What are recessions? This has been a subject of heated debate among economists for a very long time. The definition of a recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. Put in simpler words, a recession can be a mild decline in the economic activity of a country that lasts months, or a long-lasting downturn with global consequences that lasts years, or anything in between. There are multiple variables contributing to an economy, making it difficult to pinpoint specific causes. Recessions occur when there is a negative disruption to the balance between supply and demand. There’s a mismatch between how many goods people want to buy, how many products and services producers can offer, and the price of services and goods sold, which prompts an economic decline. An economy’s relationship between supply and demand is reflected in its interest and inflation rates. Inflation happens when the price of goods and services increases, i.e, the value of money decreases. Still, inflation isn’t necessarily something bad. In fact, a low inflation rate is said to promote economic activities. But high inflation that isn’t accompanied with high demand causes problems for the economy and eventually becomes cause for a recession. Interest rates, meanwhile, reflect the cost of taking on debt for individuals and companies. Low interest rates mean that the companies can afford to borrow more money, which they can use to invest in more projects. Meanwhile, high interest rates increase costs both for producers and consumers, slowing economic activity. Modern markets are complex, making today’s recessions difficult to navigate. But each recession provides new data to help anticipate and respond to future recessions more effectively.
Effect of recessions on businesses
Recessions don’t affect everyone the same way. “If your neighbor gets laid off, it’s a recession. If you get laid off, it’s a depression”, Harry Truman once said.
A recession ripples through many parts of the economy. When consumer demand for products and services drops, businesses typically slow down operations, in turn requiring less labor and materials. As a result, unemployment increases, which further lowers consumer demand.
Here are a few ways businesses could be impacted by recessions:
- Reduced Profits: During recessions, consumers tend to start losing confidence in the market and buy less. This makes it difficult for businesses to generate sales and hence start cutting costs accordingly. This also means that owners are less likely to reinvest in their companies and fund new products, employees have higher chances of being made redundant and operating costs are slashed to account for a reduction in profit.
- Credit Crunch: Not just businesses and consumers become more cautious with their spending but lenders tighten their belts as well. They often apply more stringent criteria when assessing the creditworthiness of loan applicants. This can leave some small businesses unable to access much-needed capital. On the consumer side, customers may face reductions in personal credit or increased interest rates, which can cause them to spend less or delay purchases – which, of course, aggravates a business’s demand-side problems.
- Cash-flow reductions: Often, SMEs don’t have big cash reserves, so when money comes in, it quickly goes to paying bills and other expenses. In a recession, consumers tend to spend less and may delay purchases or payments, which could have a ripple effect on a business’s cash flow and financial commitments. In turn, they may not be able to pay their employees and suppliers in a timely fashion. Bigger businesses may be forced to dip into their cash reserves, making no more than minimum payments on debt and stretching out payment terms as far as they can. For example, a restaurant owner will continue to purchase food supplies from the supplier to be able to run his business, while also stretching out the payments to him. As a result, even the supplier’s cash flow slows down.
- Declining dividends and stock prices: Not only small businesses are affected but even public companies face the effect, which may cause their stock prices to decline due to lower-than-anticipated earnings results. This is problematic since capital markets are a huge source of funding for these companies and hence dividend payouts may be lesser than anticipated when the profits are squeezed. This can agitate shareholders, possibly mess with the reputation of company management and potentially lower stock prices. Shareholders might even call for new leadership as stock prices drop.
- Decline in product quality: As an effort to reduce their costs and maintain their profitability in the face of declining sales, businesses may decide to skimp on raw materials. Shrinkflation, when a company offers less product for the same price, is also perceived by consumers as a decline in quality. These tactics may be beneficial to the company during the short-term, but they can be detrimental over time. Consumers tend to value quality and durability even more when money gets tight, and a noticeable reduction in quality may cause demand to decline even further.
Despite these downsides, there are a few silver linings to look at when going through a recession. Inflation rates drop, and borrowing rates tend to remain low. Certain industries are naturally more recession-proof than others, such as healthcare, food and beverage, utilities and other so-called “defensive” industries, because customers consider their products essential regardless of economic conditions. But for businesses in other industries, the challenges caused by a recession may drive creative thinking and give them the chance to reinvent themselves by looking at innovative ways to cut costs. Competition may also be cut, as some businesses are unable to remain open.
COVID-19’s Effect on the Indian Economy
India wasn’t spared by the onslaught of the COVID-19 crisis. With tens and thousands losing their lives to the deadly virus and even more losing their livelihood, the Indian economy took a massive hit; one analogous to the 2009 recession.
India’s GDP growth dropped by 23.9%, largely due to the no-notice lockdown imposed by the country circa April 2020. The GDP shrank 7.3%, the worst state it’s been since Ambedkar penned our beloved constitution.
The Indian economy was expected to lose over ₹32,000 crore (US$4.0 billion) every day during the first 21 days of the lockdown. Upto 53% of businesses took the brunt of the pandemic, with 45% of households reporting a drop in income and the unemployment rates reaching an unheard of 19%. Sectors like hospitality, tourism, automobiles and what not came under massive pressure. These factors together contributed towards a sizable chunk of the Indian economy.
In response to salvage public morale, the prime minister announced the first of three economic stimulus packages worth US $250 billion, intended to go towards food, medicine and shelter causes. In December 2020, under the Right to Information petition, it was revealed that only around 10% of the total stimulus package had been disbursed. The government went on to announce two more stimulus packages bringing the amount up to US $370 billion.
Coming to the conclusion, Recessions are cyclical and generally have a negative impact on many businesses. Understanding a recession’s potential impact can help business leaders better prepare and put measures in place to minimize the consequences the next time one comes around. With long-term planning and the understanding that no economic recession lasts forever, businesses can be made to survive any temporary setbacks.
To read more about Recessions and Freudian slips, click here.
– By Mahesh Alluri and Vishnu Radhakrishnan, Third Year Department of Chemical Engineering