The world's largest economy, the United States, has been in slowdown since early 2007 when the first signs of the subprime crisis began to take their toll on the American financial system and economy. The collapse of the housing bubble and the sharp increase in foreclosures left the reckless strategy of financial institutions to lend to high-risk borrowers (subprime borrowers) badly exposed. A number of major banks needed large rescue packages provided in large number by sovereign wealth funds. The consequence was obvious – banks and financial institutions were either unable or unwilling to lend to borrowers, even at relatively low levels of interest. The subprime contagion eventually spread to Europe – the collapse of Northern Rock in the United Kingdom had similar foundations to that of the subprime crisis in the U.S.

At the time, there was a widespread belief that certain countries in Asia, particularly India and China, would not be affected by the subprime crisis and slowdown in the West – there was, in fact, an even stronger argument that these countries had de-coupled their economies from those of the West; and the strong performance of these economies would instead, quite conceivably, provide the engine of growth for the rest of the world.

That particular argument seems in tatters when examined in the present context. Both India and China have begun to show signs of slowdown, which is a result only partly of the subprime crisis – the more direct cause is the soaring price of crude oil combined with the spiralling prices of food commodities, two factors which have converted a recession in the West to a much worse situation of stagflation – recession combined with high inflation.
Is the subprime crisis responsible for the spurt in oil and commodity prices? The answer is yes, but only to a very limited extent. The severe slowdown in financial systems in the West meant that there was a lot of money looking for a lucrative parking slot – a large amount of it was invested into oil and other commodities driving up their price. However, it would be a folly to blame the problems of inflation in India, China and the rest of the world on 'speculation' alone. In the final analysis, speculation does follow the real economy, and it is here that perhaps we find that China and India have fallen victim to their own success.

Take oil. The soaring demand for oil and its derivative products in the rapidly growing economies of India and China is, in part, responsible for the growing mismatch between global supply and demand. The developed countries, though, still account for the larger share in consumption and must shoulder a larger part of the blame. What makes things worse in the cases of India, China and the rest of Asia are the huge government subsidies given to consumers of petroleum products. So while there has been a correction of demand in the West, particularly in the U.S. (people have stopped using gas-guzzling SUVs), there has been little correction of demand in India and China. Thus, the two countries are preventing a correction in global oil prices, which will ultimately hurt both these countries through higher inflation in the long run – a vicious cycle.

Also, both India and China import most of their requirements of crude oil – they have very limited domestic reserves – and there will be an increasing strain on their import bill. This is particularly problematic for India whose exports are much less than China's – how will the import bill be footed without worsening the balance of payments and risking a possible crisis?
The other point of pressure on India and China comes in the form of the rising prices of food commodities. Again, some of the increase in prices can be rightly attributed to a demand and supply mismatch. Some of this is admittedly to do with growing demand in China and India. Some of it has to do with the diversion of food crops into the production of bio-fuels – particularly in the U.S. and certain developing countries like Brazil. Whatever speculation there is, it is based on these fundamental and real trends.
The inflationary impact of rising oil and food prices has not spared much of Asia – India and China have taken blows. Inflation is, of course, a very sensitive political issue in both China and India and governments need to take steps to curb rising prices to avoid mass public unrest (in China) or electoral defeat (in India). Under such circumstances, governments are left with little choice but to slow growth. Both India and China have raised interest rates in the recent months and are likely to raise them even further if inflation does not come down substantially. This will inevitably choke lending to consumers and lending to industry for investment.

This is not to suggest that either India or China is heading for recession. They are not. But it would be safe to assume that growth in both countries may come down by a couple of percentage points. India and China cannot be immune from global economic trends. The large size of their domestic markets, though, can help insulate them to some extent. Ironical is the unintended contribution that the success of India and China has made to their own and the world's economic troubles. The world economy (on the supply side) seems to have been unprepared for India and China's dramatic growth. In fact, the rest of the world may, now, actually be wishing for a decoupling from Asia's two monster economies.

The writer is senior assistant editor with 'Indian Express Group' in New Delhi.

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