Uncertain global outlook may impact India

The US Fed's clawback of liquidity and higher interest rates will likely lead to capital outflows that will impact the Indian economy

Six years after the financial crisis of 2008, global economic growth continues to be anaemic. In its latest World Economic Outlook, the International Monetary Fund (IMF) has scaled down its estimate of growth in global gross domestic product this year from 3.4 per cent to 3.3 per cent.

The report, however, painted a few bright spots — among developed countries, the US was showing signs of strength, while among emerging economies, India appeared on the upswing, the IMF said.

Though the IMF has raised its growth estimate for India this year from 5.4 per cent to 5.6 per cent, there are several caveats. An immediate risk is the possibility of higher interest rates in the US, owing to strong growth and a fall in unemployment numbers in that country. While stronger growth in the US is good for the global economy, higher yields may lead to capital outflows from emerging economies such as India.

The last time the US Federal Reserve hinted at raising rates, the rupee plunged. In the past, countries that were impacted the most had high current account and fiscal deficits, as well as high inflation. While India has made considerable progress on these fronts since then, ambiguity remains on whether the clawback of liquidity by the US Fed will be balanced out by liquidity injections by the European Central Bank (ECB) and the Bank of Japan, which are embarking on various versions of quantitative easing programmes to stimulate their depressed economies.

Madan Sabnavis, chief economist at CARE Ratings, says, “Higher interest rates in the US are likely to impact flows, especially to Indian debt markets. But this might be balanced by liquidity injections from the ECB, as India still offers higher returns.”

A consequence of these divergent monetary policies is the likely strengthening of the dollar, which will exert downward pressure on commodities. This will benefit India by lowering the cost of imported oil, reducing its current account and fiscal deficits.

While the fact that the IMF raised its estimate of growth in India is based on the assumption of stronger exports and investments, its estimate of global trade growth was slashed from 4.9 per cent in October 2013 to 3.8 per cent, indicating sluggish demand. Aditi Nayar, senior economist at ICRA, says, “Sluggish growth in various advanced economies such as the Euro Zone and Japan suggests a muted outlook for Indian exports to these geographies in the remainder of this financial year. However, a relatively optimistic growth outlook for the US should support demand for Indian exports.”

Economist Eswar Prasad, with his co-authors, wrote on the Brookings website, “India’s growth prospects have improved in recent months, but are likely to remain muted in the absence of broad-ranging structural reforms.”

Nayar says, “A revival in economic growth, led by investment in infrastructure and other sectors, is likely to prove more durable than a pick-up in consumption demand, as the latter might reignite inflationary pressures.” While a project management group has cleared projects worth $105 billion, bank credit offtake continues to remain low, signalling poor demand from companies. Also, recent trends in the Index of Industrial production suggest the incipient recovery isn’t broad-based.