. Recovery will not be sharp as there has been collateral damage in the system. But we expect decent returns from the current levels. At the moment, it is extremely difficult to put figures for sales volume, margins, interest rates, and currency risk for Indian Corporates. This, in turn, is not allowing analysts to calculate profits for the coming quarters. However, some positive developments are not getting counted due to wider negative sentiments in the market. The outlook for 2009, in terms of commodities, is of softer prices. The peak of interest rates is behind us and it should only go down from here. The combination of these two factors means that the earnings outlook is far more optimistic going forward compared to what it is in retrospective terms. Apart from global events and the domestic earnings outlook, which will affect investors? sentiments, the outcome of the general elections will play a major role. If the verdict is fractured, it will be difficult for the government to focus on development as it will end up spending more time on its survival. Analysts believe that the outcome of the assembly elections held in 2008 had a strong message — development. This will encourage the current government to push speedy implementation of projects during its remaining tenure, and this will have a positive impact on the broader economy and the markets. Investors entering the markets at this stage should have at least a 3-year investment horizon. We believe that the worst is not yet over and bad news will continue to flow in for some more time. The first two quarters of 2009 will be crucial for the markets as well as the economy. Markets will start recovering with the first sign of stability in the global economy. However, don?t expect it to bounce back to the January 2008 highs in a hurry. The global risk aversion is likely to continue for some more time, and the excess liquidity, which was there in the system till early 2008, is not available anymore. Also, we will not see the kind of liquidity we saw in last few years. 29
The large government deficits, which the developed markets are creating for bailouts and stimulus packages, will result in a supply of sovereign bonds, which will suck liquidity from the system. The global liquidity situation is not allowing the money to flow into equities and forcing the institutions to sell, either to meet redemption pressure or to generate cash for their own survival. At the same time, individuals and institutions, which have cash, are staying away from the market as they anticipate further corrections and are waiting to buy at lower levels. In such a scenario, stock selection becomes extremely important because now prices will be based on the earnings expectations and not on PE expansions.
BANKING
The Indian banking system is relatively insulated from the factors leading to the turmoil in the global banking industry. Further, the recent tight liquidity in the Indian market is also qualitatively different from the global liquidity crunch, which was caused by a crisis of confidence in banks lending to each other. While the main causes of global stress are less relevant here, Indian banks do face increased challenges due to domestic factors. The banking sector faces profitability pressures due to higher funding costs, mark-to-market requirements on investment portfolios, and asset quality pressures due to a slowing economy.The strong capitalisation of Indian banks is a positive feature in the current environment. The problems of global banks arose mainly due to exposure to sub-prime mortgage lending and investments in complex collateralised debt obligations whose values have seen sharp erosion. Globally, banks have also been affected by the freeze in the inter-bank lending market due to confidence-related issues. On both counts, Indian banks have limited vulnerability. Indian banks? global exposure is relatively small, with international assets at about 6 per cent of the total assets. Even banks with international operations have less than 11 per cent of their total assets outside India. The reported investment exposure of Indian banks to distressed international financial institutions of about USD1 billion is also very small. The mark-to-market losses on this investment portfolio, will, therefore, have only a limited financial impact. Indian banks? dependence on international funding is also low. The reasons for tight liquidity conditions in the Indian market in recent weeks are quite different from the factors driving the global liquidity crisis. Some reasons include large selling by Foreign Institutional Investors (FIIs) and subsequent Reserve Bank of India (RBI) interventions in the foreign currency market, continuing growth in advances, and earlier increases in cash reserve ratio (CRR) to contain inflation. RBI?s recent initiatives, including the reduction in CRR by 150 basis points from October 11, 2008, cancellation of two auctions of government securities, and confidence-building communication, have already begun easing liquidity pressures. The strong capitalisation of Indian banks, with an average Tier I capital adequacy ratio of above 8 per cent, is a positive feature in their credit risk profile. Nevertheless, Indian banks do face challenges in the current Indian economic environment, marked by a slower gross domestic product growth, depressed capital market conditions, and relatively high interest rate regime. The profitability of Indian banks is expected to remain under pressure due to increased cost of borrowing, declining interest spreads, and lower fee income due to slowdown in retail lending. Profit levels are also likely to be impacted by mark-to-market provisions on investment portfolios and considerably lower profit on sale of investments, as compared with previous years. Moreover, those Indian banks considering accessing the capital markets for shoring up capital adequacy may be forced to curtail growth plans, if 30
capital markets remain depressed. While these challenges will play out over the medium term, we expect the majority of Indian banks? ratings to remain unaffected, as they continue to maintain healthy capitalization, enjoy strong system support and benefits of government ownership in the case of public sector banks.
AUTO
India has been relatively unaffected by the direct impact of the economic slowdown; however, the ripple effects are very much here. Despite the government?s sops, auto sales have declined in November by 18%. As demand slows down, auto makers like Tata Motors, Hyundai and Ashok Leyland have cut down production. It is unlikely that sales will rise in December either, forcing carmakers to keep prices low until the time demand picks up. In December, customers generally prefer not to buy vehicles and wait for the new year. The real impact of the tax cut, if any, will be clear in only by the end of January 2009. Most car launches planned for India towards the begining of 2009 have already been quietly pushed forward by „a few months?. Looming over the bleak economy is the potential collapse of America?s Big Three automakers General Motors, Chrysler and Ford. If any of these companies with trancontinental operations go bust, it can spark a chain reaction, pulling down operations in numerous countries, affecting even successful rivals lke Toyota and Honda and leading to millions of jobs losses across borders. It is true that the Indian arms of the troubled three US auto companies have been doing rather well. However, buyers tend to avoid cars which have foreign parents in trouble.This is because they fear a potential disruption in services and warranties if the parent companies go bankrupt. In the US too, General Motors has - so far shied away from filing for restructuring under bankruptcy, since it fears that people will not buy cars from a company under Chapter 11 protection. A bankruptcy at any of the Big Three can, in theory, force consumers to cut out that company?s cars while looking for a new set of wheels. This could be true of consumers in India as well. After much leading and grovelling, the US car CEOs managed to get a $15 billion loan from the US government, which they must repay by March if they fail to come up with a viable restructuring plan during that time. Simply put, they will have to cut thousands of jobs, renegotiate many contracts, abandon several car brands and get their creditors to agre to easier repayment terms. This is not going to be an easy task for the employers nor he employees, but that is the only way these companies will be able to keep their heads above water during these stormy times. And, since the loan is tied to their ability to restructure viably, a potential failure to do so can still drive them to bankruptcy. The auto bakruptcies can create a riple effect across nations. In India, China and Mexico, there are thousands of companies supplying a steady stream of parts - ranging from light bulbs to transmission systems - to the Big Three automakers in the US. With car sales declining in the US, these suppliers are ?already in trouble and a bankruptcy at Detroit can send hundreds of them belly-up across countries, and render additional lakhs of workers jobless. Just last financial year, India exported Rs 14,400 crore worth of components to the US alone.This year, it will be substantially less. There is the fact that in India, the effects of the slowdown are already well visible. The days of quick job-hopping are over, and so are big increments are salary hikes. Unlike the average customer in the US, Indians have always been keen on saving. With uncertainty on the horizon, the Indian customer is saving even more - and as they save more, the less they spend, leading to a further showdown in sales in all industries. It is a vicious circle, with no easy way out. 31
There is a silver lining in all this, though. A restructured US auto industry might turn out to be leaner and meaner. The Japanese companies are more efficient and are working towards even more efficiency, learning the right lessons from the crisis. No one expects the slowdown to last more than an year, though things would be tough in that period for sure. However, anyone who is financially secure and have plans for a car should not think twice. After the tax cut, prices for vehicles are really attractive, and dealers desperate for sales might offer even more discounts.
TEXTILE
The future outlook of the Indian textile industry is predicted to remain gloomy for 2009 due to negative impact of the recession on international markets. Textile exports tumbled nearly 30% and the production contracted 20%-30% since April 2008. If one takes orders placed into account, then the export in the current year dropped even more. As per the available data, orders placed in the third quarter of 2008 by leading exporters slumped 15-20% on an average whereas the sales in domestic market slammed 10-15% on year-on-year basis. The grim outlook for the Indian textile industry for next year is forecasted in the backdrop of forex losses and economic slowdown in the international market. These factors along with lengthening cash cycles and rising working capital requirements have put extensive pressure on the short-term liquidity of the industry. Moreover, the impact of the global financial crisis was inevitable to fall on the Indian economy, resulting in drying up of investments in the country. Manufacturing sector will certainly see the direct impact of the crisis. The Indian textile industry rallied under declining domestic demand and high input costs in the current year. Drop in demand from external markets (like the US and Europe, both absorb nearly 50% of the total production) created panic among manufacturers who have started trimming production in a phased manner. Indian companies have adopted a policy of temporarily discharging workers to deal with menace of the global economic meltdown. Not only this, textile manufacturing units at major hubs like Delhi, Bangalore and Tirupur have been closed, rendering thousands of people jobless. The industry had asked the Ministry of Textiles to continue the interest subvention on credit for packing across value chain. The global financial crisis has made the Indian textile industry to bleed white because it is driven by exports and the present scenario is likely to remain as it is until December 2009. As the effect of recession is higher on developed markets, the demand is expected to remain weak. This will be visible in the financial performance of exporters in the current financial quarter.
REALTY
Rentals plunged and even freebies offered by realtors failed to pep up demand. Reports had it that there are no takers for Mumbai 100cr flats. Profits for most realtors listed in the Bombay Stock Exchange reflect downturn in the sector. BSE Realty index plunged by 25per cent in last one month and 75per cent in last one year. Second quarter results indicated that DLF (once responsible for raising $2bn from the capital market) logged a 4% drop in net profits. Omaxe reported a whopping 87% drop. Realty bubble bust is even impacting hospitality sector as hotel developers have cut down on budgets owing to slow business traffic.
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CBDs markets are likely to face vacancies in 2009, as the first impact of the global recessionary economy is being felt by the financial and other fore-runner organizations. The vacancy may be further fuelled in CBD areas by the consolidation moves of many organizations. We will also see a reversal of the trend witnessed over the last two expansionary decades where large organizations moved from owned to leased assets. Given the drop in prices and availability of choice properties, this will be a good time for surviving organizations to announce their new leadership positions through trophy purchases. Jones Lang LaSalle Meghraj is currently transacting in many such mandates. This CBD vacancy rate, if triggered, can add significant pressure to the upcoming/newly developed premises in upcoming front-office districts such as Lower Parel in Mumbai and Nehru Place in Delhi. While the sentiment in the US and Europe towards outsourcing is positive in the long term, as the corporations there realize its need more than before, the active decision-taking for expansion by BPOs is totally suspended for the moment. We do not expect this to change in the 2009. Hence, the pressure on upcoming and announced projects -especially SEZs - will continue in 2009. In 2009, IT SEZs will also experience further pressure from the fact that the STPI concessions may be extended for another couple of years. While these concessions are important for IT companies? survival during the recession, they will adversely impact SEZ developments. In 2009, the peripheral areas of metros as well as the Tier II/III cities will need to compete with the central or secondary business districts for the same set of talents, thus dissolving the clear segmentation which was emerging and separating various micro-markets over the last couple of expansionary years. Newly developed or announced projects are especially going to suffer and may see continued vacancy in 2009. However, 2009 will also see practices in the real estate business become more organized and professional, as they did in the late „90s and early 2000s with the introduction of FIs, foreign money and the creation of Government-supported large development formats. This time around, a similar professional approach may reach warehousing land acquisitions.
ENERGY
Oil prices are appearing to reflect state of economies. Rising prices between 2003 and 2007 reflected the best economic growth in the recent times. This high economic growth was brought to an end not only by under-pricing of risk, excess liquidity and over-confidence but also by an increasingly unsustainable commodity boom - of which oil was a crucial part. Now, as the world has dropped into recession, oil prices have fallen by around 80% (as we write) from the high of $147/bbl to touch $33/bbl. While shortage of refining capacity was considered as the prime reason for increase of crude prices, now the same refineries are going under due eroding GRMs. For example, the profitability of RIL's new refinery is projected to come under severe pressure. The other elements of energy chain are no better whether it is the collapsed rig markets or delayed construction of new power projects. Rising prices for a long term gestation projects also mean domino effect in terms of delayed decisions by consumers, governments and businesses that have changed the course of demand. Another matter of concern is that Indian economy is also appearing to be cooling down faster than expected. People may cheer fast declining inflation rate but it is also a dangerous indicator towards declining economic activity. All hydrocarbon products consumption took a nose dive of more than 15% from May 2008 to October 2008. Though, the fall in oil prices and economy in general is a great relief to hard-pressed consumers and the fall in oil prices is a sort of de facto tax cut - a stimulus package that does not have to be approved by the Parliament or paid for out of RBI's efforts. Lower prices are forcing energy companies to cut their budgets, hold back on starting some new projects and look for new survival gymnastics by retrenching people and cutting down expansion 33
plans, developing efficient processes and optimising systems. This will make itself felt in a new turn of the cycle after an economic recovery. Probably, every recession contains the seeds of the new economy order. The lower costs will start making sense for a lot of new businesses ideas that would become profitable and thus a whole of new generation of activities would take over. But what would be those activities? The energy policies of the new India, as in other countries, will emphasise greater energy efficiency and renewables. A "green stimulus programme" is already high on the transition agenda. But the worried question around the economy now is: to what degree lower prices will crimp investments in existing and new projects. The answer will not be determined just by energy prices, important as they are. The biggest impact will come from the health of the economy, the nation's fiscal position and the availability of capital and credit. With the impaired credit system, resources for energy capex and opex purposes are likely to be severely constrained. In such circumstances, it is important that a collaborative efforts are made to understand how deep the problem is and what are the best survival strategies. Rather, how can these problems are turned into opportunities for a robust performance in the revived economic future. This one day programme has been designed specifically to seek answers to these questions from the industry veterans, the leading consultants and the players themselves. Probably the new mantra for survival is to synergize and join together.
INSURANCE
Insurance is to provide for a future contingency. As the premium has to come from savings, it gets the last priority after meeting the immediate needs. For this reason insurance requires selling through persuasion. Economic recession and unemployment will adversely affect growth of insurance business and build-up of funds. Insurance like banking is a strong pillar of the economy and needs to be immunized against the ill effects of recession. Otherwise the economy as a whole will suffer.
In life insurance, initial symptoms will be default in payment of premiums followed by surrender of policies in force. For the first time in the last fifty years this is a major threat to the growth of insurance. It can create a crisis of confidence.General insurance will also be affected due to economic slow down and decline in production and consumption.
MANUFACTURING
The global financial malaise has had a significant feed-through effect to India. According to a report inlate October in India's daily Business Standard, the interest rates for project financing operations rose to14% -16% from 9%-11% before the summer. This jeopardises the financial viability of highway projectsworth over US$2bn, which in turn represent approximately 40% of projects that have been approved bythe National Highways Authority. This of course will delay the realisation of the government's ambitionsto fast track highway construction through the National Highway Development Programme, the firstphase - the multi-billion dollar 'Golden Quadrilateral' programme. India's infrastructure sector has registered strong growth in recent years, with 2006 and 2007 witnessing real construction sector growth of 20% and 14% per annum respectively, thanks to strong activity by both private and public sources. This development has been spurred by a virtuous cycle of strong economic growth, rising government revenues and foreign investment, which has begun to pull the under-developed infrastructure sector up by its bootstraps. However, this progress is now threatened by the global financial crisis and economic downturn, which has seen foreign investment 34
flows to the country reverse. Exports are also under pressure, undermining economic growth and government revenues. As such, future funding for infrastructure from both the public sector and the private sector is very much threatened. The government is attempting to find ways to underpin the infrastructure sector, and the economy as awhole. One proposal is for the government to subsidise loans by effectively setting a ceiling lending rateand absorbing the costs of the higher rates. But the government's ability to fund such projects has itslimits, given its own significant (and growing) fiscal constraints. In this context, rating agency Fitch hasexpressed considerable concerns about the outlook for the infrastructure sector, especially given thatmany key projects require imminent refunding. This pending refinancing and debt re-structuring 'couldnot have come at a worse time', according to the rating agency. On the plus side, multilateral support is significant. As reported in December 2008, India was granted anew US$3bn loan from the World Bank for infrastructure spending. For the time being, we have reviseddown our forecast for real growth in India's construction sector to 5.7% in 2009, from a previous forecastof over 10%. We estimate real construction sector growth in 2008 to have been just under 9%, comparedto just over 14% in 2007. For 2010, we currently forecast that real construction sector growth willrebound to 9%. Risks to our forecasts are very much to the downside. Much depends on how prolonged the recession indeveloped markets lasts, and whether the financial crisis will resurface. Our core global scenarioenvisages a recovery in most key markets in 2010, but the outlook is extremely uncertain and thisscenario is by no means guaranteed. Indeed, the US (and other economies) could remain in recession in2010, further starving India of export revenues and capital to finance its infrastructure development, justat a time when major projects are due to be refinanced. As such, there is a particularly severe downsiderisk to our 2010 infrastructure forecasts.
REASONS BEHIND A TYPICAL RECESSION
Recessions have a variety of causes and a wide range of symptoms. 1. Some causes are domestic in origin, stemming from policy mistakes on behalf of the economic authorities. For example, the central bank might allow the money supply to grow too slowly and keep interest rates above the level needed to maintain a steady rate of growth. Higher interest rates have the effect of dampening down spending by both households and businesses and can lead to plant closures and job losses. 2. External shocks can also bring about recession. For example in 1973-74 the large jump in world oil prices caused a sharp rise in cost push inflation and an acceleration in wages. Falling real purchasing power of consumers and a deflationary fiscal and monetary policy from the government sent the economy into reverse. 3. Inflation is another main factor which contributes more towards the situation. The higher the rate of inflation, the smaller the percentage of goods and services that can be purchased with the same amount of money. This may be because of increased production costs, higher energy costs and national debt. When the prices of goods reach their ever higher stage, people tend to cut on overall spending, luxurious spending, restrict them towards basic necessities and thus save more n more. As a result, GDP declines when people begin to cut expenditures in order to cut down costs. This makes the companies to cut their costs as well and they chuck out workers which brings unemployment.
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4. Another one of the important causes of economic recession is falling demand for goods and services. It's not hard to understand that if we produce more than we are consuming, the demand for the excess production just won't be there, and we have a waste of resources. 5. Economic recessions are caused by a decline in GDP growth, which is itself caused by a slowdown in manufacturing orders, falling housing prices and sales, and a drop-off in business investment. The result of this slowdown is falling employment, and rising unemployment, which causes a slowdown in retail sales. This creates a downward spiral in manufacturing and increased layoffs. 6. High interest rates are also a cause of recession. That's because it limits liquidity, or the amount of money available to invest.
CHARACTERISTICS OF A TYPICAL RECESSION
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Declining demand for output leading to higher levels of spare productive capacity Contracting employment / rising unemployment as firms lay-off workers to control their costs (see the chart below) A sharp fall in business confidence & profits A decrease in fixed capital investment spending because there is insufficient demand to justify new capital projects De-stocking and heavy price discounting - this leads to lower inflation Reduced inflationary pressure in the labour market as unemployment rises Falling demand for imports Increased government borrowing
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PREDICTING NEXT RECESSION USING ARIMA MODELS
ARIMA MODEL
In statistics and econometrics, and in particular in time series analysis, an autoregressive integrated moving average (ARIMA) model is a generalisation of an autoregressive moving average or (ARMA) model. These models are fitted to time series data either to better understand the data or to predict future points in the series. They are applied in some cases where data show evidence of nonstationarity, where an initial differencing step (corresponding to the "integrated" part of the model) can be applied to remove the non-stationarity. The model is generally referred to as an ARIMA(p,d,q) model where p, d, and q are integers greater than or equal to zero and refer to the order of the autoregressive, integrated, and moving average parts of the model respectively. Here we have predicted the next recession using these models by taking past 50 years GDP growth rate of USA as input to the model to predict future GDP growth rates till 2021.USA is taken as the past behavior of recessions are predominantly seen by fall in GDP growth rate of USA. Output of ARIMA Model
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Estimates at each iteration Iteration 0 1 2 3 4 5 6 7 SSE 305.672 253.840 216.043 192.445 183.147 182.992 182.991 182.991 0.100 -0.043 -0.186 -0.328 -0.470 -0.488 -0.490 -0.490 Parameters 0.100 0.100 0.100 -0.050 -0.028 -0.017 -0.200 -0.157 -0.135 -0.350 -0.288 -0.255 -0.500 -0.418 -0.376 -0.521 -0.437 -0.394 -0.522 -0.438 -0.395 -0.522 -0.438 -0.395 0.080 0.101 0.116 0.124 0.126 0.123 0.122 0.122
Relative change in each estimate less than 0.0010 Final Estimates of Parameters Type AR 1 AR 2 AR 3 AR 4 Constant Coef -0.4897 -0.5219 -0.4382 -0.3952 0.1224 SE Coef 0.1445 0.1480 0.1485 0.1453 0.3033 T -3.39 -3.53 -2.95 -2.72 0.40 P 0.002 0.001 0.005 0.009 0.689
EQUATION
ifferencing: 1 regular difference Number of observations: Original series 48, after differencing 47 Residuals: SS = 181.545 (backforecasts excluded) MS = 4.323 DF = 42 Modified Box-Pierce (Ljung-Box) Chi-Square statistic Lag Chi-Square DF P-Value 12 12.0 7 0.099 24 28.1 19 0.081 36 34.2 31 0.316 48 * * *WE HAVE ESTIMATED FUTURE VALUES OF GDP GROWTH RATE OF USA USING ARIMA(4,1,0) MODEL SINCE P-VALUES OF ALL THE COEFFIIENTS HERE ARE LESS THAN 0.05 HENCE SIGNIFICANT FOR THE PREDICTION.BY TAKING DIFFERENCES OF TWO ADJACENT YEARS? GDP GROWTH RATE WE FIND THE ESTIMATED EQUATION TO BE:Y(T)-Y(T-1)=-0.4897*[Y(T-1)-Y(T-2)]-0.5219*[Y(T-2)-Y(T-3)]-.4382*[Y(T-3)-Y(T-4)]0.3952[Y(T-4) -Y(T-5)]+.1224, where Y(T)= GDP GROWTH RATE AT TIME t=T (YEARLY) EXTRAPOLATING THE DATA GDP GROWTH RATES UPTO 2021 ARE:2003 2004 2005 2006 2007 2008 2009 2010 2011 2.5 3.9 3.2 2.9 2.3 1.1 2.53 2.96 2.89 37
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
3.10 3.33 2.99 2.18 2.52 2.86 2.94 2.89 2.71 2.78
GDP GROWTH RATE OF USA WITH PREDICTION TILL 2021
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NEXT RECESSION
6 4 2 0
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Series1
HENCE WE PREDICT THAT THE NEXT RECESSION WILL OCCUR NEARABOUT YEAR 2015.
2021
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