Washington: The world may be heading for its worst recession in a quarter of a century—if it’s lucky. A steep slump looks likely as the credit squeeze crunches economies from the US to Singapore and panic engulfs global financial markets.

Worried: Investors react as they watch a display showing stock prices in Hong Kong on 10 October when the key Hang Seng index fell 7.2%. Vincent Yu / AP

“It’s certainly going to be the worst since the 1980s," says Bradford DeLong, an economics professor at the University of California at Berkeley who worked at the US treasury department from 1993 to 1995. “The hope is that it won’t become the worst unemployment business cycle since the Great Depression."

Of special concern: The two big bulwarks of the global economy in recent years—US consumer spending and the rapid growth of emerging markets—may be finally giving way in the face of the 14-month-old turmoil.

That raises the odds that the coming economic decline will be long and deep, despite US treasury secretary Henry Paulson’s $700 billion (Rs33.7 trillion) rescue plan, similar efforts by European leaders and the coordinated interest rate cuts engineered by US Federal Reserve chairman Ben Bernanke and other central bankers.

“This is the worst crisis I’ve seen in my 50-year career," William Rhodes, senior vice-chairman of Citigroup Inc. in New York, told fellow bankers in Washington on Sunday. “We still have to deal with the effects on the real economy here and elsewhere."

Slowing growth

The International Monetary Fund’s (IMF) World Economic Outlook last week forecast that global growth will slow to 3% in 2009, from 3.9% this year and 5% in 2007. That would mean a world recession under the fund’s informal definition—growth of 3% or less—although current IMF chief economist Olivier Blanchard declined to describe it as such.

One of his predecessors wasn’t so shy. “It’s hard to imagine it not being the worst recession in at least 25 years," says Kenneth Rogoff, who is now a professor at Harvard University in Cambridge, Massachusetts.

“You can take most of the official forecasts for 2009 and knock two" percentage points off them, he adds. That would make it the worst slump since 1982, when the world economy grew 0.9%.

“We’re heading into a global recession," Simon Johnson, also a former IMF chief economist and now a senior fellow at the Peterson Institute for International Economics in Washington, said last month.

Pressures of rate cut

Even if the financial markets settle down soon, the deepening decline will put pressure on central bankers to cut interest rates further and on finance ministers to reduce taxes and boost spending.

“There will be more cuts out of all of the central banks," says Ethan Harris, economist at Barclays Capital in New York. “We are looking at a global recession, and it isn’t going to turn quickly."

US lawmakers, who already enacted one economic-stimulus package this year, will reconvene after the 4 November presidential and congressional elections to consider another.

“We are going to do a stimulus," House Financial Services Committee chairman Barney Frank, a Massachusetts democrat, said on Sunday on the ABC News television programme This Week.

The US, where the two-and-a-half-year-old nosedive in the housing market is now taking down the rest of the economy, is the epicentre of the global slump. Gross domestic product contracted in the third quarter and is set to shrink further in the fourth, according to a survey of 52 economists by Bloomberg this month.

Giving way

Consumer spending, after growing uninterruptedly since 1991, finally gave way last quarter in the face of rising unemployment, declining wealth and tightening credit.

Further weakness seems to be in store. The jobless rate, already at a five-year high of 6.1%, may rise to 8%, says Jan Hatzius, chief US economist at Goldman Sachs Group Inc. in New York. That would bring the cumulative increase in unemployment during the recession to 3.5 percentage points, second in the post-World War II era only to the 4.1 point increase recorded in the mid-1970s.

Household finances are also being pinched. The steep decline in US stock prices last week alone wiped out some $2.16 trillion from investors’ wealth. And banks are getting stingier: Borrowing by the US consumers fell in August by the most on record as lenders shut access to loans, according to data from the Fed.

The consumer pull back is already sending ripples throughout the economy. Vacancies at US neighbourhood and community shopping centres rose to a 14-year high in the third quarter, New York-based real estate research firm Reis says.

A sharp reduction in household spending could turn what is shaping up to be the biggest recession since the early 1980s into something worse, Bruce Kasman, chief economist at JPMorgan Chase and Co., told a meeting of the Institute for International Finance, or IIF, in Washington on Sunday.

Cracks are also showing up in the emerging markets, until now the dynamos of the world economy. The MSCI Emerging Markets Index fell 20% last week as global investors yanked money from countries such as Brazil and Russia.

Michael Mussa, another former IMF chief economist now with the Peterson Institute, says he has cut his forecast for emerging market and developing country growth next year to below 5% from 5.7% just two weeks ago. That would be the slowest since the Asian financial crisis in 1998 and would compare with an IMF projection of 6.9% growth for this year.

“The credit crunch has taken hold in emerging markets, particularly in central Europe and now in Latin America," Mexican central bank governor Guillermo Ortiz told the IIF on Sunday. “This has happened in a few weeks, even days."

Brazilian budget minister Paulo Bernardo said in an interview published on Sunday by O Globo newspaper that the government may cut spending and postpone social programmes as the financial crisis takes its toll on the economy.

Asia is also feeling the effects. Reserve Bank of India deputy governor Rakesh Mohan says India’s economy faces “downside risks" as global investors turn more cautious.

Even China is feeling the effects, as its exporters are pinched by slowing demand from the US and elsewhere.

“The financial crisis really has an impact everywhere in the world," Yi Gan, the deputy governor of the People’s Bank of China, told investors in Washington on Sunday.

That impact will grow the longer the crisis drags on. In a bid to restore calm to the financial markets, European leaders agreed on Sunday to guarantee bank borrowing and use government money to prevent big lenders from going under.