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Dummy’s guide to recession

The technical definition of recession is ‘two consecutive quarters in which the gross domestic product (GDP) decreases’.

business Updated: Jan 27, 2008 00:10 IST

What is a recession?

It is a protracted slowdown of the economy. The slowdown is usually classified as a recession if it lasts at least six months. The technical definition is ‘two consecutive quarters in which the gross domestic product (GDP) decreases’. The GDP is all the goods, services and products a country produces.
The typical symptoms of a recession are:
n People buying less (retail decline).
n Decrease in factory output.
n Growing unemployment (In the US, unemployment recently rose to 5 per cent, another sign of an imminent recession).
n Slump in personal incomes.
n A dipping stock market.

What causes the downward spiral?

As the saying goes, what goes up must come down. An economy that has undergone a long period of expansion will contract as part of the normal economic cycle. Most recessions are short-lived and followed by a growth spurt. The economy will typically expand for six to 10 years and then enter a recession for six months to two years. This is how it happens:
n Consumers don’t feel confident about the economy, and spend less.
n Decreased demand forces producers to lay off employees.
n The laid-off workers spend less, further depressing demand.
n This makes investors fear a fall in stock values, they invest less, sell what they have.
n Stock markets crash.

Why are stock markets falling?

In the US, the declaration of a recession is based on the GDP data compiled by the Bureau of Economic Analysis. While a full-blown recession has not been declared yet, stock investors around the world are worried. They are unwilling to invest in stocks and are selling large parts of their holdings, pushing down prices. Some US banks, in fact, are pretty certain that the economy is already in recession.

What went wrong in the US?

Blame it on record defaults on sub-prime mortgages. Sub-prime credit is high-risk, high-interest debt offered to people with inferior credit records or unpredictable incomes. Many US banks found themselves on shaky ground after the defaults. This made banks jittery about lending money to each other, because they did not know which ones were creditworthy and whether they should take the risk of letting go of their deposits. This, in turn, led to a credit crunch, making it harder for industry and consumers to get loans.

How do economies get out of a recession?

n Tax cuts are a common tool used by
governments — the more money people get to
keep, the more they spend.
n Another popular tool is an increase in government spending, resulting in more jobs. This was how Franklin Roosevelt tried to end the Great Depression. However, the present trend is to favour private sector growth instead.
n Monetary policy. The US Federal Reserve has just introduced a 0.75 per cent cut in interest rates, a desperate measure to cushion the recessionary fall. The Fed’s counterparts — in India, it’s the Reserve Bank — across the world can adopt the same measure or increase holdings in government bonds, a way of infusing money into the government’s coffers.

Why you should care about a recession in the US

n The US is a big customer for virtually every country, including India. A downturn there would have a domino effect worldwide.
n Banking majors may try to make up for their sub-prime losses by selling their stock holdings in emerging markets like India, driving down indices like the Sensex.
n Jobs will be less secure, loans will be harder to get, those saving for life post-retirement may eventually land up with less to retire on.
n A slowdown also means less tax money in government coffers for vital development schemes, hugely important for a country like India.
n Everybody will feel the effect of a US recession.

How a recession in the US will affect India
n A slowdown in India’s export industries like informationtechnology, BPO, pharma, textiles, gems and jewellery.
n It could slow the rate of India’s overall growth.
n The impact on the economy would be limited as India is predominantly a domestic demand-led economy.
n A weak dollar could lead to a flood of foreign money in Indian markets, which can’t be insulated.
n Oil could get cheaper, easing inflation.
n Loans could get cheaper too.

Can Indian markets withstand the crisis? How will it affect us in the long run?

n The outlook remains more robust than in many parts of the world. So, when the US Federal Reserve cut interest rates to avert a recession, the rupee started appreciating as global funds were expected to divert capital to India.
n There is lot of confidence about India. As Indian Commerce and Industry Minister Kamal Nath said recently, the economic bleakness in the West is at odds with the buoyancy in the East, where growth of trade between developing countries can cushion the effect.
n A slowdown in the US, which consumes 28 per cent of the world’s oil, has pushed down oil prices towards $90 (Rs 3,600) per barrel from a $100 (Rs 4,000) high earlier in the month. A recession could drag down the price to $70 (Rs 2,800).