In this article we will discus about:- 1. Introduction to Recession 3. Factors Responsible for Recession in India 3. Impact.
Introduction to Recession:
It is, of course, true that recent global crisis originated in the USA and Britain on account of construction bubble and sub-prime mortgage crisis leading to the collapse of a number of financial and other institutions. It then spread to the countries of Europe and emerging economies like China and India too were afflicted by it.
By January 2008, the effect of the critical global situation was felt by India too; when Sensex had a steep decline of 1430 points in line with sharp fall in equity markets the world over. Compared with GDP growth rate of 9.3 percent in the second quarter of fiscal 2007-08, the GDP growth rate declined to 7.6 percent in the second quarter of the fiscal 2008-09.
This growth rate was the lowest since the GDP growth rate in the last quarter of 2004. However, the situation continued to worsen thereafter. In the last quarter of 2008-09, the growth rate had slumped down to 5.8 percent.
The annual growth rate of GDP had fallen to 6.7 percent. The manufacturing got slowed down in the second quarter of 2008 to 5 percent from 5.6 percent in the first quarter. The growth rate declined in several sectors including agriculture, mining and quarrying, electricity, construction, trade, transport, communications and financial services.
By November 2008, centre’s direct tax collections had declined by 40 percent. The extent of decline in the GDP growth rate suggested that about 40 lakh jobs had been lost in the economy in 2008-09. In the organised sector alone, the job loss was approximately six lakh. The squeeze on employment in the medium and small firms in the unorganised sector threatened a decline in wages. The capacity utilisation in all industrial sectors got reduced by 1.32 percent per month during October to December 2008 period.
The strengthening of the conditions of recession was amplified by the persistent fall in the rate of inflation to 0.44 percent in March 7, 2009 compared with 7.78 percent a year ago.
Although exports accounted for only 15 percent of the GDP of the country, yet it was definitely a matter of concern that the exports fell for the fifth consecutive month in February 2009. There was a steep fall in exports by 33.3 percent and 33.2 percent in the months of March and April 2009 respectively.
The gloomy conditions in the Indian economy were reflected also by the huge net outflow of capital by foreign institutional investors during the financial year 2008-09 of the order of Rs. 47,706.2 crore.
In contrast, the net inflow of capital was of the magnitude of Rs. 53,000 crores in the fiscal year 2007- 08. The state of investment and business confidence was greatly depressed on account of sharp crash of the equity prices even below the earlier minimum limit of 8000. Thus, the whole economic system had been experiencing the depressing conditions.
Factors Responsible for Recession in India:
Although the recent recession had been a global phenomenon as it started from the USA and Britain and later spread to other regions of the world including India, yet the conditions of recession in the economy were created in this country not only by the global factors but also by a host of internal factors.
All these factors are discussed below:
(i) Fall in Demand for Exports:
The exports constitute just 15 percent of the GDP of India. The conditions of slump in the USA, Britain, European Union and Japan had a serious adverse effect upon the Indian exports of textiles, gems and jewellery, ores and metals and several other products. The exports had been falling for the last 8 months in 2008- 09.
Even in May 2009, exports drifted down by 29 percent. This persistent fall in Indian exports resulted from shrinkage of purchasing power in advanced countries, low international prices of commodities, accumulation of inventories with foreign producers, protectionist policies of developed countries, currency turmoil and high cost of borrowing. The decline in demand for exports hit hard the export industries in particular and other related industries in general.
(ii) Net Outflow of Capital:
The high growth rate of investment in the Indian economy in the last few years was partly on account of large inflow of capital from abroad. Even in the financial year 2007-08, there was huge inflow of capital due to foreign institutional investments of the order of Rs. 53,000 crore. The sub-primal mortgage scandal in the United States led to banking crisis in that country.
The serious liquidity crisis faced by them coupled with appreciation of dollar made foreign banks to pull out their funds from everywhere including India so that they could shore up liquidity. In the fiscal 2008-09, the FII’s net outflow amounted to Rs. 47,706.2 crore. It had serious recessionary effect on corporate investment and equity prices in the stock market in India.
(iii) Fall in International Commodity Prices:
The conditions of recession in the Indian economy were somewhat strengthened by a fall in the international commodity prices including oil, metals, automobiles, farm products etc. Such a situation coupled with large inventories with foreign firms had a discouraging effect upon some of the Indian exports and industrial production.
(iv) Protectionist Policies in Developed Countries:
The recessionary conditions in the Indian economy got influenced also by the protectionist policies adopted by some of the advanced countries who had been the staunch advocates of free international trade. The US administration laid emphasis on such policies as ‘buy American’ goods and restrictions upon outsourcing by the US enterprises in the emerging countries like India.
(v) Fall in Domestic Demand:
Sometimes the view is expressed that Indian economy is immune from the effect of fall in demand for exports because the country is endowed with a large domestic market. But even the domestic demand had been showing a declining trend due to increasing unemployment, high interest rates and liquidity constraints.
Consumption of not only the well-off sections was on the decline, there had been fall also in retail sales forcing many enterprises to close down their retail outlets, so domestic consumption had not been as robust as was sometimes claimed.
(vi) Fall in GDP Growth Rate:
One of fundamental factors showing declining level of economic activity during the 2008-09 had been the fall in the growth rate of GDP in the country. The GDP growth declined from 9.3 percent in 2007-08 to 7.1 percent in 2008-09. The decline in the GDP growth rate was caused by slump in productive activities in agriculture, mining and quarrying, construction, manufacturing, trade, transport, communications, tourism and financial services.
(vii) Fall in Industrial Growth:
It has been a matter of serious concern that there was a fall in industrial production to a 15-year low registering negative growth in October and November 2008, of the total 17 industries included in the Index of Industrial Production, as many as 10 recorded a negative growth. It had a quite significant impact upon the whole system.
(viii) Decline in Business Ranking:
The ranking of India, as published by Forbes, on the basis of such areas as trade freedom, technology, corporate tax rate and corruption for 2008-09 slipped down from 64th position to 75th position in the world. Similarly Moody also made adverse report about manufacturing and business activity. Some of the blame for the dismal situation in manufacturing sector was apportioned by it to the RBI which continued to tighten the monetary policy until July, 2008 due to its heavy pre-occupation with the inflationary conditions.
According to Moody, “Losing support from external orders, India will unlikely to see a rebound in manufacturing output any time soon.” But the conditions emerging in the economy in 2009-10 did not support the fears of the rating agencies.
(ix) High Interest Rates:
Although economy had slipped into a state of recession and there was the need of having low interest rate regime, yet the RBI kept the interest rates high to counteract the increase in the rate of inflation. Even when the interest rates were reduced, that was late and inadequate. That allowed the recessionary conditions to get more strengthened. High cost of borrowing affected adversely the competitiveness of Indian manufactures in the home and foreign markets.
(x) Unfavourable Investment Climate:
The economy slipped into recession and revival would possibly take still some quarters because the investment climate has not been favourable on account of fall in the foreign and domestic demand for manufactured products, high rates of interest, liquidity crunch, outflow of capital, instability in stock market, possibility of heavy government spending and consequent crowding-out of private investment and the inventory buildup in many industries like textiles, chemicals, steel, metals, auto, building materials etc.
According to Moody, “As the current focus of many firms is to refinance debt and survive the financial turmoil, investment is expected to be subdued this year.”
(xi) Liquidity Crunch:
The control of recession required expansion of liquidity and easy access to credit of the business sector. When the central banks in many countries were engaged in the enlargement of liquidity, the RBI had been tightening the screws and pushing up interest rates. The liquidity crunch had serious depressing effect upon investment activity. The situation is still not satisfactory as the clamor for reduction in interest rates and larger flows of liquidity is still being heard.
(xii) Low Credit Off-Take:
In view of slowdown in the economy, the RBI cut rates quite substantially since October 2008 and pumped in more than Rs. 4,00,000 crore of liquidity, yet the low interest rates could not make the desired impact on account of low off-take of credit. This was because of slump in demand, fall in exports, low industrial growth and accumulation of inventories. The demand for borrowing has been still low.
At the same time the conditions of uncertainty made the commercial banks reluctant to expand lendings by any large extent. They largely made use of available liquidity for the restructuring of their assets portfolio. As a consequence, the turmoil persisted in 2009.
(xiii) Volatile Conditions in the Stock Market:
The stock market in India witnessed very volatile conditions in 2008. The Sensex crashed from a high point of over 20,000 to the trough level of about 8000 in line with the stock markets the world over. The appreciation of dollar led to large outflow of capital amounting to over Rs. 47,706 crores. Such conditions had serious depressing effect upon both the domestic and foreign investment.
(xiv) Reluctance to Bring Fiscal Bail-Out Package:
The various countries attempted to deal with recession through huge bail-out packages. The United States declared $ 7 trillion worth of bail-out package. The European Union and China announced the bail-out packages of the size of $ one trillion and $ 586 billion respectively. Japan announced a package worth $ 295 billion.
India was found to be reluctant to spell out the size of fiscal package in a misplaced belief that the monetary softening would do wonder which actually did not happen. In December 2008, the government came out with a very small government expenditure plan amounting only to $ 4 billion, followed by a second dose in January and interim budget in February 2009. On the whole, the approach of the government reflected a too late and too little bail-out effort for the economy.
(xv) Borrowing Programme of the Government:
In order to protect the economy from the slowdown, the government was required to make huge borrowings amounted to Rs. 46,000 crore in the Fiscal year 2008-09. Those borrowings were to be made in four tranches by selling the government bonds. The oil ministry also sought additional oil bonds worth about Rs. 13,000 crore for covering the revenue loss on fuel sale in the last quarter of the fiscal 2008-09.
The anticipation of the government borrowing programme made the financial institutions show reluctance to advance loans to other sectors in case of which there was a relatively higher degree of risk than the subscription to government bonds. In addition, the borrowing and spending programmes of the government could have crowding-out effect on private spending and cause disruptive effect on the whole economy.
Impact of Global Recession on the Indian Economy:
The conditions of recession that appeared first of all in the United States and Britain soon engulfed all the regions of the world. It is pertinent to assess what was the impact of recent global turmoil upon India. According to the Reserve Bank of India, the impact of the global financial crisis has been of the degree far higher than expected.
It said, “The extent of impact has caused dismay, mainly on two grounds- first, because our financial sector remains healthy, has had no direct exposure to tainted assets and its off-balance sheet activities have been limited; and second, because India’s merchandise exports at less than 15 percent of the GDP are relatively modest.”
(i) Decline in Growth Rate:
India had an average growth rate of 9.4 percent during 2005- 2007 period. It could maintain its growth momentum along with moderate inflation, manageable current account deficit, dynamic capital market and favourable foreign exchange reserves. The GDP growth rate slumped to 7.1 percent in 2008-09.
The real GDP growth, according to RBI, would be about 6 percent in 2009-10. The projections made by IMF, World Bank and ADB were even lower than that made by RBI. Despite three fiscal stimulus packages and liberal RBI actions, the economic system had to contend with several challenges.
(ii) Slip Down of Industrial Production:
The manufacturing activities were very adversely affected by the economic meltdown. The growth rate in mining sector was only 3.8 percent in 2008-09 compared with 9.1 percent in 2003-04. The manufacturing sector experienced a healthy average growth rate of 10.4 percent between 2003-04 and 2006- 07. The growth rate of output in this sector was just a trickle at 0.7 percent in 2008-09 owing to a sharp fall in demand for exports as well as the domestic demand.
The growth rate in electricity generation was on the average at 7.0 percent between 2003-04 to 2006-07. It had fallen to 2.8 percent in 2008-09. In the case of other productive sectors, the average growth rate between 2003-04 and 2006-07 was 9.5 percent. But it had slumped down to 1.4 percent only in 2008-09. The agricultural production too received setback as the growth rate of agriculture slumped down to 1.6 percent in 2008-09.
(iii) Fall in Exports:
Indian exports were badly affected by the international economic and financial crisis. Indian exports fell the most in 14 years by 33.3 percent in April 2009. This had been a fall in exports for the seventh month in a row. Even in May 2009, there was a further dip in exports by 29 percent. There was a decline in the export of textiles, gems and jewellery, metals and ores, software and a host of many other products. This resulted in an adverse effect on the production in several export industries and other related industries.
(iv) Increase in Unemployment:
The slump in domestic and international demand for products aggravated the unemployment situation in the country. According to an estimate, over 5 lakh people were rendered jobless in the organised sectors between Octobers to December 2008 due to recession. According to another estimate, the decline in GDP growth rate from over 9 percent to 7 percent was likely to cause a job loss of over 40 lakh workers.
(v) Outflow of Capital:
During 2004-2008 period, a high growth rate was basically because of buoyant conditions in the stock market and substantial inflow of foreign capital. During that period the capital inflow was about 223 billion dollar. However, the state of recession in several developed countries hit hard the foreign investor’s sentiment resulting in a large outflow of capital. In the last quarter of 2008, the capital outflow totaled $15-17 billion. In the fiscal 2008-09, the FII’s net outflow was of the order of Rs. 47,706 crore.
It happened on account of sub-prime mortgage scandal in the United States resulting in increased demand for liquidity in that country, currency turmoil and highly volatile conditions in the equity market in India. The adverse investment and business sentiment during 2008-09 was reflected by the Forbes ranking which slipped by 11 positions from a rank of 64 to 75 out of 127 nations of the world. India’s credit rating also got downgraded during the year.
(vi) Increase in Fiscal Deficit:
The targeted level of fiscal deficit was 2.5 percent. The aggressive monetary policy and three fiscal packages were bound to increase the fiscal deficit. It was likely to go beyond 6 percent of the GDP in view of heavy pressure upon the government to boost its spending for reviving the aggregate demand. If the fiscal deficit is filled up through government’s borrowing programme, the liquidity available with banks would get absorbed leading to the possible crowding-out of private investment.
Any attempt to monetize the fiscal deficit, would strengthen the inflationary pressures which would have adverse repercussion on costs, exports and balance of trade.