Trade cycles are a part of every economy, especially of the capitalist system. After the great Depression of the 1930s, the recent global recession beginning somewhere in the year 2008 spread panic all over the world. The downturn has now stopped and the world is on the way to recovery. As the world braces itself up for recovery, countries like India and China certainly get a pat on their back for coming out of the recessionary phase with only minor bruises here and there. To know about why India was not affected much by the recent widespread recession, let us first go to the basics of economics and understand what is trade cycle and the causes of recession.
Trade cycle & causes of recession
Trade cycle or business cycle refers to the phenomenon of cyclical booms and depressions, also called expansion and contraction of the economy. In a trade cycle there are wave like fluctuations in aggregate employment, income, output, price and demand. Economies pass through periods of good trade characterized by rising demand and prices and low unemployment, altering with periods of bad trade characterized by low demand, falling prices and high unemployment. The occurrence of these phases does not have a fixed time period.
During prosperity, demand, output, employment and income keep rising till it reaches a peak. High demand, employment and income result in rise in price. Prices rise (inflation), but wages, salaries, interest rates, rentals and taxes do not rise in the same proportion. The gap between price and cost increase the margin of profit. Large profit expectation leads to rapid widespread expansion in economic activities. This expansion gradually leads to disequilibrium in the economy in the form of over full employment and high inflation- both indications of end of prosperity and beginning of recession.
The seeds of recession are thus contained in the expansionary or prosperity phase itself. Continuous expansion begins to put strain on economic resources. The increasing demand of resources leads to-
- Scarcities of labour, raw material etc. leading to rise in costs relative to price. This in turn brings down the profit margin.
- Scarcity of capital leads to rise in the rate of interest. This makes investment costly and lowers business expectation.
- Rising prices reduces consumption. Also after a certain increase in income, consumption stabilizes, leading to stagnant demand. This causes piling of inventories/low sales.
India and recession
When the world was reeling under recession, India stood still and watched with bated breath! We clearly saw it approaching. Business sector panicked, but the global economic nightmare could only cause minor fluctuations to the Indian economy.
The causes of recession lie dormant in the way the economy moves towards the peak phase through prosperity. Theoretically speaking, Indian economy has not yet reached the peak. We are still in the expansionary phase, with still some time to go when we reach the peak and head towards downturn.
The scattered effect of recession that we saw in the economy was due to the increased exposure to the world market and economy. The impact was mainly on those companies which are either internationally exposed (like the export sector, he import based industries & tourism) or those whose revenues are in dollars. Indian economy is more domestically driven.
Government control on capital flows is another big reason for succesfull handling of recession. We took our own time to globalize and liberalize the economy, learning from the experiences of the capitalist world. Moving at its own pace, India has always adopted a very cautious approach. The economy was opened up to the world step by step, but we stopped at the Current account convertibility, adopting a wait and watch policy for full convertibility of the Capital Account of Balance of Payments. This policy largely saved India from the effects of global recession.
The Capital account of BOP is related to foreign investments. Because we still do not have full capital account convertibility, the flow of capital to and from the country is under control. This saved us from the South East Asian financial crisis of 1997, and it also saved us now. Capital flight is the immediate reaction of an upcoming depression. India in fact witnessed a different outcome of the global recession. The strong resilient fundamentals of the Indian economy attracted more foreign investments during the recessionary phase. Investments were diverted to stable economies like India and China, from the more advanced economies which were badly in the clutches of recession. Even though the recession phase is over, India can still benefit as a safe investment destination, till the advanced countries recover fully.
Secondly, developed countries were facing mounting fiscal deficits and high debt levels, whereas India, true to the ancient Indian values, practiced austerity to check fiscal deficit and current account deficit and keep debts low.
Another important cause of lower impact of recession in India was the quick adoption of corrective measures by the Reserve Bank Of India. The RBI saved Indians from overspending by changing the interest rates, wherever required, on time. RBI first lowered interest rates during the global slowdown in order to boost demand in the economy. At the same time, RBI ensured tightening of credit in the more speculation oriented industries like real estate, which was sustaining very high property prices. To manage inflation and promote growth the RBI has raised its key policy rates six times since March 2010. When the crisis began in September 2008 the RBI rapidly reversed its earlier tightening of credit to meet the new and changed circumstances of the global scenario. The CRR, the repo and the reversed repo rates were rapidly lowered in a series of quick steps. Some initiatives were also taken to enhance access to bank credit by non-banking finance companies. Signs of panic withdrawals from private sector banks were met with strong reassurance by both the government and the RBI. Instructions were issued like designing financial regulations to avoid excessive risk taking, keeping in mind that banks must protect their balance sheets from cyclical variations.
“Slow & steady wins the race.” This holds true for India, the way it maneuvered its path through global recession. The prosperity of the advanced nations was certainly attractive and tempting, but excess of anything is harmful. It’s a bubble waiting to burst. It is better to move slowly and cautiously, observing and learning from our own as well as from the world’s experiences.