Recently on one of the business channels, some analysts were discussing what kind of recovery will happen in the coming months. Some said U type recovery, some said L, some said J and some said W-shaped recovery.

Countries like US, UK, Germany, France, Japan have faced recession while countries like India and China have faced slow down. Many people confuse recession and slow down as one and the same thing although the difference between the two is very marginal. A recession is defined as two consecutive quarters of negative growth. A Slowdown can be defined as declining growth rate i.e. the GDP growth may still be positive but it is not as much as previous quarters. For Eg. if the economy were growing by 4% last year, and 3% this year, that can be considered as a "slowdown". A slowdown can result into a recession if the growth keeps on declining and becomes negative i.e. Negative growth.

W shaped recovery means double dip recession as the symbol W has two dips. This means that markets will rise as it is happening now (In India Sensex has increased by nearly 100% since bottoming out in Oct 2008) and again fall to recession levels. Hence the name double dip as second leg of W will be tied to the first i.e. it is part of the same recession. A W-shaped recovery depicts the shape of certain economic indicators such as unemployment rate, GDP, industrial output(IIP index in India) etc. A W-shaped recovery involves a sharp decline in these indicators(\) followed by a sharp rise back to the previous levels(/), followed again by a sharp fall(\) and ending with another sharp rise(/). Add all the brackets and a ‘W’ is formed. The middle section of the W represents a recovery that was cut short by a further economic crisis. This is bad news for investors, policy makers and for world as a whole. The efforts that government across the world is putting will count to nothing if there is a W shaped recovery to take place.

W shape recovery happens when GDP numbers have improved mainly due to increased spending of the government and then government decides to raise interest rates to stave off inflation even before economy has recovered which again slackens the demand and economy goes back from where it started. In other words macroeconomic support is removed way too quickly. W-shaped recovery represents an extremely volatile scenario, where nothing is certain.

Most countries have pumped in a lot of monies to increase the demand. Rates across the world are at historic low. RBI in India has also not changed the rates keeping in mind the slack in the demand. This method to pumping in money is called artificial recovery because the recovery is not happening due to actual increase in demand but due to the money the government is spending to increase that demand.

India’s 1st quarter GDP was impressive though not as impressive as pre slow down times. A 6.1% GDP second behind China’s 8.1% is something many countries would love to have. But 9% levels were achieved primarily because of world economy and unless and until world economy recovers, 9% is a dream. Till then an average of 6.5 - 7% GDP numbers is all we can hope for.

These numbers can really take a beating if W-shaped recovery happens. India will then only grow at an average of just 3-4% which is a scary prospect. Already many economists have predicted that numbers will fall in the coming quarters given drought like situation across the country and one can expect 5-5.5% average growth in the coming quarters. The logic behind this argument is that although agriculture has a very less share in India’s GDP, but 65% of the population is dependent on agriculture and that will surely impact the domestic demand. As income reduces, the purchasing power goes down and with it the demand and once again there will be a drop in GDP numbers.

China who grew at 8% in the first quarter in 2009 does not have a rosy picture to present, as this growth was mainly due to stimulus that government provided and not due to actual recovery. There is a fear that China will face a subprime crises similar to what US has faced mainly because of cheap credit provided to the people without any background check done. China has focused more on quantity rather than quality of credit which will haunt them later. Interest rates are at historic low and if this fear turns out to be real, W-shaped recovery will be a reality.

The world economy is mainly dependent on US economy. If US economy grows at a good pace, the world economy as a whole will also pick up. US government is pumping a lot of money in the system so that the demand picks up. Also the Fed has kept the rates low. Unemployment rate in US is still very high. Unemployment rate is a lagging indicator which means even if recession ends, the rate will be high.

True recovery cannot happen in US, unless and until unemployment rates reduces, Housing market shows signs of improving and banks are back to normal health with adequate capital. Impressive GDP numbers might be out in 3rd and 4th quarters of 2009 but that should not be a reason for celebration as that is artificial growth or recovery.

As explained above, double dip can happen if Government raises rates at first sign of recovery to prevent inflation from swelling. Closer home RBI has an arduous task ahead knowing fully that GDP will drop in coming months due to poor monsoon and with inflation rising (negative due to base effect as of now), it has to use its monetary and fiscal tools properly. RBI is expecting U-Shaped recovery for India, but if they increase rates in a premature way, GDP will fall further and double dip (W-shaped recovery) will become reality in India. Inflation is rising over past months and RBI has to define a threshold level as to how much is too much. The timing of RBI will be of utmost importance. If they feel 6-7% inflation is acceptable then they should keep rates unchanged till that time but at the same time keep an eye on GDP numbers.

Increase in interest rates have an effect only after some months which means that economy which has started to recover, will go down after some months if the rates were increased. It is akin to a person who has just met with an accident and broken his leg and is recovering, but he starts to walk again even before recovery has happened and injures his leg again in the process.

Signs of double dip or W-shaped recovery occurring:

• Increase in short term interest rates without economy gathering any real pace.
• High unemployment rates.

Inorder to prevent W-shaped recovery to take place, Government across the world should keep the interest rates unchanged unless the economy gains momentum, even if inflation rises. A threshold level should be decided as to what governments see as a high inflation keeping growth in mind. Apart from this some regulation also has to be in place when money is being lended, so that world does not experience the same pain that it is experiencing now.

US government has to take a lead in this being the biggest economy in the world. Last time they raised interest rates after keeping it low after the dotcom bust( around 14 times in 2005) subprime crises happened though this was not the only reason. This time they have to make sure that they do not raise rates till their economy is out of ICU and unemployment rates have declined considerably. They also have to make sure that some regulation is in place so that financial bigwigs do not give mindless credit to all and sundry and repeat the same cycle resulting in another subprime crisis. US economy mainly depends on consumer spending and once employment picks up, spending will pick up and with it economy will also pick up. Once this happens world economy will also pick up including that of India’s. RBI’s job will become bit easier if economy grows at a faster rate.

To conclude double dip or W-shaped recovery is just a threat but can become a reality for the reasons explained above. Governments across the world are treading on a very narrow path. One wrong move can spell disaster specially if that move comes from the US. The next two quarters are going to be very important for world and India. India’s GDP will be affected by the monsoon and unemployment rates will be watched very closely in US. If everything goes fine things should get normal by mid 2010 although the rate of growth might be slow and by early 2011 the probability of economy gaining momentum will be a reality. Till then lets keep our fingers crossed.

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