10 ways the US crisis will impact the Indian economy

Manika Premsingh Aug 10, 2011

Ever since Standard & Poors announced a downgrade in the US sovereign rating, predictions have been flying thick and fast on whether India will benefit or suffer from the latest turn of events. A look back at the start of the crisis clearly indicates that India, being largely domestically driven, is in large part insulated from the global crisis even with a temporary hit to growth.

But the devil is really in the details.

Various aspects of the economy will react differently to the ongoing US crisis and continued sluggishness in growth, which will be further exacerbated by the cutback in government spending and now the S&P downgrade. This could mean lower investments in the economy.

In this post, the 10 most important trends arising from this global trend have been analysed.

Overall growth is expected to remain largely neutral to the current play of events over the medium term (next one year), as the negatives play off the positives, barring further negative developments. The positives are largely on the domestic economy front. Commodity price pressures are likely to ease, thus impacting inflation beneficially, and interest rates and credit growth as a result.

Overall growth is expected to remain largely neutral to the current play of events over the medium term (next one year), as the negatives play off the positives, barring further negative developments. AFP

The case for foreign direct investment (FDI) remains strong, resulting in an appreciation bias for the rupee. On the negative side, foreign institutional investor (FII) flows could remain choppy and exports might take a hit. Indian companies might not be enthusiastic about overseas acquisitions.

#1. GDP growth: The global recession, which started in 2008, saw India report slower than trend growth rate of 6.8 percent, and it was quickly back up to 7.4 percent the following year. This time around, the ensuing crisis is less of a shock since no one was betting on global growth. And unlike a lack of history the first time around, the economy’s resilience may make a stronger case for investments. In fact, barring any more significantly untoward global economic occurrences, the negatives and positives (explained below) should cancel each other out, making the Indian economy largely neutral to the US downgrade.

#2. Inflation: Commodity prices, barring precious metals like gold and silver, have been under severe pressure since the downgrade. The Reuters-Jefferies CRB commodities index is down to its lowest since December 2010 on global growth fears. This could bode well for India’s inflation which has been dangerously close to a double-digit figure for almost one year now. Fuel alone accounts for over 15 percent of the headline inflation index (Wholesale Price Index), and already there is talk of cutting fuel prices as crude edges lower.

#3. Interest rates: The Reserve Bank of India (RBI) has tightened policy 14 times since February 2010 owing to high inflation. However, with an expected decline in inflation over the short to medium term, we can reasonably expect the RBI to slow down the interest rate hike cycle, more so since there are already signs of a slowing in industrial growth.

#4. Credit growth: Since credit growth is at the heart of monetary policy transmission, a slowdown in interest rate hikes augurs well for it. Some softening in credit growth to 19.9 percent as of mid-July in comparison with 21.3 percent for the corresponding period of the previous year is visible. Added to this is the fact that the impact of the last few rate hikes will play out over the next 3-6 months. A decline in inflation and, hence, an easing of the interest rate hike cycle, could keep credit growth healthy.

#5. Exports: The US economy is one of the largest destinations for Indian goods’ exports, with an almost 11 percent share. It also has a substantial share in services exports. A continued decline of the US economy does not bode well for India, partly because of the direct effect, but also because export-led Asian economies will also be impacted by it, a number of which are among India’s top trading partners.

#6. Imports: Continued domestic strength has resulted in a healthy 36 percent growth in imports for the first quarter of 2011-12 and the negative trade balance has increased to about $ 32 billion in comparison with $ 27 billion during the same time last year. With an expected decline in exports, a fall in crude price is a welcome development for India’s import and trade balances, since oil imports account for about a third of India’s total imports.

#7. FDI Inflows: With the US no longer looking like a safe haven for investments, a surge in global liquidity created by quantitative easing and continued expectations of resilient performance by the Indian economy, FDI inflows could be impacted positively.  An indication of this is visible in the fact that FDI inflows surged by 133 percent in the first quarter of 2011-12 to  $ 13.4 billionn.

#8. Outbound FDI: The downgrade of the US economy will only consolidate the declining trend in outbound investments from India. The ongoing softness in advanced economies is seen as a key reason for India’s outbound investments declining by 33 percent for the April-July period. With no resolution to the global weakness and some expected softening in the domestic economy, investments could stay away from any aggressive overseas investments.

#9. FII inflows: Risk aversion is always negative for the equity markets, and this time is no exception. Despite the fact that India Inc has shown decent earnings recently, a downbeat global mood is expected to lend volatility to equity markets in the short-term at least. While some of the blow could be cushioned by a strong growth story for India – in July alone FIIs have invested US$ 1.8 bn in India – FII flows could retain a risk to the downside over the coming months, even with bouts of buying interest.

#10. USD/INR: It has been argued earlier as well that the US$/rupee exchange rate has anappreciation bias. Over the medium term, continued strength in FDI inflows, slowing FDI outflows and declining crude prices are likely to keep the bias intact. However, volatile FII flows could keep the appreciation trajectory from being smooth.

In sum, it will be some time before the clouds clear and the real picture emerges, but for now the risks for India look balanced with the positives.

Manika Premsingh is the promoter of Orbis Economics, which provides research on the economy.

[Source: http://www.firstpost.com/business/10-ways-the-us-crisis-will-impact-the-indian-economy-57612.html]

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