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The signs have been apparent since last June or July. The stock market has been moving sideways rather than up. There were signals that the economy, which had been hopping from one record to another for the last six years, needed a breather.
Then the sub-prime loan crisis began to unfold. Banks and financial institutions began to take losses, followed by other related companies. Later the housing market began to collapse, induced by the sub-prime loan crisis. When this was followed by less-than-spectacular Christmas retail sales, the "R"' word began to be uttered.
The recession will not be officially confirmed for awhile, and rapid interest rate cuts announced on Jan. 22 may reduce its impact. A near agreement between Congress and the White House on an additional aid package as unveiled on Jan. 24 may further reduce the impact of the upcoming slowdown -- yet a general slowdown is inevitable.
Half a trillion dollars spent on the Iraq war, $200 billion in losses in the sub-prime loan crisis, and a huge trade deficit with China are structural factors that cannot be helped by any aid package.
Global stock markets suffered catastrophic losses on Jan. 21. Japan's stock market dropped 6 percent, India's 8 percent, Canada's 4.5 percent and European markets fell from 4 to 6 percent. The U.S. market, closed for a holiday, was spared catastrophic losses.
Luckily for U.S. markets, the Federal Reserve stepped in on the morning of Jan. 22 and cut interest rates by 75 basis points, which had the desired effect. It curbed investors' rush to sell, and a day later profiteers stepped in to buy stocks cheap, which helped reduce losses.
India suffered miserably on Jan. 21, as well as a few days prior to that day of infamy. Institutional investors from abroad, who had driven the Indian stock market sky high, pulled back. As in the United States, the investors were back the next day, helping the stock market recover some of its losses.
The Chinese are not immune to the worldwide financial crisis, although they are less exposed to institutional investors. Their worst nightmare may be yet to come. With reduced merchandize exports, factories will be idle. Layoffs may follow and social unrest begin -- not good for the upcoming Olympics in Beijing.
When the United States goes through a slowdown, Canada is next, followed by Europe and the rest of the world. The impact of a U.S. slowdown will be:
a) A fall in commodity prices; oil for example would be out of reach at US$100 a barrel;
b) Layoffs and the closure of factories will send the unemployment rate soaring, with the side effect of high benefits payments;
c) With less money to spend, consumers will leave their wallets and credit cards at home, reducing retail sales. Sales of housing, cars and other big-ticket items will undergo a dramatic drop;
d) Stock markets in upcoming months will perform miserably. The value of people's assets and other holdings will contract. They will be less likely to indulge in cruises or holidays or other extravagances;
e) With less money all around, there will be less for the United States to spend on war on terror in Iraq and Afghanistan. It is possible that the United States may prematurely wind up and leave the war halfway;
f) There may be a complete re-look at the North American Free Trade Agreement, which has moved jobs to Mexico and Canada;
g) Unequal China trade, which has been a sore point for quite some time, may come under the scanner. The dollar-yuan currency relationship may be revised or, in the worst-case scenario, a few countervailing duties may be applied. In other words, a long-avoided protectionism may creep into the U.S. political thought process.
Apart from whatever happens in the United States, India and China will be at the receiving end of a few unpleasant jolts. China's ever-increasing exports to the United States may find an uneven reception. India may suffer the consequences of the withdrawal of investments from the stock market.
In China itself the booming real estate cum infrastructure reconstruction may cease. Cities in China are on a spending binge to boast of new infrastructure, which they finance by borrowing from the banks without adequate checks and balances. When all hell breaks loose, banks will either go insolvent or foreign reserves stashed in the United States -- now US$1.3 trillion -- will have to be transferred to keep them afloat. That is one reason China has been keeping its foreign reserves close to its chest.
This will cool off the overheated Chinese economy by a few percentage points. Domestic consumption may be increased to offset the decline in exports. China may also begin investing in U.S. companies with financial troubles, like their US$5 billion investment in Morgan Stanley. A much greater U.S. buying binge by China is unlikely, however. There are domestic consequences to worry about, and cash stashed away as reserves may be urgently needed at home.
The impact on India will be indirect. Globalization, in which India is a small fry, will impact it less. It is the institutional investors who will place India on the slippery slopes. In seven days including Jan. 21, the Indian stock market lost 8 percent of its value. This translates to about US$400 billion of investors' paper money wiped out, or about two years of steady gains made by the little guys in the market.
The U.S. recession will thus lower expectations in India but will not have consequences as severe as in China. An already unhappy textile export sector may find it difficult to achieve its 2008 export target. Alternatively, a boom in the information technology and business processing outsourcing sector will continue. U.S. companies looking for cheaper alternatives may outsource additional work.
One salient feature of India's spectacular economic performance in the last six years is that it is driven by domestic consumption. Not being dependent upon the United States makes the impact of the U.S. recession a bit more manageable. This is completely opposite for China, where exports drive the economy and domestic life may be ruined if orders dry up.
India will have to worry about rapid interest rate cuts by the U.S. Federal Reserve Board. That would widen the gap between Indian and U.S. commercial interest rates, resulting in a capital outflow from U.S. to India where interest rates are still high.
The arrival of excessive cash in India would not be welcome today. India would not know what to do with a huge inflow, and would have to cut its interest rates appropriately. Combine this with a weakening dollar and it would erode any export advantage. Hence additional rapid interest rate cuts by the Fed would require an appropriate response from India.
In the end the world may emerge out of this U.S. slowdown much more sober. The United States will develop a bit of a protectionist attitude. China's free reign of cheap exports may be a thing of the past. Domestic demand will keep India's growth high, though a drop by a few percentage points for miscellaneous reasons is not unexpected. India's stock market will receive a sobering lesson on overemphasizing foreign investors. Foreign investors will remain, but in a much more controlled manner.
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(Hari Sud is a retired vice president of C-I-L Inc., a former investment strategies analyst and international relations manager. A graduate of Punjab University and the University of Missouri, he has lived in Canada for the past 34 years. ©Copyright Hari Sud.)
