Indian economy is in a low-risk low-reward position if there is a global slowdown
The world economy has been living from one scare to another in the past few years
The world economy has been living from one scare to another in the past few years. In 2020 it was the Covid-19 pandemic. Then came the global supply chain disruptions associated with it. By the time the global economy was trying to limp back to normalcy, the Russia-Ukraine war dealt another major blow. Then came the spike in global inflation, especially in advanced countries. Now, interest rate hikes which were rolled out to tackle inflation have started taking a toll on banks in US. The root of the crisis lies in business practices and investment decisions which assumed that inflation and therefore interest rates would always remain at low levels.
Will the US Federal Reserve hold back on its aggressive monetary tightening? Is the global financial system at the cusp of yet another crisis that originated in the US ? What will this entail for the rest of the world? And how will this uncertainty impact India?
Here are three charts which argue that while India does not stand to lose much from global economic uncertainties, it will not be very satisfied with its economic performance.
Indian economy is the opposite of “irrational exuberance” at the moment
The period before the 2008 global financial crisis (GFC) was the best ever as far as economic growth is concerned in India. Investment and exports were booming. There was a strong degree of optimism about the economy’s future prospects and even a sustained double digit growth phase was seen as possible. This led to what is now described as “irrational exuberance” in the economy. Investments were made assuming that the economic boom would last forever. Banks happily financed these investments. Data from the Centre for Monitoring Economy (CMIE) shows this clearly. New investment announcements (they essentially measure market sentiment) saw a massive jump as a share of overall GDP. To be sure, the share of Gross Fixed Capital Formation (GFCF) – it measures actual investment spending – in GDP also increased.
This optimism came crashing when the GFC killed the export boom and a commodity price shock triggered a massive increase in external and fiscal deficit. Both companies and banks ended up with bad loans on their books which triggered what is now known as the Twin Balance Sheet crisis.
The situation right now, as can be seen in sharp fall in share of new investment announcements in GDP, is the opposite of “irrational exuberance”. Simply speaking, the private sector has a pessimistic view about the economy’s future and therefore is unwilling to commit to new investments (much of the investment has been coming from the government). While this means low growth, it also means a much lower probability of a post-2008 kind of crisis of bad loans which severely affected investments and growth.
See Chart 1: Share of new investment announcements (govt and private) in GDP
Fall in export growth in 2022-23 and possibly 2023-24 is only the restoration of the new normal
One of the biggest fallouts of a global slowdown will be the impact on exports. However, the Indian economy has been living in a low export growth phase after the GFC in any case. In the 10-year period from 2000-01 to 2009-10, annual growth in exports (in dollar terms) was more than 20% in seven years. The 10-year period from 2012-13 to 2021-22 saw an export growth of more than 20% in only one year.
There is another way to look at this issue. While the net impact of exports on GDP must account for imports as well, there is some merit to the argument that rise in exports, even if imports are rising, generates a positive effect for jobs and incomes for domestic workers. Merchandise exports as a share of GDP (in current price terms) saw a consistent rise in the in the decade preceding the GFC and reached a peak of over 16% in 2011-12. This number had fallen gradually to 11% by 2019-20 before showing a spike to 13.4% in 2021-22. The spike seen in 2021-22 is expected to come down as the global economy slows down. But it will only be a return to the new normal of exports mattering less for the economy in the recent past.
See Chart 2: Share of exports in in India GDP
But this “stability” comes with a cost -- growth
While the pre-2008 growth boom was driven by exports and bullish investor sentiment, the fact remains that it did deliver high growth. The period after 2008, especially the second half of the last decade did not have these destabilising factors but it was also low on growth even before the pandemic hit. India can take reasonable solace from the fact that a global turbulence will have a relatively milder impact on its economy at the moment, but it will be first to acknowledge that it needs higher growth to be able to fulfil its economic aspirations. As of now, the drivers of such growth do not seem to be in sight.
See Chart 3: Five-year GDP growth