Recession overview


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Recession Impact of US Recession on Indian Economy Santanu Kumar Dash [email protected]

What is a recession? Causes? :

What is a recession ? Causes? 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. 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. This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment. Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment.

What is Recession?:

What is Recession? Recession is the economy shrinking for two consecutive quarters (=6 months) with a decrease in the GDP (=Gross Domestic Product) GDP = Value of all the reported goods and services produced by the people operating in the country GDP = MONEY VALUE OF {C + I + G + (X – M)} C = Consumables, I = Gross Investments, G = Government Spending, X = Exports, M = Imports

What is Recession?:

What is Recession? GDP is a good indicator of economy; Other indicators could be; -Unemployment Rate -Consumption Rate -Actual Personal Income -Etc.. If GDP is growing, then market is growing due to increased demand; Note : If the recession continues for next quarter, (>6 months) then we go through “DEPRESSION” Economy;

Why Recession happens ?:

Why Recession happens ? Why Recession happens? Over Production Low Confidence level

Why Recession happens ?:

Why Recession happens ? Over Production A situation in which the supply exceeds the nation’s ability to consume what has been produced; Supply > Demand PSEUDO DEMAND ACTUAL NEED WAS NOT THERE; WRONG PROJECTIONS Companies Produced More

Why Recession happens ?:

Why Recession happens ? Low Confidence level Spend Less Decreased demand for goods and services decrease in production, lay-offs and a sharp rise in unemployment. Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment.

Why Recession happens?:

Why Recession happens? Bad Incidences Happening ; Example : September 11 Terrorist Attack in US; International Airport block in Thailand; Mumbai Attacked in India; etc … Series of such incidences leading into a kind of Business impact

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Terrorists’ Attack on 11 th September in US Created fear in people People cancelled their travel plans Airlines & Hotel Industries badly hit Resulted in low occupancy rates Airline & Hotel Industries offered discounts, gift coupons, to attract people But, still, no improvement in occupancy rate Airline & Hotel Industries started “Cost Reduction” activities CONTINUED IN NEXT SLIDE

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Airline & Hotel Industries started “Cost Reduction” activities i] Reduce No. of flights In flight meals reduced Meals supplying company got the hit Catering company now, lays off people iii] Salary reduction to “Not laid off people” They became careful due to the fear of loss of job Started saving money instead of spending Demand for other goods come down ii] Lay off people Low or No income to spend and buy goods Demand for other goods come down Terrorists’ Attack on 11 th September in US

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Availability of Easy Money & Excess Liquidity. Low Interest Rate Higher Borrowing by US Households Consumption Led Growth & Asset Price Bubble. Resulted in High Inflation & Increasing Interest Rate What has happened in the Global Markets?

Current crisis in the US :

Current crisis in the US The defaults on sub-prime mortgages ( home loan defaults) a high risk debt offered to people with poor credit worthiness in trouble after people could not pay back loans. The housing market soared on the back of easy availability of loans. sustain the momentum for long, and it collapsed under the gargantuan Foreclosures spread like wildfire putting the US economy on shaky prices at $100 a barrel, slowed down the growth of the economy.

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Sub-prime Issue: Sub Prime lending is lending to people who have very poor credit history. In US, a lot of loans, particularly mortgages, were extended to a wide target group including people who had very low repayment capacities and paid very low margin. These loans then were bundled into packages by Investment Bankers and were sold to investors like pension funds, insurance companies, hedge funds etc. Today these loans constitute the largest component of the US Debt Market.

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There are mainly two reasons why this market became so large: Sustained Lower interest rates in the US saw most asset prices going up for long time. This encouraged prospective home buyers to take loans and buy houses. Around the same time, a lot of financial innovations took place, main being securitization of assets. In this, mortgage companies used to extend loans to home buyers and sell these loans onwards to investors. Since mortgage companies were not holding these mortgages, basic due diligence of creditworthiness of home loans deteriorated. On the other hand, due to lower interest rates, there was a lot of demand for mortgage bonds as they were yielding attractive yields.

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Increasing pressure of inflation lead to higher interest rate. (Interest Rate cycle turned around middle of 2007) As result cycle of taking loans and consumer spending practically stopped. Demand for homes dropped due to rise in interest rates. People with low credit profile (to whom sub prime loans were given) came under pressure and started defaulting. Housing prices came down (the basic calculation of mortgage players of increase in property prices went wrong) and mortgage players failed to provide cover for the mortgage loans when sub prime borrowers started defaulting. What went wrong?

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What went wrong? Easy liquidity gradually started vanishing from the system. Foreclosures increased which further put pressure on housing prices. Ever increasing defaults by borrowers and slump in housing prices forced mortgage players to write off these loans of large amount. US Fed has already spent $900 bn in taking over failing companies due to sub prime crisis and has announced bail out package of $700 bn. Major players in the US has already announced huge write offs in excess of $500 bn due to sub prime.

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