American anxieties

Last week, data put out by the US department of commerce indicated that the US economy grew by a relatively modest annualised rate of 1.6 per cent during the quarter ended September 30. This is the slowest quarterly number since the first quarter of 2003, and comes after two quarters of 5.6 per cent and 2.6 per cent growth. The recorded rate was below the consensus of 2 per cent, immediately evoking fears of domestic recession and the inevitable consequences of this for the rest of the world. Is this the beginning of a recessionary phase in the US? And, what will be its impact on the Indian economy and the rest of Asia, which is in a particularly buoyant state, due significantly to demand for its products and services in the US?

Some of the slowdown was anticipated, as reflected by the consensus forecast. The US Federal Reserve raised its benchmark federal funds rate 17 successive times before adopting a wait-and-watch position in the last couple of meetings. The cumulative impact of these increases was bound to be felt at some point and this slowdown manifests the typical lagged response of economic growth to a contractionary monetary policy. The slowdown would also have been contributed to by the pattern of oil prices over the last couple of years. The two largest US automakers, General Motors and Ford, have had enormous problems as a consequence of falling demand for their relatively fuel-inefficient cars, while Japanese automakers have seen a significant revival in their US market. Both these factors are clearly reversible in the short term. Interest rates can be reduced and oil prices appear to be settling at more consumer-friendly levels. However, the third major factor in the slowdown may be more structural in nature and much more difficult to visualise a quick turnaround in. This is the state of the housing market. House prices have dropped rather sharply in recent months, which is a double whammy to GDP growth. Housing starts, an important leading indicator in the US, have fallen dramatically; the residential construction component of GDP declined by 20 per cent during the third quarter. And high real estate valuations induce high consumption spending by homeowners. This "wealth effect" is now likely to move in the opposite direction, dampening consumer spending and, hence, GDP growth.

If the slowdown persists for a while, Asia is vulnerable. Net US spending on Asian products is reflected in the massive trade deficit that the country has been running with Asian economies, most prominently China. Most Asian economies have the US as their largest market; slower-growing consumer spending in the US is, therefore, bound to hurt them. However, the big Asian economies, led by Japan and China, are also very large consumers themselves and domestic demand in a recovering Japan and a still rapidly growing China will provide some ballast. This will be reinforced by softening oil and commodity prices, which will contribute to reduced inflationary pressures in the region and allow central banks to ease their positions. India, whose exports to the US are now a balanced mix of products and relatively non-competing services, is perhaps even more protected, as a US downturn may induce greater volumes of offshoring. Yes, the world economy is still heavily dependent on the US, while Asia is rapidly developing its defences against this dependence.