South Asian countries have been experiencing macroeconomic problems during the past year: inflation in Sri Lanka is over 17 percent, in Bangladesh 11 percent; Pakistan’s current account deficit is at 5 percent of GDP; the Maldives’ fiscal deficit is likely to be about 12 percent of GDP; and the Indian economy showed signs of overheating in mid-2007, with inflation rising above 6 percent. Although the rate has come down since then, capital flows remain buoyant, posing challenges for macroeconomic management. India’s trade deficit is forecast to be 8 percent of GDP.
Meanwhile, the sub-prime mortgage crisis in the U.S. is threatening to lead to a global credit crunch and a recession in the country. Will these global developments exacerbate South Asia’s macroeconomic problems and reduce its chances of ending poverty in a generation?
The short answer is “No.”
India in particular had very little exposure to mortgage securities. Even if there is a global credit crunch, there is a fair amount of liquidity in the domestic economy. A recession in the U.S. will have only a mild effect on South Asia because the U.S.’s share in the subcontinent’s trade has been declining. China has replaced the U.S. as India’s largest supplier of imports. Sri Lanka is shifting its garment exports to Europe. Analysis by Hong Kong Shanghai Bank estimates that a one percentage point drop in U.S. economic growth will translate to a 0.2 percentage fall in India’s growth. So even in the worst case of a major recession in the U.S. (a 5 percentage point drop in GDP growth, say), the effect on India will be of the order of one percentage point which, from a base of 8 percent growth, is not devastating. Finally, a recession in the U.S. may slow the increase in oil and other commodity prices, which would have a favorable effect on South Asian countries, all of whom are net importers.
This does not mean that South Asian countries can relax. The macroeconomic problems some of them face are serious. But they are due to the huge terms of trade shock and certain domestic circumstances, and not the U.S. sub-prime crisis. Nevertheless, they should be addressed if South Asia is to sustain its economic growth for the coming decades.
Mariam Claeson
Thu, 01/31/2008 - 01:57 The World Bank after 50 years has done all the "indirect" ways to end world poverty. Examples: water projects, population control, anti-corruption... The World Bank has failed to arrest the gap between rich and the poor. Any improvement in the economy goes to the upper rich (e.g. 30% of wealth belongs to 5% of the people)... Maybe, it's because the World Bank has been using inflation-centric economics which is good only for First World countries but not for the Third World. Now, why haven't the World Bank adopted the Hyperwage Theory?
Wed, 01/30/2008 - 18:43 Thanks for the video and your commentary on this timely topic (Impact of sub-prime crisis on South Asia). In case there is an extended liquidity crunch in the US and Europe as a result of the crisis, and hedge funds and other private pools of capital start withdrawing their 'investments' from India, do you think the Sensex will be affected, a la East Asia in 1987? If yes, will that affect current asset values (real estate, stock valuations, etc.)? Regards and looking forward to your answer.