Recession and depression

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In a layman's language, considering his emotions, the term "Recession" is taken to be synonymous with the term "Depression". However, actually the recession is a situation wherein, all the economic activities like incomes, expenditures, consumptions, investments and the earnings face a critical downfall leading to a downturn in the economy's GDP growth rate consecutively for two or more than two quarters in a particular year.

Recession always leaves a negative mark on the economy, which may be in any form, like - sharp increase in the level of unemployment and the external borrowings by the government along with an impulsive downfall in the stock markets, thus leading to a situation where there are lesser investments and hence, less inflation.

During the time of recession, the earnings of the government falls drastically in the form of the tax revenues because of the lesser amount of income tax and the corporate tax paid by the industries and the industrialists. Consequently, the government is under severe pressure to incur more expenditure for the welfare of those who are unemployed, thus, forcing the government to indulge into more borrowings from outside and getting indebted.

As a result of the recession, the firms earn fewer profits and are not in a position to pay off to its investors, a higher rate of return, thus paying off lesser dividends. This leads to fall in the trust of the shareholders in the company. Also the prices of the shares fall due to certain anticipations regarding the future prices of the shares in lieu of recession.

It is only due to recession that the investors' sentiments get shaked and they are reluctant to invest into the shares of the company leading to the instability in the country's economic growth.

What is a recession?

When the gross national product or the gross domestic product of an economy faces a downfall consecutively for two quarters in a particular year then it means that the economy is entering into the recession phase.

The main indicators which mark the arrival of recession in an economy are - fall in the production pattern, interest rates and reduction in the demand for money along with the rise in the number of those who are unemployed.

In such a period of recession, the consumers start losing their trust in the performance of the companies or the economic growth of the country; reduce their consumption levels and thus their demands for the goods and services leading to the lowered production levels and also the higher rates of unemployment.

What causes it?

Usually the recession sets down in an economy when the following incidents occur:

  • When the expenditure on the part of the consumers declines, as a result of loss of their faith in the economic growth of the country.
  • Due to the above mentioned situation, the consumption pattern of the consumers for the goods and services produced within the economy i.e. it declines.
  • The decreased consumption of goods and services by the consumers leads to lesser amount of production, lay-offs, retrenchments, very high level of unemployment.
  • The investment on the part of the investors in the stock markets declines because of the loss of confidence in the shares of the companies.

However, the Indian economy has not yet faced a true picture of recession still it is facing a 'slowdown'. It seems to be the most promising economy in terms of economic growth and development. The situation is such because the Indian economy has the 2nd largest GDP in the world and is completely justifying its ranking by going on the absolutely appropriate track of the sustainable development. Although the GDP of India has seen a downfall from 9% to 6.5-7.5% but it hasn't entered the phase of recession rather it is facing a slowdown, unlike other western economies which have already entered the phase of recession.

The bank failures in the western countries and the liquidity and the global mortgage crisis had a little effect on the Indian economy.

In terms of consumption, the consumer market of India is the largest with middle class population of around 300 million consumers. Also in terms of the rate of savings, the India is ranking on the top with the rate of around 27% of the gross domestic product. One more advantage or it can be said that one more positive aspect of the Indian economy is that it has the lowest debt ratio of around 23% of the gross national product.

Impact of recession on the behavior of the consumers in India:

Although the Indian economy has not been completely affected by the recession, but still it is undergoing an economic slowdown due to which the behavior of the consumers has turned in such a way that they, as investors have stopped believing in the creditworthiness of the companies and have stopped investing in the shares of such companies. During recession the some of the companies have even undergone the liquidation or have faced the situation of bankruptcy due to which the confidence of the investors has been highly shaken and much of the funds have been withdrawn from the financial markets leading to a downfall in such markets.

Impact On Indian Economy:

Recession in India has not hit that severely but still it has had a bad impact on the Indian economy thus, worsening the situation in both the consumer and the producer markets along with leaving the worst effects on the financial markets. Even in such bad times of recession the Indian economy has been able to fair well because of the following few positive aspects:

  • The banks in India had a little exposure to the external economies and its tainted assets due to which the effect of recession in the western countries could not directly affect the Indian economy.
  • Most of the growth of the Indian economy has been due to the demand within the domestic boundaries and the dependence of the Indian economy on the savings from the foreign countries just amounted to 1.5%.
  • Even the forex reserves of the country are satisfactory and the recession has not affected the exports of the country that adversely.
  • As a result of the mandatory agricultural lending programs even the demand of the rural population has not declined.

In spite of all the above mentioned factors India is yet to face a proper recession as it is just facing an economic slowdown right now because the US mortgage market has a very limited integration with the Indian economy.

Although the trading activities of the Indian economy with the external economies has increased manifold, example, the amount of the total external transactions as against the gross domestic product was just 46.8% in 1998-99 which increased tremendously to 117.4% in 2008-09 i.e. just within a decade, the Indian economy has developed tremendously setting aside the myths of all those who perceived the Indian economy as one of the weakest and doubted its growth prospects.

Stock Market

Both, the Indian economy and the stock market are very closely related. Due to the economic slowdown entering into the Indian economy the Indian stock market faced a sharp downfall from 20,000 points to a low of around 7000 points. For most of the companies , the performance also faced a drastic downfall which could be clearly seen in their falling profits, prices of their shares and demand in the current fiscal year. Such a drastic downfall in the Indian stock market has been mainly due to the substitution effect of:

  • The foreign/overseas financial institutions' funds got dried up and couldn't invest their funds in the Indian banks and the corporate sectors.
  • Funds could not be raised efficiently in the domestic capital market due to the prevalence of the bear run.
  • Even the internal accruals of the corporate were on a declining verge.

So it can be rightly said that the cumulative effect of the reversal of portfolio equity flows, lesser availability of the international debt and equity and the perceptions of the investors about the rise in prices of equity has landed the Indian stock market into the bearish trend.

Forex Market

The current economic crisis taking place in the Indian economy have been greatly insulated by the withdrawal of the foreign institutional investments (FIIs), external commercial borrowings (ECBs) and the trade credit.

Its clear effects were seen in September-October 2008 when the investors sucked up a record of as high as USD 13.3 billions from the forex market leading to fall in the value of rupee from Rs. 40.36 per USD to Rs. 51.23 in march 2009 showing a depreciation of about 23.2% in the financial year 2008-09.

Since the 1991 crisis, the biggest ever loss in terms of rupee was that the average annual exchange rate during 2008-09 was Rs. 45.99 per USD in comparison to Rs. 40.26 per USD in 2007-08. It also led to a sharp decline in the receipts of the capital account in 2008-09 and consequently, the total net capital flows fell down from USD 17.5 billion in April-June 2007 to 13.4 billion in April-June 2008.

So, after discussing all the above mentioned facts and figures, it can be rightly said that due to the sudden fluctuations in the forex rates and sharp depreciation in rupee was due to the cumulative effect of the global credit crunch and the process of deleveraging prevailing in the Indian forex market.

Money Market

The major constituents of the money market are the debt market, credit market and the government securities market. These markets are solely regulated by the Reserve Bank of India (RBI) so the health of the markets depends on the soundness of the banking system within the country.

For the purpose of judging the soundness of the money market, a committee has been set up jointly by the government and the RBI i.e. Committee for Financial Sector Assessment (CFSA) and according to report submitted by this committee, the Indian financial markets are soiund. However, the Reserve Bank of India expects the Non-Performing assets (NPAs) with the banks to rise because of the on-set of the economic slowdown within the economy.

Due to the prevalence of the tight liquidity situations within the economy in September-October 2008, the borrowings of the banks from the RBI shot up to Rs. 50,000 crores along with the rise in the call money rate to over 20% right after the collapse of the Lehman Brothers.

Slowing GDP

Although since past five years the Indian economy showed a stable growth rate of 8-9 percent but since the on-set of the economic slowdown the gross domestic product of the country started to decline in the first quarter of 2008 and then it gradually started declining

The projected mid-year review of the economy as presented in the parliament for the gross domestic product at factor cost at constant prices as on December 24, 2008 was 7% but as according to the review done by the Central Statistical Organization (CSO), the actual growth rate came out to be meager 6.7% in 2008-09.

In 2006-07, the gross domestic product at factor cost at the constant prices i.e. 1999-2000 prices in the economy was 9.7%, in 2007-08 it was 9% and in 2008-09 it came out to be just 6.7% which clearly depicts the impact of the economic slowdown. In its annual policy statement 2009, the Reserve Bank of India has projected the growth of the gross domestic product at factor cost at the rate of 6% in 2009-10.

For more clear understanding of the slowing down of the gross domestic product, the growth rate of the GDP in the successive quarters of 2008-09 can be seen. The growth rate of the gross domestic product in the first two quarters of 2008-09 was 7.7% and 7.6% respectively which fell down drastically in the third and the fourth quarters of the same year i.e. to 5.8%. It was all due to the fact that there was a drastic decline in the manufacturing, construction, hotels and restaurants sector in the third quarter of the same fiscal year. The condition even worsened in the fourth quarter because it witnessed a serious downfall in the manufacturing sector due to the onset of the global recession and the economic slowdown leading to the slowdown in the domestic demand.

So from all the above mentioned facts and figures it can be rightly said that due to the economic slowdown within the Indian economy, most of the sectors were adversely affected like manufacturing, construction, hotels, infrastructure and restaurants leading to a sharp downfall in the growth rate of the gross domestic product.

Strain On Balance Of Payments

Although there were very strong signs of the strain on the capital and the current accounts of the Balance Of payments of the economy in the year 2008-09 because of the global recession and the economic slowdown yet the situation of the overall BOP was under control.

The current account deficit, during the first three quarters of the fiscal year 2008-09 i.e. from April to December 2008 was USD 36.8 billion in comparison to USD 15.8 billion for the same period during the last fiscal year i.e. 2007-08.

Also the balance in the capital account faced a significant downfall and stood at just USD 16.1 billion in the year 2008-09 as against USD 82.58 billion for the same period during the last fiscal year i.e. 2007-08.

The forex reserves of the economy stood at USD 253 billion during the year ended march 2009.

Reduction In Import-Export

In the fiscal year 2008-09 the rate at which the exports of the country grew was robust till august 2008 but it started facing a downfall from September 2008 and turned negative in the month of October and remained just the same for the whole of the financial year. Such declining trend of the exports had occurred for the first time in the past seven years.

As a result of the global recession, the global demand had contracted and the above mentioned chart shows that the exports have declined since October 2008. In the same way, the growth rate of the importsalso witnessed a sharp decline in the months of October-November 2008, before the same turned negative. Also a sharper decline could be observed in the imports as against the exports because the merchandise trade deficit declined during April-May 2009.

Reduction In Employment

Whenever the recession sets in, in any economy the first and the foremost impact is on the employment. It is the worst effected and the same has happened during the current global meltdown which seriously affected the Indian service sector i.e. BPO, KPO, IT companies etc.

According to a report given by the commerce ministry, during the period between August to October 2008 around 109517 people lost their jobs and became jobless, most of whom belong to the export relating companies in the different sectors like primary textiles, handicrafts, food processing, leather, engineering etc.

A red alert has been indicated by the economic survey of India keeping in mind the current trend of increasing number of jobless people as the after-effects of the global economic slowdown especially in the unorganized sector and has declared an urgency on the part of the government to be responsive in such matter:


The tax collections at the centre have been very adversely affected especially the collection of the indirect taxes because of the applicability of the economic slowdown within the economy.

Although the tax-GDP ratio was on an increasing trend from 2000-01 to 2007-08 and had increased from 8.89% to 12.46% but it started declining just because of the reduction in the tax collection, especially the indirect taxes like, customs and the excise tax, and fell down to around 10.98% during the current fiscal year.

Response To The Crisis

Future is always uncertain, so is the future of this economic slowdown because it is not clear that what will happen and how it will come to an end? Still the Indian government along with the Reserve Bank of India has taken it up as a strong challenge and reacted to it in the best possible manner by injecting more liquidity into the money markets and thus making the Indian financial markets more trustworthy.

In response to it, the Indian government introduced the stimulus package whereas the Reserve Bank of India shifted its monetary policy from money tightening to money easing so that the inflationary pressures are eased.

Under mentioned are the fiscal and the monetary response:

Fiscal Response

During the time period between December 2008 and February 2009, the Indian government launched the three stimulus packages which included safety-net program for the poor, the farm loan waiver package and the payout after the Sixth Pay Commission report came out, adding to the stimulating demand.

The challenge for fiscal policy is to balance immediate support for the economy with the need to get back on track on the medium term fiscal consolidation process. The fiscal stimulus packages and other measures have led to sharp increase in the revenue and fiscal deficits which, in the face of slowing private investment, have cushioned the pace of economic activity.

The borrowing programme of the government has already expanded rapidly in an orderly manner by the Reserve Bank of India which would spur investment demand in the domestic market. So while the government will continue to support liquidity in the economy, it will have to ensure that as economic growth gathers momentum, the excess liquidity is rolled back in an orderly manner.

In India monetary transmission has had a differential impact across different segments of the financial market. While the transmission has been faster in the money and bond markets, it has been relatively muted in the credit market on account of several structural rigidities.

In order to address these issues, the government has to effectively and carefully take up the following steps -

  • Enhance coordination and harmonization of the regulatory apparatus internationally, given the global scope of the recent crises with increased crossborder financial integration;
  • Introduction of countercyclical prudential regulatory policy;
  • Design regulation and supervision of financial companies for non-deposit taking financial entities having the potential to cause systematic instability, as evident in the current crisis;
  • Supervision and management of liquidity risk and greater transparency in the financial sector to improve better risk assessment by the customers and investors;
  • Improvement in transparency in the structured credit instruments.

The rise in macroeconomic uncertainty and the financial dislocation of the year 2008 have raised a problem of adjustment in market interest rates in response to changes in policy rates gets reflected with some lag.

The Union Budget for 2009-10, presented against the backdrop of persistent global economic slowdown and the associated dampened domestic demand, has placed the fiscal deficit at 6.8 per cent of GDP in 2009-10 with a view to providing the necessary boost to demand and thereby support a faster recovery.

Monetary Response

The RBI has taken several measures aimed at infusing rupee as well as foreign exchange liquidity and to maintain credit flow to productive sectors of the economy such as infusing liquidity through interest rate management, risk management and credit management which is described in detail under the following heads:-

Interest Rate Management

In order to deal with the liquidity crunch and the virtual freezing of international credit, RBI took steps for monetary expansion which gave a cue to the banks to reduce their deposit and lending rates. The major changes in the interest rate policy of RBI are given below-

  • Reduction in the cash reserve ratio (CRR) by 400 basis points from 9.0 per cent in August 2008 to 5 per cent in January 2009
  • Reduction in the repo rate (rate at which RBI lends to the banks) by 425 basis points from 9.0 per cent as on October 19 to 4.75 per cent by July 2009 (the lowest in past 9 years) in order to improve the flow of credit to productive sectors at viable costs so as to sustain the growth momentum.
  • In order to make parking of funds with RBI unattractive for banks, the reverse repo rate (RBI's borrowing rate) was reduced by 275 points which currently stands at 3.25 per cent.

The above said policy changes since mid-September 2008, enabled Reserve Bank of India to infuse

Rs.5,61,700 crore (excluding Rs.40,000 crore under SLR reduction) in market in order to ensure ample liquidity in the banking system.

Risk Management

There has been a sustained demand from various quarters for exercising regulatory forbearance in regard to extant prudential regulations applicable to the banking sector.

As a part of counter-cyclical package, RBI has already made several changes to the current prudential norms for robust risk disclosures, transparency in restructured products and standard assets such as-

  • Implementation of Basel II w.e.f. March 2009 by all Scheduled Commercial Banks except RRBs which would promote closer cooperation, information sharing and coordination of policies among sector wise regulators, especially in the context of financial conglomerates.
  • Further guidance to strengthen disclosure requirements under Pillar 3 of Basel II.
  • Counter-cyclical adjustment of provisioning norms for all types of standard assets (except in case of direct advances to agriculture and small and medium enterprises which continue to be at 0.25 percent)
  • Reduction in the risk weights for claims on unrated corporate and commercial real estate to 100 percent;
  • Reduction in the provisioning requirement for all standard assets to 0.40 per cent;
  • Improve and converge financial reporting standards for off balance sheet vehicles;
  • Develop guidance on valuations when markets are no longer active, establishing an expert advisory panel in 2008.
  • Market participants and securities regulators will expand the information provided about securitized products and their underlying assets.
  • Permitting housing loans to be restructured even if the revised payment period exceeds ten years;
  • Making the restructured commercial real estate exposures eligible for special treatment if restructured before June 30, 2009.

Hence, RBI has ensured perseverance of prudential policies which prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent.

Credit Management

There was a noticeable decline in the credit demand during 2008-09 which is indicative of slowing economic activity- a major challenge for the banks to ensure healthy flow of credit to the productive sectors of the economy.

The reduced funding demand on the banks should enable them to reduce the interest rates on deposit and thereby reduce the overall cost of funds. Although deposit rates are declining and effective lending rates are falling, there is clearly more space to cut rates given declining inflation. In order to facilitate demand for credit in the economy the Reserve Bank has taken certain steps such as-

  • Opening a special repo window under the liquidity adjustment facility for banks for on-lending to the non-banking financial companies, housing finance companies and mutual funds.
  • Extending a special refinance facility, which banks can access without any collateral
  • Unwinding the Market Stabilization Scheme (MSS) securities, in order to manage liquidity
  • Accelerating Government's borrowing programme
  • Upward adjustment of the interest rate ceilings on the foreign currency non-resident (banks) and non-resident (external) rupee account deposits
  • Relaxing the external commercial borrowings (ECB) regime
  • Allowing the NBFCs and HFCs access to foreign borrowing
  • Allowing corporates to buy back foreign currency convertible bonds (FCCBs) to take advantage of the discount in the prevailing depressed global markets
  • Instituting a rupee-dollar swap facility for banks with overseas branches to give them comfort in managing their short-term funding requirements
  • Extending flow of credit to sectors which are coming under pressure include extending the period of pre-shipment and postshipment credit for exports
  • Expanding the refinance facility for exports
  • Expanding the lendable resources available to the Small Industries Development Bank of India, the National Housing Bank and the Export-Import Bank of India

Future Outlook For India

In the end it can be rightly concluded that the economic slowdown which has set in the Indian economy is an outcome of the sub-prime crisis that started in the US and consequently took many countries into its trap. The consequence of the setting up of such an economic slowdown in the Indian economy was such that it had adverse effects on the GDP growth rate which continued to be same or above 9% since the last four years but tend to decline since the last quarter of the year 2008 leading to a decline in the employment rate, exports and imports, tax-GDP ratio, reduced capital inflows and significant outflows etc.

In spite of the smooth liquidity position in the system, the demand for the bank credit is lowering significantly. Lesser demands and the higher rates of the input costs have very adversely affected the profit margins of the corporate. Also the uncertainty accompanied with the global crisis has deeply affected the confidence of the potential investors in the business which has consequently lead to a sharp downfall in the Indian stock market and the forex market.

However, the Indian economy has still managed to survive and come out as a very stable economy due to the fact that it has such a banking system which is not that vulnerable to the external influences due to its limited relations with the external economies, well-functioning financial markets sufficient forex reserves and the most appropriate liquidity management, payment and settlement system.

So from all the above discussion of various factors, it can be clearly observed that although the uncertainty element still exists in the global economic environment but the contraction rate of the economic activitiesand the pressure on the financial system is decreased since the very first quarter of the fiscal year 2009-10.