Will Wall Street’s Flu Make India Sneeze?

As the fear of recession grows in the US, VISI TILAK, SHANTANU GUHA RAY and VIVEK SINHA examine the possible impact it will have on our economy

AN EARTHQUAKE with a magnitude of over 8 on the global economy’s equivalent of the Richter scale, a huge ebb in the largest economic ocean of them all — can a tsunami that could engulf most economies, wipe out many minnows and seriously damage others, be far behind?

As uncertainty grips the world, and the US economy flounders between the Scylla of the sub-prime crisis and the Charybdis of a credit crunch, economists and political leaders around the globe have been providing a plenitude of opinions, united only on one thing: everyone agrees a big storm is coming. Where they differ is on the intensity, the toll it will extract and which economies, if any, will be able to provide a safe port.

Already weakened by the dollar in decline, the sub-prime crisis and the credit market downturn hit the US amidships. While it’s too early to tell whether this collision was of the Titanic iceberg variety or whether the battered US economy will limp back to recovery, what is definite is the palpable list.

Consider just one comment from Bloomberg News: “US corporate profits are in a recession and the entire economy may not be far behind.” Hence the rushed repair job carried out by the Federal Reserve (75 basis points cut in interest rates) and the Bush Administration (a $156 billion stimulus package).

The result: Emerging markets, which, by definition, are provided ballast by the consumerist czar of the economic world, are bound to be buffeted about. The question is, by how much? More important, will the internal buoyancy in the Indian economy be enough to offset the global tempest unleashed by the US in crisis?

That New Delhi is concerned is clear: at the World Economic Forum in Davos, hours before the Reserve Bank of India decided against slashing interest rates, Finance Minister P. Chidambaram told a news channel that New Delhi’s top priority was to curb inflation. “We have a large number of poor people who don’t feel anything about growth. Their main concern is inflation. We have to moderate inflation without affecting growth,” Chidambaram told CNBC-TV 18.

It was as good as a red flag notice that the government is aware that India is not immune to the effects of the US slowdown and possible recession. “The US slowdown also has inflationary concerns,” he said, adding that further weakening of the dollar will portend problems for Indian exporters.

It’s certain that the exports sector, already suffering the ill effects of the beating the US dollar has taken, will feel the effects of a US slowdown keenly. A Sakthivel, vice president, Federation of Indian Export Organisations warns that exporters have lost 15 percent of their business already and if the US recession seriously hits India, that figure could double.

The culprit, as always, is the one phrase that was the darling of economists around the world, globalisation. That big inter-linkage of economic activity around the globe, which helped businesses source raw material, products, services and capital from anywhere, anyplace — the buzzword is now the bugbear.

The links and, therefore, the impact, have been evident: on January 21, 2008, Martin Luther King day, US markets were closed — but there was a sell-off worldwide. India and Germany saw stock prices drop over 7 percent, China and Britain had a 5 percent fall and Japan a loss of 3 percent.

Today, globalisation is out of the economists’ lexicon — the key words today are insulation, decoupling, isolation. How protected is country X from the depredations a slowdown in the US can cause? “India has become more integrated with the US and the rest of the world, but we have also become more resilient and our growth engines are very strong,” says DK Joshi, principal economist at rating agency Crisil. He believes that India’s strong purchasing power, growing in tandem with rising income levels, could act as a counterfoil to the dip in demand in the US and parts of Europe. Economic Advisory Council (EAC) chairman C Rangarajan also suggests that Indian companies can offset the disadvantage of a US slowdown by focusing on productivity gains and the domestic markets.

Not all experts are sanguine about the Indian economy’s ability to ride out the storm without some serious damage. If the slowdown balloons into a full-scale recession, the adverse impact is obviously going to be more severe. Many economists believe that there could be pressure on capital inflows — despite the fact that Indian markets offer among the highest returns in the world.

The strong anchoring point for the Indian economy is its relatively low reliance on exports. New Delhi’s exports constitute about 33 percent of its gross domestic product; Beijing’s, on the other hand, are a whopping 70 percent. “The upheaval will not be much,” feels Mohan Guruswamy, chairman, Centre for Policy Alternatives.

Other experts question the strength of the economic downturn in the US. FICCI General Secretary Amit Mitra feels fears of a recession are overstated. “In the last two decades, they have kept business cycles in check through monetary and fiscal tools. The Fed had already cut interest rates and a fiscal package is ready,” he explains. Even the EAC believes this is just a cyclical slowdown that pre-dates the sub-prime crisis. The EAC, which projected a drop in Indian growth rates, from 9.4 percent in 2006-’07 to 8.9 percent in 2207-’08, believes the US slowdown will be mild and the impact low.

DESPITE SOME optimism, others point out that though India may be relatively insulated, sentiment plays a strong role in market behaviour. Negative sentiment, therefore, could adversely impact domestic markets. “Empirical data may reflect some decoupling but sentiment plays a bigger role on a day-to-day basis. Obviously, a crash in the US cannot be followed by an upswing in the domestic market,” explains Arun Kejriwal, an investment advisor. Amitabh Chakraborty, head of equities, Religare Securities, agrees with the assessment. “At the most, there could be some divergence but complete decoupling cannot be achieved overnight or, perhaps, never,” he says.

In a study released by Goldman Sachs, Can India ride out the US recession storm?, authors Tushar Poddar and Pranjul Bhandari make a case for cautious optimism: “We think that the economy has sufficient internal ballast so that it won’t be blown off course, but it will lose some momentum. In particular, we believe merchandise and software and other services export growth will halve in FY09 due to the global slowdown, with negative implications for employment growth. The structural growth story remains intact and opportunities to invest in one of the more dynamic economies will remain plentiful and, as a result, our equity strategists remain overweight on India.”

In the medium-term, what can Indian companies expect? Experts agree that sectors such as gems and jewellery, handicraft, textiles, leather and infotech will see maximum impact. Ajay Sahai, director general, Federation of Indian Export Organisations says that the handicrafts sector will be the most severely hit, followed by gems and jewellery. “There has been a massive decline of 40-50 percent in handicraft exports from last year,” he says. That’s because this market is almost completely US-driven. In gems and jewellery, growth was projected at 20 percent, but due to the dwindling value of the dollar and the slowdown in the US, he says the growth rate is down to 10 percent. “It could have been worse, except for the offset provided by European markets,” he adds. Sahai sees a fall in growth figures of other export-oriented industries, such as textiles (10 cent growth) and leather (3-5 percent growth), and a decline of 10 percent in marine products.

THAT THE rising rupee has affected the IT industry is evident: one effect has been lightened pay packets. In an internal communication, Tata Consultancy Services, Asia’s largest software services firm and India’s largest private sector employer recently informed employees of an imminent cut of 20 percent in the variable component, which forms almost a third of an employee’s compensation package. Could that have been in response to the fact that, in Q3 of 2007, revenues dropped for the first time below 50 percent from the North American region?

Export-oriented firms in other sectors are gearing up to face the crisis. South-India based Farida Shoes, which supplies footwear to Wal- Mart, JC Penny and Timberland, is trying to reduce dependence on the US market. “Initially, it will be housing, auto and white goods which will be affected. If the problem persists for another 12 months, then you will haveproblems in clothing and footwear,” says Farida Shoes boss Rafique Ahmed. He has already cut his exposure to the US market from 50 percent in late 2006 to 40-45 percent: now, he’d like to slash it to around 30 percent by the end of 2008, focusing more on Europe.

Others are following suit, and trying to cut costs too. Ashok Kumar Jain, chairman, Carpet Export Promotion Council, says the industry is trying to innovate to offer cheaper products and retain cost competitiveness. “We are also organising shows in newer markets of Latin America and European nations like Portugal and Turkey to increase our geographical reach,” he adds.

Ahmed and Jain are hardly in a minority: Satyam Computers has pared exposure to the US from 70 percent of revenue three years ago to 57 percent. “The rest of the world has numerous opportunities that can be tapped,” says Sailesh Shah, chief strategy officer, Satyam Computers.

Such activity is, however, revealing — it shows just how powerful a punch US purchasing really packs all over the world. And that Indian producers are no exception to the rule that if the US sneezes, the rest of the world gets a cold. Mira Kamdar, Bernard Schwartz Fellow at the Asia Society in New York and author of Planet India: The Turbulent Rise of the Largest Democracy and the Future of Our World, agrees that if the US goes into a recession it will affect the Indian economy. “The information technology sector alone risks suffering adversely, as the United States is by far the largest market for Indian outsourcing services. There will also be less capital floating around to invest in India, both in the stock market and in direct investment in various enterprises,” she told TEHELKA.

Kamdar feels that there was a section of experts that hoped India and other emerging markets would not be affected by a downturn in the US because they were increasingly investing in each other and looking at markets and sources of capital beyond the US. But that has been belied by the stark fall of the Sensex in tandem with stock markets around the world. “This now has people jittery that so-called emerging markets, including India, will not remain unshaken if the giant stumbles,” says Kamdar.

She believes that the US recession will affect both the appetite for Indian exports of goods and services and the capital available to invest in India. “It will also shake Indian consumer confidence and may trigger a burp or even a bursting of India’s own credit market, which has exploded in recent years and is a huge factor in the fast growth of India’s consumer market for everything from houses, to cars, to other consumer durables,” she adds.

Pankaj Ghemawat, Professor of Global Strategy, IESE Business School in Spain and author of a recent book, Redefining Global Strategy, believes that much depends on the drivers of the recession. “The housing-driven downturn that started in the US last year didn’t have much of an effect on the rest of the world because housing is mostly a domestic story,” he explains.

BUT THE credit crunch that began in the summer seems to be a global phenomenon that is spilling over. “As a result, the notion of a decoupling between the US and the rest of the world, particularly emerging markets, is no longer popular (e.g., at Davos last week). And given that we’re talking about the US, which accounts for 20 percent of global GNP and 30 percent of imports — and is one of India’s leading trading partners, a downturn there will inevitably have some impact on the Indian economy.” But he agrees that effect on the Indian economy is likely to be moderated by its relatively low levels of exposure to foreign trade and investment — lower than for China, for instance.

Anupam Chander, a leading scholar in the law of globalization and digitization, Visiting Professor, Yale Law School, and Professor, University of California, Davis, surmises that some American companies may have less capital to invest abroad, including in India, while others may be anxious to diversify their investments into foreign countries, including India. An American recession might induce cost-cutting which may spur drives to increase efficiency, including through outsourcing services cross-border to countries such as India.”

While most experts and industry-watchers are either doomsayers or holding out the hope that India will be somewhat battered but safe, , there is a small minority that actually believes that India and other emerging markets might well ride out the storm largely unscathed, much like a champion surfer.

What is the possibility that a recession in the US could actually work to India’s advantage? Infosys mentor NR Narayana Murthy is optimistic: he feels that a recession will create opportunities for Indian corporations, including IT companies, emphasizing that a focus on better allocation of money means a greater opportunity for India. Guruswamy categorically feels that a recession in the US will see organisations such as banks cut jobs, which means more BPO operations in countries like India. Kamdar agrees with the possibility that in the long-term, a prolonged recession in the US may well wean Indian industry from its heavy dependence on US markets and capital and push the development of other markets and sources of capital within Asia and across the world. “This diversification could be a good thing for India’s economy,” she says.

“If the emerging markets continue to be engines of global growth even if the US goes into a downturn, it will tell you we are in a new chapter of global economic history,” says Cambridge Energy Research Chairman Dan Yergin.

If all this seems idealistic rather than practical, it does reveal the truism that every crisis contains within it both the potential for disaster — and the kernel of an opportunity. Although it might be impossible to deny that the coming storm will inflict some damage, it’s how India handles it that will allow it to both weather it, and emerge the stronger as a result.

With inputs from Morgan Harrington

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shantanu@tehelka.com