Markets around the world showed signs of quick recovery after the emergency US Fed rate cut. The behaviour of markets, both in terms of the fall following bad news about the US and expectations of a further slowdown in the US economy, as well the recovery after the rate cut, shows that financial markets do not believe in the ‘decoupling’ theory. For the last few months some analysts have been arguing that there is a decoupling of the economies of Asia from the US. It is also thought that the world economy no longer depends on how the US economy performs because economies in Asia such as India and China are contributing an increasing share to the addition in world GDP growth and because their growth is not dependent on the US economy. The high growth in Asia has, however, been part of their process of rapid globalisation over the last decade and not as separate islands delinked from the world economy.What happened in financial markets worldwide over the last two days is a reflection of the deep links on the real side of these economies. As the governor of the People’s Bank of China said on Sunday, Chinese exports and the economy will suffer if there is a slowdown in the US. India, too, must prepare for such a slowdown. Lower demand from the US will affect a wide range of sectors such as commodities, outsourcing, software and consumer goods among others. The US economy constitutes about a fourth of world GDP and we should have no illusions that when the US sneezes the world will not catch a cold. Moreover, this time it looks like the US is not merely sneezing, it may have a serious prolonged illness. While the Fed rate cut might help, it is not clear whether it will be able to completely avoid the slowdown. In India, too, the biggest risks to the economy today are from a slowdown in the world economy. The eight-plus per cent GDP growth after 2002 has come with high growth in the world economy. A slowdown in the world economy is bound to reduce our high growth rate. While only two per cent of Indian GDP is exported directly to the US, a lot more of what is exported goes to countries that either reprocess those exports or whose GDP growth also depends on US GDP growth. The government and the RBI need to mount a well thought out and coordinated monetary and fiscal policy response to the developments in the world.
