There is no reason for India to fear the worst from a U.S. slowdown. But it would be foolish to be complacent about the likely future implications of the international downturn.
THERE is no longer any doubt about the economic slowdown in the United States, or indeed about its effect on the world economy. Aggregate economic growth in the last quarter in the U.S. slowed to an annual rate of only 1 per cent, retail sales growth slowed to just above 2 per cent and industrial production was down by 1 per cent. Capital investment by business is down. Labour productivity actually fell in the first quarter of 2001 for the first time since 1995, throwing even more doubt on the notion that the "new economy" puts productivity on an endless growth path.
To add to these, projections for the future are becoming more pessimistic across the board. The International Monetary Fund (IMF) recently revised its growth projections for 2001 downwards quite substantially, with U.S. growth projected to be only 1.5 per cent compared to the 3 per cent it had earlier anticipated, and world economic growth down to 3.2 per cent compared to the 4.2 per cent that it had projected only six months ago. Other forecasters have been even more gloomy, with some of them suggesting that the U.S. economy could slow down to only 1 per cent growth and the world economy to 2.5 per cent growth in the current year.
Of course economic forecasts are notoriously dicey, and most of the time they tell us more about the prejudices, hopes and fears of the forecasters than about the economies that are being considered. Nevertheless, there seems little doubt that the much-predicted downturn is upon us. Even the major tax cuts that President George Bush has managed to get through Congress would have at best a marginal effect in engineering any sort of quick recovery.
Unfortunately, what happens in the U.S. economy continues to be very significant to the rest of the world. The U.S. has been the major - some would say the only - engine of growth internationally, and its voracious appetite for imports has kept export growth at least stable if not growing for many developed and developing economies. The U.S. trade deficit now stands at a whopping $455 billion for the latest 12 months. But any slowdown is bound to affect imports into the U.S., which is seen as one of the important transmission mechanisms though which the domestic slide would get converted into an international recession.
WHAT does all this mean for India? Indian policy-makers and the English language media have always been remarkable in interpreting international economic processes in the most Panglossian of ways. Thus, during the Uruguay Round talks, it was declared that this would herald a wonderful new dawn for the Indian economy which would benefit in all sorts of ways from the proposed trade liberalisation. Now that international trade values have slowed down so drastically, it is instead being suggested that Indian consumers will benefit from the inflow of cheap imports from abroad (regardless of the fact that Indian consumers, like consumers everywhere, require purchasing power and therefore income from some economic activity).
Now that the U.S. slowdown is unambiguous, much of the media has chosen to argue that India is likely to be relatively unaffected. A lot of prominence has been given to the statement in a recent IMF Report that the "emerging economies of India and China will sustain their growth activity and provide an important source of stability". (Incidentally, it is ironic that the IMF sees such stability and growth in China and India as stemming from the fact that their "exposure to external developments is moderate" - a feature which is normally criticised for being inadequately globally integrated.)
Similarly, it is being suggested that Indian exports will be hit but not as much as those from other developing economies which are more dependent upon the U.S. market. In fact, the share of the U.S. market in total Indian exports has gone up significantly in the 1990s, but it is still around 22 per cent, which is less than the share of the European Union and close to the share of Asia.
Another intriguing reaction has come from some sources in the Indian IT sector, who argue that the U.S. slowdown may actually be good for this sector. Thus, the Indian IT sector could use the opportunity to project itself as the place where hard-hit American software companies can park their computer services and solutions. Also, now that the U.S. has begun to reduce the issue of work permits to Indian computer professionals, this would actually allow the domestic industry to retain expensively trained professionals.
CLEARLY, there is a silver lining to every cloud, and there is no reason to fear the worst from a U.S. slowdown. Certainly, the historical experience of the 20th century suggests that the Indian economy, like many other developing economies, did rather well in periods of international recession and depression. One important reason for this was that these periods of world slowdown allowed greater space for domestic production to merge, diversify and grow.
But there are important reasons to believe that the current slowdown may have a different impact on the Indian economy, and this is why it would be foolish to be complacent about the likely future implications of the international downturn. In this context, a recent news report (The Hindu, June 14, 2001) is of some interest. This report refers to a disagreement between the Planning Commission, which in its Approach Paper to the Tenth Plan has suggested possible adverse effects on the Indian economy of a U.S. slowdown, and the Commerce Ministry, which would like to remain very upbeat about India's prospects.
In fact, the Planning Commission document makes a very important point. It argues that "the U.S. economy, in particular, would have to be monitored carefully, since the backwash of a U.S. slowdown on India can be substantial as countries which are heavily dependent on the U.S. market search for alternative export avenues." Note that the focus of attention here is not on the effect on Indian exports, but rather on imports into India.
This is the crucial feature which our policy-makers need to take note of much more explicitly. The worldwide recession will intensify competitive pressures which will lead to a fall in international prices for a wide range of traded goods in both primary and manufacturing sectors. Already over the period since 1996 there has been a substantial decline in the unit value of imports into India, which has been the major reason why total import values have remained low despite much larger import volumes. (For more details see C.P. Chandrasekhar and Jayati Ghosh, "Has India contained an import surge?", Macroscan, Businessline, May 29, 2001; also at www.macroscan.org).
Once the world economy falls more into recession, exporters will search for more ways of entering markets other than the U.S., and further push down international prices. Since imports have been substantially liberalised and import tariffs have come down progressively, such declines in world prices will be quickly translated into lower domestic prices for imported goods.
This will mean greater pressure on domestic producers, who will be forced to compete with cheaper imports even as their own costs not only do not decline but increase. The effect is likely to be particularly strong for small scale operators in the material producing sectors, which have already been adversely hit in recent years.
This is why the coming world economic recession - led by the U.S. slowdown - may well have very different implications for the Indian economy than previous such slowdowns. And policy-makers who try to avoid these unpleasant realities, and pretend that there are no such problems instead of intervening actively to counter these tendencies, may end up making matters worse.