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Tough Times Ahead

The ‘decoupling’ theory has finally been given a quite burial

Every single analysis of the ongoing international economic crisis indicates that the worst is not yet over. Are we going overboard in our prognostications of gloom just as many economists had displayed irrational exuberance till the point Wall Street collapsed in mid-September? Not really. Since many analysts had been in a state of denial until the recession hit them in their face, realism is back in fashion. The optimistic are today talking about an economic revival in 2010 while the pessimistic claim the depression could continue for two, perhaps three, years.

The ‘decoupling’ theory has finally been given a quiet burial. In a discussion paper released in early-March entitled ‘Global Financial Turmoil and Emerging Market Economies: Major Contagion and a Shocking Loss of Wealth?’, the Asian Development Bank stated that during 2008, the newly industrialized countries of Asia had lost wealth aggregating $ 9.6 trillion, that was 106 per cent more than the gross national incomes of countries in this region. The paper observed that the loss of wealth all over the world was not less than $ 50 trillion — an amount that is almost equal to the total value of all goods and services produced across the globe last calendar year.

These estimates have been computed after adding up losses in the market capitalization of stocks and shares, the decline in the value of bonds backed by mortgages and the depreciation in the value of currencies against the US dollar (only two currencies have gained against the American greenback in recent months and these are the Chinese yuan and the Japanese yen). The impact of such losses on domestic expenditures would be “enormous” and this would be aggravated by sharp losses in export earnings resulting in a reduction in incomes to the tune of between two per cent and 2.5 per cent of GDP the world over. As for emerging economies in Asia, the ADB paper predicts that “growth in 2009 will decline by at least 3 percentage points”.

The huge loss of wealth in Asia, the paper points out, is on account of the integration of the financial systems of newly industrializing countries in Asia with the markets of the West. Between 2003 and 2007, the total value of all financial assets (including highly-leveraged derivatives) in the Asian region jumped from 230 per cent of GDP to 370 per cent. All those who worshipped the false god of ‘decoupling’, should read what the paper states: “In the end, emerging market economies only have limited room for domestic expansion. Thus, they will also have to rely on the effect of the stimulus packages of the larger economies, in addition to the effect of their own actions…it is unlikely that a recovery will take place more than two-three years.”

That is rather bland way of saying the chances of an economic recovery in Asia may have to wait till the end of 2009 or 2010 which, if proved correct, is pretty bad news for the world as China and India have emerged as the principal drivers of economic growth. The ADB estimates that China’s economy will grow by 6.7 per cent in 2009 against 11.4 per cent in 2007.

What does the worldwide economic turmoil mean for India? If the ADB’s prediction is correct, it means that the rate of growth of this country’s gross domestic product would decelerate sharply from close to 9 per cent to around 6 per cent — the Bank specifically predicts a 5.1 per cent growth for India during 2009 which is identical to the estimate made by the International Monetary Fund in late-January. The new government will have a rather difficult task reviving the economy and protecting it from the financial tsunami sweeping across the globe.