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Why The World Economy Is Going Down -- And This Time It Could Be Worse Than 2009

04/02/2016 8:16 AM IST | Updated 15/07/2016 8:25 AM IST
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Chinese investors chat while monitoring stock prices at a brokerage house in Beijing Monday, July 13, 2015. Chinese authorities have accused securities firms of manipulating share prices and allowing improper trading during the country's market plunge, in a possible effort to deflect blame for investor losses totaling several trillion dollars. (AP Photo/Andy Wong)

The recent plunge in global equity markets has led to fears of another economic downturn - one that might be a lot worse than what we saw in 2009. So, why is it happening? Here's a rundown of the various factors -- from the China problem to the crash in oil prices it the Federal Reserve's interest rate hike - that led to a perfect storm.

1. The China problem

The Yuan devaluation played the role of a trigger in the crash in equity markets. If one notices the timing of the Yuan devaluation, the first decision was taken around the time when the US raised their interest rates for the first time in a decade whilst the second took place about 10 days ago. Agreed that the Yuan devaluation was taken in a bid to boost exports but with a slump in demand in countries like Japan and other developing nations, it is unlikely to help China.

Although China plans to infuse $91 billion in the system by February end, until it manages to offload 13 million unsold homes, problems will continue to prevail.

The main problem in the Chinese economy lies with the unsold inventory and not with liquidity. With the People's Bank of China slashing interest rates six times in just one year, in 2015 to 4.35%, China has enough liquidity to kick-start investment and growth. Although China plans to infuse $91 billion in the system by February end, until it manages to offload 13 million unsold homes, problems will continue to prevail.

2. Crude oil price crash

Crude oil has become the main villain in today's global economy. While developing economies like India cheer at falling crude oil prices, investors in China and the US have lost trillions. Slowing demand from the top importer of crude -- China -- has raised a concern as demand in crude oil signifies manufacturing that ultimately leads to growth. With the World Bank and IMF predicting slower growth rates of 6.8% and 6% for China in 2016 and 2017, things have started looking gloomy.

Moreover, lifting of sanctions from Iran has made things worse. With Iran now open to supply crude worldwide, the prices per barrel are likely to fall near $20. After China, India has consistently remained the biggest importer of crude, meeting 70% of demand through imports. Until now, it used to purchase limited crude from Iran due to sanctions. But from now it will likely import more as Iran gives India the benefit of paying in rupees. This will negatively affect the supply chain of OPEC nations.

Either the developing nations have to slash their interest rates to kick-start manufacturing or the crude oil producing nations have to stop supply until supply-demand equilibrium is established.

The problem with crude oil originally started from the time the US started producing shale gas. Crude oil prices entered into the crash phase when it became the largest crude oil producer in the world. The crash in crude can only be contained if supply is engineered to meet the world's demand. In a bid to control supply, either the developing nations have to slash their interest rates to kick-start manufacturing or the crude oil producing nations have to stop supply until supply-demand equilibrium is established.

3. Interest rate rise by Federal Reserve

No one is really talking about this as a factor that led to the selloff, there is a connection. With the Federal Reserve raising interest rates for the first time in nearly a decade, it has definitely resulted in capital flight from Indian stock markets. Even in India, which is being pinned as a "bright spot" in turbulent days by the World Bank and IMF, FII has withdrawn about $1.4 billion in just a fortnight, the worst figure registered since 1999. The massive exodus of funds has also led the Indian rupee to fall to its lowest levels since September 2013.

A crash in the property market led to 2009's financial crisis. But this time it is actually worse. This time the fundamentals of various economies are in question.

Why this could be worse than the 2009 crisis

It remains an established fact that a crash in the property market led to 2009's financial crisis. But this time it is actually worse. This time the fundamentals of various economies are in question. With consistent capital flight from developing economies and continuous fall in value of emerging currencies due to rise in interest rates, it is highly unlikely that economies would revive in three to four years. As these factors lead to slowdown in manufacturing and ultimately leads to slower growth.

As of now, the only thing an investor or trader can do is turn them in wait and watch mode. No company or country is powerful enough to control a worldwide free fall.

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