By Adhvith Dhuddu, Regular Columnist
U-Shaped, L-Shaped or V-Shaped recovery?
Governments and central banks all over the world have taken unprecedented steps in the last few months to reverse the global economic meltdown, so far yielding little results. Most economists have accepted that this crisis is so deep that an L-shaped recovery is inevitable. A V-Shaped recovery is close to impossible due to the unfortunate and destructive nature of deleveraging. What started off as deleveraging at investment banks and writing off bad loans has morphed into a colossal global economic, finance and trade crisis. GDP's are being revised down, international trade and investments are falling, confidence levels are at record lows and the tentacles of this crisis have extended to affect even philanthropic and aid packages. A U-Shaped recovery cannot be ruled out, but for this to happen; the animal spirits of corporations, capitalists and bankers all over the world have to be rejuvenated and trust and confidence in the system must be restored.
Usually when governments try to, "help," economic recoveries always slow down and take time. And with billions being pumped in by governments, it seems clearer that global economies will take a long period to recover.
Disturbing statistics
It's widely accepted that the root of this economic debacle was a decline in US home prices. Even though real estate prices in the US and around the world have taken a beating, more downside is inevitable if home prices have to revert back to long term means. In the US, home prices rose at an annualized rate of 0.7 percent from 1930 to 1997, and at a startling rate of 8 percent per annum from 1998 to 2006. This coupled with the outrageous trade and fiscal deficits that the US is burdened with will only aggravate the current crisis. Total US debt as a percent of GDP is increasing at unprecedented rates and savings of households in the US is at near zero levels. Knowing how indebted the US consumer is, it's only more discouraging when you realize that 70 percent of the US GDP is consumer driven.
The current crisis is already dampening consumer spending, but as time goes by deflationary pressures could have even more aggravating affects on consumer spending. Deflation is a vicious cycle that leads to lower wages, lesser spending, less capital expenditure and a depressed economic environment. Wages and incomes are not rising anytime soon, and it will only be a matter of time before employees are willing to accept wage cuts instead of a total job loss. This is when a deflationary cycle initiates, and lower consumer spending forces businesses to cut prices. Anticipating price cuts, both consumers and businesses will postpone spending which will only lead to a depressed economic environment.
The Indian picture
It'll be interesting to watch how corporate India and the country as a whole manages this downturn. This economic slowdown is the first significant and full-fledged slowdown striking the Indian economy after liberalization. We have experienced consistent growth over the last 18 years (since liberalization) and have not been confronted by anything of this scale and magnitude. We were relatively immune to the Asian financial crisis during 1997-98, and the dot com bust of 2001 helped rather than hurt our economy.
The resilience of our economy will be tested and decreasing foreign inflows and trade, will also measure the power and sustainability of our internal consumption levels. But we are far better positioned than many other emerging economies and will not be victimized by downgrades on government debt, etc, like Spain or Greece. The era of cheap capital came to an end in the summer of 2007, and countries around the world will have to access to capital at a much higher cost. Again, we will partially be immune to this because our foreign exchange reserves will help pad any significant impact.
There are many aspects that affect an economy at any given time, and although it is challenging to quantify future foreign investments and assess the overall confidence in a country’s economy, our own Home Minister (and former Finance Minister, P. Chidambaram), once outlined major factors that affect a foreign investors’ decision making process. There could not be a better time to revisit these factors and assess them individually to see how well positioned India is to tackle this crisis.
The eight major risk factors are: Political risk, Security risk, Policy risk, Commercial risk, Legal risk, Legislative risk, Judicial risk and Regulatory risk. Let’s briefly examine each one.
Political Risk: With general elections less than 5 months away, political risk does exist and is an important factor. The outcome of 2009 general elections will decide who will lead India out of an unprecedented global economic crisis. The possibility of a third-front at the center not only adds instability to the government but uncertainty in corporate India’s mind as to what policies will be pursued. During these testing times, a steady hand is required at the helm.
Security Risk: Without doubt the Mumbai attacks elevated security risk to a new level. The magnitude and audacity with which the attack was carried out sent shivers down all our spines. This crisis can be used as an opportunity to improve our security apparatus to thwart future attacks. But unfortunately security risk remains high and this is not a very comforting factor.
Policy Risk: Although policy risk is not as directly tied to general election results as legislative risk there will definitely be some impact on policy making with a new government. While our fundamental long term growth policies are deeply rooted, many policy changes will be driven by the new government and might affect the way certain sectors of our economy function. For example, the different ministries like, the petroleum ministry, telecommunications ministry, ministry of power etc, largely affect how businesses in those sectors function. So any drastic changes that significantly affect our long term policies will be unwelcomed.
Commercial Risk: Commercial risks exist everywhere and the general risk of being in business and succeeding is something that the business owner or proprietor largely controls. However, the general business environment when it pertains to corruption, level of transparency, accountability, etc, has drastically improved from a decade or two ago. This should not be a deterring factor.
Legal Risk: In the wake of an extraordinary corporate governance failure at Satyam Computers, all eyes are currently on the legal and judicial system in India. Although some commendable action has been taken, it’ll be important to watch how the legal proceedings of the case unfold. The magnitude and extent of the Satyam saga will mean the decision taken by the courts will leave a dominant precedent. The only other factor in this area is the ability to enforce laws well. Having world class laws means little if they are not enforced with authority due to fear of retribution.
Legislative Risk: Legislative risk is again interrelated with political and policy risk. All these three factors, legislative, political and policy risk hinge on the outcome of the general elections in the next few months.
Judicial Risk: Judicial risk largely pertains to how our courts apply and interpret the laws of the land. This is driven by how well separated the judiciary, the legislative and executive branches of government are. Although it is generally accepted in India that there is some intermingling between the three branches, over the years, the judicial independence practiced has improved dramatically. So even though a factor, it would definitely not be a risk.
Regulatory Risk: The biggest fear given the current global economic scenario is widespread protectionism for India or any other economy. This will drastically affect the progress of our economy, and take us backward rather than forward. If populous policies are followed and over-regulation or misguided regulation takes over, then our economic growth will slow down and eventually stagnate. Although a valid fear, over the years the loosing up of regulators and the freedom given to the markets is an encouraging sign.
So one can think, analyze and assess for themselves how India ranks in all these categories and come to a conclusion as to how well we are positioned for short and long term growth.
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