When Federal Reserve Chairman Ben Bernanke announced the hefty cut in interest rate in August he had also indicated that the downside risk to growth had increased considerably. Since then, the trends have worsened making recession in US almost imminent.
Alan Greenspan put a date on it. "It is possible we can get a recession in the later months of 2007," he said, though most forecasters expect it in 2008. The reason why Greenspan feels recession may descend early is that profit margins of US companies have begun to stabilize. Besides, in August more than 4000 employees lost their jobs. Recession will be the cumulative effect of sub-prime mortgage crisis and housing burst.
The US economy has been expanding since 2001 and is now almost at the end of the cycle. An economy is in recession when economic growth becomes negative for at least two consecutive quarters. Since the US recession will be brought about by housing burst it is likely that the drag on the economy will continue for a much longer time. Japan took nearly a decade to normalize from a similar shock.
Recession in the US is a concern for the rest of the world because the US is the largest economy generating more than 28 per cent of the world GDP and absorbing 16 per cent of world imports. Therefore when the US economy goes into recession the ripple effect is bound to be extensive.
With the fall in US incomes and of US dollar, the US will buy less from and will possibly sell more to the rest of the world. That will eventually affect EU, Japan, China, Brazil and India.
The US has 18 per cent share in our merchandise exports with major products being gems and jewellery and apparel.
The US is an even bigger customer for services, principally software and BPO. Some of these exports will be met with demand resistance.
The impact will be more on goods which are income and price elastic. As such gems and jewellery may be hit more than others. At the same time US companies, faced with the prospects of stagnation, would strive to cut costs and consequently generate more demand for computer software and take recourse to outsourcing a number of services.
Both can favour India.
This would also be the time when US companies will be tempted to invest abroad to take advantage of better returns.
The short term funds can distort the rupee-dollar exchange rate in India and also create liquidity problems if the RBI intervenes. Interest rates may be pushed down as well as fuel inflation. Long term investment can come through mergers and acquisitions and India can be a good hunting ground for many US companies.
Broadly, with recession in US it is possible that the growth of merchandise export may dip but of services climb and, with inflow of unwanted dollars, the rupee go up and interest rate down. But the total impact on our growth may not be large.
The writer is president, RPG Foundation