ECONOMIC ENIRONMENT FOR BUSINESS REPORT

TO COME OUT OF THIS SLOWDOWN, EMERGING ECONOMIES SHOULD CONSUME MORE AND SAVE LESS AND VICE-VERSA WITH DEVELOPED COUNTRIES.Submitted on: 13th June, 09 Prepared By:Aditya Agarwal Kashif Ziad Kiranpal Singh Mayank Sharma Priyanka Nagpal Saumya Sinha Section F7

ContentsIntroduction....................................................................................3 The 1980s Recession and Recovery...........................................3 The Recession of 1990 91.........................................................4 The Recession of 2008 onwards..................................................4 Theoretical Insight..........................................................................6 Case Study 1 Japan......................................................................8 Case Study 2 Great Britain........................................................18 Case Study 3 Vietnam...............................................................22 Case Study 4 United States of America.....................................28 Case Study 5 India.....................................................................40 Conclusion....................................................................................46 Bibliography.................................................................................47

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IntroductionPeople in industrialized nations are far wealthier than people living in less developed countries. But still these wealthier nations suffer most during the slowdown period. There was boom in 2007 and then the slowdown started showing its presence prominently in the year 2008. Before economies could take it seriously, there was recession. This is what explained by Business Cycle which says everything which goes up is bound to come down. All these activities are studied under macroeconomics which is concerned with the behavior of economy as a whole. This is not the first time world economies are facing slowdown, there has been 5 recessions in the last 30 years around the globe which includes the most remembered Great Depression. Inflation, Employment Cuts, Price hike, low demand etc is all characteristics of slowing down of the economy. The main problem faced by the countries is not nuclear threat but high inflation rates. Before starting with the current slowdown of the world economies, lets have a look at the scenarios of 1980s and 199091 recessions. Lets observe the policy mix taken by the economies like US and Europeans at such situation.

The 1980s Recession and RecoveryEconomic policies in the united states in the early 1980s, departed radically from the policies of the previous two decades. First, tight monetary policy was implemented at the end of 1979 to fight an inflation rate and then, in 1981, an expansionary fiscal policy was put in place of tax cuts and increased defense spending. In 1973, the US and rest of the world were hit by first oil shock, in which the oil exporting countries more than doubled the price of3

oil. This led to rising inflation which was extremely unpopular. In October 1979, the Fed acted, turning monetary policy in a highly restrictive direction. The monetary squeeze was tightening in the first half of 1980, at which point the economy went into a mini recession. The reason for the sharp decline on the activity was tight money because inflation was still above 10% and money stock was growing at only 5.1% in 1981, the real money supply was falling. With a policy mix of easy fiscal and tight monetary policies, it was found out a rise in interest rate was expected. With investment subsidies increased, investment increased with interest rates. This the fiscal expansion of 1984 and 1985 pushed the recovery of the economy forward.

The Recession of 1990 91The policy mix in early 1980s featured highly expansionary fiscal policy and tight money. The tight money succeeded in reducing the inflation of late 1970s and very early 1980s, at the expense of serious recession. Expansionary fiscal policies then drove a recovery during which the real interest rates increased sharply. By middle of 1990 it was clear that the economy was heading for the recession. The price of oil jumped and for a time the Fed was faced with the quandary of deciding whether to keep monetary policy tight while holding interest rates up, in order to fight inflation, or pursue an expansionary policy in order to fight the recession. The fiscal policy was immobilized because the budget deficit was already large and was expected to rise and thus no one was enthusiastic about increasing it. From end of 1990, Fed began to cut interest rates aggressively and the economy showed signs of recovery in second quarter of 1991 but faltered in fourth quarter.4

Thus, Fed cut the interest rate very sharply at the end of 1991. In retrospect, this was sufficient to ward off a recession.

The Recession of 2008 onwardsThe Credit Crisis began in August 2007, when interbank lending markets in the US, UK and Europe began to seize up. These markets had rarely received much public attention, and it was not immediately obvious why this should have happened. But loans on interbank markets, from overnight to several months, were not just important in keeping the flow of credit circulating amongst banks, and hence amongst almost all economic agents in a market system, they were made without collateral being necessary, and were increasingly important to the banking model developing across market economies. That model relied to an increasing extent on wholesale markets for supplies of capital, rather than on the deposits of individuals or companies. At the same time the degree of leveraging on capital was also increasing. So with larger supplies of credit and greater leveraging higher profits were possible. As were higher risks, as banks sought out increasing rates of return to satisfy their shareholders and those of their employees whose wages and bonuses were linked to levels of business or profits. But the increasing levels of risk seemed manageable by the device of securitisation, which appeared to allow the securitising bank to simultaneously sell on the risk and replenish its capital. When a rapidly deflating housing market bubble in the USA exposed weaknesses in this banking model, and similar bubbles in Ireland, the UK, Australia and Spain also began deflating, doubts about the location and value of securitised assets led eventually to an evaporation of trust between first banks, and then other financial and non-financial companies.5

By the autumn of 2008 the lack of trust in the financial sector was sufficiently great to almost completely seize up credit flows and threaten the stability of the world financial system. The financial system was in effect broken, and by October 2008 a coordinated action by large numbers of central banks and countries was needed to stabilise it. This involved giving widespread promises of state protection to depositors, large injections of capital to banks, vast liquidity supplies to gummedup financial market and increasing guarantees for all sorts of short term bond issues. Most recently the Crisis moved into the realm of sovereign default, as countries such Hungary and Ukraine struggle to refinance foreign currency loans, bringing in international agencies such as the IMF and the World Bank to provide assistance. At the same time the Credit Crisis has spawned an international economic downturn, and in some cases recession, the depth and severity of which cannot at the moment be estimated. All of these responses have public finance consequences tax revenues and expenditures and risk and uncertainty consequences that are still growing and evolving.

Theoretical InsightTheoretical insight about the recession and how to tackle recession can be given by the help of macroeconomic studies. But before that we should pay attention to what is meant by recession? In economics, a recession is a general slowdown in economic activity over a sustained period of time, or a business cycle contraction. During recessions, many macroeconomic indicators6

vary in a similar way. Production as measured by Gross Domestic Product (GDP), employment, investment spending, capacity utilization, household incomes and business profits all fall during recessions. To come out of this slowdown different economies adopt different policies mainly under the heads of Fiscal Policy and Monetary Policy. Tight Monetary policy affects the economy, first, by affecting the interest rates and then by affecting the aggregate demand. An increase in the money supply reduces the interest rate, increases investment spending and aggregate demand and thus, increases equilibrium output. Loose Fiscal policy is implemented by increasing government spending, cutting taxes etc. A cut in taxes will increases the consumption of the public and thus increase in demand. There are again two extreme cases in the operation of monetary policy and fiscal policy. First is the Classical Case where the demand for real balances is independent of the interest rate, monetary policy is highly effective and any kind of fiscal policy will be ineffective and thus there will be crowding out of private spending by government. Second is the case where there is Liquidity Trap, i.e., public is willing to hold any amount of real balances at the going interest rates, thus, monetary policy is highly ineffective but fiscal policy is effective. In all cases, the main concern of tightening the monetary policy and easy fiscal policy is to increases consumption and increases demand in the economy. Thus, consume more and save less. But7

in developed countries like Japan saving is encouraged to come out of the slowdown. But just by implementing these policies will not help in getting the desired results. A key component is there which plays an important role for the success of any policy. This key component is Multiplier. Multiplier Effect is explained as the changes in the real variables due to the changes in the exogenous variables. If the multiplier is greater than 1 , then it indicates that any increases the in government spending will result in greater change in the aggregate demand and any decrease in the interest rates will result in much less money supply. In such economies where multiplier is greater than 1, expansionary fiscal policies will be effective and can give very good results and vice versa. In the current scenario, many economies under economic slowdowns are implementing a policy mix of monetary and fiscal measures. Reduction in interest rates, introducing stimulus packages in different sectors, cutting tax rates and increasing government spending in buying bonds etc are all measures taken up by different emerging as well as developed economy to survive in this recession period. These measures and how developing economies follow consume more and save less strategy and developed economies follow consume less and save more strategy will be explained further by the case studies of different countries and steps taken by them.

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Case Study 1 Japan History About Japanese RecessionIn the decades following World War II, Japan implemented stringent tariffs and policies to encourage people to save their income. With more money in banks, loans and credit became easier to obtain, and with Japan running large trade surpluses, the yen appreciated against foreign currencies. This allowed local companies to invest in capital resources much more easily than their competitors overseas, which reduced the price of Japanesemade goods and widened the trade surplus further. And, with the yen appreciating, financial assets became very lucrative. With so much money readily available for investment, speculation was inevitable, particularly in the Tokyo Stock Exchange and the real estate market. The Nikkei stock index hit its all-time high on December 29, 1989 when it reached an intra-day high of 38,957.44 before closing at 38,915.87. Additionally, banks granted increasingly risky loans. With the economy driven by its high rates of reinvestment, this crash hit particularly hard. Investments were increasingly directed out of the country, and manufacturing firms lost some degree of their technological edge. As Japanese products became less competitive overseas, the low consumption rate began to bear on the economy, causing a deflationary spiral. The Japanese Central Bank set interest rates at approximately zero. When that failed to stop deflation some economists, such as Paul Krugman, and some Japanese politicians, advocated inflation targeting.9

The easily obtainable credit that had helped create and engorge the real estate bubble continued to be a problem for several years to come, and as late as 1997, banks were still making loans that had a low probability of being repaid. Loan Officers and Investment staff had a hard time finding anything to invest in that would return a profit. They would sometimes resort to depositing their block of investment cash, as ordinary deposits, in a competing bank, which would bring howls of complaint from that bank's Loan Officers and Investment staff. Correcting the credit problem became even more difficult as the government began to subsidize failing banks and businesses, creating many so-called "zombie businesses". Eventually a carry trade developed in which money was borrowed from Japan, invested for returns elsewhere and then the Japanese were paid back, with a nice profit for the trader.

Economic Policy & Fiscal Policy Global financial markets remain fraught with instability The U.S. financial crisis, which was initially triggered in 2007 by defaults among subprime mortgage borrowers and the resulting accumulation of bad loans, continued deteriorating to the point where it had caused an acute credit crunch following the failure of Lehman Brothers in 2008. With a number of financial institutions across the world exposed to derivatives based on such soured assets, the U.S.-initiated financial crisis quickly spread to other countries. While Japanese financial institutions are not immune to the crisis, their European counterparts have felt a much greater impact. The extreme tension in the financial markets has caused a global credit crunch, a flight to quality10

among global investors, and a huge plunge in asset prices. Thus, global financial markets remain fraught with great instability. In the United States, the financial crisis has dragged down prices of subprime-related securitized products, mortgage loans, and commercial real estate. Not only has this resulted in greater burdens on financial institutions by increasing the amount of nonperforming assets to be disposed of, it has also substantially reduced the value of household assets. Indeed, stocks and real property held by American households lost 10% of their value in one year, and the effects of this have rippled throughout the real economy and caused a steep drop in consumer demand. In the wake of the sharp decline in consumption, many American companies have decided to forego or postpone capital investment projects, and the nation's employment situation has deteriorated significantly. But the impact is not limited to the U.S. Many other countries that have been dependent on the continuous growth of U.S. consumer demand are now suffering from a big drop in exports to the U.S. In many countries, shrinking domestic demand and falling asset prices, both direct results of the credit crunch, have been compounded by falling external demand caused by the drastic downturn in the U.S. economy. The combination of these events has depressed consumption, driven companies to cut back on production, and begun to have a serious impact on the employment situation. And that is an outline of the financial crisis and subsequent economic recession experienced by the world in 2008. But, as the ongoing parade of bad news continues to spread across the world in a chain reaction, it serves as a renewed reminder of just how tightly countries are integrated with each other in both international finance and trade.11

Comparison between Japan and the U.S. in terms of policy response The U.S. government has been both quick and bold in its policy response to the crisis. In addition to providing $700 billion in public funds for financial institutions to facilitate the disposal of bad assets, the government has also made emergency bridge loans available for the three biggest U.S. automobile manufacturers to help them stave off imminent bankruptcy. Furthermore, the incoming administration of President-elect Barack Obama has already laid out plans for large-scale fiscal expenditures. Meanwhile, in December 2008, the U.S. Federal Reserve effectively adopted a zero interest rate policy by lowering its target for the benchmark federal funds rate to 00.25%. The Federal Reserve also announced its decision to purchase agency debt and mortgage-backed securities, thus embarking on a quantitative easing of monetary policy. Although poor in comparison to the bold and rapid steps taken by U.S. officials, Japanese policymakers are also moving in the same direction as their U.S. counterparts by easing monetary policy and pursuing expansionary fiscal policy. The Japanese government committed to 1.8 trillion and 4.8 trillion of expenditures to the first and second supplementary budgets, respectively, for fiscal 2008 (April 2008 through March 2009). At the same time, the government decided to re-launch its emergency share purchase plan with a maximum of 20 trillion compared to the previous ceiling of 2 trillion - set aside for purchasing shares held by banks. The plan was designed to prevent financial uncertainty, alleviate the credit crunch, and increase the amount of public funds available for injections into banks.12

For fiscal 2009, the Cabinet has approved a record budget amount that calls for more than 88 trillion in general account expenditures. Meanwhile, the Bank of Japan lowered the target of the benchmark uncollateralized overnight call rate from 0.3% to 0.1%. In addition, the central bank decided to proceed with quantitative easing measures such as increasing its outright purchases of long-term Japanese government bonds (JGBs) and commercial paper (CP) from financial institutions. All these measures taken by the Japanese fiscal and monetary authorities before the end of 2008 are emergency plans in nature, designed to put the brakes on the steep downward slide in asset prices and prevent the economy from receding further. As shortterm measures they are definitely needed, but they do not come without non-negligible side effects. In its fiscal policy, the government relies on debt to finance its aggressive spending plans, which has led to an increase in government bond issuance to about 33 trillion in both fiscal years 2008 (after the second supplementary budget) and 2009. The expansionary fiscal measures come with serious side effects, namely an acutely deteriorating primary balance. Japan's primary deficit more than doubled from 5.2 trillion in the initial budget for fiscal 2008 to 13 trillion in fiscal 2009, with the ratio of government debt outstanding to gross domestic product (GDP) reaching 114%. In its monetary policy, the central bank has begun shouldering some of the credit risks of private-sector companies, but since returning to an ultra-low interest rate policy it is once again left with virtually no room to maneuver in money market operations. Obviously, the government cannot afford to continue today's expansionary fiscal and monetary policies forever. However, in13

spite of the extraordinary fiscal and monetary steps implemented or proposed to date, it is hard to expect the credit crunch will subside and the Japanese economy will emerge from recession in the coming fiscal year. Reversing slowing GDP and combating surging unemployment are top priorities The current state of the world economy, where recent declines in energy, resource, and asset prices are occurring simultaneously with the deepening of the recession, can be defined as the beginning of a deflationary spiral caused by the credit crunch and declining demand. It will be a long time before the world economy recovers from the crash of both financial asset values and real property prices. And it will take even longer for the recovery of depressed demand, i.e., consumption and capital investments. Last year the U.S. economy slipped into negative growth and its unemployment rate has been rising sharply. For the Japanese economy, the government is now forecasting zero growth for fiscal 2009. Meanwhile, BRICs, which had recorded high growth for years, have also begun making significant downward revisions to their 2009 growth forecasts. Unfortunately, as far as this year is concerned, the gloomy outlook will not be too far off the mark. How soon countries can stem sharply declining GDP growth and bring down high unemployment are shaping up to be the biggest challenges in 2009. Japanese fiscal and monetary authorities have little room to take additional measures. As a result of steering into expansionary policy, by the time the government finalized its budget bill for fiscal 2009 it had already destined itself to running a large fiscal deficit, which may cause profound negative effects for years to14

come. Furthermore, even if the situation further deteriorates in 2009, it will be impossible to bring about a sustainable economic recovery simply by continuing the expansionary policy of the past several months. In the not-so-distant future, the time will come for the government to leave things to the market. However, overcoming today's unprecedented difficulties and transforming the Japanese economy into one capable of bringing long-term prosperity to the people are much more demanding than what can be achieved by small government and market functions. In this context, the government still has many cards that need to be played. As many people may remember, World War II is what finally put an end to the Great Depression, which had begun in 1929. If the depression engulfing the world economy today is worse than the Great Depression, the way out definitely involves a drastic transformation of social and economic structures. That is, in order to find an exit from the worldwide depression, radical changes must take place in the structures of demand, production, fiscal discipline, and financial rules across the world. And such changes must come with innovation-driven "creative destruction" of social structure. A new social infrastructure is needed In the formulation of further policy measures to respond to the economic shocks stemming from the ongoing crisis, the Japanese government needs to develop and incorporate a long-term vision for drastically changing the nation's economic structure. Such a vision must be constructed on the basis of innovation and new rulemaking. If the government irresponsibly continues vast fiscal expenditures on infrastructure construction and other conventional public works projects for the sake of economic15

stimulus, taxpayers will be forced to bear the costs for many years to come. Obviously, this will not lead to economic recovery. To the contrary, it would increase people's anxiety about growing future tax burdens and could conceivably delay the recovery. Fiscal expenditures of this kind cannot provide any foundation for inducing innovation. Instead, the government needs to (1) promote innovation by creating a social infrastructure and systems capable of overcoming challenges posed by climate and other environmental changes (2) establish a financially sustainable social security system that can reliably address health and welfare needs arising from the nation's rapidly aging population and decreasing birthrate (3) accumulate internationally competitive human resources by allocating intensive capital resources to the area of human resource development; and (4) work to develop global market rules that ensure the proper evaluation and management of risks related to new financial instruments such as the subprime and nonrecourse loans that triggered the current financial crisis. These proposed measures are fundamentally different from the short-term, emergency measures formulated and/or implemented in rapid succession during 2008. The most critical pending policy issue for overcoming the oncoming depression is the creation of a new social infrastructure capable of sustaining economic growth over a long period of time. No optimism is warranted regarding the possibility that the Japanese economy will bottom out in 2009. However, if this year marks the beginning of structural innovation, the recovery will definitely start earlier than it would have otherwise. The Japanese16

economy is not big enough to lead the recovery of the global economy, and neither does it have the capacity to bear such a burden. Yet by spearheading innovation and structural changes in its economy and society, Japan will be able to send out an effective message - and thus make a great contribution - to rebuilding the integrated world economy. Many a Japan economic policy has been adopted by Bank of Japan in view of effects global financial recession are having on its economy. These Japan economic policies had been adopted in last phase of 2008. Tadao Noda, who is a board member with Bank of Japan, has reiterated that an effective economic policy of Japan needs to be hit upon pretty quickly as Japanese economy is at present in a very bad state. In January 2009 exports went down at a rate of 45.7 percent compared to January 2008. This resulted in an unprecedented amount of trade deficit. Output of factories in Japan has also gone down in January 2009 by a record 10 percent. Rate of unemployment in Japan reached a record figure in terms of last four years. This surely calls for an unfailing economic policy in Japan so that present weaknesses can be weeded out. In final quarter of 2008 gross domestic product of Japan went down at a rate of 12.7 percent for that particular fiscal. An economic policy at Japan is presently a need of hour if domestic demand in Japan is to be revived. Economists have opined that consumer demand in domestic markets would be on wane as a result of economic uncertainty. Exports of Japan, which are among its major sources of revenue,17

would be on a downward curve as well since economies of other countries would be recovering from aftereffects of global financial recession. As per economists, makers of Japan economic policies need to look at after effects of imposing constraints on financing opportunities. As part of their Japan economic policy major opposition parties in Japan are trying to introduce financial stimulus packages that so that effects of recession could be allayed to a certain extent. Democrats, major opposition party in Japan, have announced that they would be providing an economic stimulus of $587.3 billion. This amount would be spent for a period of four years and would be looking to spruce up Japans economy. At present every Japan economic policy is geared towards addressing imbalances across various sectors of Japanese economy.

National BudgetIn the postwar period, the government's fiscal policy centers on the formulation of the national budget, which is the responsibility of the Ministry of Finance. The ministry's Budget Bureau prepares expenditure budgets for each fiscal year based on the requests from government ministries and affiliated agencies. The ministry's Tax Bureau is responsible for adjusting the tax schedules and estimating revenues. The ministry also issues government bonds, controls government borrowing, and administers the Fiscal Investment and Loan Program, which is sometimes referred to as the "second budget."18

Three types of budgets are prepared for review by the National Diet each year. The general account budget includes most of the basic expenditures for current government operations. Special account budgets, of which there are about forty, are designed for special government programs or institutions where close accounting of revenues and expenditures is essential: for public enterprises, state pension funds, and public works projects financed from special taxes. Finally, there are the budgets for the major affiliated agencies, including public service corporations, loan and finance institutions, and the special public banks. Although these budgets are usually approved before the start of each fiscal year, they are usually revised with supplemental budgets in the fall. Local jurisdiction budgets depend heavily on transfers from the central government. Government fixed investments in infrastructure and loans to public and private enterprises are about 15 % of GNP. Loans from the Fiscal Investment and Loan Program, which are outside the general budget and funded primarily from postal savings, represent more than 20 % of the general account budget, but their total effect on economic investment is not completely accounted for in the national income statistics. Government spending, representing about 15 % of GNP in 1991, was low compared with that in other developed economies. Taxes provided 84.7 % of revenues in 1993. Income taxes are graduated and progressive. The principal structural feature of the tax system is the tremendous elasticity of the individual income tax. Because inheritance and property taxes are low, there is a slowly increasing concentration of wealth in the upper tax brackets. In 1989 the government introduced a major tax reform, including a 3 % consumer tax. This tax has been raised to 5 % by now.19

After the breakdown of the economic bubble in the early 1990s the country's monetary policy has become a major reform issue. US economists have called for a reduction in Japan's public spending, especially on infrastructure projects, to reduce the budget deficit. To force a reduction of the loan program, partially financed through postal savings, then-Prime Minister Junichiro Koizumi aimed to push forward postal privatization. The postal deposits, by far the largest deposits of any bank in the world, would help strengthening the private banking sector instead.

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Case Study 2 Great BritainThe first official confirmation that the UK is in recession came on Friday after figures from the Office for National Statistics showed gross domestic product fell 1.5pc in the final quarter of 2008. That followed a 0.6pc contraction in the third quarter and two quarters of contraction means we're are technically in recession is here. The number was significantly worse than the 1.2pc expected by economists, and is the biggest three-month GDP fall since the second quarter of 1980 when it shrank by 1.8pc. That means U.K. is already in a recession deeper than that of the early 1990s, when the most the economy shrank in a single quarter was 1.2pc. How long this recession stays, and whether it overtakes the 1980s in terms of depth, is less certain. The news that they are a nation in recession will come as no surprise, but it will do nothing to quash the uncertainty that is feeding economic decline. Commenting on the figures, Stephen Gifford, Grant Thornton's chief economist, said: "The sheer fall in GDP is staggering. Financial meltdown has probably been averted but the economy has now entered a recession which is sure to be as bad as the early 80s." There are mixed views on how severe the recession will be, and the goal-posts seem to be shifting on a weekly basis as retailers21

go to the wall, company profits plunge, unemployment rises, and the housing market stands stubbornly still. Ultimately a crisis that began in the US banking sector and is characterised by a credit squeeze has filtered through to the broader UK economy, which contracted 1% between September and November, the National Institute of Economic and Social Research (NIESR) has estimated. This fall followed after a 0.8% drop in the three months to the end of October, said the think tank. Indicating that the rate of output decline is "accelerating", the NIESR now expects a fall of more than 1% in the last three months of the year. Official data showed that the economy shrank 0.5% from July to September. But it will not be until January that the Office for National Statistics reports on the final quarter's GDP. If it reports a decline for the three months to December, then the UK will be in officially in recession under the generally accepted definition of two consecutive quarters of decline. The NIESR says it has a good track record in forecasting GDP growth in advance of the official figures.

Economic prospectsDespite his revised forecast, Mr Darling has taken a more optimistic view of the UK economy than many independent forecasts. He is expecting the UK economy to recover to a growth rate of 1.5% to 2% by 2010, and to return to its normal growth rate of 2.75% in subsequent years. "Because of the wide-ranging22

measures I am announcing today, and the many strengths of the British economy, I am confident that the slowdown will be shallower and shorter than would have been the case," Mr Darling said. But other forecasts suggest that the economic recovery will not begin until well into 2010, and that the economy could shrink by as much as 2% next year. If the world economic recovery is indeed delayed, then even the grim budget forecasts made by the chancellor could be too optimistic. Some economists argue that if Mr Darling's stimulus is not enough to turn around the economy, he will need a further stimulus package in the Budget. "The economy still faces powerful contractionary forces in the shape of widespread recession abroad, and at home falling house prices and stock markets, blunted monetary policy as banks constrain lending and rock-bottom business and consumer confidence," says Andrew Smith, chief economist at KPMG. "If this package fails to kick-start the economy, further expansionary measures can be expected in next year's budget proper."

Fiscal squeezeThe government is also planning a sharp cut in the rate of growth in public spending over the next few years. Public spending is now expected to grow by just 1.2% per year, less than the growth rate of the economy as a whole, and a sharp decrease from the 1.8% previously planned. This compares to an annual growth in public spending of around 3% under the previous Labour government. In addition, the government has pencilled in 5bn in efficiency savings by 2011. This spending slowdown is part of the23

plan to bring the public finances back into balance by 2015. But it will not be enough on its own.

Tax risesThe government is also going to implement a very large shift in the tax burden in years to come. Compared to tax giveaways of 19bn this year, the government is expecting to raise taxes by 20bn in four years' time. The largest slice of tax increases will come from the 0.5% increase in National Insurance contributions, which will raise 4.7bn. Taxes on the rich, including the 45% higher rate and restrictions on personal allowances, will add 2bn in tax revenues. And, if growth is slower than predicted, there may have to be other tax increases in the pipeline.

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Case Study 3 Vietnam Overview of Vietnams Economy Vietnams economy has been bogged down in difficulties since early this year Many economic sectors are slowing down Causing production stagnancy Economic growth has slowed from 8.8% last year to 6.5% in the third quarter of this year The markets consumption power has declined since the start of the year. According to Nielson Global Online Consumer Survey, a global ealding company, showing that Vietnams confidence declined nine points to 97 points during last four months. In 2009, the gov expects the growth to be from 6.0 to 6.5% Due to ramping inflation The main causes were rigid monetary policies and public investment ineffectiveness

Status of Vietnams Economy

Vietnam's economy grew by 8.5% last year, but the target for this year and next has been scaled back to about 6.5% as the economy has been battered by a widening trade deficit and double-digit inflation.

According to IMF, Vietnam's economic growth will drop to five per cent next year while the government grapples with25

a large current-account deficit and weak banking and corporate sectors. Vietnam has announced a stimulus plan worth more than $1 billion to avoid recession as the global economic crisis bites into its export-led economy Prime Minister Nguyen Tan Dung approved a number of measures to boost production, investment and consumer spending at a monthly cabinet meeting Tuesday Dung said the stimulus would fund public works projects, including a large irrigation canal in the northern Red River delta, and help finance rice storage depots for about one million tons of grain in major farming areas.

A package of measures applied to combat the economic slowdown and cushion the impact of the global financial crisis Measures outlined by PM at a gov meeting last week included: Revving up stagnant domestic production and exports Fuelling weakening consumption power, Applying flexible monetary and financial policies Ensuring social security, Care for the poor and speeding up administrative reforms

Actions Taken by MoF & Central Bank Draw up proposals on tax cuts,26

Tax exemption Delay of tax levies for enterprises Further rate cuts and assistance Funds

Corporate Income tax cut Bringing the corporate income tax dwon from 18 to 25% Cutting corporate income tax by 30% for small & medium sized enterprises Postponing the implementation of the personal income Tax Law to July 2009 Reducing the basic interest rate from 11 to 10% . The Governments report, presented by Standing Deputy Prime Minister Nguyen Sinh Hung at the opening day of the fifth session of the 12th National Assembly which began on May 20, 2009 outlined main developments of the economy in the first months, and worked out key solutions to preventing an economic slowdown, setting it a leading target in the upcoming time. The report, under the theme Actively preventing economic slowdown, stabilizing the macro economy, maintaining reasonable and sustainable economic growth, ensuring social welfare, provides vivid figures which are evidence of the efficiency of the policies issued by the Party and State, and the efforts of all levels, sectors, enterprises and the whole people.

Positive changes27

According to the report, the country has realized three basic targets of the 2008 plan, including curbing inflation and stabilizing the macro economy, continuing to maintain economic growth and ensure social welfare. The Government assesses that in the first months of 2009, despite many difficulties, the economy has seen positive development and shows signs of recovering from the most difficult period. The situation has created conditions and the ability to achieve better results in the upcoming time, the report said. The positive change in the first quarter was shown in industrial production increasing by 2.1%, and GDP increasing by 3.1% compared to the same period last year. The first quarter also saw the registration of 15,000 new enterprises, a year-on-year increase of some 22%. The Government has strictly followed the situation, promptly asked for advice from the Politburo, the Party Central Committee and the National Assembly Standing Committee, in order to issue synchronous policies and solutions to realize the 2009 targets, and focusing on drastic measures to bring the economy out of crisis and better peoples lives, Deputy Prime Minister Nguyen Sinh Hung said. However, the Government noted that the global economic and financial crisis was still continuing in complexity, and affecting Vietnams economy. Our difficulties remaining are large, the Deputy Prime Minister said. We cannot be optimistic with results achieved over the past several months.

Key management28

The Government announced five key management directions to prevent economic slowdown, maintain growth, and ensure social welfare. They focus on efficiently realizing stimulus and consumption packages, preventing economic slowdown, restoring reasonable growth; increasing production and business, expanding the domestic market and developing the export market; shifting the tightening financial and monetary policies to active, cautious and flexible financial and monetary policies, in order to stimulate the growth and prevent inflation. The Government will also remain concerned about peoples lives, with an increase in job creation and poverty reduction; and followed with manageable situations that will create a consensus among society to successfully realize the 2009 targets.

Some main targets adjustedTo implement well key tasks, the Government asked the NA to prioritize the four main issues. Firstly, the NA was suggested to decide that the urgent and key task for the 2009 socio-economic development plan was to mobilize all efforts to prevent an economic slowdown, maintain the sustainable and reasonable economic growth, keep the stability of the macro economy, prevent inflation, ensure social welfare, national defence and security, maintain political stability and social order, in which, preventing an economic slowdown should be considered the leading prioritized task. Secondly, the Government suggested that the NA should adjust GDP growth target for 2009 from 6.5% to 5%. Thirdly, it proposed the issuing of an additional VND 20 trillion in Governmental bonds, the amendment of some tax policies, under29

the jurisdiction of the NA, and some other policies regarding construction investment and bidding. Fourthly, based on targets and basic policies, the Government suggested the NA entrust the NA Standing Committee and the Government in actively and flexibly operating the policies and solutions.

Future Landscape of Vietnams EconomyOfficials from international agencies including the World Bank, EuroCham, AmCham, AusChamall agreed that Vietnam is facing the toughest-ever challenges and worsening business outlook. Vietnam has faced the toughest-ever challenges such as high inflation, hefty trade deficit, fluctuations in forex rates and the slumping stock market, Martin Rama, the World Banks Country Director in Vietnam told the Vietnam Business Forum held Dec 1 on threshold of the Consultative Groups of Donors Meeting. Speaking about the global gloomy outlook, Thomas ODore, chairman of the American Chamber of Commerce (AmCham) said Vietnams economy will be facing with similar problems as exports, which account for more than half of its GDP value, are declining due to shrinking purchasing power in the U.S., EU and Japan. Vietnam should boost productivity and cut production costs, and the government of Vietnam should create favorable conditions for exporters to borrow loans with appropriate interest rates, Alain Cany, chairman of EuroCham proposed. Officials at the VBF proposed the government of Vietnam further boost reforms in infrastructure developments, intellectual property rights, courts30

systems, efficiency of the public administration and high-quality human resources.

Case Study 4 United States of AmericaThe United States housing market correction (a possible consequence of United States housing bubbles) and subprime mortgage crisis has significantly contributed to a recession. Apart from that US faced major crisis because of

Rising oil prices at $100 a barrel31

Global Inflation

High unemployment rates A declining dollar value

All this slowed down the growth of the economy and as the GDP growth rate fell to 2%, recession set in. The 2008/2009 recession is seeing private consumption fall for the first time in nearly 20 years. This indicates the depth and severity of the current recession. With consumer confidence so low, recovery will take a long time. Consumers in the U.S. have been hard hit by the current recession, with the value of their houses dropping and their pension savings decimated on the stock market. Not only have consumers watched their wealth being eroded they are now fearing for their jobs as unemployment rises. U.S. employers shed 63,000 jobs in February 2008, the most in five years. Former Federal Reserve chairman Alan Greenspan said on April 6, 2008 that "There is more than a 50 percent chance the United States could go into recession." On October 1, the Bureau of Economic Analysis reported that an additional 156,000 jobs had been lost in September. On April 29, 2008, nine US states were declared by Moody's to be in a recession. In November 2008 Employers eliminated 533,000 jobs, the largest single month loss in 34 years. For 2008, an estimated 2.6 million U.S. jobs were eliminated. The unemployment rate of US grew to 8.5 percent in March 2009, and there have been 5.1 million job losses till March 2009 since the recession began in December 2007. That is about five million more people unemployed compared to just a year ago. This has become largest annual jump in the number of unemployed persons since the 1940s. Although the US Economy grew in the first quarter by 1%, by June 2008 some analysts stated that due to a protracted credit crisis and "rampant inflation in commodities such as oil, food and steel", the country was nonetheless in a recession. The third32

quarter of 2008 brought on a GDP retraction of 0.5% the biggest decline since 2001. The 6.4% decline in spending during Q3 on non-durable goods, like clothing and food, was the largest since 1950. A Nov 17, 2008 report from the Federal Reserve Bank of Philadelphia based on the survey of 51 forecasters, suggested that the recession started in April 2008 and will last 14 months. They project real GDP declining at an annual rate of 2.9% in the fourth quarter and 1.1% in the first quarter of 2009. These forecasts represent significant downward revisions from the forecasts of three months ago. A December 1, 2008, report from the National Bureau of Economic Research stated that the U.S. has been in a recession since December 2007 (when economic activity peaked), based on a number of measures including job losses, declines in personal income, and declines in real GDP. Recent economy slowdown as we all know started in U.S. last year in October & initially it was concentrated on U.S. economy only but as expected & as experts forecasted that it is going to affect whole world & it did. So now let`s examine some facts & figure related. The US Economy has seen an unprecedented growth over the last decade, which accelerated to over 4% per year over the last four years. The year 2000 saw this growth at an all-time high of 5.1% a figure that is staggering in enormity when one considers that a 1% growth in the US economy is comparable to an 8% growth in the Chinese Economy. Further, 33% of the global growth is linked either directly or indirectly to the US economy. With this in mind, it was a common belief that the American honeymoon would never end. It was the Industrial Revolution all over again - with increasing productivity levels, happy days were here to stay. This growth however, had - and continues to have - a flip side - serious33

imbalances are present in the US economy, indicated by the following factors. A huge current account deficit at US $500billion - over 5% of the GDP. So far, the current account imbalance, which has been quite high over the last 4-5 years, has mainly been sustained by capital inflows from Euroland to the US. European investors had great confidence in the ability of American companies to earn greater profits in the future by way of increases in productivity allegedly taking place in the US Economy. How much of this perceived productivity increase is true of all or most of corporate America and not just IT firms is, however, debatable; extremely high Private Sector borrowing; gross over-valuation of the asset market and the fact that the American consumer, leveraging on notional wealth, is borrowing more and more, to spend, resulting in a national dis-saving. Consumption expenditure far outstrips disposable income. It has been argued that domestic consumption was buoyant on the basis of strong equity markets and although some of these have also been corrected more recently, the risks are a currency collapse or something going wrong in the equity market, thus rendering the whole system vulnerable. Of disturbing significance is the fact that each of the above mentioned factors of imbalance has preceded other recessions of the past. In fact, the situation today is a close replication of 1998. Then, the Federal Reserve reduced the interest rates by 75 basis points, thereby reviving the markets. With dot coms and software successes waiting to happen, a huge boom took place and consumption spending came back with a bang. 1998 was a classic example of the 'markets driving the economy' syndrome, which continues to be the norm. What remains to be seen is whether the gamble will pay off this time around. The soft landing will be brilliant for global markets34

and for global economies. On the other hand, however, if Alan Greenspan, Chairman, Federal Reserve, is not able to revive the market with interest rate cuts, the current account deficit will further increase, leading to investors shying off potentially "risky" US assets. All of this can only result in much larger dis-equilibrium - and subsequently, a much larger recession, therefore, than what we are seeing today. It is, however, too early to predict the final outcome. The current probability of soft vs a hard landing is 2:1. One can also take heart in the fact that a global recession, which would be the result of a hard landing of the US Economy, has not happened in the last 50 years - not even during the 1973 oil crisis. The most likely possibility, therefore, is a growth recession or reduction. The after effects will be manifold with over 33% of global growth linked either directly or indirectly to the US economy, there is a disproportionate global dependence on the US Economy. Turmoil in the US, in turn, therefore, causes a substantial ripple effect on a number of global economies. So now after having a closer look on U.S. economy we examine we examine its effects on other parts of globe. ASIA Japan would be the worst hit, so to say. Before the Euro, everything moved in linear correlation to the US Dollar. If the US Dollar strengthened, the deutsche Mark weakened, as did the yen. This time, however, a fundamental change was witnessed - the Euro strengthened and the Yen weakened. The Yen, which has come down by 12% in the last 4 months, seems to be the only currency taking a beating despite the slowdown in the US economy. The Japanese have tried everything in the book to revive and stimulate the economy to its previous glory but to no avail. The Nikkei, which used to be 40,000 at one time, is about 13,000-15,000 now. Further, retail sales in Japan have been coming down for a straight 44 months. Japanese exporters talking down their currency has not helped.35

The biggest irony is that corporate Japan is doing well but this has not reflected anywhere in stock market prices, which are once again down to levels where a number of banks are facing capital inadequacy problems. If exports to the US decline as a result of the slowdown and Japan continues with a weak Yen policy, it will result in some more and graver imbalances. All banks have huge equity portfolios and anytime the market goes up a little, they start dumping these and the market comes down. The worrisome factor is that the banks are now all unsure about investing money in Japan. On the other hand, Japanese corporates have huge holdings in the west, but prefer to leave most of their earnings in US Dollars and the Euro. Toyota, for example, has just decided to do so with US$ 26 billion of their earnings. The logic really is that since most Japanese companies remit their profits to Japan in March, they would end up remitting more Yen in the current scenario. If more and more companies begin to do this, the Yen would weaken even more.Other Asian economies, like Malaysia, Taiwan (where chip manufacturing companies are already running lower at 85% capacity), Hong Kong and Singapore would feel the ripple effect far more than others. In other parts of the world, Canada, Mexico and Brazil are most certainly way more vulnerable than any other countries. EUROLAND Sunnier days are ahead as far as the Euro is concerned as all factors determining the Euro - interest differentials, oil prices and relative productivities are favourable to the currency. A 10-year Euro bond today yields about 4.65% as compared to 5.15% by a 10-year US Treasury bond. This spread is going to narrow down a bit further with further expected cuts.

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The falling oil prices, lower-than-expected productivity levels of American companies and the fact that oil producing and oil revenue earning countries have invested in US dollar denominated assets traditionally and will continue to do so, are all factors that are Euro positive. According to the experts a base will be formed around the Euro at 92-93, where it will see a brief honeymoon. It is, however, too early to predict where it will go thereafter. What remains clear, however, is that if the US economy does not revive, more money will flow into Euroland or else, the Euro will continue to gravitate around these levels. So these are the after effects of U.S. slowdown on Asia & Europe the other two most important parts of the world now we can shift our attention to our own country the India. INDIA It is far too presumptuous to think that India is going to be hugely and adversely affected by the US economy slowdown. At 0.6%, India's share of the global trade is too tiny for this. At the same time, however, one must always bear in mind the far-reaching impact of globalisation, which has, in turn, led to the interdependence of economies, particularly where the US is concerned. 25% of India's IT exports, for example, are to the US. The value of the Rupee, however, as far as interest rates are concerned, would depend on fund flow and valuation dynamics and the Reserve Bank of India's policy towards this. In the end count, the Rupee still moves the way the Central Bank wants it to - we are still a closed economy to that extent. And the RBI tracks currencies other than the US Dollar - the Euro, Yen, RMB, as also a few other competitor currencies, whilst deciding the fate of the Rupee. The wild cards, in this entire play of currency management is the weakness of the Yen and the RMB. Any significant weakening in either of these currencies could very well have a domino effect across the entire region, including India and the Indian currency,37

the Rupee. The RMB is closely linked to the US dollar - the latter's fortunes really determine what the RMB will do. The dollar weakening against the Euro and other currencies is a huge breather as far as Chinese exports are concerned. If, however, the dollar starts appreciating, then the Chinese will want to kickstart their economy through a possible RMB devaluation. It is critical to remember, therefore, that despite the over Rs 3,000 crore of investments that came into the Indian market in the first 20 days of January, 2001, (partly, some feel, because of a certain perceived under-valuation of the Indian markets and the not so high 'risk', and partly because interest rates have been cut in the US), there is always a possibility of something going wrong externally that could affect the Rupee. In the end count: A decrease in exports as a result of the US Economy slowdown will be certainly negative from the Indian standpoint but the decrease in oil prices (from a peak of $35 a barrel to $20-$22) will be positive for the Indian Rupee and the funds flow, given the US interest rate cuts, would be positive. However, the FDI track record will continue to be shoddy, so the effect would be neutral. The amazing growth of frontline IT companies at 55-60% is a thing of the past. The global slowdown will definitely affect these companies. What inevitably needs to change is to shift our exports focus from being US-centric to newer markets. The Reserve Bank, however, is far more concerned with the slowdown in growth rather than inflation, which will be counter-balanced by the lower oil import bill. Its focus will, therefore, be on re-igniting the 'feel-good' factor in order to stimulate consumer spending patterns as a function of their aggregate net worth rather than disposable income. Measures to this effect must be set in motion at the earliest, as38

2001 is the only year when any fundamental policy changes can be made. 2002 will be too close to the general elections. So now we examine why U.S. slowdown is affecting us with reasons: Firstly the United States is India's largest trade partner, source of foreign direct investment and external job opportunities for the Indian middle class. Any slowing of the US economy is likely to hurt India more today than at any time in the past. The fact is that the US is not only India's largest trade partner, but that India has the highest trade surplus with the US and any slowdown in Indian exports to the US is likely to have a larger impact on the trade deficit than a slowdown in trade with European Union or developing Asia. India's trade with the EU and non-Opec developing Asia, our other two major trade partners, is more or less balanced with exports to these markets equal to imports from them. Our huge trade deficit with Opec countries is largely balanced by the trade surplus we enjoy with the United States. Recently published data shows that India's trade surplus with the US has actually increased since India's exports to the US have continued to grow, while its imports from the US have declined. Indian exports to the US have been mainly in the area of consumer durables and these have grown, with the recent growth of the US economy. Thus, while in the first quarter of 2000-01, Indian exports to the US went up by 26 per cent, imports from it were down by 18 per cent. This trade data does not include software exports. The software segment is another main area of concern. The US has emerged as the biggest market for Indian software exports. A slowdown of the US economy will hurt the "new economy" in India since it is still largely exportdependent and has not yet found a domestic market large enough to offset any loss in the external market. But analysts and software CEOs argue that in a slowing economy, jobs are cut and39

companies invest in automation, so that the demand for software services and for IT products is likely to increase as the economy slows down. Also, many US firms may offload work to lower-cost countries like India, especially in the area of data-processing and office management work, and that this is likely to increase the demand for new economy services in India rather than hurt them. On the negative side is the concern that firms tend to put on hold expansion plans and investment in new projects when there is a fear of a generalised slow down. This is likely to hurt demand for Indian IT services and products. The final outcome may be a combination of both factors. But one must realise that most of the companies who service the lower rung areas of maintenance etc., will not really stand to loose. They may face a squeeze on their margins but the business will continue. Another area which will be impacted, will be the capital markets. Today the world markets dance to NASDAQs tune. Dr Huang, who has spend 20 years in US and Taiwan, China, to develop and implement a method to track accurately daily financial markets, said at an investment forum early last year that NASDAQ was overheated, would face a correction upto 2800-3000 and the Dow, he stated, would be back to 9600. and global markets would follow US for 20 % correction. His logic was that there is never a bull market before economic softlanding. The bulls must take 20 % or more correction and consolidation reflecting economic slowdown impact on consumer demand and corporate earning decline. Bull markets, according to him, exist under expanding monetary policy. Expectations of higher profits resulted in an unbelievable rally in the equity markets over the last five years. NASDAQ, the technology stock heavy index, rallied from the start of 1995 and increased by a whooping 5.8 times till March last40

year. Capital market rally resulted in the `wealth effect', which further fueled the economy. Americans saw their investments in equity markets growing dramatically in value. However with this wealth effect wearing off and the risk consciousness rising, we will see a lower deployment of funds to the world equity markets, which are also in a slump at the moment. For the Indian markets, the impact is two fold - firstly, lower funds coming into the market through the FII route and secondly, companies who had planned NASDAQ listings etc. have had to put their plans on hold and this will delay their funds inflow as well as growth plans. So, we in India, will definitely need to be prepared for some fall out on the slowdown in the US economy and fine tune our corporate and export strategies as the picture develops. So here comes the real picture lets now move our focus to reports published by IMF about this situation last year when the International Monetary Fund issued its half-yearly report, the world, in the words of one its leading officials, appeared to be a much safer place. Growth was continuing in the United States, the European economy was expanding, East Asia was recovering from the crisis of 1997-98 and there were even signs that a Japanese recovery might finally get under way. The picture presented in the latest World Economic Outlook released is very different. Apart from cutting the world growth forecast by 1 percentage point, the main feature of the report is the uncertainty over the future course of the global economy and the warnings that, notwithstanding the hopes that the situation could quickly turn around, it could also worsen quite rapidly. In his press conference releasing the report, IMF director of research Michael Mussa pointed out that last September in Prague world growth for 2001 was predicted to be 4.2 percent. This has been41

revised down to 3.2 percent. It is clear, he said, that global growth is slowing more than was anticipated, or is desirable. For the United States, which has been the mainstay of global expansion in the past decade, growth this year is forecast to be only 1.5 percent, down from almost 5 percent last year and from an earlier forecast of over 3 percent for this year. The projection for the year 2002 has been reduced to 2.5 percent, at least one percentage point below the estimated potential growth rate for the US economy. In the euro-zone, the IMF estimates the growth rate will be 2.4 percent, a full percentage below what it forecast last September. Mussa said the situation in Japan was even more worrying with growth for this year forecast to be barely over 0.5 percent and growth for next year expected to reach only 1.5 percent. Asia will be hit by the slowdown in North America and Japan and by the global downturn in telecommunications and high technology with estimates for growth coming in at between 1 and 3 percentage points less than six months ago. Mussa, however, did not confine his remarks to the details of the report but delivered a stinging rebuke to the European Central Bank and its refusal to cut interest rates, following rate cuts in the US and Japan. After noting that the euro area was not contributing sufficiently to world economic demand, Mussa continued: In a period when general economic slowdown is the main problem and when inflation is not likely to be a continuing threat, the euro area, the second largest economic area in the world, needs to become part of the solution rather than part of the problem of slowing down world growth. Mussa took the opportunity to deliver another broadside when taking questions from journalists on the briefing. Asked to comment on whether calls on the ECB to cut interest rates by the managing director of the IMF and the US treasury secretary could42

be regarded as interference Mussa replied: Here in the IMF we don't call that interference. We call it surveillance. And it is mandated by the Articles of Agreement. Global recession In delivering its pronouncements, and particularly in setting out policy prescriptions for countries that are considered not to have measured up, the IMF strives to create the impression that it is fully in command of the situation, with a deep understanding of the processes taking place in the global economy. But it seems the impression is starting to wear a little thineven among financial journalists who can usually be relied upon to echo its analysis without asking too many questions. As one journalist pointedly commented: Mr Mussa, it seems that yourself and Wall Street and every economist has been caught by surprise by this slowdown. In the last WEO you said the prospects were the best in a decade. Now you say we'll avoid recession. Given the situation is so fluid, how can you be so certain that we won't actually dip into a US recession and possibly a global recession? Mussa replied that there was no certainty in this business and offered the reassurance that policy in most countries, which had policy flexibility, had been adjusted promptly and reasonably aggressively to the threat that things might be even somewhat worse than we have allowed for in the baseline. The WEO report itself claims there is a reasonable prospect that the slowdown will be short-lived but warns that the outlook remains subject to considerable uncertainty and a deeper and more prolonged downturn is clearly possible. So far, it notes, the effects of the global slowdown have been most visible in countries which have close trade ties with the US, including Canada, Mexico, and East Asia. The outlook for the rest of the year will depend on how deep and prolonged the slowdown in the United States proves to bean issue which43

remains subject to considerable uncertainty. The WEO says its baseline scenario is that the US economy will pick up in the second half of the year, growth will remain strong in Europe, while recovery in the Japanese economy will resume in 2002. But it adds that while this scenario is plausible it is far from assured and the risks of a less favourable outcome are clearly significant. One of those risks, it states, is that the virtuous new economy' circle of rising productivity, rising stock prices, increased access to funding, and rising technology investment that contributed to the strong growth in the 1990s could go into reverse. Even this is a somewhat optimistic assessment, given that most observers of the US economy have concluded that, whatever the immediate outcome of the present downturn, overcapacity in all sections of industryand above all in hightech investmentmeans that there is no prospect of the boom of the latter 1990s returning. The report notes that if the slowdown does prove to be deeper and more prolonged than anticipated this would pose several interlinked risks for the global outlook that would significantly increase the chance of a more synchronised and self-reinforcing downturn developing. Among those risks is the possibility that what the report calls apparent misalignments among the major currencies could unwind in a disorderly fashion. It points out that current account deficits of the size presently experienced by the US more than $430 billion, equivalent to around 4.5 percent of gross domestic producthave not been sustained for long and that adjustment is generally accompanied by a significant depreciation [of the currency]. If there were increased economic growth in Europe and Japan, then it would be possible to reduce the US imbalances in a relatively manageable and nondisruptive fashion. However, in an environment where US growth slows44

sharply, the portfolio and investment flows that have been directly financing the US current account deficit could adjust more abruptly. In other words, there could be a rapid movement of capital out of the US and a sharp fall in the value of the dollar. This would heighten the risk of a more rapid and disorderly adjustment, possibly accompanied by financial market turbulence in both mature and emerging markets. Large swings in exchange rates could also limit the room for policy manoeuvre. That is to say, according to the IMF's latest forecasts, there could arise a situation in which the US dollar starts to fall and financial markets are hit by a crisis, under conditions of a deepening slump. The fact that such a possibility is even being canvassed is a measure of how far and how fast the world economic situation has moved in the past six months. So here IMF also clearly specifies the picture of global slowdown. Lets move to the perception of IMF about Indian economy. The US consumer price index inflation is expected to fall to a rate of 2.4 per cent by end-2001. Both producer and consumer prices continue to decline in Japan, where consumer prices have fallen at a rate of 0.6 per cent (annual rate) and a similar decline is expected for the year as a whole. The decline in asset prices, in particular, the real estate prices, has generated new gaps in the adequacy of collateral for bank debts. The decline in growth of the global economy has been caused by a combination of global and country-specific factors. One universal cause has been the persistent rise in the energy prices during 1999-2000. Another key factor to the reduction in growth has been the sharp and sudden downturn in hi-tech investment in the second half of 2000. This weakened growth, notably in the US and Europe, while brutally reducing the export performance of many Asian countries. This pervasive setback has contributed to the45

weakness of manufacturing sector in virtually every industrial country and driven many Asian economies, including Singapore, into recession. Particular mention must be made of the rise and fall of demand for hi-tech equipment. In the US, the output of hitech equipment accelerated at an annual growth rate to 70 per cent in early 2000, before collapsing. The crisis worsened because not only was demand falling but the unit price equipment in the hi- tech sector also collapsed. US investment spending was sharply reduced, particularly on hi-tech equipment. The unexpected decline in the demand for hi-tech investment goods undermined stock prices, reversing the earlier surge in the value of new economy stocks. One other factor responsible for straining the earlier growth and subsequent slowdown in the US has been the tightening of monetary policy. While the tightened monetary policy did help control inflation, it also contributed to subsequent economic slowdown. Both US and Japanese policy-makers have made it clear that they are prepared to accept a weak yen if that is the result of market reactions. The devaluation of the yen will not be without impact on other currencies. It is quite possible that China may react with the devaluation of yuan, which may well force the various Asiaspecific countries to follow suit. This will have serious repercussions on the world economy. Incidentally, the fact that oil prices will remain high indicates further fiscal tightening for the Government. The oil pool deficit will grow higher. Unpleasant decisions, which will have serious political repercussions, cannot be delayed. The sooner they are taken, however, the better it will be for fiscal health. The Finance Minister and the Prime Minister have yet another difficult challenge to meet. The decline in the world's major economies has its repercussions, unpleasant ones, on India's economy, in particular on its export prospects. The46

Government has to take note of this trend and be ready to handle the adverse consequences of a continuing global economic slowdown. It cannot be `business as usual'.

Case Study 5 India Impact on India of SlowdownA slowdown in the US economy is bad news for India because: Indian companies have major outsourcing deals from the US India's exports to the US have also grown substantially over the years.

Indian companies with big tickets deals in the US are seeing their profit margins shrinking.

Anatomy of the economic depression in India Share Market

More people have sold the shares in the Indian share market than they bought in the recent weeks. This has added to the fall of sensex to lower points.

Foreign investors have pulled out from stock markets leading to heavy losses in stocks and mutual funds Stock broking houses are laying-off people Because of such uncertainty many people have started saving money in banks rather than investing47

IT and Real Estate Sector The key challenges faced by the industry now are inflation and the psychological impact of the US crisis, leading the companies to hit the panic button. Bonuses, perks, lavish parties, and many other benefits are missing as companies look to cut cost.

India's IT export growth is also slowing down One of the casualties this time are real estate, where building projects are half-done all over the country and in this tight liquidity situation developers find it difficult to raise finances.

Layoffs and Unemployment Hundreds of workers have lost jobs in diamond jewellery, textiles and leather industry. Companies in IT industry have stopped hiring and projected lower manpower need. Firms attached to the capital market are laying off people and large companies are putting their future expansion plans on hold.

Industrial sector

Government and other private companies are reluctant in starting new ventures and starting new projects.

Projects that are halfway to completion, or companies that are stuck with cash flow issues on businesses that are yet to reach break even, will run out of cash. Car, bike & truck sales down48

Steel plants are cutting production Hospitality and airlines are hit by poor demand

On this issue Mr. Manmohan Singh suggested A coordinated fiscal stimulus by countries that are in a position to do so would help to mitigate the severity and duration of the recession It would also send a strong signal to investors around the world. Resort to fiscal stimulus may be viewed as risky in some situations, but if we are indeed on the brink of the worst downturn since the Great Depression (of the 1930s), the risk may be worth taking.

Corrective Steps to Check Recession RBI needs to neutralise the outflow of FII money by unwinding the market stabilisation securities that it had used to sterilise the inflows when they happened. This will mean drawing down the dollar reserves which is important at this hour. In the IT sector, there should be correction in salary offerings rather than job cutting Public should spend wisely and save more

Taxes including excise duty and custom duty should be reduced to lighten the adverse effect of economic crunch on various industries49

In real estate the builders should drop prices, so as to bring buyers back into the market. Also, the government should try and improve liquidity, while CRR and SLR must be cut further

Indian Companies have to adopt a multi-pronged strategy, which includes diversification of the export markets, improving internal efficiencies to maintain cost competitiveness in a tight export market situation

Opportunities in India due to recession US recession may be a boon for Indian offshore software companies The impact of recession is higher to small and medium sized (SMEs) enterprises whose bottom lines get squeezed due to lack of spending by consumers SMEs in the US are under severe pressure to increase profitability and business margins to survive. This will force them to outsource and even have M&A arrangements with Indian firms. India is going to be a great beneficiary of this trend which will minimize the impact of the US recession on Indian industry By March 2008, India had received SME outsourcing deals worth $7 billion from the US as against $6.2 billion in the previous year50

A Ray Of Hope Experts see a ray of hope in the fiscal stimulus I package of Rs 10,000 crore which is expected to boost demand for the capital goods sector and the infrastructure industries which primarily include power, cement, coal, crude oil and petroleum. Indias growth is based essentially on investing its own savings, and so is relatively insulated from global finance and fashions. Indias savings rate has shot up from 23.5% in 2001-02 to 37.4% today, a phenomenal achievement. High savings constitute a structural change that is here to stay. This will suffice to finance an investment rate of at least 36% of GDP. So, given that output in India rises at roughly a quarter the rate of investment, a realistic GDP growth of 9% should be sustainable. If the world economy recovers in the next six months, a 7% growth looks feasible. This will mean little deceleration from the current year and hence, little additional pain. This scenario depends on a resumption of global growth early in the next fiscal year. Assocham President, S. Jindal hopes that money will flow into the system to support the projects that have been put on hold. The Prime Minster who holds the Finance portfolio also, is confident that the country will be able to maintain the growth rate around 8 percent in the current fiscal. The most pessimistic estimates put it at 7 percent. It is important now is that the industry and other sectors of economy respond to government initiatives in full measure and pass on the benefit of price cuts to the consumers. They need to realize that in the current global crisis when international demand51

is shrinking, it is only the domestic demand that can keep the business going. Fortunately, India with its 1.1 billion population has a huge potential of keeping demand afloat. All they need is the purchasing power which the Government is trying to do by pumping in funds into the system. A silver lining has been the consistently falling inflation rate which has now come down to around 6 percent. With the fall in petrol and diesel prices, the general price line is bound to fall further as petrol prices constitute an important ingredient of transport costs. We may thus witness a more comfortable inflation rate much too soon. Industry sector has welcomed the measures though it expects more to defuse the situation. FICCI described the measures as a good start in the right direction. While a number of banks have already announced lower lending and deposit rates with effect from January 1, 2009, a further softening in interest rates seem to be in the offing. FICCI secretary general Amit Mitra said: The steps should hopefully give big boost to the slowing economy, adding that he expected business confidence would be restored. The bond market quickly reacted to the rate cuts. The yield on the bond dropped to 5.07%, from the previous close of 5.29%. Industry is hoping that its lending costs, too, will drop. Interest rates are expected to come down further with a lag as banks will first align their deposit rates.

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The funding of the purchase of buses under JNNURM would help increase capacity utilization. This is crucial at a time when plant shutdowns and temp layoffs are becoming routine. The business environment of the future will be intensely competitive. Countries will want their own interests to be safeguarded. As tariffs tumble, non-tariff barriers will be adopted. New consumer demands and expectations coupled with new techniques in the market will add a new dimension. Ecommerce will unleash new possibilities. This will demand a new mindset to eliminate wastes, delays, and avoidable transaction costs. Effective entrepreneur-friendly institutional support will need to be extended by the Government, business and umbrella organisations. Experts, who earlier predicted easing of trade credit by December 2008, are now hoping that it would be achieved by June 2009. The world economy continued to contract at a near-record pace in December 2008, but the rate of contraction has slowed. There was a marked improvement in the services sector, with the Global Services Purchasing Managers Index (PMI) at 40 in December, well above the 36.1 level it plummeted to in November 2008. India does not have a PMI for the services sector yet, but looking at the global pattern, its very likely that in India too the rate of contraction of services will be less than that of the manufacturing sector. And since services account for 60% of Indias economy, any resilience there will provide a big cushion for the downturn.

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ConclusionThe global economy is in a tough spot, caught between sharply slowing demand in many advanced economies and rising inflation everywhere, notably in emerging and developing economies. Global growth is expected to decelerate significantly in the second half of 2008, before recovering gradually in 2009. At the same time, rising energy and commodity prices have boosted inflationary pressure, particularly in emerging and developing economies. Against this background, the top priority for policymakers is to head off rising inflationary pressure, while keeping sight of risks to growth. In many emerging economies, tighter monetary policy and greater fiscal restraint are required, combined in some cases with more flexible exchange rate management. In the major advanced economies, the case for monetary tightening is less compelling, given that inflation expectations and labor costs are projected to remain well anchored while growth weakens noticeably, but inflationary pressures need to be monitored carefully. Now countries needed to put their energies into restoring credit flows since economic stimulus plans would otherwise struggle to work.Monetary policy "should be capable of taking more into account ... the accumulation of risks that it had left a bit to one side before." If governments adopted the right policy mix and stimulus programmes were accompanied by the restoration of a functioning financial system, it was possible for the world economy to begin its recovery early next year.

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BibliographyBooks Dornbusch and Fisher Macro Economics Web Links

http://crisistalk.worldbank.org/2009 http://economictimes.indiatimes.com/archive.cmswww.scrib d.com www.wikipedia.com www.livemint.com http://economictimes.indiatimes.com/articleshow/3928470.c ms http://economictimes.indiatimes.com/News/Economy/Policy/ StimulusII_India_Inc_gets_more_room_to_grow/articleshow/3929013.c ms http://economictimes.indiatimes.com/articleshow/3929007.c ms http://economictimes.indiatimes.com/articleshow/3929043.c ms http://www.rediff.com/money/2008/dec/07bcrisis-govtannounces-package-to-boost-economy.htm

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