A 21st century myth
The world economy suffers from multiple fractures. Its two crutches – the US and the surging Asian economies of India and China – are also in shaky situation. The bigger crisis comes here: both the economies are critically linked thus pushing the global economy into deeper crisis. Can the two economies be decoupled? The former federal finance minister P Chidambaram was insistent for almost two months saying the global meltdown wouldn’t impact India. It was a hope many other economists believed in. In fact, to believe many finance ministry bureaucrats, the government was preparing strategic notes on how India could exploit the slump in global market for enlarging its footprints. China, the other Asian big economy, literarily treated the global crisis as an ‘internal affairs’ of the US. Emerging stronger after the Olympics, it thought it had all the arms of its economy were insured against the US economic crisis. India and China, accounting for more than 40 percent of the world population, believed that themselves as the new island of economic prosperity. It was like a fairy tale. For both the countries primarily fueled their economies using the US economy. On the other hand the US economy is an overheated pot of unrestrained consumption. It is often said that without an over consuming US citizen, the world would have been consuming less and less. This is also the umbilical cord that India and China ignored to acknowledge. The credit crisis started with a housing recession in US, a bust in housing price bubble and resulting losses in sub-prime home mortgages. Other sectors have been affected now. This has spread to other economies in the world intimately dependent on the US economy. The credit dependent US consumer is retrenching, putting consumption driven US economy on the brisk of severe and prolonged recession. The dragon in an economic cage The devil is in the details. Let us take the example of China having gross domestic products (GDP) of USD 4 trillion. The structure of Chinese economy suggests that consumer spending (a less volatile component) comprises 37 percent of the GDP while exports account 37 percent of the GDP and private-funded investment 39 percent – a more volatile & cyclical components- together comprise a whopping 76 percent of the Chinese economy. Easy credit availability fueled a consumption boom in USA in early 2000s. And Chinese economy prospered as a manufacturing outsourcing destination by US retailers. This has resulted in increasing share of exports in Chinese GDP from 18 percent in 1998 to 37 percent in 2007. This has also fueled a massive capacities build up by Chinese manufacture and foreigners (through FDI) in China resulted in increasing share of private fixed asset investment in Chinese GDP from 33 percent in 1998 to 39 percent in 2007. Now both the growth engines of China are gearing for a drastic slowdown thanks to likely massive retrenchment by US consumer. Export growth will dry up and as many factories will be operating at less then optimum, private fixed asset investment growth will also tumble. Though Chinese government has announced a massive fiscal stimulus package of USD 500 billion to be spent over a period of next two year, it is unlikely to cover for growth damages likely to be done by exports and private fixed capital investment. Chinese growth is likely to tumble to 5.5-6.5 percent in 2009 as a result from double digit growth recorded in recent years. Forget about the insularity, it is like a hard landing for the world’s fastest growing economy. Other Asian countries depending on exports and related fixed capital formation for growth, will also meet with the similar fate. India’s global genetic makeover Like China, India’s export growth is also likely to tumble due to a recessionary environment in the US and Europe. As far as capital formation in particular and India’s GDP in general is concerned, both are dependent to some extent on external capital (both equity and debt) to finance the growth. In the scenario of heightened risk aversion, deteriorating demand scenario and scarcity of capital, a huge external capital flow is unlikely after seeing a huge capital outflow in 2008. It is likely to affect the growth of capital formation in India heavily though India’s gross saving rate is as high as 35 percent of its GDP. It is also likely that though India has sufficient savings to finance its growth, changing demand outlook across the globe is unlikely to entice borrower to borrow heavily. As far as domestic consumption in India’s is concerned, it is the most resilient part of India’s GDP and likely to be affected the least in current scenario. But will it provide a growth fillip to a growth void created by export and capital formation? The answer is definitely ‘no’. First, a bigger chunk of household savings has gone into equities in recent times (from a low of around one percent in 2000-04 period to as high as 8-10 percent in 2007). Indian household is also witnessing huge networth erosion due to fall in Indian equities to the tune of 60 percent from its peak. Though materially it will have a moderate impact, psychological impact will be high. Second, more than 40 percent of urban consumption and more than 30 percent of rural consumption in India is on non-essential items and India’s consumer has a tendency to save more in the time of crisis thus cutting consumption heavily on non-essential items. Is India in a position to give big fiscal stimulus like China (around 25 percent of its GDP)? Again the answer is no. India’s fiscal deficit is likely to be around 8 percent in year 2009-2010, sparing not much room for a robust fiscal stimulus like China has announced. So, as far as India is concerned, though it is less vulnerable to US recession through trade linkages, financial linkages to the rest of world (for a capital need and psychological influence on risk appetite) makes India’s de-coupling story a myth. At least, as of now
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