Commentary

Sliding into Recession

After four years of 9% GDP growth, and boasts of overtaking China, Indians are reluctant to believe that the economy is headed for a serious fall. But the stock market has crashed, an indication of the pain ahead.

Western observers have lavished praise on India as a rising economic superpower, so many Indians believe we have achieved 9% growth simply because we are so clever and resourceful. This is a delusion of grandeur. In fact, a global tide has lifted the whole world economy — India along with all others. Now that the global tide is ebbing, India will fall with all others. Given our strengths, we will not suffer as badly as some others. But suffer we will.

After more than a decade of 6% growth, India accelerated to almost 9% in the last four years. But sub-Saharan Africa also accelerated, from 2.4% per year in the 1990s to almost 5.8 % in the last four years, a stronger acceleration than in India! Azerbaijan grew by a whopping 31% in 2006 and maybe 27% in 2007. Turkmenistan grew by 18% in 2006.

Alas, no boom based on over-consumption can last forever.”

Sudan is enduring a civil war and genocide in Darfur, but even its latest growth rate is a staggering 12%. Rwanda, site of the genocide made famous most recently by the film Hotel Rwanda, is enjoying 8.5% growth. Liberia, site of the Hollywood hit Blood Diamond, is growing at 9%.

So India’s 9% growth in the last four years is hardly exceptional.

The core cause of India’s boom was huge overspending by Americans in the last decade, based on a long housing boom. Americans borrowed ever more billions against their rising property values, and went on a spending spree that greatly exceeded their disposable incomes. Overspending led to a record U.S. trade deficit of $700 billion per year.

The mirror image of this was rising trade surpluses — and hence, foreign exchange reserves — in other countries. These for-ex surpluses were in turn used to buy U.S. securities, depressing U.S. interest rates and making borrowing even more attractive. Americans borrowed still more, spent still more, and imported still more.

This created a huge consumption-based growth cycle across the globe. The U.S. consumer splurge was especially helpful to China, the most competitive exporter of manufactures, which grew rapidly through an export boom. India, which exported competitive services, also benefited. Other Asian countries, from Vietnam to Pakistan, also began growing at rapid rates.

But these Asian countries needed to import huge quantities of commodities, partly for conversion into manufactures for export, and partly to meet rising domestic needs. So the global demand for commodities skyrocketed, lifting all exporters of commodities. These countries were mainly in central Asia, Africa and Latin America. All joined the great global boom.

Alas, no boom based on over-consumption can last forever. The U.S. housing bubble burst, and prices started falling. This revealed the ugly fact that many lenders had made huge property loans to people who could not or would not repay. Banks and other mortgage lenders suddenly found themselves with hundreds of billions in bad debts. The consequent financial crunch hit the whole U.S. economy. This now threatens a recession, which will lower consumer spending.

Lower U.S. spending will mean a big drop in U.S. imports from Asia. When that happens, Asia will demand fewer commodities from Africa, Latin America and Central Asia. So, the very countries that benefited from U.S. overspending will now suffer as U.S. spending declines.

How bad will the impact on India be? It all depends on the pace at which the U.S. reduces its overspending to manageable proportions. Consider three scenarios.

In scenario 1, the U.S. will only experience a slowdown, rather than an outright recession, and will recover in the second half of 2008. There will be only a small blip in overspending, which will soon resume. World growth will not be badly hit, and India can hope to achieve 8% growth in 2008. This scenario looks hopelessly optimistic.

More realistic is scenario 2, which postulates a recession for two or three quarters in the U.S., followed by a recovery in 2009. This will hit the global economy significantly. Indian growth will decline to 7%.

In scenario 3, the U.S. will suffer a prolonged slowdown with a recession lasting 18 months or more. This is very unlikely, given the ammunition available to the U.S. Fed to revive the economy. Yet a cold shiver is running down the spines of stock market experts, who sense a small but significant chance of a long, painful slog. That will translate into huge global pain. Under these circumstances, India’s GDP growth will fall to 6% — no higher than in the 1990s.

Even if the worst were to happen, it wouldn’t mean that all recent progress was illusory. India has raised its savings rate to 34%, and built up strong skills that are here to stay. But our sustainable long-term growth rate, in less-than-booming global conditions, may be only 7-8%.

The last four years have been great, but let’s not get too carried away.

Swaminathan S. Anklesaria Aiyar is a research fellow at the Cato Institute.