Meaning of Recession A recession is a decline in a country's gross domestic product (GDP) growth for two or more consecutive quarters of a year. A recession is also preceded by several quarters of slowing down. An economy, which grows over a period of time, tends to slow down the growth as a part of the normal economic cycle. An economy typically expands for 6-10 years and tends to go into a recession for about six months to 2 years. A recession normally takes place when consumers lose confidence in the growth of the economy and spend less. This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment. Investors spend less; as they fear stocks values will fall and thus stock markets fall on negative sentiment. Risk aversion, deleveraging and frozen money markets and reduced investor interest adversely affect capital and financial flows, import-export and overall GDP of an economy. This is exactly what happened in US and as a result of contagion effect spread all over the world due to high integration in the global economy.
Global recession, its root causes and its impact on Indian Economy Recess refers break time, in context with an economy it is a break time in development. In broad sense recession is a business cycle of contraction and a general slowdown in economy over a period of time. Global recession is the state of the economy declines, a wide spread declines in the GDP and employment and trade lasting from six months to a year. It is a time of less business activity, usually lasting at least three quarters of the year on nine months. If the global economic growth is 3% or less it is termed as global recession. In 2008, the United States experienced a serious financial crisis which turned into a major economic recession and affected the most of the countries of the world. The main roots causes of this recession unwise decision of lending money by US bankers and financial institutions, predatory lending, sub-prime lending mass outsourcing and tremendous hike in oil price in early 2007 to 2008.The Fannie Mae and Freddie Mac, an institution expanded the depth of mortgage markets by popularizing securitization of mortgages, pooling together mortgages into a lower risk,
marketable securities, it created a huge financial slow down in US economy. According to the leading economists the financial crisis of 2007-10 is the worst financial crisis since the great depression of 1930. The origin of that recession was in US and origin of the current recession is also in US. The main reason of recession in US are: (a) US Current Account and Trade Deficit between 1996 and 2004 was increased by $ 65 billion, it is about 5.8% of GDP. (b) Sub Prime Lending such as providing loan at higher risk with down value of mortgage. (c) Predatory lending was severely practiced. Loans were provided into unsafe or unsound loan for inappropriate purposes.(d)Increased debt burden of households and financial institutions all over the world was also a major reason before crisis.(e) Out sourcing was also a problem for the counties at global basis specially in US. Their own working hand migrated to other countries and returned back caused a great unemployment. (f) Oil price tripled from $50 to$140 from early 2007 to 2008.During the recession period Indian Stock Market crashed from high of 20,000 to low of around 8,000 points. The real estate sector also caught in the grips of recession due to less investment. The Indian industrial sector was worst affected because of lower demand of goods and services. It sector suffered 5% decline in man power utilization. During this recession the total employment in textile and garment industries metals and metal products, Information Technology and BPO, automobiles, Gems and jewellery, transportation, construction and mining had gone down from 16.2 million in September 08 to 15.7 million by December 2008.The back bone of Indian economy agricultural sector’s share in GDP in declining which express the less concentration on the sector, but it played a vital role in this kind of situation which was unaffected. The majors were taken by the government of India were tremendous which copped up very well with such crisis as CRR has been reduced 6.5% to 5%, Repo rate has been reduced from 9% to 4.75%, SLR also was reduced from 25% to 24% between October 6 to 20 ,2008 . The RBI had injected Rs.1, 86,000 crores. The present out going recession which affected globally was not self stimulated. It was created by the big US companies and financial institutions due to lack of foresightness. Although, so called recession definitely affected the Indian economy but wisdom of government and major backbone of our economy sector compensated it.
CAUSES OF RECESSION
1. Sub-prime mortgage crisis:The sub-prime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe. The crisis, which has its roots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financial industry regulation and the global financial system. The risks to the broader economy created by the housing market downturn and subsequent financial market crisis were primary factors in several decisions by central banks around the world to cut interest rates and governments to implement economic stimulus packages.
When USA house prices began to decline in 2006-07, mortgage delinquencies soared, and securities backed with sub-prime mortgages, widely held by financial firms, lost most of their value. Effects on global stock markets due to the crisis have been dramatic. Between 1 January and 11 October 2008, owners of stocks in U.S. corporations had suffered about $8 trillion in losses, as their holdings declined in value from $20 trillion to $12 trillion. Losses in other countries have averaged about 40%. Losses in the stock markets and housing value declines place further downward pressure on consumer spending, a key economic engine.
2. High Oil Prices:-
The rise in oil prices has become a very pressing issue. Certainly, nobody has to be reminded that crude was hovering just below $150 per barrel, while gasoline has surpassed $6 per gallon on average around the nation. The widely accepted explanation for oil prices' recent steep climb is strong demand. The global economy is firing on all cylinders, and that US and India have emerged as major consumers. In addition, supplies are tight; that the margin between what is produced and what is consumed on a daily basis has never been narrower; and furthermore, that major new discoveries of oil are few and far between. These explanations certainly sound plausible, and perhaps we can even attribute some portion of the price rise to them. A closer analysis, however, shows that they are not sufficient to explain the full extent of the increases. A new report released last month by the Senate Permanent Subcommittee on Investigations concludes that market speculation has played a role in the rise of oil and gas prices. It points a finger not only at commodity funds and hedge funds, but also at large institutional investors such as pension funds and mutual funds, which have become major participants in the energy markets over the past several years. The investigations, found that an estimated $75 billion has poured into regulated U.S. oil futures markets in the past few years. While this sounds like a lot (and it certainly is), the amount that has gone into non-regulated exchanges overseas is inestimable. The Commodity Futures Trading Commission oversees all futures trading on U.S. markets, and it's constantly monitoring the positions of large speculators. However, the CFTC (Commodity Futures Trading
Commission) has no jurisdiction over exchanges that are outside the U.S. or in the murky over-the-counter market where billions of dollars of contracts are traded all the time.
3. Inflation, the silent killer:Most likely, the prime cause has been the important role of productivity growth in developing countries, especially the large-sized countries like US and India. With Africa and Latin America now joining the development party, subdued world inflation is more likely than not. World inflation is broadly composed of three commodities: energy, agriculture and metals (both precious and other metals). In India only inflation rate touched to just below 13% in mid of 2008. A reasonable speculation is that this recent burst in prices has more to do with old-fashioned speculation than even older-fashioned fundamentals. In this regard, the recent hysteria pertaining to the Indian rupee is relevant. The normal inflation rate in developed countries 1% to 4% typically; developing countries 5% to 20% typically; national inflation rates vary widely in individual cases, from declining prices in Japan to hyperinflation in one Third World country (Zimbabwe), inflation rates have declined for most countries for the last several years, held in check by increasing international competition from several low wage countries (2005 est.) .In 2008, the prices of many commodities, notably oil and food, got so high to cause genuine economic damage, threatening stagflation and a reversal of globalization .In January 2008, oil prices surpassed $100 a barrel for the first time, the first of many price milestones to be passed in the course of the year. By July the price of oil reached as high as $147 a barrel although prices fell soon after.
4. Liquidity crisis:From late 2007 through September 2008, before the official October 3rd bailout, there was a series of smaller bank rescues that occurred which totaled almost $800 billion. In the summer of 2007, Countrywide Financial drew down $11 billion line of credit and then secured an additional $12 billion bailout in September. This may be considered the start of the crisis. In mid-December 2007, Washington Mutual bank cut more than 3,000 jobs and closed its sub prime mortgage business. In mid-March 2008, Bear Stearns was bailed out by a gift of $29 billion non-recourse Treasury bill debt assets. In early July 2008, depositors at the Los Angeles offices of Indy Mac Bank frantically lined up in the street to withdraw their money. On July 11, Indy Mac, a spin-off of Countrywide, was seized by federal regulators - and called for a $32 billion bailout. The mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures. That day the financial markets plunged as investors tried to gauge whether th e government would attempt to save mortgage lenders Fannie Mae and Freddie Mac. The two were placed into conservator ship on September 7, 2008. On September 16 2008, news emerged that the Federal Reserve may give AIG an $85 billion rescue package; on September 17, 2008, this was confirmed. The terms of the rescue package were that the Federal Reserve would receive an 80% public stake in the firm. The biggest bank failure in history occurred on September 25 when JP Morgan Chase agreed to purchase the banking assets of Washington Mutual The year 2008, as of September 17, has seen 81 public corporations file for bankruptcy in the United States, already higher than the 78 in 2007. Lehman
Brothers being the largest bankruptcy in U.S. history also makes 2008 a record year in terms of assets with Lehman's $691 billion in assets all past annual totals. The year also saw the ninth biggest bankruptcy with the failure of Indy Mac Bank. The Wall Street Journal states that venture capital funding has slowed down which in the past led to unemployment and slowed new job creation.
5. Large Trade Deficit Spells More Difficulties Ahead for US Economy:Since December 2001, the monthly trade deficit has increased $37.6 billion, and petroleum products account for 47 percent of this increase. The growing U.S. appetite for low-cost consumer goods, capital goods, and industrial materials and components, especially from Asia, account for more than half of the growth of the trade deficit. This situation is likely to become worse in the months ahead. Crude oil prices, after falling in November, have been rising again, and the dollar has strengthened in recent months, making most imports cheaper. In 2005, business and political conditions in Europe weakened, and prospects for the Japanese economy improved only modestly; consequently, the dollar rose against industrial country currencies. The dollar remains as much as 40 percent overvalued against the Chinese Yuan and other Asia currencies. Together, higher oil prices and a strong dollar will push the trade deficit to new record highs, with the monthly trade deficit likely exceed $75 billion by mid 2007. High and rising trade deficits tax economic growth. Specifically, each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment. Worker productivity is at least 50
percent higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into these industries would increase GDP. Were the trade deficit cut in half, GDP would increase by nearly $300 billion, or about $2000 for every working American. Workers wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying good wages and offering decent benefits. Manufacturers are particularly hard hit by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 3 million jobs. Following the pattern of past economic recoveries, the manufacturing sector should have regained about 2 million of these jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.
Economic Indicators of Recession
Recession in an economy, in general terms is described as a situation when an economy features slow economic activities. During this period the economy also suffers a steep fall in GDP growth rate, which tends to worsen situation further. The American economy is considered as the ‘mother’ economy of all other nations. Any fall in the parent economy affects the income and growth of the dependent economies. The global economy is facing a downturn since last few months that has given birth to a number of consequences that can be tagged as the ‘Indicators of Recession’ in a particular economy. The outcome of recession is unquestionably disastrous for the economy and comprises of the following five major indicators:-
1. Inverted yield curve:An inverted yield curve is perhaps the best measurable indicator of inbound recession - the point in which yields on long-term investments fall below the yields on short-term deposits. This demonstrates the holistic ability of the market to identify itself, in that pricing and yields on such investments are determined by wholly supply-and-demand models. If the market knows that the value of money, or its ability to produce yield is going to fall in the future, borrowers are going to be less willing to borrow money at higher rates; more specifically though, the formulation of risk in to the calculation ensures that if the market perceives a decrease in expected monetary value, that will be included in the price (more clearly, the rate, or yield). 2. Reduction in the consumer expenditure:The first and the foremost effect of Recession is that, it influences the spending habits of customers and prompts them to save more for the approaching period of depression. This in turn affects the business and production activities of the market and drags the income generating sector in trouble. 3. Mounting Unemployment The consequences generated by the first indicator, opened ways for the second to penetrate and grow during the recession period. The economy lands into a situation where the existing jobs will face a steep decline leave alone the generation of fresh job opportunities. 4. Fall in investment and interest rates
The chain is carried on and third indicator signals of a fall in the interest rate in future that leads to the drawing back of money invested by many investors who could might feel insecure for their investments and can fear of the approaching market situation. 5. Inflation Inflation is always the most predictable and inevitable consequence of all the recession forces in an economy. It brings along high prices, less purchasing power, slow income growth and unemployment in a bunch.
All these indicators are clear signs of the impending financial crisis that every economy has to face.
STEPS TAKEN BY GOVT. AND RBI
The central bank even cut its benchmark Repo rate by 150 basis points (bps) to 7.5% on October 19 in an attempt to get some of that money moving out of the bank vaults. Still no go.
The RBI recently turned up the thermostat once more, this time to prod banks to start lending at reduced interest rates. It cut its benchmark Repo and reverse rate by 100 bps. But, again, there’s hardly any movement. The banks are still carting their surplus cash over to the RBI and dumping it there for safekeeping, for even as a low a return as 5%. Take a look at the money being tipped over at the RBI window.
For the first five days of the month, till the RBI cut the rates, banks plunked Rs 243,310 crore with the Reserve Bank, for a return of only 6%. Over the next three working days, banks again deposited Rs 84,635 crore with the central bank, for a return of just 5%. The total — for just eight days — works out to over Rs 327,000 crore.
In effect, this means banks are still wary of lending to corporate, despite the sea of liquidity and rate cuts unleashed by the central bank. This also then conveys how banks are still uncertain about the future and that they are doubtful about the ability of their corporate clients to pay up in time. HERE’S an example a public sector unit was able to issue five-year bonds to banks with a coupon of 9.33%. Around the same time, one of the Top five India Inc companies also borrowed three year money, but at 10.10%. Clearly, banks are willing to take a risk on the government, even if it is a subsumed sovereign guarantee, but not on even AAA-rated private companies. Banks have not forgotten the nightmares of the early 1990s, when bank NPAs ruled around 10-14%. This time, despite the prodding from the government and the central bank, they are unwilling to stick their necks out. The RBI has allowed banks to restructure loans a euphemism for looking the other way when a loan turns bad that might in ordinary times have been called for st ricter treatment. But, the banks are still not biting.
The problem also seems to be in the system’s liquidity absorption capacity. Whatever steps the government takes at the moment such as, providing cheap
cash to corporate through a variety of refinance windows — not only are banks reluctant to lend, even corporate are loath to load up their balance sheets with fresh debt. Many of them are drawing down their existing credit lines with banks emboldened somewhat by the new restructuring space to finish existing projects but are unwilling to bet on new projects. With aggregate demand having fallen, India Inc is also contending with reduced top line and bottom line projections. In such a scenario, they may not be in a mood to pile up additional debt.
Therefore, the key to the current economic impasse might lie on the demand side. The government has tried addressing the issue by spending on infrastructure and by cutting taxes to boost demand. These are also not without their associated problems. Any investment in infrastructure will yield results only after a long lag, and the nature of improved technology does not allow for the higher employment generation that one saw a few years ago. Plus, to get an infrastructure project started is also time consuming financial closure in these days of clammy credit markets is a tough call.
Some economists say that the production orientation of the economy has changed in favor of expensive consumer products, a sector that might be slow off the blocks in reviving. In such a situation, reviving demand for wage goods might just do the trick. Even this hypothesis needs to be tested. The occasion might present itself soon — with experts forecasting a better-thanaverage winter crop, the government should facilitate hassle-free movement of the harvest to the markets and consumables to centers where the ensuing
agricultural income can be spent. This may sound simplistic, but sorting the physical, infrastructural infirmities could be one of the first achievable steps on the long road to recovery.
Policy Response
There is not much room for further fiscal policy action as the consolidated fiscal deficit of the central and state governments in 2008-09 is already about 11 percent of the GDP. This is likely to rise further as further necessary public expenditures are announced in the next budget and economic activity slows down. Any further increase in 1 Rajiv Kumar, et al, ‘The Outlook of Indian Economy’, ICRIER Working Paper No. 235 fiscal deficit to GDP ratio could invite a sharp downgrading of India’s credit rating and a loss of business confidence.With inflation down at less than one percent and likely to remain below five percent in the coming months, there is room for bringing down the repo rate further. However, the more important issue is to try and induce commercial banks to bring down their lending rates as these currently remain at around 10 percent even for their prime borrowers. This is largely a result of the ‘crowding outeffect’ of the large government borrowing programme.To address it, the government may have to consider monetizing its borrowing requirement so that liquidity is not squeezed out of the system. This poses the danger of stoking inflation in the medium-term but perhaps more importantly the breakdown of macro-prudential discipline that has been achieved after considerable effort. It would seem, therefore, that government’s options for taking counter cyclical and reflationary measures in the short term are rather limited. In our view, it is more important to focus policy attention on removing some of the many remaining structural bottlenecks on raising the potential GDP growth rate. Essentially, this will imply efforts at improving the investment climate both for domestic and
foreign investors; removing the entry barriers for the entry of corporate investment in education and vocational training; improving the delivery of public goods and services and expanding physical infrastructure capacities including a major effort at improving connectivity in the rural regions. These measures will constitute the package of second generation of structural reforms and will enable the Indian economy to climb out of the downward cyclical phase and then to extend the upward phase for a longer period than was achieved in the last cycle.
REFERENCES
? http://www.commodityonline.com/hottopics/US-Recession.html ? http://www.fibre2fashion.com/industry-article/9/877/impact-of-recession-inamericaneconomy-on-india1.asp ? http://www.indiadaily.com/editorial/09-12f-04.asp ? http://www.economywatch.com/world_economy/usa/indo-usa-traderelation.html ? http://www.thehindubusinessline.com/2008/12/31/stories/200812315130050 0.htm ? http://profit.ndtv.com/2008/11/01005242/IndoUS-trade-relations-What.html ? http://www.thestandard.com/news/2008/03/20/five-reasons-why good-time-startcompany ? http://forum.lowyat.net/topic/610764 ? http://EzineArticles.com/?expert=Azaz_Motiwala recession-
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Global recession, its root causes and its impact on Indian Economy Recess refers break time, in context with an economy it is a break time in development. In broad sense recession is a business cycle of contraction and a general slowdown in economy over a period of time. Global recession is the state of the economy declines, a wide spread declines in the GDP and employment and trade lasting from six months to a year. It is a time of less business activity, usually lasting at least three quarters of the year on nine months. If the global economic growth is 3% or less it is termed as global recession. In 2008, the United States experienced a serious financial crisis which turned into a major economic recession and affected the most of the countries of the world. The main roots causes of this recession unwise decision of lending money by US bankers and financial institutions, predatory lending, sub-prime lending mass outsourcing and tremendous hike in oil price in early 2007 to 2008.The Fannie Mae and Freddie Mac, an institution expanded the depth of mortgage markets by popularizing securitization of mortgages, pooling together mortgages into a lower risk,
marketable securities, it created a huge financial slow down in US economy. According to the leading economists the financial crisis of 2007-10 is the worst financial crisis since the great depression of 1930. The origin of that recession was in US and origin of the current recession is also in US. The main reason of recession in US are: (a) US Current Account and Trade Deficit between 1996 and 2004 was increased by $ 65 billion, it is about 5.8% of GDP. (b) Sub Prime Lending such as providing loan at higher risk with down value of mortgage. (c) Predatory lending was severely practiced. Loans were provided into unsafe or unsound loan for inappropriate purposes.(d)Increased debt burden of households and financial institutions all over the world was also a major reason before crisis.(e) Out sourcing was also a problem for the counties at global basis specially in US. Their own working hand migrated to other countries and returned back caused a great unemployment. (f) Oil price tripled from $50 to$140 from early 2007 to 2008.During the recession period Indian Stock Market crashed from high of 20,000 to low of around 8,000 points. The real estate sector also caught in the grips of recession due to less investment. The Indian industrial sector was worst affected because of lower demand of goods and services. It sector suffered 5% decline in man power utilization. During this recession the total employment in textile and garment industries metals and metal products, Information Technology and BPO, automobiles, Gems and jewellery, transportation, construction and mining had gone down from 16.2 million in September 08 to 15.7 million by December 2008.The back bone of Indian economy agricultural sector’s share in GDP in declining which express the less concentration on the sector, but it played a vital role in this kind of situation which was unaffected. The majors were taken by the government of India were tremendous which copped up very well with such crisis as CRR has been reduced 6.5% to 5%, Repo rate has been reduced from 9% to 4.75%, SLR also was reduced from 25% to 24% between October 6 to 20 ,2008 . The RBI had injected Rs.1, 86,000 crores. The present out going recession which affected globally was not self stimulated. It was created by the big US companies and financial institutions due to lack of foresightness. Although, so called recession definitely affected the Indian economy but wisdom of government and major backbone of our economy sector compensated it.
CAUSES OF RECESSION
1. Sub-prime mortgage crisis:The sub-prime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major adverse consequences for banks and financial markets around the globe. The crisis, which has its roots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financial industry regulation and the global financial system. The risks to the broader economy created by the housing market downturn and subsequent financial market crisis were primary factors in several decisions by central banks around the world to cut interest rates and governments to implement economic stimulus packages.
When USA house prices began to decline in 2006-07, mortgage delinquencies soared, and securities backed with sub-prime mortgages, widely held by financial firms, lost most of their value. Effects on global stock markets due to the crisis have been dramatic. Between 1 January and 11 October 2008, owners of stocks in U.S. corporations had suffered about $8 trillion in losses, as their holdings declined in value from $20 trillion to $12 trillion. Losses in other countries have averaged about 40%. Losses in the stock markets and housing value declines place further downward pressure on consumer spending, a key economic engine.
2. High Oil Prices:-
The rise in oil prices has become a very pressing issue. Certainly, nobody has to be reminded that crude was hovering just below $150 per barrel, while gasoline has surpassed $6 per gallon on average around the nation. The widely accepted explanation for oil prices' recent steep climb is strong demand. The global economy is firing on all cylinders, and that US and India have emerged as major consumers. In addition, supplies are tight; that the margin between what is produced and what is consumed on a daily basis has never been narrower; and furthermore, that major new discoveries of oil are few and far between. These explanations certainly sound plausible, and perhaps we can even attribute some portion of the price rise to them. A closer analysis, however, shows that they are not sufficient to explain the full extent of the increases. A new report released last month by the Senate Permanent Subcommittee on Investigations concludes that market speculation has played a role in the rise of oil and gas prices. It points a finger not only at commodity funds and hedge funds, but also at large institutional investors such as pension funds and mutual funds, which have become major participants in the energy markets over the past several years. The investigations, found that an estimated $75 billion has poured into regulated U.S. oil futures markets in the past few years. While this sounds like a lot (and it certainly is), the amount that has gone into non-regulated exchanges overseas is inestimable. The Commodity Futures Trading Commission oversees all futures trading on U.S. markets, and it's constantly monitoring the positions of large speculators. However, the CFTC (Commodity Futures Trading
Commission) has no jurisdiction over exchanges that are outside the U.S. or in the murky over-the-counter market where billions of dollars of contracts are traded all the time.
3. Inflation, the silent killer:Most likely, the prime cause has been the important role of productivity growth in developing countries, especially the large-sized countries like US and India. With Africa and Latin America now joining the development party, subdued world inflation is more likely than not. World inflation is broadly composed of three commodities: energy, agriculture and metals (both precious and other metals). In India only inflation rate touched to just below 13% in mid of 2008. A reasonable speculation is that this recent burst in prices has more to do with old-fashioned speculation than even older-fashioned fundamentals. In this regard, the recent hysteria pertaining to the Indian rupee is relevant. The normal inflation rate in developed countries 1% to 4% typically; developing countries 5% to 20% typically; national inflation rates vary widely in individual cases, from declining prices in Japan to hyperinflation in one Third World country (Zimbabwe), inflation rates have declined for most countries for the last several years, held in check by increasing international competition from several low wage countries (2005 est.) .In 2008, the prices of many commodities, notably oil and food, got so high to cause genuine economic damage, threatening stagflation and a reversal of globalization .In January 2008, oil prices surpassed $100 a barrel for the first time, the first of many price milestones to be passed in the course of the year. By July the price of oil reached as high as $147 a barrel although prices fell soon after.
4. Liquidity crisis:From late 2007 through September 2008, before the official October 3rd bailout, there was a series of smaller bank rescues that occurred which totaled almost $800 billion. In the summer of 2007, Countrywide Financial drew down $11 billion line of credit and then secured an additional $12 billion bailout in September. This may be considered the start of the crisis. In mid-December 2007, Washington Mutual bank cut more than 3,000 jobs and closed its sub prime mortgage business. In mid-March 2008, Bear Stearns was bailed out by a gift of $29 billion non-recourse Treasury bill debt assets. In early July 2008, depositors at the Los Angeles offices of Indy Mac Bank frantically lined up in the street to withdraw their money. On July 11, Indy Mac, a spin-off of Countrywide, was seized by federal regulators - and called for a $32 billion bailout. The mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures. That day the financial markets plunged as investors tried to gauge whether th e government would attempt to save mortgage lenders Fannie Mae and Freddie Mac. The two were placed into conservator ship on September 7, 2008. On September 16 2008, news emerged that the Federal Reserve may give AIG an $85 billion rescue package; on September 17, 2008, this was confirmed. The terms of the rescue package were that the Federal Reserve would receive an 80% public stake in the firm. The biggest bank failure in history occurred on September 25 when JP Morgan Chase agreed to purchase the banking assets of Washington Mutual The year 2008, as of September 17, has seen 81 public corporations file for bankruptcy in the United States, already higher than the 78 in 2007. Lehman
Brothers being the largest bankruptcy in U.S. history also makes 2008 a record year in terms of assets with Lehman's $691 billion in assets all past annual totals. The year also saw the ninth biggest bankruptcy with the failure of Indy Mac Bank. The Wall Street Journal states that venture capital funding has slowed down which in the past led to unemployment and slowed new job creation.
5. Large Trade Deficit Spells More Difficulties Ahead for US Economy:Since December 2001, the monthly trade deficit has increased $37.6 billion, and petroleum products account for 47 percent of this increase. The growing U.S. appetite for low-cost consumer goods, capital goods, and industrial materials and components, especially from Asia, account for more than half of the growth of the trade deficit. This situation is likely to become worse in the months ahead. Crude oil prices, after falling in November, have been rising again, and the dollar has strengthened in recent months, making most imports cheaper. In 2005, business and political conditions in Europe weakened, and prospects for the Japanese economy improved only modestly; consequently, the dollar rose against industrial country currencies. The dollar remains as much as 40 percent overvalued against the Chinese Yuan and other Asia currencies. Together, higher oil prices and a strong dollar will push the trade deficit to new record highs, with the monthly trade deficit likely exceed $75 billion by mid 2007. High and rising trade deficits tax economic growth. Specifically, each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment. Worker productivity is at least 50
percent higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into these industries would increase GDP. Were the trade deficit cut in half, GDP would increase by nearly $300 billion, or about $2000 for every working American. Workers wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying good wages and offering decent benefits. Manufacturers are particularly hard hit by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 3 million jobs. Following the pattern of past economic recoveries, the manufacturing sector should have regained about 2 million of these jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.
Economic Indicators of Recession
Recession in an economy, in general terms is described as a situation when an economy features slow economic activities. During this period the economy also suffers a steep fall in GDP growth rate, which tends to worsen situation further. The American economy is considered as the ‘mother’ economy of all other nations. Any fall in the parent economy affects the income and growth of the dependent economies. The global economy is facing a downturn since last few months that has given birth to a number of consequences that can be tagged as the ‘Indicators of Recession’ in a particular economy. The outcome of recession is unquestionably disastrous for the economy and comprises of the following five major indicators:-
1. Inverted yield curve:An inverted yield curve is perhaps the best measurable indicator of inbound recession - the point in which yields on long-term investments fall below the yields on short-term deposits. This demonstrates the holistic ability of the market to identify itself, in that pricing and yields on such investments are determined by wholly supply-and-demand models. If the market knows that the value of money, or its ability to produce yield is going to fall in the future, borrowers are going to be less willing to borrow money at higher rates; more specifically though, the formulation of risk in to the calculation ensures that if the market perceives a decrease in expected monetary value, that will be included in the price (more clearly, the rate, or yield). 2. Reduction in the consumer expenditure:The first and the foremost effect of Recession is that, it influences the spending habits of customers and prompts them to save more for the approaching period of depression. This in turn affects the business and production activities of the market and drags the income generating sector in trouble. 3. Mounting Unemployment The consequences generated by the first indicator, opened ways for the second to penetrate and grow during the recession period. The economy lands into a situation where the existing jobs will face a steep decline leave alone the generation of fresh job opportunities. 4. Fall in investment and interest rates
The chain is carried on and third indicator signals of a fall in the interest rate in future that leads to the drawing back of money invested by many investors who could might feel insecure for their investments and can fear of the approaching market situation. 5. Inflation Inflation is always the most predictable and inevitable consequence of all the recession forces in an economy. It brings along high prices, less purchasing power, slow income growth and unemployment in a bunch.
All these indicators are clear signs of the impending financial crisis that every economy has to face.
STEPS TAKEN BY GOVT. AND RBI
The central bank even cut its benchmark Repo rate by 150 basis points (bps) to 7.5% on October 19 in an attempt to get some of that money moving out of the bank vaults. Still no go.
The RBI recently turned up the thermostat once more, this time to prod banks to start lending at reduced interest rates. It cut its benchmark Repo and reverse rate by 100 bps. But, again, there’s hardly any movement. The banks are still carting their surplus cash over to the RBI and dumping it there for safekeeping, for even as a low a return as 5%. Take a look at the money being tipped over at the RBI window.
For the first five days of the month, till the RBI cut the rates, banks plunked Rs 243,310 crore with the Reserve Bank, for a return of only 6%. Over the next three working days, banks again deposited Rs 84,635 crore with the central bank, for a return of just 5%. The total — for just eight days — works out to over Rs 327,000 crore.
In effect, this means banks are still wary of lending to corporate, despite the sea of liquidity and rate cuts unleashed by the central bank. This also then conveys how banks are still uncertain about the future and that they are doubtful about the ability of their corporate clients to pay up in time. HERE’S an example a public sector unit was able to issue five-year bonds to banks with a coupon of 9.33%. Around the same time, one of the Top five India Inc companies also borrowed three year money, but at 10.10%. Clearly, banks are willing to take a risk on the government, even if it is a subsumed sovereign guarantee, but not on even AAA-rated private companies. Banks have not forgotten the nightmares of the early 1990s, when bank NPAs ruled around 10-14%. This time, despite the prodding from the government and the central bank, they are unwilling to stick their necks out. The RBI has allowed banks to restructure loans a euphemism for looking the other way when a loan turns bad that might in ordinary times have been called for st ricter treatment. But, the banks are still not biting.
The problem also seems to be in the system’s liquidity absorption capacity. Whatever steps the government takes at the moment such as, providing cheap
cash to corporate through a variety of refinance windows — not only are banks reluctant to lend, even corporate are loath to load up their balance sheets with fresh debt. Many of them are drawing down their existing credit lines with banks emboldened somewhat by the new restructuring space to finish existing projects but are unwilling to bet on new projects. With aggregate demand having fallen, India Inc is also contending with reduced top line and bottom line projections. In such a scenario, they may not be in a mood to pile up additional debt.
Therefore, the key to the current economic impasse might lie on the demand side. The government has tried addressing the issue by spending on infrastructure and by cutting taxes to boost demand. These are also not without their associated problems. Any investment in infrastructure will yield results only after a long lag, and the nature of improved technology does not allow for the higher employment generation that one saw a few years ago. Plus, to get an infrastructure project started is also time consuming financial closure in these days of clammy credit markets is a tough call.
Some economists say that the production orientation of the economy has changed in favor of expensive consumer products, a sector that might be slow off the blocks in reviving. In such a situation, reviving demand for wage goods might just do the trick. Even this hypothesis needs to be tested. The occasion might present itself soon — with experts forecasting a better-thanaverage winter crop, the government should facilitate hassle-free movement of the harvest to the markets and consumables to centers where the ensuing
agricultural income can be spent. This may sound simplistic, but sorting the physical, infrastructural infirmities could be one of the first achievable steps on the long road to recovery.
Policy Response
There is not much room for further fiscal policy action as the consolidated fiscal deficit of the central and state governments in 2008-09 is already about 11 percent of the GDP. This is likely to rise further as further necessary public expenditures are announced in the next budget and economic activity slows down. Any further increase in 1 Rajiv Kumar, et al, ‘The Outlook of Indian Economy’, ICRIER Working Paper No. 235 fiscal deficit to GDP ratio could invite a sharp downgrading of India’s credit rating and a loss of business confidence.With inflation down at less than one percent and likely to remain below five percent in the coming months, there is room for bringing down the repo rate further. However, the more important issue is to try and induce commercial banks to bring down their lending rates as these currently remain at around 10 percent even for their prime borrowers. This is largely a result of the ‘crowding outeffect’ of the large government borrowing programme.To address it, the government may have to consider monetizing its borrowing requirement so that liquidity is not squeezed out of the system. This poses the danger of stoking inflation in the medium-term but perhaps more importantly the breakdown of macro-prudential discipline that has been achieved after considerable effort. It would seem, therefore, that government’s options for taking counter cyclical and reflationary measures in the short term are rather limited. In our view, it is more important to focus policy attention on removing some of the many remaining structural bottlenecks on raising the potential GDP growth rate. Essentially, this will imply efforts at improving the investment climate both for domestic and
foreign investors; removing the entry barriers for the entry of corporate investment in education and vocational training; improving the delivery of public goods and services and expanding physical infrastructure capacities including a major effort at improving connectivity in the rural regions. These measures will constitute the package of second generation of structural reforms and will enable the Indian economy to climb out of the downward cyclical phase and then to extend the upward phase for a longer period than was achieved in the last cycle.
REFERENCES
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