Effects of Recession in US, on Indian Economy

 

“When Uncle Sam sneezes, the world catches a cold”

This is an oft quoted saying when it comes to the dominance of the US. This saying is also justified when it comes to the world economy and other economic matters. The US existed as a sole economic power throughout the 80’s and the 90’s. The US is also the biggest consumer in the whole world. It is also the largest economy in the world. As such, US influence on all economic matters around the world is substantial.  

 

The US economy boasts of being the largest and the most technologically advanced economy in the world, with a per capita GDP of 46,000 $. The US GDP is 13.86 million$ with a growth rate of 2%. The US also has an unemployment rate of 4.7% and only 12% of the population lives below the poverty line. All of these statistics point to a large though sluggishly-growing economy.

 

The future however is uncertain and the danger of an economic recession looms over the largest economy of the world. Indications are already there and analysts are falling over each other to decide whether, there is a possibility of a recession now and whether it can be averted, if it can & what and how far reaching will be its impact. This is the million dollar question which doesn’t have any conclusive defined answers as yet.

 

This paper endeavors to find out the impact of a US recession on India and the consequences of such a recession. India all around the world is seen as a global economic superpower. The Indian Economy is one of the top six fastest growing economies all around the world. The Indian economy is also very well known for its extensive resources of trained, skilled and efficient human capital. India is also gifted with large quantities of natural resources which helps make India, a very powerful economy. According to the latest analysis, the Indian economy is growing at a healthy rate of more than 9% p.a. which is another big positive for the Indian economy.

 

India and US share a rich and flourishing nexus of trade and commerce. Indian exports to the US exceed the Indian imports by a large margin. So in such a scenario what happens if the US economy goes down? Will the Indian economy suffer a similar downslide? What will be the affect of a weak dollar on world trade and especially the Indian economy? Will the Indian economy be able to come out unscathed? These are some of the pertinent questions plaguing the economists today which we seek to answer in the course of the paper.

 

1.    The Reasons and Causes of a US recession.

 

With the advent of the 21^st century, one thing has become extremely clear- The US is no longer the sole economic power in the world. The European Union is exerting and building its economic power and the value and the significance of the dollar is already showing signs of faltering in front of the might of the Euro. Further Asia on the basis of the combined economic strength of the two fastest growing economies has also become a giant economic power. The OPEC countries have already showed inclination towards trading in Euros which seriously undermines the monopoly which dollar exerted over international trade.

 

There are also serious indications that the US economy will be facing a situation of a recession in the near future, probably in the current year itself. There are certain reason which have led to this economic downturn, of which some of the most important and the most damaging are.-

 

·      The biggest factor leading to this recession is the decrease in the consumer expenditure on goods in America which has resulted because of the sharp fall in the consumer disposable income. The rise in fuel prices and the already present inflation has reduced, rather almost nullified the effect of any gains in income which have occurred. Adding to this mix, the problem of rising interest rates and lack of credit, it is safe to say that the consumers will now face the pinch. The rise in prices being more than the rise in income, the consumers are forced to reduce their expense on goods which lead to lesser income movement in the economy and leads to a negative multiplier effect which cripples the economy and its allied structures as well.

·      The American Economy is plagued by a problem which is known in economic circles as the problem of sub-prime mortgage fiasco. In the US, there had been an increase in credit consumption since 2000, as there was an increase in the consumer expense on autos and housing purchases by the consumer. With the rapidly decreasing consumer disposable income, as has been stated above, houses became more and more unaffordable which led to increasing number of houses becoming unsold which led to a dip in the housing prices and thus the bubble burst and suddenly with the burden of loans mounting and consumer spending decreasing, people are trying to sell of their properties before they lose their equity or the bank repossess it. This has led to an unprecedented increase in the supply of housing, which has dropped the prices further.

This has a primary effect on the loaned, but its ramifications and secondary effects have other far reaching consequences too. Basically if there is an over-supply of houses, then the construction of new houses will be adversely affected, which will lead to lowering of the level of economic activity in the economy and also increased unemployment which will lead to further credit and will lead to a vicious cycle which will drag the economy down unless attended to at the earliest.

·      Another factor effecting negatively not only the American economy but economies all around the world is the rising prices of crude oil. On 2^nd January 2008, the price of crude oil per barrel for the first time crossed $100 a barrel. This has lead to an increase in the cost of energy, an essential pre-requisite when it comes to production and has thus eaten into the producers profits, thus forcing them to either cut the wages or reduce employment which again leads to increase in unemployment rate of the country. This again leads to a downward cycle which ends only in a state of depression.

 

 

 

 

2.    Impact of a strong rupee on the Indian Economy.

 

Indian economy is among the fastest growing economies of the world. The appreciation of the rupees against the dollar would be another giant sign towards its economic prosperity. The Dollar in comparison to the rupee has fallen from a rate of 48 Re. for 1$ to a rate which is expected by the RBI to range from 39.15 Re - 39.50 Re. There has been almost a 20% increase in the Indian rupee. The appreciation of the rupees will help the economy in many ways. The dollar has been the popular medium of foreign exchange for a long time. Most of the payment for the export or import is made through dollar.

 

This development has a significant bearing on the Indian Economy. This is because, the dollar though comparatively weak is still strong and is still used as, an in demand currency for all forms of foreign trade and commerce. Moreover most of the countries have accumulated their reserves in the form of dollars, which further adds to its strength. There are 3 major and significant variables which will suffer the impact of a stronger rupee first. They are-

·      In respect of Exporters- The exporters in India, in a case of depreciating dollar will have a lesser income than before. The price of an export goods cannot be said to be unit elastic to the exchange rate because as the dollar depreciates, if the exporters increase their prices so as to receive the same income in rupees as they did before, the demand of their commodities will fall and lead to greater losses. As such in the case of a depreciating dollar, exporters will have to bear the loss as a cut in margins which in some cases will also lead to loss. This will lead to an adverse effect on India’s economy and lead to a long term loss to India’s growth.

·      In respect to Importers- India imports generally Petroleum products, capital goods, fertilizers, chemicals, pulp and uncut stones. The importers in the case of a stronger rupee will now have to pay less for the same commodity. As such the imports to India will increase in quantity and importers will gain increased profits which will lead to economic growth in the country.

·      In respect of FDI- FDI or Federal Direct Investment, is the investment by foreign nationals in a country’s industries. In case of weakening of US$, there will be lesser funds in terms of rupees, invested by the US citizens and thus the FDI from US as such will be effected adversely. However with the US industries in turmoil, India will become a very attractive destination for all investment, within the US and without. Therefore the impact of a weak US dollar on FDI as such will be suitably compensated by the increase in FDI from other sources.

 

The following figures and statistics help elucidate the impact of a US recession on the economy.-

INDO-US TRADE
US trade with India (2007)
(In US$ million)

 

 It can be clearly seen in the table above, that the exports to the US exceed the imports by a substantial amount. As such, in a purely economic sense, exports to the US are much more essential for the economy and for the livelihood of all involved. Thus it can be said that the loss which Indian economy will face through the loss in exports will far out-weight the gain for the importers.

 

 

3.    The Impact of a Possible US recession on the Indian Economy.

 

It has been already said in the Introduction to this paper that the US is a powerful economy. The US is the largest economy of the world and it is also the biggest consumer in the world. As such many countries in the world export their products to the US and their economies are as such centered on the US economy.

 

A US recession if it occurs will thus completely offset such economies. The effect of a US recession will devastate their economies and as such render them economically backward. There are many countries such as which depend upon the US for such trade.

 

Examining such an affect on the continent of Asia, some noteworthy points can be deduced. India and China are the main force behind economic development in Asia. However the impact of a US recession on both of these will be very different. China is an economy which thrives on exporting low-cost, high-quality goods to the US market. A recession in the US and a weakening dollar will adversely and substantially affect the Chinese economy.

 

However the impact on India will be lesser in comparison to other smaller countries. This is because India unlike other Asian Countries possesses a strong and well establshed domestic market. The Indian factors such as those of a strong internal demand, a richer population, an exploding middle class, increased employment along with the increasing basket of services which India has to offer will cushion the impact of the shockwaves which will spread, once a recession occurs in the US economy.

 

However, India’s neighbors and the other small Asian States will be badly affected by such a recession. Even China, which is another growing economy, will suffer the impact, assuming that they do not devalue the yuan again. As such the trade ratio of India with other countries will also be affected, courtesy a US recession. Thus a US recession will have a sizable impact, directly and indirectly on the Indian Economy. However the adverse impact on India will not be as much as that on other countries. Some of the industries which will be worse affected in the light of such a recession will be the BPO industry for one and also the export industry.

 

Another practical ramification of a US recession, will be the forex reserves of all countries around the world. Most of the countries all around the world maintain their reserves in dollars. Due to a US recession, there will be widespread devaluation of dollar as a currency and it will lead to the meltdown of US dollar. This will thus lead to an evaporation of a country’s forex reserves leading to huge and substantial losses. The countries at present are waiting with bated breath as even if one of the countries shifts its reserves to any other currency, there will be a huge drop in the dollars prices which will lead to a selling spree leading to a fall in dollar prices and loss to all countries around the world.

 

 

 

 

 

 

 

 

 

 

 

 

4.    Conclusion.

 

This paper sought to identify and examine the effect of a US recession on the Indian Economy. For this purpose the factors responsible and the indicators of US recession were analyzed. There are mainly 3 main factors which are mainly responsible for the recession in the US. They are-

·      Decrease in Consumer Expenditure.

·      Sub-prime mortgage fiasco.

·      Increase in energy prices.

 

The depreciation in the value of dollar is a natural consequence of recession. Such a recession will adversely affect the exporters and favor the importers. However as has been analyzed, the quantum of Indian exports to the US far exceeds the imports. Thus for the greater gain and good of the India businesses, it is safe to say that a US recession will be unfavorable to the Indian trade.

Further, it can also be said that, a US recession though not having any major direct impact on the Indian economy, will adversely affect the economy in many other ways. The Indian economy is shielded in part from an impending recession as India has a well established and growing domestic market and a booming economy to offset any direct impact of recession. However, a US recession will hamper the economic development of other countries and thus adversely affect India’s trade over a long period.

Another important point is that, the Indian forex reserves which presently stand at a figure of 276,250 million dollars will be instantly evaporated in case of a US recession and a depreciating dollar.

It can be thus concluded that the impact of a US recession on the Indian economy though comparatively minimal will have a substantial affect on India’s future prospects and growth opportunities and thus reduce the rate of growth.

 ARTICLE BY : SHREYANSH MARDIA & KARTHIK MUDALIAR  

 

Bibliography

 

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