The decision at the Tuesday meeting of Federal Reserve was no surprise. For the seventh straight time it left the interest rate unchanged while admitting that “economic growth slowed down in the first part of this year”. The rate however was not cut because “inflation continues to run a little stronger than it should be”. This combination makes it look that the United States is amidst stagflation.
The US GDP growth in the first quarter of 2007 was 1.3 per cent, down from 2.3 per cent in the previous quarter. That is the lowest quarterly growth in the last four years. The fall in growth has been mainly due to the slump in construction. The industrial sector is also feeling the pinch except companies that are in export business.
The slump in construction was in response to the persistent rise in Fed’s overnight interest rate from 1.0 to 5.25 per cent. Home loans became costly resulting in depressed demand for new loans and default in repayment of loans with floating interest rate contracted earlier. Banks are now left holding houses they would like to sell. If they come to the market in large numbers construction activity will be more seriously affected and the suspected recession may become a reality.
For the present, the concern is about the slowdown of the US economy which has also knocked down the dollar. Both developments are of great consequence. The US economy is one-fourth of the world economy. In recent years its impact has been somewhat subdued because the interdependence of countries has become more broad based. Even so, with the slowdown, the US will buy less from and will possibly sell more to the rest of the world. That will eventually affect the European Union, China, Brazil and India that are presently doing well.
The US has 18 per cent share in our merchandise exports with major items being gems and jewellery and apparel. The US is even a bigger customer for services, principally software and BPO. Some of these exports will be met with demand resistance. The impact will be more on goods which are income and price elastic. Gems and jewellery may be hit more than others. At the same time US companies, faced with the prospects of stagnation, would strive to cut costs and consequently generate more demand for computer software and take recourse to outsourcing a number of services. Both can favour India.
This would also be the time when US companies will be tempted to go in for mergers and acquisitions in order to maintain and even increase their market share. Many US companies will be on a lookout for M & As and India can be a good hunting ground. Quite likely there will be more acquisitions and joint ventures.
Broadly, with the slowdown in US it is possible that the growth of merchandise export may dip and of services export may climb up. At the same time US presence in Indian corporate sector may increase.
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