ASSIGNMENT ON:

RECESSION, CAUSES AND

ITS IMPACT

BY:-
SUSHMA
PGDM-IB
ROLL NO: 45
Recession

According to the National Bureau of Economic Research (NBER),

recession is defined as "a significant decline in economic activity
spread across the economy, lasting more than a few months,
normally visible in real gross domestic product (GDP), real
income, employment, industrial production and wholesale-retail
sales". The agency that is officially in charge of declaring a
recession in the United States is known as the National Bureau
of Economic Research, or NBER

A recession is a decline in a country's gross domestic product

(GDP) growth for two or more consecutive quarters of a year. A
recession is also preceded by several quarters of slowing down.
Moreover, Recession (or contraction) is a natural result of the
economic cycle and will adjust for changes in consumer
spending and consumption or increasing and decreasing prices of
goods and labor.

What causes it?

An economy which grows over a period of time tends to slow
down the growth as a part of the normal economic cycle. An
economy typically expands for 6-10 years and tends to go into a
recession for about six months to 2 years.

A recession normally takes place when consumers lose

confidence in the growth of the economy and spend less. In an
environment where inflation is prevalent, people tend to cut out
things like leisure spending. They also budget more, spend less
on things they usually indulge in, and start saving more money
than they did. As people and businesses start finding ways to cut
costs and derail unneeded expenditures, the GDP begins to
decline. Then, unemployment rates will rise because companies
start laying off workers to cut more costs, because consumers
are not spending like they were. It is these combined factors that
manage to drive the economy into a state of recession.

Investors spend less as they fear stocks values will fall and thus
stock markets fall on negative sentiment.

Internal factors

Stock markets & recession

The economy and the stock market are closely related. The
stock markets reflect the buoyancy of the economy. In the US, a
recession is yet to be declared by the Bureau of Economic
Analysis, but investors are a worried lot. The Indian stock
markets also crashed due to a slowdown in the US economy.

The Sensex crashed by nearly 13 per cent in just two trading

sessions in January. The markets bounced back after the US Fed
cut interest rates. However, stock prices are now at a low ebb in
India with little cheer coming to investors.

Between January 2001 and December 2002, the Dow Jones

Industrial Average went down by 22.7 per cent, while the Sensex
fell by 14.6 per cent. If the fall from the record highs reached is
taken, the DJIA was down 30 per cent in December 2002 from
the highs it hit in January 2000. In contrast, the Sensex was
down 45 per cent.

TIPS and commodities, to be specific.

TIPS, or Treasury Inflation Protected Securities, are Treasury

bonds that carry a nominal interest rate, similar to other
Treasury securities. The major difference is that the interest rate
payments and underlying principal are automatically increased to
account for inflation, as measured by the consumer price index.
TIPS have soared in the last 12 months because of increasing
speculation of inflation and the decline of the dollar. Since March
30, 2007, the Lehman Brothers US TIPS index is up 14.54 percent
(S&P 500 over the same period is down 5.08 percent). The same
index was up 5.18 percent in the first quarter.

Similarly, as economic forecasts have been revised downward,

investors continue to flock toward assets with intrinsic value or
increasing global demand -- commodities such as gold, silver,
agricultural products, building products, oil and gas, etc. As a
result, the Dow Jones AIG Commodities Index, an unmanaged
index composed of future contracts on 19 commodities, was up
12.41 percent in the first quarter and increased 17.23 percent
during the last 12 months.

Current crisis in the US

Prima-facie the current crisis in the U.S. is basically a housing-
led (read sub-prime crisis) slowdown. Sub-prime is a high risk
debt offered to people with poor credit worthiness or unstable
incomes.the crisis has its effects on the stock market and
causes heavy volatility and affecting the investor. Major banks
have landed in trouble after people could not pay back loans and
this overall affects consumers and thus consumption. All these
factors cause the slowdown.

The housing market soared on the back of easy availability of

loans. The realty sector boomed but could not sustain the
momentum for long, and it collapsed under the gargantuan
weight of crippling loan defaults. Foreclosures spread like
wildfire putting the US economy on shaky ground. This, coupled
with rising oil prices at $100 a barrel.

Some experts view that this crisis has the potential to be far
deeper than the collapse of the dotcom boom at the start of the
decade. The decline in home prices is causing a broader set of
problems than what was witnessed during the technology bubble.
The indications of slowdown were there during the start of 2008.
Infact, the US Commerce Department confirmed that the US
economy grew by 0.6pc in the last three months of 2007.Fresh
economic data also revealed that the number of jobless claims in
the US rose by 19,000 recently to a seasonally adjusted 373,000,
showing a weakening labour market. It is estimated that as many
as two million Americans could lose their homes as a result of
the sub-prime crisis this year

External Factors

According to Nobel Prize-winning economist Joseph Stiglitz,the

Iraq war has cost the US 50-60 times more than the Bush
administration predicted and was a central cause of the sub-
prime banking crisis threatening the world economy. According
to the former World Bank vice-president said the war had, so far,
cost the US something like $US3trillion ($3.3 trillion) compared
with the $US50-$US60-billion predicted in 2003. The spending on
Iraq was a hidden cause of the current credit crunch because the
US central bank responded to the massive financial drain of the
war by flooding the American economy with cheap credit. "The
regulators were looking the other way and money was being lent
to anybody this side of a life-support system," he said. That led to
a housing bubble and a consumption boom, and the fallout was
plunging the US economy into recession and saddling the next
US president with the biggest budget deficit in history, he said.

Impact of US recession on India

A slowdown in the US economy is bad news for India.

Indian companies have major outsourcing deals from the US.

India's exports to the US have also grown substantially over the
years. The India economy is likely to lose between 1 to 2
percentage points in GDP growth in the next fiscal year. Indian
companies with big tickets deals in the US would see their profit
margins shrinking.

The worries for exporters will grow as rupee strengthens further

against the dollar. But experts note that the long-term prospects
for India are stable. A weak dollar could bring more foreign
money to Indian markets. Oil may get cheaper brining down
inflation. A recession could bring down by 22.7 per cent, while
the Sensex fell by 14.6 per cent. If the fall from the record highs
reached is taken, the DJIA was down 30 per cent in December
2002 from the highs it hit in January 2000. In contrast, the
Sensex was down 45 per cent.

The whole of Asia would be hit by a recession as it depends on

the US economy. The United States accounts for one-fourth of
the world GDP and any significant slowdown is bound to have
reverberations elsewhere. On the other hand, interdependencies
between the US economy and emerging economies like India and
China has reduced considerably over the last two decades. Thus,
the effect may not be as drastic as would have been the case in
the 1980s.

Even so, fears of a US recession led to panic in the Indian stock

market. January 21 and 22 saw a meltdown with a mind-boggling
US$450 billion in market capitalization being vaporized. An
unprecedented interest cut by the Fed led to a bounce-back on
January 23 and at the time of this writing, the benchmark index
(BSE) has gained 2.5%, almost in line with Hang-Seng, Nikkei,
and Kospi.
History might hold a clue here. The last time the bubble burst
(2001-2002), the DJIA went down by 23%, while the Indian Index
fell by 15%.

Much has happened between then and now. The Indian economy
has shown a robust and consistent growth trajectory and the
projection for 2008 is 9%. Indian exports to the United States
account for just over 3% of GDP. India has a healthy trade
surplus with the United States.

In other words, the effects of this recession on India may be

quite distinct from those of the past. Here are some areas worth
following:

1. A credit crisis in the United States might lead to a

restructuring of asset allocation at pension funds. It has
been suggested that CalPERS is likely to shift an additional
US$24 billion to its international portfolio. A large portion of this
is likely to flow into India and China. If other funds follow suit, a
cascading effect can be expected. Along with the already
significant dollar funds available, the additional funds could be
deployed to create infrastructure--roads, airports, and seaports--
and be ready for a rapid takeoff when normalcy is restored.

2. In terms of specific sectors, the IT Enabled Services sector

may be hit since a majority of Indian IT firms derive 75% or
more of their revenues from the United States--a classic case of
having put all eggs in one basket. If Fortune 500 companies slash
their IT budgets, Indian firms could be adversely affected.
Instead of looking at the scenario as a threat, the sector would
do well to focus on product innovation (as opposed to merely
providing services). If this is done, India can emerge as a major
player in the IT products category as well.

3. The manufacturing sector has to ramp up scale

economies, and improve productivity and operational efficiency,
thus lowering prices, if it wishes to offset the loss of revenue
from a possible US recession. The demand for appliances,
consumer electronics, apparel, and a host of products is huge
and can be exploited to advantage by adopting appropriate
pricing strategies. Although unlikely, a prolonged recession
might see the emergence of new regional groupings--India, China,
and Korea?

4. The tourism sector could be affected. Now is the time to

aggressively promote health tourism. Given the availability
of talented professionals, and with a distinct cost advantage,
India can be the destination of choice for health tourism.

5. A recession in the United States may see the loss of some

jobs in India. The concept of Social Security, that has been
absent until now, may gain momentum. Nearly 50,000 to 150,000
Indian workers, most of them from the Gulf countries, have
probably returned to the country due to the global economic
slowdown.

6. The Indian Rupee has appreciated in relation to the US dollar.

Exporters are pushing for government intervention and
rate cuts. What is conveniently forgotten in this debate is that a
stronger Rupee would reduce the import bill, and narrow the
overall trade deficit. The Indian central bank (Reserve Bank of
India) can intervene anytime and cut interest rates, increasing
liquidity in the economy, and catalyzing domestic demand. A
strong domestic demand would also help in competing globally
when the recession is over.

In summary, at the macro-level, a recession in the US may bring

down GDP growth, but not by much. At the micro-level, specific
sectors could be affected. Innovation now may prove to be the
engine for growth when the next boom occurs.

For US firms, who have long looked at China as a better

investment destination, this may be a good time to look at India
as well. After all, 350 million people with purchasing power
cannot be ignored. This is not a sales pitch for India, but only a
gentle suggestion to US corporations.
Jobs in recession

The present job recession has also hit the aspiration level of the
Indian youth. The myth of IT and the glamour if private jobs are
all history now. Now in an age of pink slips and mounting
recession, the Indian Youth is once again looking in public
sectors for jobs.

How to fight recession

• Tax cuts are the first step that a government fighting

recessionary trends or a full-fledged recession proposes to
do. In the current case, the Bush government has proposed
a $150-billion bailout package in tax cuts.

• The government also hikes its spending to create more jobs

and boost the manufacturing and services sectors and to
prop up the economy. The government also takes steps to
help the private sector come out of the crisis.

• the government has decided to inject Rs.1 trillion

(Rs.100,000 crore) in association with the private sector in
the Indian economy to stimulate internal demand to
insulate it from the effects of global recession This is to
increase productivity, control inflation and increase
employment opportunities.

• Government has encouraged foreign direct investment.

Past recessions
The US economy has suffered 10 recessions since the end of
World War II. The Great Depression in the United was an
economic slowdown, from 1930 to 1939. It was a decade of high
unemployment, low profits, low prices of goods, and high poverty.
The trade market was brought to a standstill, which
consequently affected the world markets in the 1930s. Industries
that suffered the most included agriculture, mining, and logging.

In 1937, the American economy unexpectedly fell, lasting

through most of 1938. Production declined sharply, as did profits
and employment. Unemployment jumped from 14.3 per cent in
1937 to 19.0 per cent in 1938.

The US saw a recession during 1982-83 due to a tight monetary

policy to control inflation and sharp correction to overproduction
of the previous decade. This was followed by Black Monday in
October 1987, when a stock market collapse saw the Dow Jones
Industrial Average plunge by 22.6 per cent affecting the lives of
millions of Americans.

The early 1990s saw a collapse of junk bonds and a financial

crisis.

The US saw one of its biggest recessions in 2001, ending ten

years of growth, the longest expansion on record.

From March to November 2001, employment dropped by almost

1.7 million. In the 1990-91 recession, the GDP fell 1.5 per cent
from its peak in the second quarter of 1990. The 2001 recession
saw a 0.6 per cent decline from the peak in the fourth quarter of
2000.

The dot-com burst hit the US economy and many developing

countries as well. The economy also suffered after the 9/11
attacks. In 2001, investors' wealth dwindled as technology stock
prices crashed.

Fiscal, monetary policies help India

Fiscal and monetary policies have helped India to curb the
recession and sustaining the economy. the downward trend in
the country's industrial output seemed to have ended, with a
pick-up likely due to new infrastructure development.
Investor confidence in India had certainly improved, as reflected
in the rapid increase in net capital inflows in the stock market
during recent months. Sherman Chan, an economist, said in a
note on the recovery of the Asia-Pacific region that amid
increased sightings of green shoots, the bottom of the global
downturn is now in sight China, India and Indonesia & have
dodged recession and maintained strong growth despite the
global turmoil.

Conclusion
Recession is a natural phenomenon of an economic cycle.It has
occurred many times throughout the history.it brings fear and
uncertainty for an economy.It has both positive and negative
effects. Some of the positive effects include taking the excesses
out of the economy, balancing economic growth, creating buying
opportunities in different asset classes and creating changes in
consumer attitudes The negative effects include rising
unemployment, a severe slowing in the economy, the creation of
fear and the destruction of asset values