The downfall: Are we moving from worse to worst?

Source: IRIS (10 January 2009)
What started in mid-2007 as a subprime mortgage fiasco in the United States, has now transformed into a major global economic slowdown, the worst ever since the Great Depression. All the economies across the globe fell into the recession. Stimulus packages, industry friendly monetary policies and massive liquidity injections, time and again by the central banks of many countries were unsuccessful in warding-off this problem, which had snow-balled into a global crisis. Stock markets world-wide are still trading at more than 50% discount of their highs in late 2007, with little signs of improvement; even commodity markets are trading extremely volatile.

In a rescue attempt, governments in both, developed as well as developing countries have started to unveil fiscal and monetary stimulus packages to prevent the global financial crisis from deteriorating further and turning into another Great Depression.

To salvage AIG, America`s biggest and one of the largest insurance companies in the world, the United States provided an emergency credit line of USD 85 billion in exchange for about 80% equity ownership in AIG. Further aid was given, raising the bailout to USD 150 billion in November 2008.

Two more large financial institutions failed; Lehman Brothers and Washington Mutual had to file for bankruptcy. Lehman`s fall is the largest in the United States history, while the latter is the largest bank ever to fail. Investment banks like DSP Merrill Lynch and Goldman Sachs were also found engulfed in this subprime crisis.

The international financial scene changed dramatically after September 2008. The crisis rapidly spread across the globe. In the United States alone, between September 2007 and October 2008, 16 banks filed for bankruptcy.
Prices of oil and non-oil primary commodities have also shown strong fluctuations during 2008, largely driven by financial factors, as well as shifts in the balance between supply and demand.

Growth of world trade decelerated to 4.4% in early 2008, down from 6.3% in 2007, mainly owing to a decline in imports of the United States.

Rough roads ahead

As per a United Nations Conference on Trade and Development (UNCTAD) forecast, more challenging times are in store for the developing economies. The cost of external borrowings is rising and the capital inflow is deteriorating in such economies.

Not only developed and developing economies have suffered, but the Least Developed Countries (LDCs) are feeling the heat. Growth in this group decelerated from 7.8% in 2007 to 6.4% in 2008, breaking a four-year trend of growth over 7%. In 2009, growth is expected to slow further to 5.3%.

According to the United Nations baseline forecast, world gross product (WGP) is expected to slow down to a meager 1% in 2009, a sharp deceleration from the 2.5% growth estimated for 2008. In the worst case scenario, WGP for 2009 is expected to be -0.4%, where as in the best case scenario it may go up to 1.6%. In the baseline scenario, per capita income for the world as whole is expected to decline in 2009.

This will be the case not only in the developed economies but also in many developing countries, where per capita income growth will be negative or well below what is needed to address poverty reduction.

In the outlook for 2009, capital inflow to developing economies is projected to drop further. The outflow of capital from emerging to developed market economies continued to be larger than the inflow. The foreign reserves of developing countries are expected to be sluggish, or even decline in some countries.
The employment situation is expected to deteriorate in most regions during 2009. Global inflation is expected to decelerate significantly in the outlook for 2009, with the risk for deflation increasing in some economies.

Among developed economies, the economy of the United States is expected to decline by 1% in the baseline scenario for 2009. Japan`s economy is in a recession and is expected to stagnate in 2009.

Developing countries will be hurt by the crisis through international trade and finance channels. The drop in commodity prices will hurt primary exporters in particular, but lower demand in the developed countries will affect export growth throughout the developing world. Growth in Africa is expected to decelerate to 4.1% in 2009 from 5.1% in 2008.
Growth in East Asia is expected to decline sharply in 2009, as the slowdown in the developed nations will decelerate exports significantly. Owing to their relatively higher exposure, some economies in the region will also experience sizeable financial losses. South Asia is experiencing an overall slowdown in economic growth from the industrial sector to the service sector as a result of the negative impact of higher costs and the global financial turmoil. Growth in Western Asia is anticipated to slow down significantly in 2009, to the lowest rate in seven years.

Where does India stand?

Mirroring the global events, India too has suffered a financial agony. Industrial production fell into negative territory for the first time since the index was launched. Exports have declined, vehicle production have shown a decline. Many companies have shelved their investment plans and projects. Meanwhile, there have been certain positives as well: Inflation has declined considerably; the government has launched aggressive rate cuts and fiscal measures to stem the economic slowdown. Though the Indian economy is better placed than many of its Asian counterparts, it is in no way decoupled with the rest of the world and in the next few quarters it will grow at a rate much lower than the average growth rate seen in the past few years.

Conclusion

Markets across the globe have frozen significantly. Governments and regulators are trying hard to come up with measures like bailouts, stimulus packages to restore confidence in the hammered financial systems. The question is - Will this work? It is hard to forecast, but doing nothing would almost certainly have pushed the world economy into a deeper crisis. A combination of more rescue packages, unconventional monetary policies worldwide should succeed in reviving the global economy. However, it will take time for most of these policy measures to take effect. In fact, given the current state of developed economies, it appears to be inevitable that the major economies will see significant economic deceleration in the coming months and the recovery in the same will be much slower, even if the bailouts and stimulus packages are a success. Till then, policymakers need to hold on and keep on their good work and come up with more measures to guard the economies and most importantly be positive and hope for the BEST.