Given that the US contributes almost one-fourth of the worlds GDP, it would be nave to assume that this slowdown will simply peter out without creating a ripple.

DR SHANTO GHOSH, PRINCIPAL ECONOMIST, DELOITTE HASKINS & SELLS, BANGALORE

The question is no longer about whether the US financial woes will impact Indian companies. The anxiety is to know the extent to which our economy is vulnerable when the US sneezes.

But wait. Are we talking about a fear of US recession? We were, but now the fears have been borne out, says Dr Shanto Ghosh, Principal Economist, Deloitte Haskins & Sells, Bangalore.

The International Monetary Fund (IMF) recently released its World Economic Outlook, which is widely regarded as the most authoritative report on the world economy, he adds, during a recent e-mail interaction with Business Line.

The Report states: The financial market crisis that erupted in August 2007 [in the US] has developed into the largest financial shock since the Great Depression, inflicting heavy damage on markets and institutions at the core of the financial system.

Given that the US contributes almost one-fourth of the worlds GDP, it would be nave to assume that this slowdown will simply peter out without creating a ripple, opines Dr Ghosh.

So where does this leave us? A bit on the back foot, he fears. We should prepare ourselves for lower growth rates, and slowdown in the services sector growth, over the next few years. There is likely to be pressure on the rupee to appreciate further which would further adversely impact the export-oriented sectors.

A globalised India will have to gear up to face the turmoil expected to rock the financial world and those days are approaching with great force, observes Dr Ghosh.

Excerpts from the interview:

What are the global forecasts that are of concern?

The World Economic Outlook predicts that global growth would slow to just 3.7 per cent this year the slowest in five years and forecasts US growth to remain very sluggish (less than 1 per cent) for the next two years.

The US lost jobs for a third consecutive month in March and the unemployment rate rose to the highest level since September 2005. The chairman of the Federal Reserve Bank, Ben Bernanke, reported to the US Congress on April 2: It now appears likely that real gross domestic product will not grow much, if at all, over the first half of 2008 and could even contract slightly.

Consumer spending has considerably slowed down and all polls indicate that a large share of the American population holds bleak prospects for the US economy in the immediate future. Even though interdependencies between the US economy and emerging economies like India and China have reduced considerably over the last two decades, it would be simplistic to imagine that this recession will have no impact on the Indian economy (as some people have suggested).

Can you explain the linkages to our financial markets?

The first of the two linkages is the impact of the US recession on our financial markets. The sub-prime crisis has revealed the lack of soundness in the US financial market.

As economist Paul Krugman puts it: US financial markets, it turns out, were characterised less by sophistication than by sophistry, which my dictionary defines as a deliberately invalid argument displaying ingenuity in reasoning in the hope of deceiving someone. E.g., Repackaging dubious loans into collateralised debt obligations creates a lot of perfectly safe, AAA assets that will never go bad.

Analysis of banking system data shows that the US financial system, and that of a large part of the world, is lethally hurt. US banks have no more money; it is as simple and dramatic as that.

Some economists have predicted that the contagion will enter a second phase of development, generating a new series of bank failures by August 2008 entailing a dislocation of the global financial system in the latter half of this year.

In what ways will such a grim scenario affect the capital flows?

We should fully expect major capital outflows from the US and investors will look to invest in other markets. This is true not only for money sourced from the US but also the glut in funds that other country governments have hoarded in US dollar-denominated financial assets.

India will be a destination for these funds and the inflow of dollars will again put pressure on the rupee.

Exporters will be hurt and this is also true for real exports to the US with whom India enjoys a trade surplus. The RBI may want to sterilise the inflow of funds but this is likely to create an inflationary pressure within the economy. The bottom line our growth rate is likely to fall by at least three percentage points!

And the second linkage?

The second, and a more direct, linkage is with respect to the services sector. Corporate profit outlook in the US is bleak. In the face of a recession, we should expect companies to announce postponement in their capital expenditures as well as information technology budgets.

The fact that the political climate in the US is currently biased against the outsourcing of jobs from the US will have a direct bearing on the amount of dollars that are likely to flow into India as payment for the outsourced jobs. This is again a negative stimulus for the service sector which has been the engine of growth for India over the past few years.

Arent some people arguing that the pressure to retain margins will actually result in a higher amount of outsourcing from the US to countries such as India?

There is a subtle fallacy in that argument. A recession is characterised by higher levels of unemployment. Moreover, it is a politically sensitive issue.

How likely is it that, while joblessness and job cuts attract media attention, a US company will announce further job cuts and start outsourcing jobs outside the country? In my humble opinion, such speculations are nothing but wishful thinking.

D. MURALI