- As the global financial markets grapple with the decision taken by the UK to exit the European Union (EU), it is clear that the question of future referendums in other EU member-countries and potential exits will likely dominate the headlines in the coming months.
- The Indian economy has seen its total exports decline for 18 straight months, hurt by an overvalued exchange rate as well as a weak global economy.
- The uncertainty that will likely unfold in the major EU countries and especially the eurozone will add to the headwinds for a recovery in India’s exports. The challenges India now faces will be two-fold: the direct impact of any slowdown in eurozone and the policy response that may be unleashed in China, Japan and other countries to counter their own economic slowdown, both domestic as well as external. The EU is China’s largest export destination after all, and China’s currency, the renminbi, already faces depreciation pressures from capital outflows. A move by the Chinese authorities to allow their currency to depreciate further will continue to hurt India’s domestic industry unless reciprocated via a weaker rupee.
- The recovery in the eurozone has been a fragile one, with the region having emerged from a prolonged recession in 2014. The past year has seen a broad- based recovery (as can be seen in the chart on eurozone industrial production alongside), which has continued into 2016 alongwith decline in the unemployment rates across countries.
- Given the results of the UK referendum and the consequent uncertainty, both for businesses and households, the broad-based recovery in the eurozone will now remain suspect.
Is broad-based recovery in the eurozone under threat?
- The broad-based recovery in eurozone, which was expected to see a gross domestic product (GDP) growth of about 1.6% in 2016, has been supported by a gradual improvement in domestic private consumption. Besides an improvement in intra-eurozone import numbers that have supported this view, one can also see evidence of this in the improvement in the export numbers on a trend basis for a number of countries that export to the eurozone.
- As can be seen from the chart alongside (Figure 2), exports from the US, China and India are on the cusp of seeing positive growth on a trend basis. Also, exports from Japan have seen a healthy pick-up in recent months. Prolonged global risk aversion and a strengthening Japanese yen will have its own set of consequences for the Japanese economy and policy responses, which should be the subject of a separate piece altogether.
- Our concerns here are focused on the direct and indirect impact on the Indian economy from a potential slowdown in the eurozone. The direct impact is clear —a stalled recovery in India’s exports to the eurozone.
- The indirect impact, in particular from the slowdown in China, warrants closer attention. The ongoing slowdown in China is impacting the global economy, and especially commodity exporters from the emerging- market countries. More than half of India’s exports are to emerging-market countries, and thus, the ensuing uncertainty will further weigh on India’s external sector.
Exports to eurozone reflect a gradual pick-up in private consumption
- China’s recent economic indicators have continued to reflect the ongoing slowdown in the economy.While growth in industrial production has been steady over the last few months, hovering around 6%, the trend in retail sales of consumer goods as well as fixed asset investment has continued to slow.
- The massive buildup in total credit in the economy, which stands close to 200% of GDP, will continue to weigh on China’s growth prospects. The authorities have already cut interest rates six times since November 2014, and further monetary easing is likely to be limited. One of the consequences of these rate cuts has been a sharp double-digit increase in real estate prices in Beijing and Shanghai.
- Liquidity will likely be a stress point in the Chinese economy, going forward. China’s foreign exchange reserves declined $600 billion in 2015, undoing much of what was earned through a trade surplus during the same period. The decline in forex reserves has continued on a year-to-date basis, having declined around $140 billion to $3.2 trillion as of May 2016, while the trade surplus has been around $220 billion on the back of a sharper decline in imports.
- Non-oil imports, a proxy for domestic demand, has also seen close to double-digit declines on a trend basis for some time now.
- Progressively weaker data out of China will add to the depreciation pressure on the renminbi. With uncertainty now clouding the outlook for its largest export destination, the EU, limited policy options with respect to the interest rate may force the Chinese authorities to choose a path of allowing for a faster pace of depreciation of the currency, which will be detrimental to the Indian industry.
- The combination of a weaker renminbi and an overvalued Indian rupee has already been gradually taking its toll on India’s domestic industry, eroding its competitiveness as well as market share in recent years. Figure 3 is telling in that Chinese imports into India grew around 7% y-o-y in 2015, the only country with positive export growth to India among some of the major global economies exporting to India.
Significance of the Chinese imports into India
- The significance of Chinese imports into India can be even better understood if one looks at Figure 4, which shows that how imports from China have grown multifold over the last 10 years.
- In 2005, the import of goods from China stood at around $10 billion whereas in 2015, imports from China were around $60 billion. To the extent that this competes with India’s manufacturing, it amounts to around 15% of India’s manufacturing sector already (not a like-to-like comparison exactly, but value added in manufacturing in India is around $320 billion at 16.2% of the GDP), which is only likely to increase in the coming years, hurting Indian manufacturing.
- Brexit, therefore, offers India a great opportunity to ask the difficult but much-needed question: what are India’s top macro-economic policy priorities? If India is to sustain growth of around 8% over the long run, it will need policies that will not only help the country counter the risks in the global economy, but also policies that will help boost productivity and increase the competitiveness of Indian firms.
- For now, the growth risks in the Indian economy are tilted to the downside.