Home / Economy / How much will a US recession hurt India?

Global economic activity is experiencing a “broad-based and sharper-than-expected slowdown", with inflation at record-high levels, the International Monetary Fund (IMF) said in its latest World Economic Outlook. Several economies, including the US, are already going through a slowdown for months. The hot question that’s dividing economists is: what’s in store for India?

For starters, the country cannot remain totally unscathed. History bears witness that India has not been immune to US recessions. Over the past five decades, the Federal Reserve’s monetary policy tightening has often orchestrated recessions in the US. Although usually shallow and short-lived, they saw ripple effects in India, too, more often than not, shows an analysis by Nirmal Bang Institutional Equities Research in August.

Some of the US recessions caused by Fed policy actions have lasted up to three or four quarters, with the average decline in GDP often staying well under 1%. But India’s growth in such instances has slowed by approximately 1.5-2.5% even in normal Fed-led recessions when there were no domestic macroeconomic stability concerns otherwise, the Nirmal Bang report suggests. For instance, in 1982 when the Fed resumed rate hikes, US GDP contracted for four quarters and India’s growth slackened to 3.5% in 1982-83 from 6% in 1981-82.

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Currently, there appears to be a phase of tranquillity in India. Domestic fundamentals have largely remained stable despite global turmoil, prompting optimistic talk from the government. However, global slowdowns can easily transmit through trade, commodity prices, capital flows, and financial dealings. For India, a vulnerable external sector is something to worry about, some experts say.

Growth pangs

Exports and investments have been the mainstay of recovery, with the former accounting for 23% of GDP in the June quarter. But that’s showing signs of moderation as rising interest rates globally to rein in inflation has hurt demand for India’s outbound shipments. The US, a major export destination, saw its India imports decline 8% and 1% in July and August. Similar declines from other Western partners widened the average monthly trade deficit to $27 billion in Q2, from $16 billion in 2021-22, as imports stay elevated.

“Any lower exports coupled with a relatively strong domestic growth (hence higher imports) could risk worsening the external balance," said Upasna Bhardwaj, chief economist, Kotak Mahindra Bank.

The impact will show up in the current account deficit, which could widen to more than 3.5% of GDP in FY23 as the trade deficit swells, said Rajani Sinha, chief economist, CareEdge.

A weak Indian rupee and depleting forex reserves to defend it can worsen the situation. “In the near term, the extent of rupee depreciation and RBI’s response through rates and forex reserves will be watched," Bhardwaj noted.

Changing realities

Even as the government strikes frequent notes of optimism, there are signs that even consumption could ebb soon. Inflation is humming along, accelerating to a five-month high of 7.4% in September, and industrial activity contracted for the first time in 18 months. Muted corporate earnings commentary and slowing purchasing managers’ index print for both manufacturing and services point towards pent-up demand running its course.

On the capital flows front, foreign direct investment inflows have remained healthy but there has been a sharp volatility in foreign institutional flows—almost 16,000 crore have been withdrawn since September after 51,024 crore of inflows in August. As a consequence of further Fed tightening, emerging economies will be exposed to an extended phase of tempered global capital flows, which is likely to put the external sector in peril. For India, this waning flow could prove inadequate to fund the rising current account deficit, some economists fear.

Optimistic tones

All said, a slowdown cannot be averted, but its length and severity are unclear. One can find echoes of the worry in recent national and international forecast downgrades, including by the IMF.

Going forward, any slowdown might take a circuitous route by pulling down prices with diminishing demand. However, India is projected to grow the fastest among major economies. It also does not have an asset bubble, which could be a sweet spot, pointed out Raghvendra Nath, managing director of Ladderup Wealth Management. Also, if weak US growth prompts the Fed to reverse track, capital flows might revive.

Such factors have led to defiant optimism. In the medium term too, a strong balance sheet and “new growth drivers" are leading to this feeling, Nomura said in a recent report. However, danger lurks: the brokerage did point out that the optimism that the momentum would carry on into FY24 was misplaced.

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Niti Kiran

Niti Kiran is a data journalist who really likes data. With over 10 years of experience in corporate and market research, she has an eye for detail. Data research is Niti's forte and constantly fascinates her.
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