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The Sum Of All Depressions

On Black Tuesday, when the twin towers of the World Trade Center crumbled after hijacked Boeings sliced through them like knife in butter, it signalled the beginning of the scariest and most volatile chapter in American economic history since the Gre

The Sum Of All Depressions
The Sum Of All Depressions
The turmoil over the next two days proved that the attackers had managed to hit where it hurt most. Panic and despair ensued as the exact damage to life and assets began to be assessed. It was clear that confidence, the superstucture of a stable financial system, had been badly shaken and sentiments would remain fragile for at least a month, making short work of predictions. But there was also hope that no effort would be spared to ensure that the US economy, famed for its resilience, bounced back and the global economic fallout contained at the earliest. Already, President Bush has supported a Marshall Plan-type fund, demanded mostly by insurance companies, worth $40 billion and rising.

The $9.2-trillion US economy accounts for a quarter of world output and, with consumer spending at two-thirds of economic activity, grease the wheels of the world's manufacturing business. The damage to it has been both structural and psychological. The wtc complex was no trading centre, but the block of offices housed many big Wall Street firms and banks among its 1,200 tenants, and just the rescue and relocation work would dislocate business for a week, said Richard Grasso, the chief of New York Stock Exchange.

And then there were the ripple effects of the disaster. Hours after the strikes on wtc and Pentagon, Brent crude oil was trading around $30-31, up from $24; dollar was beaten down; and gold, the safe haven in a disaster, spiked. And most stockmarkets went chillingly down—Japan's benchmark Nikkei 225 Stock Average plunged 6.6 per cent to 9610.10, below the psychologically-sensitive 10,000 mark for the first time in more than 17 years. India, already in the grip of a slowdown, saw its benchmark Sensex go below 3000 to touch a new low in three years as well as the rupee losing ground fast. While most of Europe markets and commodity prices clawed back after the initial shock, Asian markets, including India, continued to slip on fears of an extended Asian impact.

In the world's richest prison of Manhattan, questions surfaced. How will an exchange like the nyse or the sec, which depends on human specialists to handle trading, or Wall Street's biggest firms like Morgan Stanley Dean Witter, which is believed to have found many of its 3,500 staff safe, function if their staff can't reach office? Even many Nasdaq-member firms were based around the wtc. The stockmarkets remained closed for the week, the longest shutdown since World War I, because of rescue efforts, even as airports opened partially. Analysts scouted for historical precedents: the closest parallel is the Tokyo earthquake of 1923, which killed 1,00,000 people, stirred financial panic and contributed to a meltdown of the financial system four years later. On 15th, the new Nasdaq building near the wtc collapsed.

Will there will be a meltdown in the stock and currency markets now?
No meltdown, but extreme volatility. But then, traditionally, in the financial markets, tragedies and crises are the time to look for opportunities. Says Arvind Panagariya, co-director, Center for International Economics, University of Maryland: "The likely impact on the US stockmarket when they reopen can be best read from market behaviour elsewhere. We can expect a similar pattern—dipping at first, then a recovery—though the net decline may be less sharp. Most of the major US companies are also traded on the British and German stockmarkets, so that's a good indicator. We can expect the insurance companies to decline the most. We really do not face an imminent danger of the dollar plunging. There may also be emergency cuts in interest rates across the globe as happened after the Wall Street crash in 1987. So the impact will be short-lived." However, some analysts see pressure mounting on the already-weakening dollar, as Arabs hold a lot of assets in the US and because of the funds taking a hit. Says Arindam Bhattacharjee of Emerging Markets Management: "I think the risk premium on emerging markets debt will increase in the short-term and there could be the risk of capital flight from there." Adds Mark Mobius, president, Templeton Emerging Markets Fund: "While it is important not to overstate the economic effect of this tragedy...we remain cognisant of the importance of carefully monitoring the holdings in view of the circumstances."

Will oil prices zoom?
The worst fear, despite an opec assurance that it will ensure steady supplies, is that oil prices will escalate. The short-term volatility will take a toll on nations which import the bulk or all of their requirements, and hit airlines and other transporting companies hard. But most analysts see the see-sawing settling down in about a month's time, unless there are heavy retaliatory strikes in the West Asian region which will prompt north European countries to speed up stocking for winter. Says former head of p&g India, Gurcharan Das: "It's in nobody's interest, least of all the US', to allow crude price hardening. Soaring prices in 1999 is one of the reasons why the world economy began to slow down late last year."

There could also be a silver lining in the dark cloud of reduced growth. According to a Deutsche Bank estimate, a percentage point decrease in global growth leads to a 4,00,000-barrel per day cut in oil demand.

Will it trigger American and global recession?
Will the US now go into a recession, dragging the world economy with it? Deputy treasury secretary Ken Dam tried to restore confidence on Wednesday when he said "the American economy is open for business." But there are two major concerns. One, it's already in a slowdown, with a million layoffs in 2001 so far and seven interest rate cuts failing to boost growth. A further pare in spending by the Americans, known as "consumers of the last resort", could lop as much as three percentage points off the US gdp this quarter and next, putting it in recession territory. (Recession is defined in the US as fall in growth in two consecutive quarters, and last quarter growth was 0.4 per cent). Adds Das: "Were it not for the free spending US consumers, encouraged by sharp interest cuts, much of the global economy would be in recession." According to Kirit Shah, senior VP and head of research, Sanwa International, London, "the US recovery will most likely be delayed and the threat of a global recession (below 2.5 per cent growth) is high. If the Dow breaks below 9000 this week, the Fed will be forced to provide an inter-meeting ease to avoid a systemic risk in global markets."

An early victim could be Asian economies praying for a US recovery. The region clawed out of its '97-98 financial crisis largely by exporting technology-related goods to the US. "Now those hopes look gone," said a Korean minister. Adds V. Anantha Nageswaran, senior economist with the Credit Suisse Group in Singapore: "To the extent that a US recovery is postponed or a recession becomes imminent, East Asia will take it on the chin.Japan is already reeling under the weight of its own burdens and this could prove the last straw."

Which will be the worst hit sectors?
The deepest immediate impact on American consumer spending will be in travel-tourism, insurance and banking, economists predict. Airlines face their most dire prospects in a decade as they contend with a panicky public, volatile oil prices and security costs. They lose up to $270 million each day their planes sit idle. Their loss may go beyond $10 billion as cancellations take their toll on them and related hotel and tourism industries. Also on the firing line is the financial sector—funds, banks and insurers, especially those who have combined businesses like Credit Suisse Group AG and ing Group, those banks which depend heavily on investment and securities operations like Deutsche Bank AG and abn Amro Bank NV, those with large exposure to tourism, hotel and travel industries and funds which have suffered a considerable loss of skilled and experienced personnel. Munich Re, the huge German reinsurer, is exposed to direct insurers of the wtc, and said it "could have considerable losses."

Despite companies and banks all over the world beginning to issue profit warnings and funds minimising emerging market operations, the medium-term outlook looks less bleak. With a budget surplus, the US won't hesitate pumping in money to keep the systems flowing. It had already pumped in $70.2 billion by Thursday and arranged a $50 bn swap with ecb. Also, the fundamentals of the economy are sound—consumers are still buying and prices under control—and there has been no damage to production facilities. Says Panagariya: "The US economy is quite resilient. It is not suffering from large deficits and productivity gains from the IT revolution are in place. I expect economy-wide effects to be relatively small and shortlived."

Then there is rebuilding Manhattan. Says Ashutosh Varshney, director, Center for South Asian Studies, University of Michigan: "Rebuilding will cost a lot, but defense spending will almost certainly go up by a large margin, adding to demand. If necessary, the government can easily go through a fiscal deficit to pump up the economy." And by speeding up the policy responses, the crisis may have done the US economy a lot of good, especially since Bush's stubborn refusal to new tax cuts or deficit spending had not gone down well with most analysts. Major central banks too pumped more than $80 billion into markets to prevent gridlock. "We're committed to ensuring that this tragedy won't be compounded by disruption to the global economy," said a G-7 statement. Says Kirit Parikh, director, igidr: "I expect the US to exact revenge. This will whip up patriotism and bullishness."

Does India stand to lose a lot?
Ironically, the fact that India has only 0.5 per cent of global trade works in its favour whenever there's a big crisis. Says Omkar Goswami, cii chief economist: "Why should fdi be affected even if the US was our largest source of it? The fundamentals of the US economy have not been affected. We are not even among the first 10 exporters into the US." The US accounts for 18 per cent of India's exports, but with export growth expected at only 8 per cent this fiscal, damage may be small, restricted only to gems and jewellery, and apparel. China could start worrying as it is far more integrated into the world economy. In the event fdi flow was hit, it might prompt policy reforms to attract investment.

Both shares and the rupee continued to slump in India though, as Oxus Research head S.S. Bhalla says, "the fundamental trend in both the markets was weak, so we can expect that to continue. But this is not the time to sell and I don't see the beginning of a long-term decline." However, if the fii selling pressure increases, there could be a further weakening of sentiment.

But India will feel the tremors in insurance—where the rise in global premia could raise the cost of big projects sharply—airlines and tourism industry. The worst impact could be in oil, though the government has enough supplies for two months. India gets most supplies on long-term contract, not spot. But future renewals could be seriously jeopardised because of uncertainties of tanker movement in West Asian routes. "Supplies could definitely be affected since bulk of India's import comes at the Vadinar Port which is on the West Coast. But I don't think prices will go through the roof," says O.N. Marwah, ioc director. But with imports around 70 per cent of over 103 tonnes crude requirement and the oil pool deficit at Rs 16,000 crore, a price hike seems imminent.

What might get worse hit though is the country's exploration efforts in the Gulf region. But India's leaders could be quick to spot the opportunity to prepare the countrymen for a few hard decisions, and push ahead some long-pending reforms. As cii said: "It could be a wake-up call for the government."

Sums up Panagariya: "In the end, recessions are in nobody's interest. So let's not raise the doomsday scenario." The imf refused to scale down its halved global growth outlook, at 2.7 per cent, saying it would be akin to "shouting fire in a crowded theatre", though adb is not so optimistic. What is clear, though, is both the US and other nations will do as much to prevent the terrorists from winning the day. The one thing that truly damages markets isn't tragedy but persistent uncertainty. And if few have answers to how the many imponderables will be solved in the coming days, so that the normal business process can be resumed soon, the world, despite its varied systems, will depend on the free financial market to resolve them, and test its strength.

Paromita Shastri With Shantanu Guha Ray, Arindam Mukherjee, Arijit Barman and Gauri Bhatia
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