How much will U.S. recovery help India?

January 10, 2014

(Any opinions expressed here are those of the author and not of Thomson Reuters)

After a prolonged slowdown, the U.S. economy is finally showing signs of recovery though much of it comes from investment in inventories and may not be sustained at the present high rate.

The United States is the largest economy with a share of more than 22 percent in the world GDP. Naturally, even small changes in its behaviour have a perceptible impact worldwide. To India, the United States counts for a lot, although possibly less than it does for China.

The Indian economy is linked with the U.S. economy through three major routes. First, the United States is a market for more than a fifth of India’s total exports. In 2012-13, our exports declined because the U.S. economy had slowed down. Since June, our exports have been growing steadily to coincide with its recovery. The sector which has and is most likely to benefit is information technology. The manufacturing industry could not share the export boom or step up growth. This is one reason why non-oil imports shrunk and consequently reduced the trade deficit and the current account deficit.

Second, there is a strong link with the United States through investment, both portfolio and direct. FII investment is extremely sensitive to U.S. economic trends and policies. When the Federal Reserve announced its intention to reduce quantitative easing (QE), the world bourses reacted adversely — the BSE more than most others. FIIs partly exited the Indian market with the result that in 2013, there was a net outflow. That put pressure on the rupee, which depreciated substantially against the dollar.

Direct investment from the United States is less susceptible to short-term considerations. But economic recovery will open up new investment opportunities in the country and deplete investment in India, more so because business investment in India has become commercially unviable. Even Indian companies have deferred new investment.

Third, the Indian economy will be indirectly affected through international commodity markets. The U.S. recovery will generate additional demand for commodities and raise international prices. There is already upward pressure on crude oil. Since India has to import two-thirds of its oil, the rise in prices will blow up trade and external payments deficits.

The impact of U.S. economic revival on India can be diverse. It will improve exports, increase international commodity prices, more particularly of oil, and inflate imports. It will also weaken inflow of FII investment due to tapering of QE, reduce support to our stock markets, put some pressure on the rupee and divert U.S. direct investment from India.

A recovery in the U.S. economy would have been a boost for India had the latter been growing at a faster pace. That would have encouraged more portfolio and direct investment. For the present, with low profitability, high interest, unstable rupee and slow growth, India will not be able to take much advantage.

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