- Date : 21/06/2020
- Read: 5 mins
Recession negatively affects economic growth as well as an individual’s goals. The world has seen some deep recessions over the past few decades. Stock markets, trade, inflation, interest rates, are all inter-connected and hence they all affect individuals in some way or the other.
Recession is a cruel cycle in which income, sales, production, and employment fall. Recession involves an extraordinary drop in the economic activity of a country, and it can extend over a few months. It is visible in a decrease in real GDP, income, unemployment, industrial production, and sales. When a recession occurs, nobody can tell when it will end.
India has experienced such dips in the past and people have borne the consequences.
Steepest recession seen since WW II
In 2009, the world faced a financial setback, suitably called the ‘Great Recession’. Developed nations were dragged into it after the housing bubble went bust in the US and raised sub-prime and mortgage rates. And the tremors of this financial crisis were felt in developing economies like India for a long time.
India's GDP and economic growth are driven by domestic consumption. In May 2009, India reported a GDP growth rate of 5.8% compared to 9% in 2007–2008 and 7.8% in April–September 2008. Indian exports and imports fell significantly. The average contraction in exports and imports was around 20% from October 2008 to September 2009, and 28% from December 2008 to September 2009.
This was in stark contrast to India’s exports and imports for the period September 2003 to August 2008, which saw robust growth of 28% and 35% respectively.
The ‘year of the perfect storm’
Through 1989 and 1990, the US economy weakened due to a restrictive monetary policy enacted by the Federal Reserve. The Tax Reform Act of 1986 resulted in sinking property values, reduced investment incentives, and job losses. The US economy entered a recession in 1990, which lasted for 8 months. This triggered a global recession and eventually brought India to its knees as exports were significantly less than imports. The situation was called ‘Balance of Payment Crisis’.
Impact on personal finances
Fear hovers around a recession. Recessions affect not only financial markets, but also other industries, the availability of global funds, exports, etc. In the financial world, a lot of things are interconnected. There is a nexus between exports and purchasing power, stock market drop and investments, liquidity and loans, etc.
Investments in mutual funds
During the 2009 crisis, some mutual fund investors were in the black, while some were in the red. The Sensex fell by 30% between August and October 2008, and the BSE Mid Cap Index and BSE Small Cap Index fell by 45% in the same period. By the end of March 2009, a monthly SIP in any of the large-cap diversified funds for a period of two years was reflecting a fall of approximately 30%.
Investment in an index fund made on 9 January 2008 fell to less than half in exactly 2 months. Investors were driven by sheer panic to sell, as the signs of a global financial crisis caused stock markets to teeter on the edge. People just wanted to latch on to cash. Liquidity was created by selling securities, borrowing from banks, and a special line of credit opened by the RBI for mutual funds. Can you beat the slowdown with SIPs? Find out here.
However, bravehearts who held on to their investments during the bloodbath and remained loyal to the long-term investments they had made, struck it big. By 4 November 2010, as the Sensex regained its peak of 2008, investors recovered their money.
During a recession, central banks try to coax rates downward to stimulate the economy. This is because when a recession is underway, people become nervous about borrowing money and are only keen on saving what they have. People assume that a property will stagnate or at best appreciate by 4%–5% and in return one will be paying 8%–9% interest on the loan.
Inflation is the rate at which prices of goods increase over a given time period. So inflation also indicates the consumer’s loss of purchasing power. During a recession, when people are cautious about spending, inflation plays a key role in moulding investors’ appetite for risk.
Whenever India has entered a recession, demand for liquidity has increased – but at the same time, the supply of credit has decreased. The central bank uses its monetary policy to counteract the movement of supply and demand to reduce interest rates, and this is why we actually see falling interest rates during a recession.
India has witnessed myriad business failures during recessions. There are various economic theories as to why this happens. Some reasons given are negative economic shocks, resource shortage, credit crunches, etc. Many businesses fail altogether and resort to lay-offs. The number of unemployed workers looking for new jobs goes up rapidly and the demand to hire new workers by businesses goes down.
Loss of jobs, fear of lay-offs, plummeting equity investments, all contribute to a sombre mood. People want to cling on to their cash. They do not want to buy cars, renovate houses, or indulge in retail therapy. They firmly believe a penny saved is a penny earned. In a slowdown, one tends to re-examine expenses and upcoming financial goals. Big-ticket purchases are postponed. This is done by either shelving the planned expenses or by substituting it with second-hand assets.
The severity of a recession is measured across 3 D’s – Depth, Duration, and Diffusion. Depth is measured in terms of loss of jobs, stock market correction, and bank losses. Duration is the number of years a recession lasts. Diffusion is how many sectors the recession affects the economy.
The word ‘recession’ naturally triggers some negative feelings in our minds – such as unemployment, stock market devaluation, inflation, bankruptcy, loss, fear, etc. But we can eventually recover from all of them by remaining resilient and making prudent financial decisions. Here are some important investment tips that will keep your finance safeguarded against the falling GDP.