23 December 2007

India and a probable recession in the US

In my earlier writing (dated 1st October) I wrote under the topic ‘Towards One World’ that “When a meteorologist says that the atmospheric pressure and the movement of air currents are the cause of a depression leading to sudden heavy downpour, we understand him. But we are yet to believe, let alone know precisely that collective human movements have behind them similar forces. Collective human action is more complicated than weather systems and therefore unpredictable. And for that matter, even the weather is often not all that predictable” I meant that whatever is related to the complexity of collective human behaviour mere mechanical or mathematical tools are not helping to precise predictability. It is the same when we find the economists working with the same data are not in unison in predicting the rate of growth of economy in India. Almost everyday the economic experts tell you in logical ways the future levels of economic variables. And the every ‘logical’ prediction differs with the other and sometimes the predictions are wide off the mark. This is very natural that the economists feel interested in discussing whether a global recession will plague the world in the next year. The question is relevant in a more globalized world now as a ripple or stir here in China or there in the US make its effects in India and other countries. Very often in India and in the world in general the economic growth rate of China is a much discussed subject. China as per some is expected to grow at an annual rate of 8 per cent during the 11th Five Year Plan (2006-10). But from a more elaborate exercise we find the following chart.

So from the above it is evident that in near future the rules and the conventional tools used to determine growth position will compel the economists to rewrite the development economics to explain this unprecedented growth. In India the experience is also good if not admirable. But the America is still the guiding factor for the economy of the world. It is because the economy of the US is the largest in the world. And almost all the countries are crucially related to the US economy. If in the US there is a sharp fall in overall demand it will cause serious concerns to the governments of other countries. The Indian government has all along been boosting exports. But now in the software industries it is not as lucrative as before. But before discussing about the US economy we should know about sub-prime mortgage. Sub-prime lending, also called B-paper, near-prime, or second chance lending, is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history. In clearer terms a sub-prime mortgage is a loan offered by a lender to a borrower with a poor credit history (meaning he has defaulted on his financial commitments in the past) against the security of his house property. Such borrowers are called sub-prime borrowers. Since the risk of default is high, these loans are offered at relatively higher interest rates compared to loans offered to people with an impeccable repayment track record. However these sub-prime mortgage loans are relatively much cheaper than completely unsecured loans to the same profile of borrowers. Some borrowers in the US who have otherwise no access to credit –this has helped them. If the financial institutions exercise required norms for lending it is not going to attract adverse features. But if for uncontrolled and injudicious lending practices in order to make money the financial institutions’ investments go to not credit worthy borrowers the loss is sometimes catastrophic in nature after a certain limit. This is what has happened in the US financial markets. Consequently there has been a severe cut back in credit supply in all the countries whose banking system is linked to the US financial sectors. This has also affected the US business seeking credit for sustenance. The housing sector has been seriously affected in the US as the new buyers find it difficult to get loans for housing which ultimately has led to the fall in prices of houses. Even those who can manage credit are not willing to buy in the apprehension of further fall in prices in near future. Eventually there has been sharp fall in construction sector as it is closely related to housing sector. It is now apprehended that this will have ramifications in other sectors of the US economy. The housing sector in the UK has already been affected and threatened the earlier boom. The Bank of England-(the Central Bank of UK) has reduced the bank rate by 0.25 per cent with the hope of raising liquidity in the British economy. Japan has also been facing the problem. But despite this issue of sub-prime mortgage one can not predict for certain that economic recession is a must in near future. Whatever the problem the US still maintains a positive growth rate along with Japan and the UK, the sliding down of the rate notwithstanding. Now it all depends how the governments step in to liberalise the credit policy. But as the liberalized credit policy leads to expansionary monetary policy and is bound to carry the adverse effect of inflation. So the economists are faced with the perennial problem of untying the knot between inflation and growth. Minor inflationary trend is not unwelcome for a positive index of growth as in the case of the UK where the growth rate is positive despite the inflationary rate of two per cent even when the oil price is in all time high level. But how a probable recession in the West will have its effect in India and China? This will depend on the intensity of inflationary course these countries may have to tread on. The economic market of China is much larger than Indian economy. So the effects of recession in the West will naturally be different in the

se two countries. If there is a recession in the US and its economy will move southward i.e. if the US market will be shrunk it will less accommodate foreign exports. In that case Chinese industry will be in jeopardy and it will have to seek alternative markets or countries for sustenance. But Indian export market is far smaller than China and for that matter she will not have to fall as lower than her neighbour. This can not allay the suffering as Indian software market will definitely be affected in a great way. Indian market is much localized and for that matter it is immune from shock from international tremors in the developed countries. Moreover a recession in developed economies might increase outsourcing work to India which account for over half of economy, continue to grow around 8 to 10 per cent.