February the Cruellest Month

INDIAN industrial growth plunged to just 0.6 per cent in February, the lowest level for years. This has led to a search for deep explanations and culprits.

Some blame high interest rates, others blame stock market shenanigans, still others blame the slowness of Indian economic reforms.

I do not doubt that the current slowdown has many such causes. But the biggest cause of all is surely the global slowdown. February was even worse for Mexico, where industrial output slumped 3.7 per cent, a sea-change from the 9 per cent increase it enjoyed in early 2000.

In the United States, the biggest economy of all, imports dropped 4.4 per cent and industrial production by over 5 per cent in February. See the pattern?

Now, Mexico is especially vulnerable to a US slowdown. For many years, it sought to distance itself from its northern giant and become self-sufficient. The old leftist joke went as follows: “Poor Mexico — so far from God, so close to the United States”.

But when decades of attempted self-sufficiency and import substitution ended in bankruptcy in the 1980s, Mexico decided to change policy.

Instead of seeking to distance itself from the US, it sought to integrate itself as closely as possible by joining the North American Free Trade Area. The result: Mexico enjoyed its fastest growth in decades.

But integration has costs as well as benefits. Now that the US is slowing down, Mexico has slowed down too.

India is not nearly as closely integrated with the US as Mexico. Yet the bilateral economic relationship has strengthened in the last decade to a degree not widely realised.

In 2000, India sold $10 billion worth of goods to the US, a quarter of its entire merchandise exports. Back in the mid-1980s, only one-seventh of India’s goods went to the US.

Moreover, India’s exports are no longer confined to merchandise. It sold an estimated $3.5 billion of software to the US in 2000, almost three quarters of its entire software exports.

So Indian dependence on the US market is now at its highest level in history. So, expect the US slowdown to affect India more than ever before.

Indeed, a global slowdown is in evidence. Japan, the second biggest economy in the world, suffered an industrial decline of 2.9 per cent in the last quarter, and Britain too declined by 2.6 per cent.

Chile, the miracle economy of Latin America, suffered a fall of 0.2 per cent in industrial production in February. In Asia, industrial output fell 2.4 per cent in the Philippines and 0.2 per cent in Hong Kong.

It decelerated sharply to 2.4 per cent in Thailand, 4.3 per cent in Malaysia and 4.5 per cent in Indonesia, all of whom had enjoyed double-digit growth a year earlier.

The fastest-growing economy in eastern Europe, Poland, suffered industrial decline of 0.1 per cent in February.

I do not want to exaggerate the gloom and doom. A few countries are still doing reasonably well. China’s industrial growth is up 12 per cent, Korea’s 8.6 per cent, France’s 7.4 per cent, Germany’s 5.3 per cent.

But the overall picture is one of marked deceleration. The two biggest economies in the world, the USA and Japan, are in serious trouble. And Europe also exhibits some signs of slowing down.

Rapid economic growth in the 1990s has raised the US share of global GDP from 25 per cent to 28 per cent. In the 1980s, it was in relative economic decline, and seemed doomed to be overtaken first by Japan, then by Germany, and then by the miracle economies of East Asia.

But in the 1990s the US has once again become the fastest growing economic power by far, while Japan has stagnated and East Asia’s shortcomings have been exposed by the financial crisis of 1997-99.

During he last global downturn in 1990-91, the US economy went into reverse gear, and some European countries too. But Japan kept surging ahead, and east Asian countries were barely touched.

At that point of time, the far East took over the role of global economic locomotive from the West. But this proved to be a temporary surge, not a new trend.

The US soon emerged again as the global locomotive. And its massive import binge was vital in pulling east Asian countries out of the 1997-99 crisis.

The US trade deficit crossed first $200 billion and then a whopping $300 billion a year. Its import demand became a major stimulus for the exports and production of countries across the globe.

Now, the party may be over. The monthly rate of US imports, which went up steadily from $90 billion in January 1999 to $126 billion by October 2000, has slipped steadily since, to $117 billion in February.

This has happened despite the fact that US GDP growth was 2 per cent in the first quarter. If the US slips into recession, its imports will contract much more sharply, affecting the rest of the world even more than hitherto.

Optimists believe that the US will pull out of its slowdown by the second half of the year. They point out that inventories generally pile up in a recession, and orders for new goods are put on hold till inventories are liquidated.

This fall in demand is what causes a recession. However, with the steady shift of factories from the US to low-wage countries, the US depends more than ever on imported manufactures.

So when demand slows down and inventories pile up, guess whose orders are curtailed? Increasingly that of foreign suppliers. So the burden of adjustment to a US slowdown is now shifting from US suppliers to foreign suppliers.

This is one reason why GDP growth has been positive in the US despite its industrial slump and inventory pile-up.

It may, indeed, be a reason why the US escapes recession altogether. But it means the adverse impact on the global economy will be larger than anticipated.

India will not be able to escape the consequences. No matter what the finance minister tries to conjure up, India is going to have a rough time until the global economy revives.

What do you think?