Has Indian economy decoupled?

Decline of America and rise of India

Dr Bharat Jhunjhunwala

The Indian stock markets had crashed in 2008 along with deepening of recession in the United States. This seems to indicate that fate of the Indian economy follows the fortunes of the American economy. But this relationship appears to have reversed in the last five months of this year. The stock markets of developed countries have crashed while those of developing countries are rising. The U.S. markets are down by 6 percent and those of U.K. and France by 1 percent. On the other hand markets in India have risen by 48 percent, China by 45 percent and Brazil by 30 percent. Question before us is this. Will the fortunes of India rise and fall with the American economy as has happened in 2008; or they will rise while the American economy declines as has been happening in 2009.

We need to examine the causes of American economic crisis in order to unravel this question. The main reason is that wages of American workers are much higher than similar workers in India. An unskilled worker in America earns Rs 5,000 per day against Rs 200 in India. The cost of production of goods in America is high as a result. General Motors is closing its plants in America and increasing production in its plants in India and China. It plans to import more cars from these countries into the United States instead of manufacturing them in there. Less production in America is leading to less employment. American workers have less income. They are not able to buy goods like garments and Basmati rice exported from India. This is causing loss to our exporters.

There is a similar negative impact on our stock markets. Western investors have been hurt badly and have clammed up like a turtle. They are unwilling to take risks of investing in emerging markets like that of India. Instead, they have resorted to large scale sales in India in the last year because they needed to raise money to make up for the losses incurred in America. They remitted large amounts to their headquarters which led to decline in the value of the rupee and crash in our stock markets. The decline of America was being transmitted to India in these ways. Thus it was held that Indian and American economies are coupled.

My assessment is that this relationship has undergone a fundamental change in the last few months. The decline of America has now become a gain for us because there are other indirect effects that will slowly manifest. Reduction of production in America will lead to increase in production in India and China. That will lead to increase in purchasing power of our workers. This tendency is likely to persist in the long run. The negative impact from curtailment of exports and reduced inflow of foreign investment will be more than made up by increase in productive activities in our country. Just as the seedling wilts for a couple of days when transplanted but then grows much stronger, similarly, Indian economy will grow much faster in the coming years once the overhang of American connection is loosened.

Foreign investment follows a similar pattern. There has been a reduction in foreign capital inflows in 2008. But foreign investors have returned in 2009. The investors have now assessed that the decline of the U.S. economy is likely to continue in the long run. They have started pulling out of the dollar. They are looking for alternate avenues of investment. For example, Arab oil-exporting countries were investing their incomes in the U.S. dollar till recently. They are likely to look elsewhere now. And, that 'elsewhere' may well be India.

Secondly, we will save much money that we have been sending to America for building our foreign exchange reserves. According to the World Bank, the developing countries have become net exporters of capital after 2003. The amount being remitted by us for creation of foreign exchange reserves and through unaccounted transfers is more that the amount received by us in the form of foreign investment. The decline in American economy will encourage developing countries to build foreign exchange reserves in currencies other than of the developed countries. Southeast Asian countries along with China have already made moves in this direction under the Chiang Mai initiative. Thus, the savings made by us by stoppage of outward remittances will more than compensate for the loss of inward foreign investment.

The value of the rupee is likely to show an upward movement. Remember that the rupee had been slowly but steadily rising for four years from 2003 to 2007. The value of rupee increased from Rs 49 to Rs 39-a-dollar. This was the long run tendency due to increasing competitiveness of our businesses. This was followed by the American crisis. American investors made exit from our stock markets and made large remittances. The rupee crashed from Rs 39 to Rs 51-a-dollar. This was the short run tendency. Now the remittances have ceased and rupee has once again come back on its upward trail. This gain is likely to sustain in the long run.

Conclusion is that the rise of Indian stock markets and value of rupee between 2003 and 2007 reflects the long term upward tendency. The decline in 2008 was a short run tendency created by sudden exit of foreign investors from the country. This tendency has come to an end now and we are back on the long term upward tendency. The decline of America and rise of India are likely to go hand-in-hand in the coming years. Indian economy is coupled with the American economy in the short run but decoupled in the long run. The decoupling will become stronger as time passes by. We can see this happening in the decline of stock markets of the developed countries and rise in developing countries in the last few months.

Author's address: bharatj@sancharnet.in