Revisiting decoupling

Buoyant India cannot ignore global economic constraints

In the aftermath of the trans-Atlantic financial crisis of 2008-09, two schools of thought had emerged in India on the likely impact of the Great Recession on the Indian economy. One school drew attention to India’s as yet limited exposure to global trade and capital flows and, therefore, suggested that India would be relatively insulated. A second school of thought rubbished such optimism and suggested that the Indian economy too would grind to a halt. Upholders of the first school of thought forecast a growth rate of upwards of 7 per cent for 2008-09, while proponents of the opposite view saw India’s growth rate declining to less than 5 per cent, perhaps even 4 per cent in that year. In the event, the Indian economy did slow down but not by as much as feared. More than the slowdown of growth and exports, India saw reduced capital inflows, higher cost of external borrowing, and such like. In one of his early speeches of great value, Reserve Bank of India Governor Duvvuri Subbarao warned, in December 2008, that despite the attractions of the “decoupling hypothesis”, the fact remained that an increasingly open and globalised Indian economy is exposed to all the vagaries of the global economy. It is useful to recall and remember those words of wisdom once again.

Last week, the media reported two sets of contrasting reports. On the one hand, the worrying reports from the United States about the likelihood of a “double dip recession”, with the head of the US Federal Reserve, Ben Bernanke, worrying about deflation and persistently high unemployment in the US. The same week, there were reports about renewed fears of an economic slowdown even in fast-rising China. The good news from Germany was overshadowed by renewed concerns about the health of other European economies and Japan. In the same week, on the other hand, India reported a robust 8.8 per cent rate of growth in its gross domestic product in the first quarter of the current financial year. Can India return to the pre-crisis trajectory of close to 9 per cent growth rate even if the world economy slows down and posts a little over 1 per cent GDP growth? The decoupling debate has been opened up again.

India’s domestic market has the capacity to sustain fairly high rates of growth and it is entirely possible that India will continue to be among the world’s fastest-growing economies. Perhaps even the fastest-growing economy, if China’s growth rate slips to below 7 per cent, as many believe it would, if it has not already done so. However, a higher current account deficit could act as a constraint on growth. The one upside of the global slowdown for India, especially China’s growth deceleration, would be the abatement of commodity price inflation globally. Lower petroleum and commodity prices will have a positive impact on inflation at home. However, if lower inflation comes with lower growth, the net outcome would only be a mixed blessing for the government and the economy. India’s macroeconomic authorities must, therefore, remain alive to the challenge posed by external economic factors, even as policy at home seeks to sustain the growth revival.