ECONOMIC ENIRONMENT FOR BUSINESS REPORT

TO COME OUT OF THIS SLOWDOWN, EMERGING

ECONOMIES SHOULD CONSUME MORE AND SAVE LESS
AND VICE-VERSA WITH DEVELOPED COUNTRIES.

Submitted on:

13th June, 09

Prepared By:
Aditya Agarwal
Kashif Ziad
Kiranpal Singh
Mayank Sharma
Priyanka Nagpal
Saumya Sinha
Section F7
Contents

Introduction...............................................................................................................3
The 1980’s Recession and Recovery......................................................................3
The Recession of 1990 – 91....................................................................................4
The Recession of 2008 onwards.............................................................................4
Theoretical Insight.....................................................................................................6
Case Study 1 – Japan.................................................................................................8
Case Study 2 – Great Britain....................................................................................18
Case Study 3 – Vietnam...........................................................................................22
Case Study 4 – United States of America................................................................28
Case Study 5 – India.................................................................................................40
Conclusion...............................................................................................................46
Bibliography.............................................................................................................47

2
Introduction
People in industrialized nations are far wealthier than people living in less
developed countries. But still these wealthier nations suffer most during the
slowdown period. There was boom in 2007 and then the slowdown started
showing its presence prominently in the year 2008. Before economies could take
it seriously, there was recession. This is what explained by Business Cycle which
says everything which goes up is bound to come down. All these activities are
studied under macroeconomics which is concerned with the behavior of economy
as a whole. This is not the first time world economies are facing slowdown, there
has been 5 recessions in the last 30 years around the globe which includes the
most remembered “Great Depression”. Inflation, Employment Cuts, Price hike,
low demand etc is all characteristics of slowing down of the economy. The main
problem faced by the countries is not nuclear threat but high inflation rates.

Before starting with the current slowdown of the world economies, lets have a
look at the scenarios of 1980’s and 1990-91 recessions. Lets observe the policy
mix taken by the economies like US and Europeans at such situation.

The 1980’s Recession and Recovery

Economic policies in the united states in the early 1980’s, departed radically from
the policies of the previous two decades. First, tight monetary policy was
implemented at the end of 1979 to fight an inflation rate and then, in 1981, an
expansionary fiscal policy was put in place of tax cuts and increased defense
spending.

In 1973, the US and rest of the world were hit by first oil shock, in which the oil
exporting countries more than doubled the price of oil. This led to rising inflation
which was extremely unpopular. In October 1979, the Fed acted, turning
monetary policy in a highly restrictive direction. The monetary squeeze was
tightening in the first half of 1980, at which point the economy went into a mini
recession. The reason for the sharp decline on the activity was tight money
because inflation was still above 10% and money stock was growing at only 5.1%
in 1981, the real money supply was falling. With a policy mix of easy fiscal and
3
tight monetary policies, it was found out a rise in interest rate was expected. With
investment subsidies increased, investment increased with interest rates. This the
fiscal expansion of 1984 and 1985 pushed the recovery of the economy forward.

The Recession of 1990 – 91

The policy mix in early 1980’s featured highly expansionary fiscal policy and tight
money. The tight money succeeded in reducing the inflation of late 1970’s and
very early 1980’s, at the expense of serious recession. Expansionary fiscal policies
then drove a recovery during which the real interest rates increased sharply. By
middle of 1990 it was clear that the economy was heading for the recession.

The price of oil jumped and for a time the Fed was faced with the quandary of
deciding whether to keep monetary policy tight while holding interest rates up, in
order to fight inflation, or pursue an expansionary policy in order to fight the
recession. The fiscal policy was immobilized because the budget deficit was
already large and was expected to rise and thus no one was enthusiastic about
increasing it. From end of 1990, Fed began to cut interest rates aggressively and
the economy showed signs of recovery in second quarter of 1991 but faltered in
fourth quarter.

Thus, Fed cut the interest rate very sharply at the end of 1991. In retrospect, this
was sufficient to ward off a recession.

The Recession of 2008 onwards

The Credit Crisis began in August 2007, when interbank lending markets in the US,
UK and Europe began to seize up. These markets had rarely received much public
attention, and it was not immediately obvious why this should have happened.
But loans on interbank markets, from overnight to several months, were not just
important in keeping the flow of credit circulating amongst banks, and hence
amongst almost all economic agents in a market system, they were made without
collateral being necessary, and were increasingly important to the banking model
developing across market economies. That model relied to an increasing extent
4
on wholesale markets for supplies of capital, rather than on the deposits of
individuals or companies. At the same time the degree of leveraging on capital
was also increasing. So with larger supplies of credit and greater leveraging higher
profits were possible. As were higher risks, as banks sought out increasing rates of
return to satisfy their shareholders and those of their employees whose wages
and bonuses were linked to levels of business or profits. But the increasing levels
of risk seemed manageable by the device of securitisation, which appeared to
allow the securitising bank to simultaneously sell on the risk and replenish its
capital. When a rapidly deflating housing market bubble in the USA exposed
weaknesses in this banking model, and similar bubbles in Ireland, the UK,
Australia and Spain also began deflating, doubts about the location and value of
securitised assets led eventually to an evaporation of trust between first banks,
and then other financial and non-financial companies.

By the autumn of 2008 the lack of trust in the financial sector was sufficiently
great to almost completely seize up credit flows and threaten the stability of the
world financial system. The financial system was in effect broken, and by October
2008 a coordinated action by large numbers of central banks and countries was
needed to stabilise it. This involved giving widespread promises of state
protection to depositors, large injections of capital to banks, vast liquidity supplies
to gummed-up financial market and increasing guarantees for all sorts of short
term bond issues. Most recently the Crisis moved into the realm of sovereign
default, as countries such Hungary and Ukraine struggle to refinance foreign
currency loans, bringing in international agencies such as the IMF and the World
Bank to provide assistance. At the same time the Credit Crisis has spawned an
international economic downturn, and in some cases recession, the depth and
severity of which cannot at the moment be estimated.

All of these responses have public finance consequences – tax revenues and
expenditures – and risk and uncertainty consequences that are still growing and
evolving.

5
Theoretical Insight
Theoretical insight about the recession and how to tackle recession can be given
by the help of macroeconomic studies. But before that we should pay attention to
what is meant by recession?

“In economics, a recession is a general slowdown in economic activity over a

sustained period of time, or a business cycle contraction. During recessions, many
macroeconomic indicators vary in a similar way. Production as measured by Gross
Domestic Product (GDP), employment, investment spending, capacity utilization,
household incomes and business profits all fall during recessions.”

To come out of this slowdown different economies adopt different policies mainly
under the heads of Fiscal Policy and Monetary Policy.

Tight Monetary policy affects the economy, first, by affecting the interest rates
and then by affecting the aggregate demand. An increase in the money supply
reduces the interest rate, increases investment spending and aggregate demand
and thus, increases equilibrium output.

Loose Fiscal policy is implemented by increasing government spending, cutting

taxes etc. A cut in taxes will increases the consumption of the public and thus
increase in demand.

There are again two extreme cases in the operation of monetary policy and fiscal
policy.

First is the Classical Case where the demand for real balances is independent of
the interest rate, monetary policy is highly effective and any kind of fiscal policy
will be ineffective and thus there will be crowding out of private spending by
government.

Second is the case where there is Liquidity Trap, i.e., public is willing to hold any
amount of real balances at the going interest rates, thus, monetary policy is highly
ineffective but fiscal policy is effective.

6
In all cases, the main concern of tightening the monetary policy and easy fiscal
policy is to increases consumption and increases demand in the economy. Thus,
consume more and save less. But in developed countries like Japan saving is
encouraged to come out of the slowdown.

But just by implementing these policies will not help in getting the desired results.
A key component is there which plays an important role for the success of any
policy. This key component is “Multiplier”.

Multiplier Effect is explained as the changes in the real variables due to the
changes in the exogenous variables. If the multiplier is greater than 1 , then it
indicates that any increases the in government spending will result in greater
change in the aggregate demand and any decrease in the interest rates will result
in much less money supply. In such economies where multiplier is greater than 1,
expansionary fiscal policies will be effective and can give very good results and
vice versa.

In the current scenario, many economies under economic slowdowns are

implementing a policy mix of monetary and fiscal measures. Reduction in interest
rates, introducing stimulus packages in different sectors, cutting tax rates and
increasing government spending in buying bonds etc are all measures taken up by
different emerging as well as developed economy to survive in this recession
period.

These measures and how developing economies follow “consume more and save
less” strategy and developed economies follow “consume less and save more”
strategy will be explained further by the case studies of different countries and
steps taken by them.

7
Case Study 1 – Japan

History About Japanese Recession

In the decades following World War II, Japan implemented stringent tariffs and
policies to encourage people to save their income. With more money in banks,
loans and credit became easier to obtain, and with Japan running large trade
surpluses, the yen appreciated against foreign currencies. This allowed local
companies to invest in capital resources much more easily than their competitors
overseas, which reduced the price of Japanese-made goods and widened the
trade surplus further. And, with the yen appreciating, financial assets became
very lucrative.

With so much money readily available for investment, speculation was inevitable,
particularly in the Tokyo Stock Exchange and the real estate market. The Nikkei
stock index hit its all-time high on December 29, 1989 when it reached an intra-
day high of 38,957.44 before closing at 38,915.87. Additionally, banks granted
increasingly risky loans.

With the economy driven by its high rates of reinvestment, this crash hit
particularly hard. Investments were increasingly directed out of the country, and
manufacturing firms lost some degree of their technological edge. As Japanese
products became less competitive overseas, the low consumption rate began to
bear on the economy, causing a deflationary spiral. The Japanese Central Bank set
interest rates at approximately zero. When that failed to stop deflation some
economists, such as Paul Krugman, and some Japanese politicians, advocated
inflation targeting.

The easily obtainable credit that had helped create and engorge the real estate
bubble continued to be a problem for several years to come, and as late as 1997,
banks were still making loans that had a low probability of being repaid. Loan
Officers and Investment staff had a hard time finding anything to invest in that
would return a profit. They would sometimes resort to depositing their block of
investment cash, as ordinary deposits, in a competing bank, which would bring

8
howls of complaint from that bank's Loan Officers and Investment staff.
Correcting the credit problem became even more difficult as the government
began to subsidize failing banks and businesses, creating many so-called "zombie
businesses". Eventually a carry trade developed in which money was borrowed
from Japan, invested for returns elsewhere and then the Japanese were paid
back, with a nice profit for the trader.

Economic Policy & Fiscal Policy

 Global financial markets remain fraught with instability

The U.S. financial crisis, which was initially triggered in 2007 by defaults among
subprime mortgage borrowers and the resulting accumulation of bad loans,
continued deteriorating to the point where it had caused an acute credit crunch
following the failure of Lehman Brothers in 2008. With a number of financial
institutions across the world exposed to derivatives based on such soured assets,
the U.S.-initiated financial crisis quickly spread to other countries. While Japanese
financial institutions are not immune to the crisis, their European counterparts
have felt a much greater impact. The extreme tension in the financial markets has
caused a global credit crunch, a flight to quality among global investors, and a
huge plunge in asset prices. Thus, global financial markets remain fraught with
great instability.

In the United States, the financial crisis has dragged down prices of subprime-
related securitized products, mortgage loans, and commercial real estate. Not
only has this resulted in greater burdens on financial institutions by increasing the
amount of nonperforming assets to be disposed of, it has also substantially
reduced the value of household assets. Indeed, stocks and real property held by
American households lost 10% of their value in one year, and the effects of this
have rippled throughout the real economy and caused a steep drop in consumer
demand. In the wake of the sharp decline in consumption, many American
companies have decided to forego or postpone capital investment projects, and
the nation's employment situation has deteriorated significantly. But the impact is

9
not limited to the U.S. Many other countries that have been dependent on the
continuous growth of U.S. consumer demand are now suffering from a big drop in
exports to the U.S.

In many countries, shrinking domestic demand and falling asset prices, both direct
results of the credit crunch, have been compounded by falling external demand
caused by the drastic downturn in the U.S. economy. The combination of these
events has depressed consumption, driven companies to cut back on production,
and begun to have a serious impact on the employment situation. And that is an
outline of the financial crisis and subsequent economic recession experienced by
the world in 2008. But, as the ongoing parade of bad news continues to spread
across the world in a chain reaction, it serves as a renewed reminder of just how
tightly countries are integrated with each other in both international finance and
trade.

 Comparison between Japan and the U.S. in terms of policy response

The U.S. government has been both quick and bold in its policy response to the
crisis. In addition to providing $700 billion in public funds for financial institutions
to facilitate the disposal of bad assets, the government has also made emergency
bridge loans available for the three biggest U.S. automobile manufacturers to help
them stave off imminent bankruptcy. Furthermore, the incoming administration
of President-elect Barack Obama has already laid out plans for large-scale fiscal
expenditures. Meanwhile, in December 2008, the U.S. Federal Reserve effectively
adopted a zero interest rate policy by lowering its target for the benchmark
federal funds rate to 0-0.25%. The Federal Reserve also announced its decision to
purchase agency debt and mortgage-backed securities, thus embarking on a
quantitative easing of monetary policy.

Although poor in comparison to the bold and rapid steps taken by U.S. officials,
Japanese policymakers are also moving in the same direction as their U.S.
counterparts by easing monetary policy and pursuing expansionary fiscal policy.
The Japanese government committed to ¥1.8 trillion and ¥4.8 trillion of
expenditures to the first and second supplementary budgets, respectively, for
fiscal 2008 (April 2008 through March 2009). At the same time, the government
10
decided to re-launch its emergency share purchase plan with a maximum of ¥20
trillion - compared to the previous ceiling of ¥2 trillion - set aside for purchasing
shares held by banks. The plan was designed to prevent financial uncertainty,
alleviate the credit crunch, and increase the amount of public funds available for
injections into banks.

For fiscal 2009, the Cabinet has approved a record budget amount that calls for
more than ¥88 trillion in general account expenditures. Meanwhile, the Bank of
Japan lowered the target of the benchmark uncollateralized overnight call rate
from 0.3% to 0.1%. In addition, the central bank decided to proceed with
quantitative easing measures such as increasing its outright purchases of long-
term Japanese government bonds (JGBs) and commercial paper (CP) from
financial institutions.

All these measures taken by the Japanese fiscal and monetary authorities before
the end of 2008 are emergency plans in nature, designed to put the brakes on the
steep downward slide in asset prices and prevent the economy from receding
further. As short-term measures they are definitely needed, but they do not come
without non-negligible side effects.

In its fiscal policy, the government relies on debt to finance its aggressive
spending plans, which has led to an increase in government bond issuance to
about ¥33 trillion in both fiscal years 2008 (after the second supplementary
budget) and 2009. The expansionary fiscal measures come with serious side
effects, namely an acutely deteriorating primary balance. Japan's primary deficit
more than doubled from ¥5.2 trillion in the initial budget for fiscal 2008 to ¥13
trillion in fiscal 2009, with the ratio of government debt outstanding to gross
domestic product (GDP) reaching 114%.

In its monetary policy, the central bank has begun shouldering some of the credit
risks of private-sector companies, but since returning to an ultra-low interest rate
policy it is once again left with virtually no room to maneuver in money market
operations. Obviously, the government cannot afford to continue today's
expansionary fiscal and monetary policies forever. However, in spite of the
extraordinary fiscal and monetary steps implemented or proposed to date, it is
11
hard to expect the credit crunch will subside and the Japanese economy will
emerge from recession in the coming fiscal year.

 Reversing slowing GDP and combating surging unemployment are top

priorities

The current state of the world economy, where recent declines in energy,
resource, and asset prices are occurring simultaneously with the deepening of the
recession, can be defined as the beginning of a deflationary spiral caused by the
credit crunch and declining demand. It will be a long time before the world
economy recovers from the crash of both financial asset values and real property
prices. And it will take even longer for the recovery of depressed demand, i.e.,
consumption and capital investments. Last year the U.S. economy slipped into
negative growth and its unemployment rate has been rising sharply. For the
Japanese economy, the government is now forecasting zero growth for fiscal
2009. Meanwhile, BRICs, which had recorded high growth for years, have also
begun making significant downward revisions to their 2009 growth forecasts.
Unfortunately, as far as this year is concerned, the gloomy outlook will not be too
far off the mark. How soon countries can stem sharply declining GDP growth and
bring down high unemployment are shaping up to be the biggest challenges in
2009.

Japanese fiscal and monetary authorities have little room to take additional
measures. As a result of steering into expansionary policy, by the time the
government finalized its budget bill for fiscal 2009 it had already destined itself to
running a large fiscal deficit, which may cause profound negative effects for years
to come. Furthermore, even if the situation further deteriorates in 2009, it will be
impossible to bring about a sustainable economic recovery simply by continuing
the expansionary policy of the past several months. In the not-so-distant future,
the time will come for the government to leave things to the market. However,
overcoming today's unprecedented difficulties and transforming the Japanese
economy into one capable of bringing long-term prosperity to the people are
much more demanding than what can be achieved by small government and

12
market functions. In this context, the government still has many cards that need
to be played.

As many people may remember, World War II is what finally put an end to the
Great Depression, which had begun in 1929. If the depression engulfing the world
economy today is worse than the Great Depression, the way out definitely
involves a drastic transformation of social and economic structures. That is, in
order to find an exit from the worldwide depression, radical changes must take
place in the structures of demand, production, fiscal discipline, and financial rules
across the world. And such changes must come with innovation-driven "creative
destruction" of social structure.

 A new social infrastructure is needed

In the formulation of further policy measures to respond to the economic shocks

stemming from the ongoing crisis, the Japanese government needs to develop
and incorporate a long-term vision for drastically changing the nation's economic
structure. Such a vision must be constructed on the basis of innovation and new
rulemaking. If the government irresponsibly continues vast fiscal expenditures on
infrastructure construction and other conventional public works projects for the
sake of economic stimulus, taxpayers will be forced to bear the costs for many
years to come. Obviously, this will not lead to economic recovery. To the contrary,
it would increase people's anxiety about growing future tax burdens and could
conceivably delay the recovery.

Fiscal expenditures of this kind cannot provide any foundation for inducing
innovation. Instead, the government needs to

(1) promote innovation by creating a social infrastructure and systems capable of

overcoming challenges posed by climate and other environmental changes

(2) establish a financially sustainable social security system that can reliably
address health and welfare needs arising from the nation's rapidly aging
population and decreasing birthrate

13
(3) accumulate internationally competitive human resources by allocating
intensive capital resources to the area of human resource development; and

(4) work to develop global market rules that ensure the proper evaluation and
management of risks related to new financial instruments such as the subprime
and nonrecourse loans that triggered the current financial crisis.

These proposed measures are fundamentally different from the short-term,

emergency measures formulated and/or implemented in rapid succession during
2008. The most critical pending policy issue for overcoming the oncoming
depression is the creation of a new social infrastructure capable of sustaining
economic growth over a long period of time.

No optimism is warranted regarding the possibility that the Japanese economy

will bottom out in 2009. However, if this year marks the beginning of structural
innovation, the recovery will definitely start earlier than it would have otherwise.
The Japanese economy is not big enough to lead the recovery of the global
economy, and neither does it have the capacity to bear such a burden. Yet by
spearheading innovation and structural changes in its economy and society, Japan
will be able to send out an effective message - and thus make a great contribution
- to rebuilding the integrated world economy.

Many a Japan economic policy has been adopted by Bank of Japan in view of
effects global financial recession are having on its economy. These Japan
economic policies had been adopted in last phase of 2008.

Tadao Noda, who is a board member with Bank of Japan, has reiterated that an
effective economic policy of Japan needs to be hit upon pretty quickly as Japanese
economy is at present in a very bad state.

In January 2009 exports went down at a rate of 45.7 percent compared to January
2008. This resulted in an unprecedented amount of trade deficit. Output of
factories in Japan has also gone down in January 2009 by a record 10 percent.
Rate of unemployment in Japan reached a record figure in terms of last four
years. This surely calls for an unfailing economic policy in Japan so that present

14
weaknesses can be weeded out.

In final quarter of 2008 gross domestic product of Japan went down at a rate of
12.7 percent for that particular fiscal. An economic policy at Japan is presently a
need of hour if domestic demand in Japan is to be revived.

Economists have opined that consumer demand in domestic markets would be on

wane as a result of economic uncertainty. Exports of Japan, which are among its
major sources of revenue, would be on a downward curve as well since
economies of other countries would be recovering from aftereffects of global
financial recession.

As per economists, makers of Japan economic policies need to look at after

effects of imposing constraints on financing opportunities. As part of their Japan
economic policy major opposition parties in Japan are trying to introduce financial
stimulus packages that so that effects of recession could be allayed to a certain
extent.

Democrats, major opposition party in Japan, have announced that they would be
providing an economic stimulus of $587.3 billion. This amount would be spent for
a period of four years and would be looking to spruce up Japan’s economy. At
present every Japan economic policy is geared towards addressing imbalances
across various sectors of Japanese economy.

National Budget
In the postwar period, the government's fiscal policy centers on the formulation
of the national budget, which is the responsibility of the Ministry of Finance. The
ministry's Budget Bureau prepares expenditure budgets for each fiscal year based
on the requests from government ministries and affiliated agencies. The
ministry's Tax Bureau is responsible for adjusting the tax schedules and estimating
revenues. The ministry also issues government bonds, controls government

15
borrowing, and administers the Fiscal Investment and Loan Program, which is
sometimes referred to as the "second budget."

Three types of budgets are prepared for review by the National Diet each year.
The general account budget includes most of the basic expenditures for current
government operations. Special account budgets, of which there are about forty,
are designed for special government programs or institutions where close
accounting of revenues and expenditures is essential: for public enterprises, state
pension funds, and public works projects financed from special taxes. Finally,
there are the budgets for the major affiliated agencies, including public service
corporations, loan and finance institutions, and the special public banks. Although
these budgets are usually approved before the start of each fiscal year, they are
usually revised with supplemental budgets in the fall. Local jurisdiction budgets
depend heavily on transfers from the central government.

Government fixed investments in infrastructure and loans to public and private

enterprises are about 15 % of GNP. Loans from the Fiscal Investment and Loan
Program, which are outside the general budget and funded primarily from postal
savings, represent more than 20 % of the general account budget, but their total
effect on economic investment is not completely accounted for in the national
income statistics. Government spending, representing about 15 % of GNP in 1991,
was low compared with that in other developed economies. Taxes provided
84.7 % of revenues in 1993. Income taxes are graduated and progressive. The
principal structural feature of the tax system is the tremendous elasticity of the
individual income tax. Because inheritance and property taxes are low, there is a
slowly increasing concentration of wealth in the upper tax brackets. In 1989 the
government introduced a major tax reform, including a 3 % consumer tax. This tax
has been raised to 5 % by now.

After the breakdown of the economic bubble in the early 1990s the country's
monetary policy has become a major reform issue. US economists have called for
a reduction in Japan's public spending, especially on infrastructure projects, to
reduce the budget deficit. To force a reduction of the loan program, partially
financed through postal savings, then-Prime Minister Junichiro Koizumi aimed to

16
push forward postal privatization. The postal deposits, by far the largest deposits
of any bank in the world, would help strengthening the private banking sector
instead.

17
Case Study 2 – Great Britain

The first official confirmation that the UK is in recession came on Friday after
figures from the Office for National Statistics showed gross domestic product fell
1.5pc in the final quarter of 2008. That followed a 0.6pc contraction in the third
quarter and two quarters of contraction means we're are technically in recession
is here. The number was significantly worse than the 1.2pc expected by
economists, and is the biggest three-month GDP fall since the second quarter of
1980 when it shrank by 1.8pc. That means U.K. is already in a recession deeper
than that of the early 1990s, when the most the economy shrank in a single
quarter was 1.2pc.

How long this recession stays, and whether it overtakes the 1980s in terms of
depth, is less certain. The news that they are a nation in recession will come as no
surprise, but it will do nothing to quash the uncertainty that is feeding economic
decline.

Commenting on the figures, Stephen Gifford, Grant Thornton's chief economist,

said: "The sheer fall in GDP is staggering. Financial meltdown has probably been
averted but the economy has now entered a recession which is sure to be as bad
as the early 80s."

There are mixed views on how severe the recession will be, and the goal-posts
seem to be shifting on a weekly basis as retailers go to the wall, company profits
plunge, unemployment rises, and the housing market stands stubbornly still.

Ultimately a crisis that began in the US banking sector and is characterised by a

credit squeeze has filtered through to the broader UK economy, which contracted
1% between September and November, the National Institute of Economic and
Social Research (NIESR) has estimated.

This fall followed after a 0.8% drop in the three months to the end of October,
said the think tank.

18
Indicating that the rate of output decline is "accelerating", the NIESR now expects
a fall of more than 1% in the last three months of the year. Official data showed
that the economy shrank 0.5% from July to September. But it will not be until
January that the Office for National Statistics reports on the final quarter's GDP. If
it reports a decline for the three months to December, then the UK will be in
officially in recession under the generally accepted definition of two consecutive
quarters of decline.

The NIESR says it has a good track record in forecasting GDP growth in advance of
the official figures.

Economic prospects

Despite his revised forecast, Mr Darling has taken a more optimistic view of the
UK economy than many independent forecasts.

He is expecting the UK economy to recover to a growth rate of 1.5% to 2% by

2010, and to return to its normal growth rate of 2.75% in subsequent years.

19
"Because of the wide-ranging measures I am announcing today, and the many
strengths of the British economy, I am confident that the slowdown will be
shallower and shorter than would have been the case," Mr Darling said. But other
forecasts suggest that the economic recovery will not begin until well into 2010,
and that the economy could shrink by as much as 2% next year. If the world
economic recovery is indeed delayed, then even the grim budget forecasts made
by the chancellor could be too optimistic.

Some economists argue that if Mr Darling's stimulus is not enough to turn around
the economy, he will need a further stimulus package in the Budget.

"The economy still faces powerful contractionary forces in the shape of

widespread recession abroad, and at home falling house prices and stock
markets, blunted monetary policy as banks constrain lending and rock-bottom
business and consumer confidence," says Andrew Smith, chief economist at
KPMG.

"If this package fails to kick-start the economy, further expansionary measures
can be expected in next year's budget proper."

Fiscal squeeze
The government is also planning a sharp cut in the rate of growth in public
spending over the next few years. Public spending is now expected to grow by
just 1.2% per year, less than the growth rate of the economy as a whole, and a
sharp decrease from the 1.8% previously planned. This compares to an annual
growth in public spending of around 3% under the previous Labour government.
In addition, the government has pencilled in £5bn in efficiency savings by 2011.
This spending slowdown is part of the plan to bring the public finances back into
balance by 2015. But it will not be enough on its own.

20
Tax rises
The government is also going to implement a very large shift in the tax burden in
years to come. Compared to tax giveaways of £19bn this year, the government is
expecting to raise taxes by £20bn in four years' time. The largest slice of tax
increases will come from the 0.5% increase in National Insurance contributions,
which will raise £4.7bn. Taxes on the rich, including the 45% higher rate and
restrictions on personal allowances, will add £2bn in tax revenues. And, if growth
is slower than predicted, there may have to be other tax increases in the pipeline.

21
Case Study 3 – Vietnam

Overview of Vietnam’s Economy

• Vietnam’s economy has been bogged down in difficulties since early this
year

• Many economic sectors are slowing down

• Causing production stagnancy

• Economic growth has slowed from 8.8% last year to 6.5% in the third
quarter of this year

• The market’s consumption power has declined since the start of the year.
According to Nielson Global Online Consumer Survey, a global ealding
company, showing that Vietnam’s confidence declined nine points to 97
points during last four months.

• In 2009, the gov expects the growth to be from 6.0 to 6.5%

• Due to ramping inflation

• The main causes were rigid monetary policies and public investment
ineffectiveness

Status of Vietnam’s Economy

• Vietnam's economy grew by 8.5% last year, but the target for this year and
next has been scaled back to about 6.5% as the economy has been battered
by a widening trade deficit and double-digit inflation.

• According to IMF, Vietnam's economic growth will drop to five per cent
next year while the government grapples with a large current-account
deficit and weak banking and corporate sectors.

22
 • Vietnam has announced a stimulus plan worth more than $1 billion to avoid
recession as the global economic crisis bites into its export-led economy

• Prime Minister Nguyen Tan Dung approved a number of measures to boost

production, investment and consumer spending at a monthly cabinet
meeting Tuesday

• Dung said the stimulus would fund public works projects, including a large
irrigation canal in the northern Red River delta, and help finance rice
storage depots for about one million tons of grain in major farming areas.

A package of measures applied to combat the economic slowdown and cushion

the impact of the global financial crisis

• Measures outlined by PM at a gov meeting last week included:

– Revving up stagnant domestic production and exports

– Fuelling weakening consumption power,

– Applying flexible monetary and financial policies

– Ensuring social security,

– Care for the poor and speeding up administrative reforms

Actions Taken by MoF & Central Bank

• Draw up proposals on tax cuts,

• Tax exemption

• Delay of tax levies for enterprises

• Further rate cuts and assistance

• Funds

23
Corporate Income tax cut
• Bringing the corporate income tax dwon from 18 to 25%

• Cutting corporate income tax by 30% for small & medium sized enterprises

• Postponing the implementation of the personal income Tax Law to July

2009

• Reducing the basic interest rate from 11 to 10%

The Government’s report, presented by Standing Deputy Prime Minister Nguyen

Sinh Hung at the opening day of the fifth session of the 12th National Assembly
which began on May 20, 2009 outlined main developments of the economy in the
first months, and worked out key solutions to preventing an economic slowdown,
setting it a leading target in the upcoming time.

The report, under the theme “Actively preventing economic slowdown, stabilizing
the macro economy, maintaining reasonable and sustainable economic growth,
ensuring social welfare”, provides vivid figures which are evidence of the
efficiency of the policies issued by the Party and State, and the efforts of all levels,
sectors, enterprises and the whole people.

Positive changes
According to the report, the country has realized three basic targets of the 2008
plan, including curbing inflation and stabilizing the macro economy, continuing to
maintain economic growth and ensure social welfare.

The Government assesses that in the first months of 2009, despite many
difficulties, the economy has seen positive development and shows signs of
recovering from the most difficult period. “The situation has created conditions
and the ability to achieve better results in the upcoming time,” the report said.

24
The positive change in the first quarter was shown in industrial production
increasing by 2.1%, and GDP increasing by 3.1% compared to the same period last
year. The first quarter also saw the registration of 15,000 new enterprises, a year-
on-year increase of some 22%.

“The Government has strictly followed the situation, promptly asked for advice
from the Politburo, the Party Central Committee and the National Assembly
Standing Committee, in order to issue synchronous policies and solutions to
realize the 2009 targets, and focusing on drastic measures to bring the economy
out of crisis and better people’s lives,” Deputy Prime Minister Nguyen Sinh Hung
said.

However, the Government noted that the global economic and financial crisis was
still continuing in complexity, and affecting Vietnam’s economy. “Our difficulties
remaining are large,” the Deputy Prime Minister said. “We cannot be optimistic
with results achieved over the past several months.”

Key management
The Government announced five key management directions to prevent
economic slowdown, maintain growth, and ensure social welfare. They focus on
efficiently realizing stimulus and consumption packages, preventing economic
slowdown, restoring reasonable growth; increasing production and business,
expanding the domestic market and developing the export market; shifting the
tightening financial and monetary policies to active, cautious and flexible financial
and monetary policies, in order to stimulate the growth and prevent inflation.

The Government will also remain concerned about people’s lives, with an
increase in job creation and poverty reduction; and followed with manageable
situations that will create a consensus among society to successfully realize the
2009 targets.

25
Some main targets adjusted
To implement well key tasks, the Government asked the NA to prioritize the four
main issues. Firstly, the NA was suggested to decide that the urgent and key task
for the 2009 socio-economic development plan was to mobilize all efforts to
prevent an economic slowdown, maintain the sustainable and reasonable
economic growth, keep the stability of the macro economy, prevent inflation,
ensure social welfare, national defence and security, maintain political stability
and social order, in which, preventing an economic slowdown should be
considered the leading prioritized task.

Secondly, the Government suggested that the NA should adjust GDP growth
target for 2009 from 6.5% to 5%.

Thirdly, it proposed the issuing of an additional VND 20 trillion in Governmental

bonds, the amendment of some tax policies, under the jurisdiction of the NA, and
some other policies regarding construction investment and bidding.

Fourthly, based on targets and basic policies, the Government suggested the NA
entrust the NA Standing Committee and the Government in actively and flexibly
operating the policies and solutions.

Future Landscape of Vietnam’s Economy

Officials from international agencies including the World Bank, EuroCham,
AmCham, AusCham…all agreed that Vietnam is facing the toughest-ever
challenges and worsening business outlook. “Vietnam has faced the toughest-
ever challenges such as high inflation, hefty trade deficit, fluctuations in forex
rates and the slumping stock market,” Martin Rama, the World Bank’s Country
Director in Vietnam told the Vietnam Business Forum held Dec 1 on threshold of
the Consultative Groups of Donors’ Meeting. Speaking about the global gloomy
outlook, Thomas O’Dore, chairman of the American Chamber of Commerce
(AmCham) said Vietnam’s economy will be facing with similar problems as

26
exports, which account for more than half of its GDP value, are declining due to
shrinking purchasing power in the U.S., EU and Japan.

Vietnam should boost productivity and cut production costs, and the government
of Vietnam should create favorable conditions for exporters to borrow loans with
appropriate interest rates, Alain Cany, chairman of EuroCham proposed. Officials
at the VBF proposed the government of Vietnam further boost reforms in
infrastructure developments, intellectual property rights, courts systems,
efficiency of the public administration and high-quality human resources.

27
Case Study 4 – United States of America

The United States housing market correction (a possible consequence of United

States housing bubbles) and subprime mortgage crisis has significantly
contributed to a recession. Apart from that US faced major crisis because of -

• Rising oil prices at $100 a barrel

• Global Inflation

• High unemployment rates

• A declining dollar value

All this slowed down the growth of the economy and as the GDP growth rate fell
to 2%, recession set in.

The 2008/2009 recession is seeing private consumption fall for the first time in
nearly 20 years. This indicates the depth and severity of the current recession.
With consumer confidence so low, recovery will take a long time. Consumers in
the U.S. have been hard hit by the current recession, with the value of their
houses dropping and their pension savings decimated on the stock market. Not
only have consumers watched their wealth being eroded – they are now fearing
for their jobs as unemployment rises.

U.S. employers shed 63,000 jobs in February 2008, the most in five years. Former
Federal Reserve chairman Alan Greenspan said on April 6, 2008 that "There is
more than a 50 percent chance the United States could go into recession." On
October 1, the Bureau of Economic Analysis reported that an additional 156,000
jobs had been lost in September. On April 29, 2008, nine US states were declared
by Moody's to be in a recession. In November 2008 Employers eliminated 533,000
jobs, the largest single month loss in 34 years. For 2008, an estimated 2.6 million
U.S. jobs were eliminated.

The unemployment rate of US grew to 8.5 percent in March 2009, and there have
been 5.1 million job losses till March 2009 since the recession began in December
2007. That is about five million more people unemployed compared to just a year

28
ago. This has become largest annual jump in the number of unemployed persons
since the 1940’s.

Although the US Economy grew in the first quarter by 1%, by June 2008 some
analysts stated that due to a protracted credit crisis and "rampant inflation in
commodities such as oil, food and steel", the country was nonetheless in a
recession. The third quarter of 2008 brought on a GDP retraction of 0.5% the
biggest decline since 2001. The 6.4% decline in spending during Q3 on non-
durable goods, like clothing and food, was the largest since 1950.

A Nov 17, 2008 report from the Federal Reserve Bank of Philadelphia based on
the survey of 51 forecasters, suggested that the recession started in April 2008
and will last 14 months. They project real GDP declining at an annual rate of 2.9%
in the fourth quarter and 1.1% in the first quarter of 2009. These forecasts
represent significant downward revisions from the forecasts of three months ago.

A December 1, 2008, report from the National Bureau of Economic Research

stated that the U.S. has been in a recession since December 2007 (when
economic activity peaked), based on a number of measures including job losses,
declines in personal income, and declines in real GDP.

Recent economy slowdown as we all know started in U.S. last year in October &
initially it was concentrated on U.S. economy only but as expected & as experts
forecasted that it is going to affect whole world & it did. So now let`s examine
some facts & figure related.

The US Economy has seen an unprecedented growth over the last decade, which
accelerated to over 4% per year over the last four years. The year 2000 saw this
growth at an all-time high of 5.1% - a figure that is staggering in enormity when
one considers that a 1% growth in the US economy is comparable to an 8%
growth in the Chinese Economy. Further, 33% of the global growth is linked either
directly or indirectly to the US economy. With this in mind, it was a common
belief that the American honeymoon would never end. It was the Industrial
Revolution all over again - with increasing productivity levels, happy days were
here to stay. This growth however, had - and continues to have - a flip side -
serious imbalances are present in the US economy, indicated by the following

29
factors. A huge current account deficit at US $500billion - over 5% of the GDP. So
far, the current account imbalance, which has been quite high over the last 4-5
years, has mainly been sustained by capital inflows from Euroland to the US.
European investors had great confidence in the ability of American companies to
earn greater profits in the future by way of increases in productivity allegedly
taking place in the US Economy. How much of this perceived productivity increase
is true of all or most of corporate America and not just IT firms is, however,
debatable; extremely high Private Sector borrowing; gross over-valuation of the
asset market and· the fact that the American consumer, leveraging on notional
wealth, is borrowing more and more, to spend, resulting in a national dis-saving.
Consumption expenditure far outstrips disposable income. It has been argued
that domestic consumption was buoyant on the basis of strong equity markets
and although some of these have also been corrected more recently, the risks are
a currency collapse or something going wrong in the equity market, thus
rendering the whole system vulnerable.

Of disturbing significance is the fact that each of the above mentioned factors of
imbalance has preceded other recessions of the past. In fact, the situation today
is a close replication of 1998. Then, the Federal Reserve reduced the interest rates
by 75 basis points, thereby reviving the markets. With dot coms and software
successes waiting to happen, a huge boom took place and consumption spending
came back with a bang. 1998 was a classic example of the 'markets driving the
economy' syndrome, which continues to be the norm.

What remains to be seen is whether the gamble will pay off this time around. The
soft landing will be brilliant for global markets and for global economies. On the
other hand, however, if Alan Greenspan, Chairman, Federal Reserve, is not able to
revive the market with interest rate cuts, the current account deficit will further
increase, leading to investors shying off potentially "risky" US assets. All of this
can only result in much larger dis-equilibrium - and subsequently, a much larger
recession, therefore, than what we are seeing today. It is, however, too early to
predict the final outcome. The current probability of soft vs a hard landing is 2:1.
One can also take heart in the fact that a global recession, which would be the
result of a hard landing of the US Economy, has not happened in the last 50 years
30
- not even during the 1973 oil crisis. The most likely possibility, therefore, is a
growth recession or reduction. The after effects will be manifold with over 33% of
global growth linked either directly or indirectly to the US economy, there is a
disproportionate global dependence on the US Economy. Turmoil in the US, in
turn, therefore, causes a substantial ripple effect on a number of global
economies.

So now after having a closer look on U.S. economy we examine we examine its
effects on other parts of globe. ASIA Japan would be the worst hit, so to say.
Before the Euro, everything moved in linear correlation to the US Dollar. If the US
Dollar strengthened, the deutsche Mark weakened, as did the yen. This time,
however, a fundamental change was witnessed - the Euro strengthened and the
Yen weakened. The Yen, which has come down by 12% in the last 4 months,
seems to be the only currency taking a beating despite the slowdown in the US
economy. The Japanese have tried everything in the book to revive and stimulate
the economy to its previous glory but to no avail. The Nikkei, which used to be
40,000 at one time, is about 13,000-15,000 now. Further, retail sales in Japan
have been coming down for a straight 44 months. Japanese exporters talking
down their currency has not helped. The biggest irony is that corporate Japan is
doing well but this has not reflected anywhere in stock market prices, which are
once again down to levels where a number of banks are facing capital inadequacy
problems. If exports to the US decline as a result of the slowdown and Japan
continues with a weak Yen policy, it will result in some more and graver
imbalances. All banks have huge equity portfolios and anytime the market goes
up a little, they start dumping these and the market comes down. The worrisome
factor is that the banks are now all unsure about investing money in Japan.

On the other hand, Japanese corporates have huge holdings in the west, but
prefer to leave most of their earnings in US Dollars and the Euro. Toyota, for
example, has just decided to do so with US$ 26 billion of their earnings. The logic
really is that since most Japanese companies remit their profits to Japan in March,
they would end up remitting more Yen in the current scenario. If more and more
companies begin to do this, the Yen would weaken even more.Other Asian
economies, like Malaysia, Taiwan (where chip manufacturing companies are
31
already running lower at 85% capacity), Hong Kong and Singapore would feel the
ripple effect far more than others. In other parts of the world, Canada, Mexico
and Brazil are most certainly way more vulnerable than any other countries.

EUROLAND Sunnier days are ahead as far as the Euro is concerned as all factors
determining the Euro - interest differentials, oil prices and relative productivities
are favourable to the currency. A 10-year Euro bond today yields about 4.65% as
compared to 5.15% by a 10-year US Treasury bond. This spread is going to narrow
down a bit further with further expected cuts.

The falling oil prices, lower-than-expected productivity levels of American

companies and the fact that oil producing and oil revenue earning countries have
invested in US dollar denominated assets traditionally and will continue to do so,
are all factors that are Euro positive. According to the experts a base will be
formed around the Euro at 92-93, where it will see a brief honeymoon. It is,
however, too early to predict where it will go thereafter. What remains clear,
however, is that if the US economy does not revive, more money will flow into
Euroland or else, the Euro will continue to gravitate around these levels.

So these are the after effects of U.S. slowdown on Asia & Europe the other two
most important parts of the world now we can shift our attention to our own
country the India. INDIA It is far too presumptuous to think that India is going to
be hugely and adversely affected by the US economy slowdown. At 0.6%, India's
share of the global trade is too tiny for this. At the same time, however, one must
always bear in mind the far-reaching impact of globalisation, which has, in turn,
led to the interdependence of economies, particularly where the US is concerned.
25% of India's IT exports, for example, are to the US. The value of the Rupee,
however, as far as interest rates are concerned, would depend on fund flow and
valuation dynamics and the Reserve Bank of India's policy towards this. In the end
count, the Rupee still moves the way the Central Bank wants it to - we are still a
closed economy to that extent. And the RBI tracks currencies other than the US
Dollar - the Euro, Yen, RMB, as also a few other competitor currencies, whilst
deciding the fate of the Rupee.

32
The wild cards, in this entire play of currency management is the weakness of the
Yen and the RMB. Any significant weakening in either of these currencies could
very well have a domino effect across the entire region, including India and the
Indian currency, the Rupee. The RMB is closely linked to the US dollar - the latter's
fortunes really determine what the RMB will do. The dollar weakening against the
Euro and other currencies is a huge breather as far as Chinese exports are
concerned. If, however, the dollar starts appreciating, then the Chinese will want
to kickstart their economy through a possible RMB devaluation. It is critical to
remember, therefore, that despite the over Rs 3,000 crore of investments that
came into the Indian market in the first 20 days of January, 2001, (partly, some
feel, because of a certain perceived under-valuation of the Indian markets and the
not so high 'risk', and partly because interest rates have been cut in the US), there
is always a possibility of something going wrong externally that could affect the
Rupee. In the end count: A decrease in exports as a result of the US Economy
slowdown will be certainly negative from the Indian standpoint but the decrease
in oil prices (from a peak of $35 a barrel to $20-$22) will be positive for the Indian
Rupee and the funds flow, given the US interest rate cuts, would be positive.

However, the FDI track record will continue to be shoddy, so the effect would be
neutral. The amazing growth of frontline IT companies at 55-60% is a thing of the
past. The global slowdown will definitely affect these companies. What inevitably
needs to change is to shift our exports focus from being US-centric to newer
markets. The Reserve Bank, however, is far more concerned with the slowdown in
growth rather than inflation, which will be counter-balanced by the lower oil
import bill. Its focus will, therefore, be on re-igniting the 'feel-good' factor in
order to stimulate consumer spending patterns as a function of their aggregate
net worth rather than disposable income. Measures to this effect must be set in
motion at the earliest, as 2001 is the only year when any fundamental policy
changes can be made. 2002 will be too close to the general elections.

So now we examine why U.S. slowdown is affecting us with reasons: Firstly the
United States is India's largest trade partner, source of foreign direct investment
and external job opportunities for the Indian middle class. Any slowing of the US
economy is likely to hurt India more today than at any time in the past. The fact is
33
that the US is not only India's largest trade partner, but that India has the highest
trade surplus with the US and any slowdown in Indian exports to the US is likely to
have a larger impact on the trade deficit than a slowdown in trade with European
Union or developing Asia. India's trade with the EU and non-Opec developing
Asia, our other two major trade partners, is more or less balanced with exports to
these markets equal to imports from them. Our huge trade deficit with Opec
countries is largely balanced by the trade surplus we enjoy with the United States.
Recently published data shows that India's trade surplus with the US has actually
increased since India's exports to the US have continued to grow, while its
imports from the US have declined. Indian exports to the US have been mainly in
the area of consumer durables and these have grown, with the recent growth of
the US economy. Thus, while in the first quarter of 2000-01, Indian exports to the
US went up by 26 per cent, imports from it were down by 18 per cent. This trade
data does not include software exports. The software segment is another main
area of concern. The US has emerged as the biggest market for Indian software
exports. A slowdown of the US economy will hurt the "new economy" in India
since it is still largely export-dependent and has not yet found a domestic market
large enough to offset any loss in the external market. But analysts and software
CEOs argue that in a slowing economy, jobs are cut and companies invest in
automation, so that the demand for software services and for IT products is likely
to increase as the economy slows down.

Also, many US firms may offload work to lower-cost countries like India, especially
in the area of data-processing and office management work, and that this is likely
to increase the demand for new economy services in India rather than hurt them.
On the negative side is the concern that firms tend to put on hold expansion plans
and investment in new projects when there is a fear of a generalised slow down.
This is likely to hurt demand for Indian IT services and products. The final
outcome may be a combination of both factors. But one must realise that most of
the companies who service the lower rung areas of maintenance etc., will not
really stand to loose. They may face a squeeze on their margins but the business
will continue.

34
Another area which will be impacted, will be the capital markets. Today the world
markets dance to NASDAQ’s tune. Dr Huang, who has spend 20 years in US and
Taiwan, China, to develop and implement a method to track accurately daily
financial markets, said at an investment forum early last year that NASDAQ was
overheated, would face a correction upto 2800-3000 and the Dow, he stated,
would be back to 9600. and global markets would follow US for 20 % correction.
His logic was that there is never a bull market before economic softlanding. The
bulls must take 20 % or more correction and consolidation reflecting economic
slowdown impact on consumer demand and corporate earning decline. Bull
markets, according to him, exist under expanding monetary policy. Expectations
of higher profits resulted in an unbelievable rally in the equity markets over the
last five years. NASDAQ, the technology stock heavy index, rallied from the start
of 1995 and increased by a whooping 5.8 times till March last year. Capital market
rally resulted in the `wealth effect', which further fueled the economy. Americans
saw their investments in equity markets growing dramatically in value.

However with this wealth effect wearing off and the risk consciousness rising, we
will see a lower deployment of funds to the world equity markets, which are also
in a slump at the moment. For the Indian markets, the impact is two fold - firstly,
lower funds coming into the market through the FII route and secondly,
companies who had planned NASDAQ listings etc. have had to put their plans on
hold and this will delay their funds inflow as well as growth plans. So, we in India,
will definitely need to be prepared for some fall out on the slowdown in the US
economy and fine tune our corporate and export strategies as the picture
develops. So here comes the real picture lets now move our focus to reports
published by IMF about this situation last year when the International Monetary
Fund issued its half-yearly report, the world, in the words of one its leading
officials, appeared to be a much “safer place.” Growth was continuing in the
United States, the European economy was expanding, East Asia was recovering
from the crisis of 1997-98 and there were even signs that a Japanese “recovery”
might finally get under way.

The picture presented in the latest World Economic Outlook released is very
different. Apart from cutting the world growth forecast by 1 percentage point, the
35
main feature of the report is the uncertainty over the future course of the global
economy and the warnings that, notwithstanding the hopes that the situation
could quickly turn around, it could also worsen quite rapidly. In his press
conference releasing the report, IMF director of research Michael Mussa pointed
out that last September in Prague world growth for 2001 was predicted to be 4.2
percent. This has been revised down to 3.2 percent. It is clear, he said, that
“global growth is slowing more than was anticipated, or is desirable.” “For the
United States, which has been the mainstay of global expansion in the past
decade, growth this year is forecast to be only 1.5 percent, down from almost 5
percent last year and from an earlier forecast of over 3 percent for this year.” The
projection for the year 2002 has been reduced to 2.5 percent, at least one
percentage point below the estimated potential growth rate for the US economy.
In the euro-zone, the IMF estimates the growth rate will be 2.4 percent, a full
percentage below what it forecast last September. Mussa said the situation in
Japan was “even more worrying” with growth for this year forecast to be barely
over 0.5 percent and growth for next year expected to reach only 1.5 percent.
Asia will be hit by the slowdown in North America and Japan and by the global
downturn in telecommunications and high technology with estimates for growth
coming in at between 1 and 3 percentage points less than six months ago. Mussa,
however, did not confine his remarks to the details of the report but delivered a
stinging rebuke to the European Central Bank and its refusal to cut interest rates,
following rate cuts in the US and Japan. After noting that the euro area was not
contributing sufficiently to world economic demand, Mussa continued: “In a
period when general economic slowdown is the main problem and when inflation
is not likely to be a continuing threat, the euro area, the second largest economic
area in the world, needs to become part of the solution rather than part of the
problem of slowing down world growth.”

Mussa took the opportunity to deliver another broadside when taking questions
from journalists on the briefing. Asked to comment on whether calls on the ECB
to cut interest rates by the managing director of the IMF and the US treasury
secretary could be regarded as “interference” Mussa replied: “Here in the IMF we
don't call that interference. We call it surveillance. And it is mandated by the

36
Articles of Agreement.” Global recession In delivering its pronouncements, and
particularly in setting out policy prescriptions for countries that are considered
not to have measured up, the IMF strives to create the impression that it is fully in
command of the situation, with a deep understanding of the processes taking
place in the global economy. But it seems the impression is starting to wear a
little thin—even among financial journalists who can usually be relied upon to
echo its analysis without asking too many questions. As one journalist pointedly
commented: “Mr Mussa, it seems that yourself and Wall Street and every
economist has been caught by surprise by this slowdown. In the last WEO you
said the prospects were the best in a decade. Now you say we'll avoid recession.
Given the situation is so fluid, how can you be so certain that we won't actually
dip into a US recession and possibly a global recession?” Mussa replied that there
was “no certainty in this business” and offered the reassurance that policy in most
countries, which had policy flexibility, had been adjusted “promptly and
reasonably aggressively to the threat that things might be even somewhat worse
than we have allowed for in the baseline.” The WEO report itself claims there is a
“reasonable prospect that the slowdown will be short-lived” but warns that “the
outlook remains subject to considerable uncertainty and a deeper and more
prolonged downturn is clearly possible.”

So far, it notes, the effects of the global slowdown have been most visible in
countries which have close trade ties with the US, including Canada, Mexico, and
East Asia. The outlook for the rest of the year “will depend on how deep and
prolonged the slowdown in the United States proves to be”—an issue which
“remains subject to considerable uncertainty.” The WEO says its baseline scenario
is that the US economy will pick up in the second half of the year, growth will
remain strong in Europe, while recovery in the Japanese economy will resume in
2002. But it adds that while this scenario is “plausible” it is far from “assured” and
the “risks of a less favourable outcome are clearly significant.” One of those risks,
it states, is that the “virtuous ‘new economy' circle of rising productivity, rising
stock prices, increased access to funding, and rising technology investment that
contributed to the strong growth in the 1990s could go into reverse.” Even this is
a somewhat optimistic assessment, given that most observers of the US economy

37
have concluded that, whatever the immediate outcome of the present downturn,
overcapacity in all sections of industry—and above all in high-tech investment—
means that there is no prospect of the boom of the latter 1990s returning. The
report notes that if the slowdown does prove to be deeper and more prolonged
than anticipated “this would pose several interlinked risks for the global outlook
that would significantly increase the chance of a more synchronised and self-
reinforcing downturn developing.”

Among those risks is the possibility that what the report calls “apparent
misalignments among the major currencies” could “unwind in a disorderly
fashion.” It points out that current account deficits of the size presently
experienced by the US—more than $430 billion, equivalent to around 4.5 percent
of gross domestic product—have not been sustained for long and that
“adjustment is generally accompanied by a significant depreciation [of the
currency].” If there were increased economic growth in Europe and Japan, then it
would be possible to reduce the US imbalances in a “relatively manageable and
nondisruptive fashion.” “However, in an environment where US growth slows
sharply, the portfolio and investment flows that have been directly financing the
US current account deficit could adjust more abruptly.” In other words, there
could be a rapid movement of capital out of the US and a sharp fall in the value of
the dollar. “This would heighten the risk of a more rapid and disorderly
adjustment, possibly accompanied by financial market turbulence in both mature
and emerging markets. Large swings in exchange rates could also limit the room
for policy manoeuvre.” That is to say, according to the IMF's latest forecasts,
there could arise a situation in which the US dollar starts to fall and financial
markets are hit by a crisis, under conditions of a deepening slump. The fact that
such a possibility is even being canvassed is a measure of how far and how fast
the world economic situation has moved in the past six months. So here IMF also
clearly specifies the picture of global slowdown. Lets move to the perception of
IMF about Indian economy.

The US consumer price index inflation is expected to fall to a rate of 2.4 per cent
by end-2001. Both producer and consumer prices continue to decline in Japan,
where consumer prices have fallen at a rate of 0.6 per cent (annual rate) and a
38
similar decline is expected for the year as a whole. The decline in asset prices, in
particular, the real estate prices, has generated new gaps in the adequacy of
collateral for bank debts. The decline in growth of the global economy has been
caused by a combination of global and country-specific factors. One universal
cause has been the persistent rise in the energy prices during 1999-2000. Another
key factor to the reduction in growth has been the sharp and sudden downturn in
hi-tech investment in the second half of 2000. This weakened growth, notably in
the US and Europe, while brutally reducing the export performance of many Asian
countries. This pervasive setback has contributed to the weakness of
manufacturing sector in virtually every industrial country and driven many Asian
economies, including Singapore, into recession. Particular mention must be made
of the rise and fall of demand for hi-tech equipment. In the US, the output of hi-
tech equipment accelerated at an annual growth rate to 70 per cent in early 2000,
before collapsing. The crisis worsened because not only was demand falling but
the unit price equipment in the hi- tech sector also collapsed. US investment
spending was sharply reduced, particularly on hi-tech equipment. The unexpected
decline in the demand for hi-tech investment goods undermined stock prices,
reversing the earlier surge in the value of new economy stocks. One other factor
responsible for straining the earlier growth and subsequent slowdown in the US
has been the tightening of monetary policy. While the tightened monetary policy
did help control inflation, it also contributed to subsequent economic slowdown.

Both US and Japanese policy-makers have made it clear that they are prepared to
accept a weak yen if that is the result of market reactions. The devaluation of the
yen will not be without impact on other currencies. It is quite possible that China
may react with the devaluation of yuan, which may well force the various Asia-
specific countries to follow suit. This will have serious repercussions on the world
economy. Incidentally, the fact that oil prices will remain high indicates further
fiscal tightening for the Government. The oil pool deficit will grow higher.
Unpleasant decisions, which will have serious political repercussions, cannot be
delayed. The sooner they are taken, however, the better it will be for fiscal health.
The Finance Minister and the Prime Minister have yet another difficult challenge
to meet. The decline in the world's major economies has its repercussions,

39
unpleasant ones, on India's economy, in particular on its export prospects. The
Government has to take note of this trend and be ready to handle the adverse
consequences of a continuing global economic slowdown. It cannot be `business
as usual'.

Case Study 5 – India

Impact on India of Slowdown

A slowdown in the US economy is bad news for India because:

• Indian companies have major outsourcing deals from the US

• India's exports to the US have also grown substantially over the years.

• Indian companies with big tickets deals in the US are seeing their profit
margins shrinking.

Anatomy of the economic depression in India

 Share Market

• More people have sold the shares in the Indian share market than they
bought in the recent weeks. This has added to the fall of sensex to lower
points.

• Foreign investors have pulled out from stock markets leading to heavy
losses in stocks and mutual funds

• Stock broking houses are laying-off people

• Because of such uncertainty many people have started saving money in

banks rather than investing

40
 IT and Real Estate Sector

• The key challenges faced by the industry now are inflation and the
psychological impact of the US crisis, leading the companies to hit the
panic button.

• Bonuses, perks, lavish parties, and many other benefits are missing as
companies look to cut cost.

• India's IT export growth is also slowing down

• One of the casualties this time are real estate, where building projects
are half-done all over the country and in this tight liquidity situation
developers find it difficult to raise finances.

 Layoffs and Unemployment

• Hundreds of workers have lost jobs in diamond jewellery, textiles and

leather industry.

• Companies in IT industry have stopped hiring and projected lower

manpower need.

• Firms attached to the capital market are laying off people and large
companies are putting their future expansion plans on hold.

 Industrial sector

• Government and other private companies are reluctant in starting new

ventures and starting new projects.

• Projects that are halfway to completion, or companies that are stuck

with cash flow issues on businesses that are yet to reach break even, will
run out of cash.

• Car, bike & truck sales down

• Steel plants are cutting production

41
 • Hospitality and airlines are hit by poor demand 

On this issue Mr. Manmohan Singh suggested –

“A coordinated fiscal stimulus by countries that are in a position to do so would

help to mitigate the severity and duration of the recession”

“It would also send a strong signal to investors around the world. Resort to
fiscal stimulus may be viewed as risky in some situations, but if we are indeed on
the brink of the worst downturn since the Great Depression (of the 1930’s), the
risk may be worth taking.”

Corrective Steps to Check Recession

• RBI needs to neutralise the outflow of FII money by unwinding the market
stabilisation securities that it had used to sterilise the inflows when they
happened.

• This will mean drawing down the dollar reserves which is important at this
hour.

• In the IT sector, there should be correction in salary offerings rather than

job cutting

• Public should spend wisely and save more

• Taxes including excise duty and custom duty should be reduced to lighten
the adverse effect of economic crunch on various industries

• In real estate the builders should drop prices, so as to bring buyers back
into the market.

• Also, the government should try and improve liquidity, while CRR and SLR
must be cut further

42
 • Indian Companies have to adopt a multi-pronged strategy, which includes
diversification of the export markets, improving internal efficiencies to
maintain cost competitiveness in a tight export market situation

Opportunities in India due to recession

• US recession may be a boon for Indian offshore software companies

• The impact of recession is higher to small and medium sized (SMEs)

enterprises whose bottom lines get squeezed due to lack of spending by
consumers

• SMEs in the US are under severe pressure to increase profitability and

business margins to survive. This will force them to outsource and even
have M&A arrangements with Indian firms.

• India is going to be a great beneficiary of this trend which will minimize the
impact of the US recession on Indian industry

• By March 2008, India had received SME outsourcing deals worth $7 billion
from the US as against $6.2 billion in the previous year

A Ray Of Hope

Experts see a ray of hope in the fiscal stimulus I package of Rs 10,000 crore which
is expected to boost demand for the capital goods sector and the infrastructure
industries which primarily include power, cement, coal, crude oil and petroleum.

India’s growth is based essentially on investing its own savings, and so is relatively
insulated from global finance and fashions. India’s savings rate has shot up from
23.5% in 2001-02 to 37.4% today, a phenomenal achievement.

43
High savings constitute a structural change that is here to stay. This will suffice to
finance an investment rate of at least 36% of GDP. So, given that output in India
rises at roughly a quarter the rate of investment, a realistic GDP growth of 9%
should be sustainable.

If the world economy recovers in the next six months, a 7% growth looks feasible.
This will mean little deceleration from the current year and hence, little additional
pain. This scenario depends on a resumption of global growth early in the next
fiscal year.

Assocham President, S. Jindal hopes that money will flow into the system to
support the projects that have been put on hold.

The Prime Minster who holds the Finance portfolio also, is confident that the
country will be able to maintain the growth rate around 8 percent in the current
fiscal. The most pessimistic estimates put it at 7 percent.

It is important now is that the industry and other sectors of economy respond to
government initiatives in full measure and pass on the benefit of price cuts to the
consumers. They need to realize that in the current global crisis when
international demand is shrinking, it is only the domestic demand that can keep
the business going.

Fortunately, India with its 1.1 billion population has a huge potential of keeping
demand afloat. All they need is the purchasing power which the Government is
trying to do by pumping in funds into the system.

A silver lining has been the consistently falling inflation rate which has now come
down to around 6 percent. With the fall in petrol and diesel prices, the general
price line is bound to fall further as petrol prices constitute an important
ingredient of transport costs. We may thus witness a more comfortable inflation
rate much too soon.

Industry sector has welcomed the measures though it expects more to defuse the
situation. FICCI described the measures as “a good start in the right direction”.

44
While a number of banks have already announced lower lending and deposit
rates with effect from January 1, 2009, a further softening in interest rates seem
to be in the offing.

FICCI secretary general Amit Mitra said: “The steps should hopefully give big
boost to the slowing economy,” adding that he expected “business confidence
would be restored”.

The bond market quickly reacted to the rate cuts. The yield on the bond dropped
to 5.07%, from the previous close of 5.29%. Industry is hoping that its lending
costs, too, will drop.

Interest rates are expected to come down further with a lag as banks will first
align their deposit rates.

The funding of the purchase of buses under JNNURM would help increase
capacity utilization. This is crucial at a time when plant shutdowns and temp
layoffs are becoming routine.

The business environment of the future will be intensely competitive. Countries

will want their own interests to be safeguarded. As tariffs tumble, non-tariff
barriers will be adopted. New consumer demands and expectations coupled with
new techniques in the market will add a new dimension. E-commerce will
unleash new possibilities. This will demand a new mindset to eliminate wastes,
delays, and avoidable transaction costs. Effective entrepreneur-friendly
institutional support will need to be extended by the Government, business and
umbrella organisations.

Experts, who earlier predicted easing of trade credit by December 2008, are now
hoping that it would be achieved by June 2009.

The world economy continued to contract at a near-record pace in December

2008, but the rate of contraction has slowed.

There was a marked improvement in the services sector, with the Global Services
Purchasing Managers Index (PMI) at 40 in December, well above the 36.1 level it
plummeted to in November 2008.
45
India does not have a PMI for the services sector yet, but looking at the global
pattern, it’s very likely that in India too the rate of contraction of services will be
less than that of the manufacturing sector. And since services account for 60% of
India’s economy, any resilience there will provide a big cushion for the downturn.

Conclusion

The global economy is in a tough spot, caught between sharply slowing demand in
many advanced economies and rising inflation everywhere, notably in emerging
and developing economies. Global growth is expected to decelerate significantly
in the second half of 2008, before recovering gradually in 2009. At the same time,
rising energy and commodity prices have boosted inflationary pressure,
particularly in emerging and developing economies. Against this background, the
top priority for policymakers is to head off rising inflationary pressure, while
keeping sight of risks to growth. In many emerging economies, tighter monetary
policy and greater fiscal restraint are required, combined in some cases with more
flexible exchange rate management. In the major advanced economies, the case
for monetary tightening is less compelling, given that inflation expectations and
labor costs are projected to remain well anchored while growth weakens
noticeably, but inflationary pressures need to be monitored carefully.

Now countries needed to put their energies into restoring credit flows since
economic stimulus plans would otherwise struggle to work.Monetary policy
"should be capable of taking more into account ... the accumulation of risks that it
had left a bit to one side before." If governments adopted the right policy mix and
stimulus programmes were accompanied by the restoration of a functioning
financial system, it was possible for the world economy to begin its recovery early
next year.

46
Bibliography

Books

 Dornbusch and Fisher – Macro Economics

Web Links

 http://crisistalk.worldbank.org/2009
 http://economictimes.indiatimes.com/archive.cmswww.scribd.com
 www.wikipedia.com
 www.livemint.com
 http://economictimes.indiatimes.com/articleshow/3928470.cms
 http://economictimes.indiatimes.com/News/Economy/Policy/Stimulus-
II_India_Inc_gets_more_room_to_grow/articleshow/3929013.cms
 http://economictimes.indiatimes.com/articleshow/3929007.cms
 http://economictimes.indiatimes.com/articleshow/3929043.cms
 http://www.rediff.com/money/2008/dec/07bcrisis-govt-announces-
package-to-boost-economy.htm

47