Primer: Recession and impact on India

What is recession?
 
Recession, in lay-man terms, is the time when there is economic decline, leading to a slowdown in trade and economic activity. This is generally identified by a fall in Gross Domstic Product (GDP) in two or more consecutive quarters.
 
How does this happen?
 
Normally, when consumers lose confidence in the growth of the economy and start to spend less, there is a decrease in demand for goods and services. This, in turn, leads to a decrease in production. On the other hand, the profit margin of companies is due to a rise in costs and they try cost cutting measures. The equity / stock markets react negatively to this. A lay-off (asking people to leave) leads to a rise in the unemployment rate and a decline in real income.
 
Past recessions
 
The US has witnessed over 11 recessions so far, since the end of the World War II. From 1930 to 1939, the US saw the Great Depression, which began with the Wall Street Crash of October, 1929 and rapidly spread worldwide. Most analysts believe the causes to be the lack of high-growth new industries, high consumer debt and bad loans given out by banks and investors.
 
In 2008, defaults on sub-prime mortgages (home loan defaults) led to a major crisis in the US. Banks had given out loans without researching on the payback power of the clients. With increasing defaulters, the banks went into bankruptcy. It was called the sub-prime crisis since it began from high risk debt offered to people with poor credit worthiness or unstable incomes.
 
Why should we be worried?
 
The US accounts for one fourth of the World's gross domestic product (GDP) and is one of the biggest markets for Indian companies, especially information technology (IT) services. While January to May 2008, exports to the US stood at $1,253 million each month, on an average. However, it has increased to $1,694.5 million a month in the same period in 2011.
 
Though the general idea is a weak US dollar may bring more foreign money to the Indian markets, the recent FII data states otherwise. Foreign Institutional Investors (FII’s) have sold stocks worth Rs 1,030.50 crore in the last three trading days (Aug 2-4) and may need to pull out more money in order to meet the redemption pressures at home.
 
During the 2008 slowdown, the slow pace of financial reforms taking place in India, cautious approach towards permitting foreign investments in Indian business sectors, numerous bureaucratic hurdles and regulatory constraints turned out to be advantageous for the country. Even before that, during the 2001-2002 market slowdown in US, the Dow Jones Industrial Average went down by 23% while the Indian markets slipped 15%.
 
At the macro level, another recession in the US may bring down the GDP growth. At the micro level, several industries may be affected - like IT, manufacturing and tourism.
 
Double-dip recession
 
A double-dip recession is said to occur when the gross domestic product (GDP) growth slides back to negative after a quarter or two of positive growth. In other words, a double-dip recession is said to occur when a recession is followed by a short-lived period of recovery, only to make way for another recession.
 
"The causes for a double-dip recession vary but often include a slowdown in the demand for goods and services because of layoffs and spending cutbacks from the previous downturn. A double-dip (or even triple-dip) is a worst-case scenario. Fear that the economy will move back into a deeper and longer recession makes recovery even more difficult," explains Investopedia, an online dictionary for educating investors.
 
The early 1980's recession in the United States is cited as an example of a "double-dip" recession. The economy fell into recession for seven months starting January 1980 and then entered a quick period of growth, and in the first three months of 1981 growing at an 8.4 per cent annual rate. As the Federal Reserve under Paul Volcker raised interest rates to fight inflation, the economy dipped back into recession (hence, the "double dip") from July 1981 to November 1982. The economy then entered a period of mostly robust growth for the rest of the decade.
 
According to current data, after the tremendous decline in US's GDP in 2009, it recovered and fared well during 2010 but declined once again in the first quarter of 2011. However, it has expanded 1.3% in the second quarter of 2011 over the previous quarter.
 
Amidst the recent crash in the global markets, talks of a double-dip recession have again begun doing rounds and have been causing worry and panic among investors. However, Dr C. Rangarajan, chairman, Economic Advisory Council on Friday ruled out the possibility ‘double dip' recession.

"There is no data which indicates that there will be a double-dip recession. I do not think that the Federal Reserve (Fed) will pump money into the system. Instead, the focus will be on job creation. We expect the US economy to muddle through, but we still need to see a decisive action from the European Union (EU) to stop the contagion, "commented Andrew Holland, CEO-Equities, Ambit Capital.

Indian context
 
Even though there are some who deny the possibility of a double-dip recession, there are yet some who believe that a double-dip recession will only benefit India's economy. One of the factors that will benefit India is the lowering of commodity prices like oil and metals.
 
If the global markets continue to sink due to the US debt crisis and the European debt worries, huge spending cuts and slowdown in economies will become the need of the hour. This may bring down oil prices, thereby softening the impact of higher inflation.
 
However, Crisil, in a recent note post the downgrade of US credit rating states, “The developments have heightened risk perception and uncertainties in a global economy where the downside risks were already material. The manner in which financial markets and governments react over the next few weeks will determine how the prevailing fragilities in the global sovereign and financial sectors play out. This, in turn, will impact the trajectory of global growth. Should global growth weaken further, India will be impacted.”