Since official data on India’s economic growth was released last Friday, social media has been abuzz with theories about an incoming recession. Some reports have already triggered debates on whether India’s economic turbulence is more than what meets the eye.
Multiple datasets released recently show that the Indian economy is facing a multi-year slowdown.
Some indicators like nominal GDP (NGDP) are worse than 2008-09 levels when a US-triggered recession ultimately wiped out more than $2 trillion if equated in terms of global economic growth.
But India’s economic story during the last US recession, which ultimately spread across several countries in Europe and Asia, was different-when top economies of the world saw growth shrink sharply, India consistently registered quarterly growth around 6 per cent through the 12 months of global during from September 2008-2009.
FACT BOX: When an economy registers negative GDP growth for two or more consecutive quarters, it could be termed as a recession. However, GDP growth contraction for subsequent quarters is considered an early sign of recession. Among other early signs of recession are when stable businesses start reporting back-to-back quarterly losses, resulting in a sharp decline in revenue and demand.
However, the country’s growth story is different this time around. Since 2009, India’s exposure to global economies has increased significantly, industry bigwigs from the West-from apparel to technology-enjoy a bigger bite of the Indian marketplace.
A slowdown in their business could upset many aspects of the Indian economy, precisely leading to job losses. And the fact that unemployment in India is at a 45-decade high has already painted a worrisome picture.
So, is India a doorknob away from a violent economic spell? Well, the answer is both yes and no. We will try to explain the paradox as we proceed further.
Let’s get you up to speed.
India’s GDP growth has slowed down to 5 per cent- the lowest in six years, instantly triggering a gloomy mood across sectors, which was already under pressure due to weak consumer demand and a credit squeeze from 2018.
Some Indian sectors are facing the worst slowdown in months, even years. The Indian automobile sector, the fourth-largest in the world in terms of sales, has been facing deep wounds for the last 10 months on account of declining demand, resulting in a significant sales slowdown. The situation is similar, if not so serious, in a few other sectors such as real estate and banking.
Meanwhile, activities of eight core sectors have fallen to 2.1 per cent in August 2019, sharply declining from 7.3 per cent in the corresponding period a year ago.
Two Purchasing Power Manager’s Index (PMI) surveys conducted by IHS Markit indicate a slowdown in both services and manufacturing activities, which are equally important for economic growth.
While the above points offer a peep into India’s economic spectrum, a deeper study of ground reports from various states indicates that the economic slowdown has hit India where it hurts most- the crucial medium and small-scale enterprises (MSMEs) or the backbone of most Indian sectors.
Economists have attributed India’s economic woes to a mix of cyclical and structural slowdown, triggered by a mix of policies and quarterly mood. But does the contraction of economy spell fear of an impending recession?
Root Of Recession Fear
A recent survey of economists conducted by the National Association for Business Economics (NABE) indicated that a recession could hit the US by 2020-21.
Out of all the 226 business economists surveyed, 34 per cent expressed deep concern over the policies of President Donald Trump, fearing that these could trigger a recession as early as 2020.
While Trump has constantly dismissed such fears citing stable economic growth, a number of factors including the US-China trade dispute are riling up economies around the world. Many of the world’s economies are currently suffering from daily stock market upset, primarily due to the US-China trade tension.
Another major recession indicator is the inversion of the benchmark US yield curve. In all nine US recessions since the 1950s, a key observation made by economists is the inversion of this curve.
FACT BOX: A yield curve is the representation of potential interest that can be earned from investing in government bonds or securities, considered the safest form of investments. It is also established the connection between long-term and short-term bonds
The yield curve usually inverses when the near-term treasury bonds generate more than the long-term treasury bonds. In layman terms, the inversion of the curve is what economists consider the first signs of a slowing economy.
Last week, the US yield curve inverted further as the 30-year Treasury Bond sank to an all-time low of 1.907 per cent. Although the situation improved Wednesday on account of geopolitical developments, the situation has kept global stock markets on the edge.
There are several other factors that could trigger, if not a recession, a sharp period of global economic slowdown – something that had severe consequences on the US and many European countries by 2008.
Recap Of 2008-09
By July 2008, the world’s largest economy contracted sharply due to a severe recession triggered by the collapse of several over-leveraged financial institutions. Ripples of the “Great Recession” were felt by all major economies across the globe, resulting in insurmountable job losses.
During the period between July 2008 and June 2009, major economies suffered a domino effect of the US recession, after the country’s housing market collapsed. It was the most severe economic crisis witnessed in the US since the Great Depression in the 1930s.
By 2008, it had knocked out 8.7 million jobs in the US alone, soon after global financial services firm Lehman Brothers, US’s fourth-largest investment bank, went bankrupt.
According to a 2011 report by the Financial Crisis Inquiry Commission (FCIC), the key cause behind the recession was the failure of the US government to regulate the country’s financial industry.
The US Federal Reserve’s failure to curb excessive mortgage lending was the prime reason behind the sudden slump, noted the report.
In a nutshell, there were too many financial firms in the US taking too many risks.
NBFCs, lending squeeze were key triggers
At the heart of the crisis were non-banking financial companies (NBFCs) or the shadow banking institutions, comprising mostly investment banks. NBFCs or shadow banks are financial institutions that offer various banking services including lending but do not have an official banking licence.
The recession finally hit the US after burdened NBFCs collapsed, affecting credit flow to consumers and businesses. This is similar to the NBFC-triggered liquidity crisis witnessed in India in 2018 after major financial investment firm IL&FS defaulted on loans to the tune of Rs 1 lakh crore.
Authorities later listed excessive borrowing by individuals and companies as the reason behind the collapse of financial institutions. The slowdown started as early as 2001 when the US Federal Reserve reduced interest rates to the lowest levels to maintain economic stability after the 9/11 terrorist attacks.
As a result, the low-interest rates combined with US policy encouraging home-ownership led to an epic boom in real estate and financial market operations. Then there were financial innovations such as subprime and adjustable mortgages. Let’s say these were loans offered to those who did not even qualify for getting a loan from traditional lenders due to low credit ratings.
Making the most of the low interest rates at the time, individuals who would otherwise not get a loan gambled and borrowed generous amounts, hoping that interest rates would remain low.
However, from 2004 to 2006, the US Federal Reserve started increasing interest rates, which pushed up interest rates and led to a drastic drop in credit flow.
People who had existing loans, especially subprime or adjustable mortgages were caught off guard as interest shot up.
This triggered the housing loan crisis as many over-leveraged financial institutions and banks started facing consequences of the slowdown by March 2008. But it was the downfall of Lehman Brothers, effects of which soon spread across continental borders, that set the panic of recession.
It was only because of the actions of the other central banks and the US Federal Reserve, which lowered interest rates to nearly zero to limit the damage.
To counter the crisis, the US government introduced several stimulus packages to smoothen flow of credit into financial institutions. In February 2009, when US Congress passed the American Recovery and Reinvestment Act, a $787 billion holistic stimulus package finally partially ended recession.
The stimulus package had benefits for unemployed, tax cuts for small businesses and other grants to end future foreclosures. However, by October 2009, unemployment in the US had peaked to over 10 per cent, the worst since 1982. The US also saw a sharp reduction in full-time employees as cautious companies rushed to hire temps.
The recession could have ended earlier if banks would not have been reluctant in lending, indicate many reports that have documented the great recession. A US Fed report showed that lending at the country’s top banks – Bank of America, JPMorgan Chase, Citigroup and Wells Fargo – had dropped 15 per cent. As a result, loans to small businesses or MSMEs fell to four per cent between April and October 2009.
During the period, American banks were more focused on lending higher amounts to secure groups, squeezing out MSMEs from the equation. A similar situation has been witnessed in India since 2018.
Lessons from 2008-2009
A number of geopolitical factors have again created an environment of global economic slowdown, with economist predicting recession to hit the US economy by 2020-21.
Since the US is the biggest economy in the world, the contagion risks in case of a recession will spread to other major economies in the world, including India.
While India was well-cushioned to tackle recession in 2008 with strong foreign reserves and lower borrowings among corporates, the scenario has changed drastically in 2019 as several top companies are presently exposed to major crisis. Loan default at IL&FS last year was the biggest jolt to NBFC sector, triggering an acute liquidity crunch.
Foreign direct investment, which is considered a stabilising force that worked in India’s favour during the 2008-09 recession, has also shrunk significantly in 2019.
While India may not face the full-fledged effects of a recession initially, a global economic recession could trigger a period of prolonged growth slump.
Like 2008, the central government should focus on implementing a combination of stimulus packages and policy boosters, to stop growth paralysis.
Many sectors have been struggling to maintain growth amid a slowdown, lakhs of employees across sectors have been laid off and foreign investors are withdrawing crores from the market every day.
For instance, the auto sector which makes up for almost 7.5 per cent of the country’s GDP and almost half the manufacturing GDP, has laid off 3.5 lakh employees as consumer demand shrunk dramatically over the last 10 months of sectoral slowdown.
Many other sectors including real estate, banking and FMCG are feeling the heat as well, but haven’t yet sizzled completely under pressure.
While economists feel that it would be an exaggeration to forecast recession but add that the economic slowdown in India is much more than expected.
As investment and consumption continue to fall in India, most economists predicted GDP growth to hit another low in the September quarter; it could further spook investors if the government is unable to come up with sector-specific boosters and tax cuts.
This, however, has to be backed by eased monetary policies, even though it could derail the government’s fiscal targets as not addressing the slowdown could have a far worse negative long-term effect.
It would be safe to say that the Reserve Bank of India’s rate cuts aided by its diktat on following external benchmarks for loans could lower interest rates, resulting in much-needed relief.
Besides adding stimulus packages, the government also needs to keep monitoring the situation for the next two-three months when demand is expected to increase due to the start of the festive season.
In case, the global economy is hit by a recession in 2020 or 2021, European countries would be worst hit due to political uncertainty over Brexit.
But considering India’s increased global exposure and present economic status, strengthening the fences by striking a balance between growth and reserves would not be a bad idea.