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U.S. slowdown’s global impact

Even without the U.S. Federal Reserve Chairman’s recent, mostly pessimistic, assessment of the state of the U.S. economy, the rest of the world would have had ample reasons to worry about the consequences of a slowdown in the world’s largest economy. In the event, Chairman Ben Bernanke’s statement to the U.S. Congress that the economy was going to get worse before it got better, proved to be the trigger for particularly sharp declines in the global stock markets. Stock exchanges in many countries that had scaled record highs went in for a sharp correction. The BSE Sensex that had crossed the 20,000 mark several times went down sharply over three consecutive days before bouncing back. The negative assessment of the U.S. economy stopped short of predicting a full blown recession. However, with no end in sight to the serious crises in the American housing and credit markets, even the mere acknowledgment of a possible slowdown is big news with strikingly negative global ramifications. The dollar has been falling to new lows against most major currencies. That in turn has major implications for global trade and currency alignments. For instance, a historically high Euro holds the prospect of the European exports being priced out of important markets, including the U.S. and China .

Although there are conflicting forecasts, the ongoing turmoil in financial markets worldwide, caused by the problems in the U.S., may well herald a phase in which “global imbalances” will start winding down. Clearly it is not possible to indefinitely sustain a situation in which the very high current account and budgetary deficits are bridged by the savings of other countries and the parking of official reserves by Asian central banks in the U.S. financial markets. The process of structural readjustments is bound to be painful. A weaker dollar has already helped in boosting exports from the U.S. However, within the U.S., most items of mass consumption imported from China and elsewhere have become more expensive. Indian policy makers need to prepare for the spillover effects of these external developments. Slower economic growth in the U.S. would mean lower exports from India, and the borrowers from India (and other emerging markets) may have to pay more. Also, with oil prices at their highest levels ever, India’s external sector management will come into sharp focus.

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