Impact of recession in American economy on India

Introduction

Thefear of a recession looms over the United States. And as the clich goes,whenever the US sneezes, the world catches a cold. This is evident from the waythe Indian markets crashed taking a cue from a probable recession in the US and a global economic slowdown.

Weakeningof the American economy is bad news, not just for India, but for the rest ofthe world too.

Sowhat is a recession?

Arecession is a decline in a country's gross domestic product (GDP) growth fortwo or more consecutive quarters of a year. A recession is also preceded by several quarters of slowing down.

Whatcauses it?

Aneconomy which grows over a period of time tends to slow down the growth as apart of the normal economic cycle. An economy typically expands for 6-10 yearsand tends to go into a recession for about six months to 2 years.

Arecession normally takes place when consumers lose confidence in the growth ofthe economy and spend less.

Thisleads to a decreased demand for goods and services, which in turn leads to adecrease in production, lay-offs and a sharp rise in unemployment.

Investorsspend less as they fear stocks values will fall and thus stock markets fall onnegative sentiment.

Stockmarkets & recession

Theeconomy and the stock market are closely related. The stock markets reflect thebuoyancy of the economy. In the US, a recession is yet to be declared by theBureau of Economic Analysis, but investors are a worried lot. The Indian stockmarkets also crashed due to a slowdown in the US economy.

TheSensex crashed by nearly 13 per cent in just two trading sessions in January.The markets bounced back after the US Fed cut interest rates. However, stock prices are now at a low ebb in India with little cheer coming to investors.

Currentcrisis in the US

Thedefaults on sub-prime mortgages (homeloan defaults) have led to a major crisisin the US. Sub-prime is a high risk debt offered to people with poor creditworthiness or unstable incomes. Major banks have landed in trouble after peoplecould not pay back loans.

Thehousing market soared on the back of easy availability of loans. The realtysector boomed but could not sustain the momentum for long, and it collapsedunder the gargantuan weight of crippling loan defaults. Foreclosures spreadlike wildfire putting the US economy on shaky ground. This, coupled with risingoil prices at $100 a barrel, slowed down the growth of the economy.

Past recessions

The US economy has suffered 10 recessions since the end of World War II. The Great Depression in the United was an economic slowdown, from 1930 to 1939. It was a decade of high unemployment, low profits, low prices of goods, and high poverty.

The trade market was brought to a standstill, which consequently affected the world markets in the 1930s. Industries that suffered the most included agriculture, mining, and logging.

In 1937, the American economy unexpectedly fell, lasting through most of 1938. Production declined sharply, as did profits and employment. Unemployment jumped from 14.3 per cent in 1937 to 19.0 per cent in 1938.

The US saw a recession during 1982-83 due to a tight monetary policy to control inflation and sharp correction to overproduction of the previous decade. This was followed by Black Monday in October 1987, when a stock market collapse saw the Dow Jones Industrial Average plunge by 22.6 per cent affecting the lives of millions of Americans.

The early 1990s saw a collapse of junk bonds and a financial crisis.

The US saw one of its biggest recessions in 2001, ending ten years of growth, the longest expansion on record.

From March to November 2001, employment dropped by almost 1.7 million. In the 1990-91 recession, the GDP fell 1.5 per cent from its peak in the second quarter of 1990. The 2001 recession saw a 0.6 per cent decline from the peak in the fourth quarter of 2000.

The dot-com burst hit the US economy and many developing countries as well. The economy also suffered after the 9/11 attacks. In 2001, investors' wealth dwindled as technology stock prices crashed.

Impact of an American Recession on India

Indian companies have major outsourcing deals from the US. India's exports to the US have also grown substantially over the years. The India economy is likely to lose between 1 to 2 percentage points in GDP growth in the next fiscal year. Indian companies with big tickets deals in the US would see their profit margins shrinking.

The worries for exporters will grow as rupee strengthens further against the dollar. But experts note that the long-term prospects for India are stable. A weak dollar could bring more foreign money to Indian markets. Oil may get cheaper brining down inflation. A recession could bring down oil prices to $70.

The whole of Asia would be hit by a recession as it depends on the US economy. Even though domestic demand and diversification of trade in the Asian region will partly counter any drop in the US demand, one simply can't escape a downturn in the world's largest economy. The US economy accounts for 30 per cent of the world's GDP.

Says Sudip Bandyopadhyay, director and CEO, Reliance Money: "In the globalised world, complete decoupling is impossible. But India may remain relatively less affected by adverse global events." In fact, many small and medium companies have already started developing trade ties with China and European countries to ward off big losses.

Manish Sonthalia, head, equity, Motilal Oswal Securities, says if the US economy contracts much more than anticipated, the whole world's GDP growth-which is estimated at 3.7 per cent by the IMF-will contract, and India would be no exception.

The only silver lining is that the recession will happen slowly, probably in six months or so. As of now, IT and IT-enabled services, textiles, jewellery, handicrafts and leather segments will suffer losses because of their trade link. Certain sections of commodities could face sharp impact due to the volatile nature of these sectors. C.J. George, managing director, Geojit Financial Services, says profits of lots of re-export firms may be affected. Countries like China import commodities from India, do some value-addition and then export them to the US.

The IT sector will be the worst hit as 75 per cent of its revenues come from the US. Low demand for services may force most Indian Fortune 500 companies to slash their IT budgets. Zinnov Consulting, a research and offshore advisory, says that besides companies from ITeS and BPO, automotive components will be affected.

During a full recession, US companies in health care, financial services and all consumer demand driven firms are likely to cut down on their spending. Among other sectors, manufacturing and financial institutions are moderately vulnerable. If the service sector takes a serious hit, India may have to revise its GDP to about 8 to 8.5 per cent or even less.

Lokendra Tomar, senior vice-president, Integreon, a BPO firm, says the US recession is likely to have a dual impact on the outsourcing industry. Appreciating rupee along with poor performance of US companies (law firms, investment banks and media houses) will affect the bottom line of the oursourcing industry. Small BPOs, which are operating at a net margin of 7-8 per cent, will find it difficult to survive.

According to Dharmakirti Joshi, director and principal economist of CRISIL, along and severe recession will seriously affect the portfolio and fixed investment flows. Corporates will also suffer from volatility in foreign exchange rates. The export sector will have to devise new strategies to enhance productivity.

Counter strategy

Karthik Ananth, senior consultant, business development, Zinnov, says there is already a shift in business strategies of corporate India. Large IT and BPO firms have started looking at other markets like Europe, and even the domestic market, to spread their risks and reduce the impact of the rising rupee. This can be best seen with Infosys setting up an India centric team.

K. Ramachandran, head, advisory desk, BNP Paribas Private Banking, says Indian companies will 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 and moving the product portfolio up in the value chain to impart resilience.

The IT sector too is keen to defend its position. R.S. Rethinasamy, vice-president, Finance Aditi Technologies, says that in case of a full-blown US recession, the onsite staffing business will see a decline in sales and profit. "At the same time, it can increase the offshore work. Recessions at this juncture may not last for more than two to three years. Smart companies will continue to make investments so that they can be ahead of the competition when the US economy comes out of recession", he says.

This means corporate India will have to spend a lot more to develop market and supply chain links in alternate markets like Asia and Europe. Experts say the export dependent sectors of the economy need to re-focus on local demand and income from non-dollar economies.

The European, West Asian and the African countries may offer viable short-term alternatives to our export-dependent sectors. BPOs, for example, will have to re-negotiate with their clients and fix appropriate price for their services.

Can India be a market option? Zinnov says IT firms can definitely find a market in India, but the deal sizes are likely to be small. India has a huge, small and medium enterprise base and it is the right time to tap this segment. As for automotive components, consumer electronics and mobile devices, they have already found a market in India and have also started looking at tie-ups in China and other BRIC countries.

Consequences of US recession on India job market

Worst affected because of US recession will be the service industry of India. Under service industries come BPO, KPO, IT, ITeS etc. Service industry contributes about 52% to India's GDP growth. Now if that is going to get hurt then it will also hurt India's overall growth but very slightly. India is not going to face a major impact due to US recession. People may say that there is going to be a huge job loss due to recession. and will cite the example of TCS firing about 500 employees but these were employees who didnt perform and for cost cutting one have to reduce Non performing asset and that exactly what has been done. There is no threat to the skilled people. According to NASSCOM India will have a shortage of about 5 million skilled people in IT/ITeS. So there are lots of opportunities.

Apart from this India's travel, tourism and power industry is going to grow at a better rate. This is again a good sign. India has a huge population so a huge consumer base so we dont have to always depend on US for our growth. India's GDP is expected to grow at the rate of 8.5-8.9 % which is again way above the growth rate of US and only second highest in the world after China.

This recession gives us opportunity to be innovative and to think out of box so that the US directly dont affect our robust growth. Due to increasing Rupee exporters are having a hard time but it has been noted that our exporters are not that efficient and in past they got the benefit of depreciating rupee. So now its time to be innovative and more effective and increase the over all efficiency and go for systematic cost cutting to balance the rupee effect. Infact there are lots of scope for improvement. In West Africa goods at departmental stores are sold at the rate 5 times than Indian price and Indian goods are not exported to several countries in West Africa. Its an excellent opportunity for our exporters.

Conclusion

Over the past couple of months, fears of a slowdown in the United States of America have increased. The impact of the subprime crisis along with a slowdown in mortgages has led to a significant lowering of growth estimates. Since the United States dominates the global economy, any slowdown there would have an impact on most of the global economic variables.

For India, it could mean a further appreciation in the rupee vis--vis the US dollar and a darkening of business outlook for sectors dependent on US companies. The overall impact of a US slowdown on India would, however, be minimal as the factors driving growth here are more local in nature. Unlike the rest of Asia, India is a strong domestic demand story, so any slowing in the US is likely to have a more muted impact on India. Strong growth in domestic consumption and significant spending on infrastructure are the two pillars of Indias growth story. No sector has a dominant influence on earnings growth and risks to our estimate are limited. Corporate India is also learning to master the art of efficient capital management, reduction in costs and delivery of value-added services to sustain profit margins. Further, interest rates are expected to be stable primarily due to control over inflation and proactive measures undertaken by the RBI.

References

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