Dealing with the US revival

Recent indicators of the US economy point to a consolidation and strengthening of the forces of recovery.

After seven successive quarters of positive though moderate numbers, GDP growth during the July-September quarter was recently revised to an estimated 8.2 per cent annualised rate of growth.

Also, while GDP growth has not till now had much impact on a particularly stubborn unemployment rate, there are now signs of unemployment inching down, however slightly.

The immediate impact of this resurgence will be on interest rates and exchange rates. As time passes, demand for commodities will firm up and, consequently, so will prices.

There are already signs of upward movements in US interest rates, a reversal from the pattern of the last couple of years. Yields on 10-year government securities have moved up by about 20 basis points in the last couple of weeks, approaching the 5 per cent (annualised) mark.

Although the dollar has still not shown signs of firming up against the euro, the upward movement in interest rates suggests that a dollar reversal is only a matter of time.

Similarly, oil prices are not showing any particular upward tendency. Growing US demand will certainly put pressure on them in the new year, although supply management by the major producers may offset that pressure.

From India's perspective, the US recovery has both positive and negative implications. The most important impact is that the flood of dollars coming in will now be moderated.

The pressure on the rupee to appreciate and the constraints that this inflow imposes on monetary management will now ease. As the upward pressure abates, export competitiveness will return, reinforced by growing global demand for goods and services.

On the other hand, the dream run that the stock markets have had has been heavily contributed to by foreign funds. To a significant extent, these inflows have been attracted by strong domestic fundamentals.

However, there was also a component driven by the temporary difference between Indian and global economic performance. As the US economy recovers, it regains its attractiveness as an investment destination.

And countries in East Asia, whose performance is closely linked to that of the US, will now become more attractive to global fund managers. Inflows into India are therefore likely to slacken somewhat.

As far as commodity prices go, India has exposure on both the export and import side, so the impact is not unambiguous; some sectors will gain while others will lose. In the net, however, it really cannot be argued that the world is better off when its largest economy is under-performing.

Adjustments will have to be made and endured. With the Indian economy performing as it is, these are likely to be relatively painless.