This presentation considers the possibility of a second recession in the face of the ongoing European Debt Crisis, misguided attempts to address the crisis through austerity and struggling world economies. It also reflects on the impact of the probable break-up of EU’s currency union, measures to avert the scenario and vulnerable positions of the economies of the USA, China and India to more trouble in the Euro-zone. The doomsday scenario has been summarized by Martin Wolf of Financial Times (May 17, 2012): “The mechanisms at work would be powerful: bank runs; the imposition of (illegal) exchange controls; legal uncertainties; asset price collapses; unpredictable shifts in balance sheets; freezing of the financial system; disruption of central banking; collapse in spending and trade; and enormous shifts in the exchange rates of new currencies. .

1. Return of the Crisis
Are we on the brink of another Recession?

2. Tethering on the Brink: Why?
 European Debt Crisis
 Uncertainties and negative outlook in major
economies of the world
 Non-viability of current economic structure and
trajectory of the European Union
 How and whether Greece might exit is the biggest
and fattest uncertainty of all (Article in The
Economist)

3. Is austerity the right way to go?
 No, the drive for fiscal austerity is completely
misplaced
 Fiscal tightening, in this context, is self-defeating
 It reduces gross domestic product (GDP) growth and
fiscal revenues
 It makes fiscal consolidation targets even harder to
reach

4. Struggling Economies
 Greece's national income is nearly 30% lower than what
it was four years ago
 The current strategy that is making the output fall further,
reducing the hope to recover (and therefore be in a
position to repay debts)
 The austerity strategy is being imposed on all the
“peripheral” countries in the euro-zone that have debt
problems.
 Ireland and Portugal which had rigorously fulfilled all the
draconian austerity measures, are still struggling to grow.
 Spain's huge economy is being pushed into a downward
spiral as the asset deflation of the collapse of the
construction boom combines with reductions in public
spending to throw more people out of employment and
cause incomes to fall further.
 Italy is set to join that group, with massive implications for
all of Europe.

5. What’s next?
 Break-up of the currency union in the dearth of
significant structural and policy changes
 Given the situation, it is only a matter of time before one
or more of these countries defaults on at least a part of its
debt and then leaves the currency union.

6. What if the currency union breaks?
 “Weaker” economies will immediately face the pressure on their domestic
banking systems, as investors begin to doubt whether their deposits will
really continue to be denominated in euros in future.
 Bank runs will start. Indeed, bank runs in Europe have already started.
 So far they have been slow, but such processes can very quickly accelerate
and precipitate a crisis. (All financial crises are usually associated with bank
runs.)
 Deposits in Greek banks have fallen by more than one-third since the
beginning of the crisis, and €1.2 billion was withdrawn in just two days after
the inconclusive election.
 Even banking systems in other countries that do not have such political
instability are experiencing similar slow runs. Deposits held in Spanish and
Italian banks have also fallen by more than €300 billion since the start of
2012.
 The “flight to safety” of Europeans has led to increases in German bank
deposits of approximately an equivalent amount.
 But since the banks of north European countries are also deeply implicated
in lending to the peripheral countries, they are not really safe either.
(Incidentally, United States banks will also be affected.)

7. What if the currency union breaks? (contd.)
 The doomsday scenario has been summarised by
Martin Wolf of Financial Times (May 17, 2012):
 “The mechanisms at work would be powerful: runs;
the imposition of (illegal) exchange controls; legal
uncertainties; asset price collapses; unpredictable
shifts in balance sheets; freezing of the financial
system; disruption of central banking; collapse in
spending and trade; and enormous shifts in the
exchange rates of new currencies.

8. What if Greece Leaves the Euro?

9. Can this be averted?
 The only way to prevent havoc is to create a common deposit
insurance and bank resolution regime that covers the entire
euro-zone, issue of jointly held euro-zone bonds and and fiscal
transfers to assist regions in distress.
 These are now seen as more acceptable: France under
Francois Hollande has already declared its support.
• But Germany and some other north European countries oppose
such reforms.
 German Chancellor Angela Merkel keeps insisting on „Budget Discipline‟.
 There is lack of recognition in surplus countries that they have been huge
beneficiaries of the monetary union.
 They have been able to preserve employment through export surpluses and
then use these to finance investments (mostly in private non-tradable
activities like real estate and some public spending like arms purchases in
Greece) that provided their banks high returns for a while and also further
benefited their own industries.
 In such a context, non-symmetric adjustment, by making only the debtors
suffer and pay, is grossly unfair.

10. German business newspaper Handelsblatt takes a
swipe at the latest cover of The Economist

11. Implications for Rest of the World
 In the last recession (2008-09), emerging economies
(China, India, Brazil, Argentina, etc.) experienced
less severe downswings and recovered faster and
more strongly to exhibit GDP growth rates similar to
those of the previous decade.
 However, this time internal trends within regions and
closer integration between regions may interfere in
the „de-coupling‟ with a global recession.

12. USA
 At G-8 summit 2012, U.S. President Barack Obama
outlined that there was “emerging consensus that more
must be done to promote economic growth and job
creation, right now”.
 However, Obama had the U.S. economy in mind, not the
Greek people, when he promoted growth in Europe.
 The U.S. was worried that a second collapse of the
European banking system would adversely threaten U.S.
banking institutions. U.S. banks have already reduced
their exposure to the Greek financial system by 40%.
 A Greek exit from the euro-zone might infect the rest of
southern Europe (Italy and Spain), in whose financial
markets the U.S. banks are more heavily leveraged both
directly and indirectly.
 A Europe-wide collapse would devastate the U.S.
financial firms.

13. China
 In China, the authorities had sought to slow growth because of
fears of “overheating” as evidenced by high inflation rates.
 However, slowdown has been sharper than expected, already
leading to calls for renewed state stimulation of the economy.
 There are problems in trying to recreate the real estate and
construction boom that has already spiralled out of control.
 Falls in real estate prices continue to have unpleasant
implications for bad loans of the banking sector and for
employment in construction, which had been an important part
of the increased employment since 2008.
 There are growing fears that further slowdown in exports can
create a “hard landing” for China's economy.
 The political instability generated by the power struggle within
the elite after the fall of Bo Xilai is also likely to have economic
implications, though these can still only be guessed at.

14. India
 India is dealing with its own unique problems of political
lethargy in introducing economic reforms in addition to rupee
depreciation, capital flight, high fiscal deficit, low foreign
exchange reserves and falling GDP growth rate.
 International ratings agency Standard and Poor‟s (S&P) has
warned that India could be the first BRIC nation to lose its
investment-grade rating, scaring away foreign investors even
further.
 There are talks of the need for austerity and harsh decisions
amidst a slowdown in growth.
 Austerity would only convert falling growth into a recession.
 “Harsh decisions” involve measures such as cutting subsidies to
reduce expenditure and raising oil prices.
 Combined with the increase in the prices of imports as a result of
the rupee's depreciation, these administered price hikes will only
fuel inflation and further aggravate the tendency towards
stagflation (prices keep rising but output stays stagnant).

15. Conclusion
 There is no doubt that the world must brace itself for
another recession, possibly greater than the recent
one.
 The performance of individual countries in this will
depend on the extent to which they are able to
insulate themselves by boosting domestic demand in
sustainable ways.