A bit of history of economic crises

The current crises got me looking into the other economic downturns in the 20th century. Here are my findings:
We all know about the great depression in the early 1930s, but I was actually surprised by the number of recessions in the world since. Here are the major ones:

1. Latin America's woes
Latin America has long endured economic problems like currency crises, hyperinflation, banking failures etc. The lack of prudent governance and macroeconomic populism continued till 1980s, when the economic reforms were introduced. These measures included:

• State - owned firms were privatized
• Import restrictions lifted
• Budget deficits trimmed, inflation became a priority

These measures led to efficiency, investor confidence and large inflows of money. But soon there was a recession in Latin America (esp. Mexico and Argentina) in 1990s, the exact reason for which is still not understood well by economists. Some of the causes were:

• Impending devaluation of Mexican pesos not handled well
• High government spendings and
• Wide spread corruption and dollar-loan exposure

This crisis was finally controlled by huge loans provided by the United States, Canada, and International Monetary Fund(IMF).

2. Japan's downturn
Japan suffered laggard economic growth and recessions in the most of the 1990s (also known as the lost decade. The crisis started in Japan in 1989-90 and the reasons were:

• Loose financial regulation, bad debts.
• Bubble in stock markets and real estate from 1986-1990

Japan has suffered economic paralysis for such a long time. The country's economy was investment driven and this recession caused investments to flow outside the country. The falling interest rates (at one point the interest rates were zero also) inhibited spending. This low consumption led to a deflationary spiral which was only strengthened by rising unemployment levels. The central bank has also dithered far too long where it alternated between public spending and budgetary control.

3. South East Asia's crash
South Asia till late 1990s was a tremendous success story. The region saw extended economic growth and was a role model for many. All that changed in 1997 when the many south Asian economies were caught in a currency crisis: Thailand, Malaysia, Indonesia and South Korea to be precise. Again economists disagree over exact reasons for this crisis, generally the following factors are considered to be the culprit:

• Started with currency collapse of Thai Baht, which was long under attack from speculators and hedge funds. Government finally floated Baht leading to its fall.
• Crony capitalism where in these economies there was a collusion between government and big business players.
• These economies had relatively free markets and light regulation, which led them vulnerable to the vagaries of foreign investors.
• This crisis led to slumping currencies, stock market devaluations and precipitous private debt

4. Internet bubble of the 21st century
Also known as the dot com bust, happenned in 2001. There was a considerable bubble in the stock markets of western economies from 1996-2001. The bubble was caused by inflated valuations of stock markets, especially internet and technology related firms. These firms in turn had flawed business models, where in all of them were rooting for growth over profits working under the assumption that finally profits will come once the markets are captured.

Impending recession and the aftermath

The bearish movement in Indian stock market in last couple of weeks draws everyone’s attention towards the world economy again. In the era of globalization, any significant move in the economy of big players is going to have well spread impact (Article on Decoupling theory). And if the movement is there in US economy no country will be left untouched...

The movement in the US economy started in the month of September with the Subprime crisis followed by credit crunch in the US market. All the major banks in US reported huge losses and Federal Reserve had to cut the interest rate first time after 2003 by 50 basis points (0.50%). The complete effect of subprime crisis was yet to be realized and that was evident with further writing off bad debt by major bank in 3^rd quarter of 2007. The economy started slowing down, and financial market came under much stress. Fed had to intervene again within 4 months of earlier cut and the interest rate was dropped by 75 basis points to 3.5%. This was again followed by reduction in benchmark short-term interest rate by 50 basis points to 3% within 9 days of previous cut. This was the most aggressive movement in interest rates since 2001, and is expected to keep the housing slump and the credit crunch brought on by a meltdown in the home-lending market from pushing the broader economy into the red.

But even after all these measures, the consumer spending in the U.S. increased at the slowest pace in last six months. The unemployment insurance jumped, U. S. economic growth slowed to 0.6% annual rate in the 4^th quarter from 4.9% in the prior three quarters. All these facts indicate towards an impending slowdown and countries need to hedge the movement to all possible extent.

Countries like India has got major exports in U.S. and reduced consumption rate will certainly impact the export business heavily. While, the export industries are already suffering with appreciation in Rupees and it will get worsen with any slowdown in demand abroad; the crude oil price had come down after the speculation on reduced demand by the world’s biggest energy consuming country U.S. This will relax the Indian oil companies a bit with reduced subsidy (more about Crude oil price and its impact).

The significant cut in interest rate by Federal Reserve is aimed to avoid any credit crunch and after the RBI (Reserve Bank of India) decision not to cut the interest rate, heavy credit inflow is expected in coming month. The volatility in stock market reflects the suspicious and bearish environment. The GDP in the year 2007 grew by 9.6% and growth is expected to be close to 9% in FY2008. The government needs to be well prepared for any uncertainty and be ready with flexible policy to avoid any major impact.

Economic Fundae -RBI Credit Policy- 2008

Recession waves roaring in U.S and the interest rate cut by the FED is sent as an abatement in response to it. Although it will benefit the recent sub-prime crisis, the impact of this rate cut to 3.0% in interest rate is far fetched.

As a common understanding we all know the interest rate cut will boost borrowing and hence economic activity. On the other hand this rate cut when done in isolation when the central bank in the rest of the world are not in a compulsion to do so, will leave the capital movement out the country. This is surely detrimental to the business in U.S. as the capital formation will be difficult. It also leaves the U.S dollar to loose value becuase of the interest rate differentials.

Largely the credit policy of RBI - the annual report of the policy measures by our central bank has laregly disappointed the Indian Industry which has to keep their investment plans in abeyance. Belying expectations of a softer interest rate regime, the Reserve Bank in its third quarter review of of monetary policy kept banks rate, repo rate, reverse repo rate and cash reserve ratio unchanged in a bid to maintain financial and price stability.

Now this stand by RBI is surely debately particularly given the current rupee strength. But certainly it is going to a be precautionary move against the price rise. Every single conservative policy has its toll in our growth story. One justification for this indifference is the shorter business cycles in India and the growth being fuelled by the capital inflows. As this is policy needs some time test which will be based on the growth in the country.

This particular scenario would have helped any one new to the macroeconomics to sum up all what we have seen so far - inflation, business cycles, interest rates, exchange rates. It may be unfavorable for many Indian Industries, but the current situation has certainly enhanced our learning in macroeconomics favourably!

How good is ‘Decoupling theory for India, China and other emerging economies?

The Decoupling theory is that emerging economies like China and India are decoupled from the US economy. The view is that the emerging economies on one hand and US economy are now very less related. How good is that assumption?

If we look merely at the GDP growth figures China and India are accelerating at 11% and 9% per annum, while US is in a slow growth phase an may even enter into recession in the coming year. This may help us in believing the decoupling theory and that China and India can keep on growing without getting affected from the US economic condition.

If we look slightly deep into it and look at two major sources of GDP: consumption & investments, we will find that although US economy has experienced a slower growth, its consumption is in healthy growth phase, and the slowdown in overall growth is mainly because of slowdown in investment activities from US firms. The reason may be that a lot of money is moving in the form of FII and FDI to India and China. Even China and India export heavily to US, so a slowdown in consumption in US is bound to affect these countries, though the extent of the damage may be different.

Investors who believe in decoupling theory think a well diversified portfolio across Asian and American countries can give good returns even in the case of US recession. That may be too optimistic assumption and this is one of the factors behind the huge rally that was seen in the Chinese and Indian stock markets in the past year. But the recent tremors shook the belief and markets all over the world fell sharply in two days following news on US economic recession.

Earlier during the subprime crisis the decoupling theory got seriously challenged. The credit crunch that followed was not a US only phenomenon, though US was hard hit. The decoupling theory also underestimates the fact that economies are in era of globalization, and recession in one big economy is bound to cause some pain in other economies.

If we look at world economy, US constitute about 22% of world GDP, while China is about 11%, India 4.6% of world GDP. So if the world economy has to grow, a recession in US economy has to be countered by a bigger increase in other economies. The decoupling theory also suffered some blow when World Bank issued that Chinese and Indian economies are smaller than that estimated earlier.

The year ahead will only tell us how independent these emerging economies are from US and whether their growth can compensate for the world slowdown if US economy goes into recession.

Is India's growth rate slowing down?

India touched GDP growth rate of 9% last financial year. It is a big achievement for the country and initially people were apprehensive of sustaining over 8% growth rate for reasonable time. For the last three years India has continued to grow at more than 8% and last year it recorded 9.3% growth. All the while people have been talking of signs of heating of the economy. This fiscal year the growth has slowed down a bit but is still above 8% level. This slowdown has been indicated by Reserve Bank of India (RBI). According to the report a slowdown in the growth of demand has led a slow down in the growth of sales in the first half of 2007-08.

According to Moody's India's growth rate will come down to 8% in 2008 due to the tighter monetary policies taken by RBI to curb inflation. Goldman Sachs has also lowered India's growth to 7.8%.

Recession in United States of America is not likely to have any significant effect on the India's GDP growth as it is mainly domestically driven growth and the fundamentals are very strong.

The growth in the industrial production numbers jumped significantly in 2006-07 which had a major contribution in the GDP growth rate. Now, since the demand had decreased because of rising interest rates the industrial production index is feeling the direct pinch and has recorded slower growth. Automobile sales has shown very little growth over last year and the housing activities have also shown a slowdown.

Though these activities appears to put a lot of pressure on growth rates and may even be successful in short run. India's story is a long term and it has just started. One can easily bet on the long term growth prospects of the country.

Economic Fundae - GDP

Good Accounting turns data into information!

This article is aimed at people trying to understand the basics of national accounting.

GDP:Gross Domestic Product is the value of all the goods and services produced in the country within a given period. This includes all the goods and services produced in the geographical boundaries of the country irrespective of who produces. The other slight variant is the GNP which include receipts from abroad made as factor payments to domestically owned factor production. For example, part of India's GDP corresponds to the profits made by Hyundai Motors from its Indian operations. But these are part of the Korea's GNP because they are income of Korean-owned capital.

Although the difference is not significant in countries like U.S. it certainly is important where most of the countries labor is abroad working for a multinational company.

The fundamental national accounting equation will be as

Y= C + I + G + NX

Consumption spending by household sector, includes spending on anything under the sky. The only exception being the investment which people make in durable goods.

Then the government purchases are the government spending on the goods and services. Think of anything which government spends like laying roads, providing higher education etc. Again the only exception being the transfer payments. The transfer payments are those which does not get a service in return to government spending. This is logical as they are not a part of any of the current production.

The letter I in the equation refers to the Gross private domestic investment. In simple words, investment is associated with the business sector's adding to the physical stock of capital, which in turn will increase the economy's ability to produce output in the future.

The last term is the Net Exports, the difference between the exports and imports. They are to account for domestic spending on foreign goods and foreign spending on domestic goods. Confused, well we just finished the accounting of the entire nation. There is more than one reason to be confused, like most of our politicians.

Governments budget deficit is often a term we hear particularly in a country like India. This essentially means the difference between the government expenditures and the taxes received. Remember to include transfer payments as a part of government expenditures (which is slightly different from the government purchases)

Quick Fact:

GDP of India: (2007-08): 41,25,725 Crores of Rupees

Without further delay we will introduce you to other macroeconomic variables which are inflation, currency exchange rates, interest rates, monetary system and the business cycles.