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US Subprime Crisis: South Asia will continue to grow

United States Subprime Mortgage Crisis: South Asia will continue to grow

United States Subprime Mortgage Crisis: South Asia will continue to grow inspite of many imbalances

Subprime Crisis

January 30, 2008 - The recently concluded 2008 World Economic Forum in Davos, Switzerland, brought many business leaders and policy makers under the theme of “The Power of Collaborative Innovation.” The forum, nonetheless, was missing the usual euphoria that existed in years past.

The United States’ subprime mortgage crisis and fear of possible impact on global credit markets had left participants with pervasive uncertainty in their minds.

- Will the subprime crisis lead to a slowdown of the U.S. economy, a recession?

- How will a recession in the U.S. affect developing countries?

Analysis of the Crisis

Shantayanan Devarajan, World Bank Chief Economist for South Asia talks about how the United States' subprime mortgage crisis will affect South Asian countries. Listen to the interview below:

Shantayanan Devarajan, World Bank Chief Economist for South Asia
Shantayanan Devarajan, Chief Economist
  • - Effect of US subprime crisis on South Asia (49s) wmv
  • - Effect of US economic slowdown on South Asian growth (52s) wmv
  • - Many IT companies of India rely solely on the revenues from the U.S. market. How would you assess the impact on India’s trade with the U.S.? (47s) wmv
  • - Will declining dollar affect South Asia's trade? (44s) wmv
  • - Do you think this current crisis along with rising oil prices will affect adversely on the Bank’s strategy in the region- ending Poverty in a generation? (1m:28s) wmv

Is South Asia At Risk?

"The current subprime mortgage crisis in the United States will not seriously impact South Asian countries", said Shanta Devarajan, World Bank Chief Economist for the South Asia Region. “The impact will be mild because of the structure of the region’s trade and financial flows, and partly because of compensating effects.”

Devarajan attributed three factors that work well for the South Asian countries: 1) Lack of exposure to U.S. mortgage securities; 2) availability of liquidity in domestic markets; and 3) the possibility that lower capital inflows could help countries such as India with macroeconomic management.

Highlighting that Indian companies do not have big exposure to U.S. mortgage securities, Devarajan said, “Even if the subprime crisis leads to a global credit crunch, it still may not have a big effect because there is quite a lot of liquidity in domestic markets in countries like India.”

He believes that if a global credit crunch leads to a decline in capital flows, it may still not be a bad thing for India. He pointed out that Indian policymakers recently were having difficulties in managing the sudden surge in capital inflows while trying to manage India's exchange and inflation rates.

Speaking on a possible slowing down of the United States economy, Devarajan said, “The impact on South Asian countries will still be relatively mild”. He drew attention to the fact that the share of South Asia’s trade with the United States has been declining and that the U.S. is no longer India's leading supplier. Sri Lanka, which used to rely on the United States for its garment exports, has now increased them to Europe and other regions substantially.

On the other hand, Devarajan expects that “a slowdown of the United States’ economic growth will moderate the increase in prices of oil and other commodity prices, which will have a favorable impact on South Asia.” Since all South Asian countries are net importers of these commodities, such a slowdown will provide some relief in their balance-of-payments.

United States Subprime Mortgage Crisis: South Asia will continue to grow

United States Subprime Mortgage Crisis: South Asia will continue to grow

Declining Value Of US Dollar

The declining value of US dollar will certainly affect India’s IT companies that sell services to the United States, and already many IT companies are feeling the effect,” Devarajan said. The Indian companies engaged in business processes such as mortgage documentation have seen a decline in work orders and loss of revenues as U.S. lenders have tightened their exposure to credit market. The Indian IT industry, which derives about 65% of its revenues from the U.S. market, will also be adversely affected if the subprime crisis leads to a recession in the United States.

However, Devarajan allayed the fears of a significant negative impact on India’s overall economy and said, “The share of IT services exports in total exports of India is not growing very fast because India has started exporting more manufactured goods and other services.” Also, he said that exports are not the only determinant of economic growth in India. He expects that domestic demand in India will continue to fuel economic growth even when there is a dampening of IT exports to the United States.

United States Subprime Mortgage Crisis: South Asia will continue to grow

Increasing Oil And Commodity Prices

Devarajan believes South Asian countries are facing more serious problems associated with global external shocks such as increasing oil and food prices, as well as country-specific “shocks” such as escalating conflicts or political turmoil.

While the countries in the region may be only slightly affected by the subprime crisis, Devarajan warned, “These critical issues should be addressed if South Asia is to protect the gains in growth and poverty reduction of the last decade. Otherwise, they could potentially threaten the goal of ending poverty in a generation.”

Reflecting on the usual reaction of governments in the region to an increase in oil prices, Devarajan said, “The temptation is to insulate poor people from this shock essentially by subsidizing prices to domestic consumers.”

Drawing attention to historical records, Devarajan said, “This actually hurts poor people more than it helps them. That subsidy has to be paid by the government which means the government has to cut back on other expenditures that might benefit poor people like health, education, and water.” Sometimes governments are forced to print money to finance the subsidy which leads to inflation which can be a huge tax on poor people.

Devarajan advised that while it might seem cruel at first, “Passing on the increase in oil prices to domestic consumers is actually in their best interest because it allows the economy to be better managed and better able to continue growing which is critical to ending poverty in a generation.”

Additional Resources

- Blog - End Poverty in South Asia
Shanta Devarajan, World Bank Chief Economist for South Asia, shares insights about the fight against poverty in the region. (Read More »)

- South Asia: Development Data
A wide range of social and economic measures on South Asia, including links to the World Bank's most important online development databases. (Read More »)

- South Asia: Analysis and Research
Compilation of all the World Bank's publications on South Asia, with 'search' options and links to analysis and research on other South Asian countries. (Read More »)

- World Bank Program in South Asia
Launching pad to all information on World Bank activities in Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka.(Read More »)

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