As the U.S. faces the possibility of a recession, its economic ripple effects may significantly impact global economies, particularly India, one of the U.S.’s key trade partners. The interconnectedness of the two nations’ economies highlights the importance of assessing potential challenges and preparing India to mitigate any negative impacts.
Overview of US Economic Situation
- Rising Unemployment: The unemployment rate has climbed to 4.2%, signalling a slowdown in job growth and economic activity.
- Credit Card Debt Surge: Credit card debt in the U.S. has soared to a record $1.1 trillion. Many consumers are struggling to meet their payment obligations, reflecting financial strain across households.
- Auto Loan Delinquencies: More people are falling behind on their car loan payments, as an increasing number of borrowers are struggling to pay back their loans on time.
- Federal Reserve Interest Rate Hike: The Federal Reserve has raised interest rates to 5.50%, the highest level in 23 years. This increase makes borrowing more expensive, discouraging new loans and slowing down consumer spending.
- Stock Market Volatility: The stock market is experiencing heightened volatility, with many investors shifting away from risky assets to government bonds. This shift reflects growing concerns about a potential recession.
According to the New York Federal Reserve, there is a 62% likelihood that the U.S. economy will enter a recession in the next 12 months, driven by rising debt, inflationary pressures, and slowing economic indicators.
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Understanding Recession
A recession is typically defined as two consecutive quarters of negative GDP growth, signalling an economic downturn.
- Impact on the Economy: The U.S. is the world’s largest economy, so if it falls into recession, the impact can be felt globally.
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- GDP Decline: During a recession, the production of goods and services decreases, leading to a drop in overall economic output.
- Employment: Job creation slows or declines, and the ones having jobs face wage stagnation or salary reductions. Unemployment tends to rise as businesses cut costs.
- Consumer Behaviour: As incomes fall or remain stagnant, consumers prioritise essential goods, reducing demand for non-essential items, which negatively impacts economic growth.
| Note: An economy is like a machine where if one part malfunctions, the entire system suffers. |
| Note: A depression is characterised by a GDP decline of more than 10 percent. It is a more severe and prolonged economic downturn compared to a recession, with widespread impacts on employment, production, and financial markets. |
| Impact of the Great Recession of 2008
The recession that began in the U.S. quickly spread across the world, causing economic turmoil.
- Most Affected Countries:
- Iceland: The country’s economy collapsed entirely, with major banks failing, leading to the fall of the government.
- Latvia: Latvia saw its GDP plummet by 25%, with unemployment peaking at 22%.
- European Countries: Spain, Greece, Ireland, Italy, and Portugal faced sovereign debt crises.
The debt was so severe that the European Union, European Central Bank, and the International Monetary Fund had to intervene. Countries were forced to implement harsh austerity measures, including cutting subsidies, halting welfare programs, and enacting painful economic reforms. |
Probable Impact of US Recession on India’s Trade
India’s economy is closely linked with the US, making any recession in the US a significant concern for India, especially in trade.
Bilateral Trade Volume
- Total Trade: In FY 2023, trade between India and the US reached $128.78 billion. India enjoys a $28.30 billion trade surplus with the US, one of the few nations where India maintains such a surplus.
- Total Exports to the US: $78.54 billion, accounting for 17.5% of India’s total exports.
- Key Exports: Engineering Goods ($11.46 billion), Gems and Jewellery ($6.96 billion), Electronic Goods ($5.8 billion), Drugs and Pharmaceuticals ($5.53 billion), Petroleum Products ($4.28 billion).
This data highlights the significant impact that a US recession could have on India’s economy, particularly in terms of reduced export demand.
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Foreign Investment
- US Investment in India: From April 2020 to September 2023, the US invested $62.24 billion in India, making it the third-largest investor in the country. This investment has created numerous jobs and bolstered the manufacturing and services sectors.
- Startup Culture: US venture capital firms have significantly contributed to the development of India’s startup ecosystem, creating jobs and encouraging innovation.
However, during a recession, Foreign Direct Investment (FDI) may decrease, and large corporations might reduce their India-based operations, leading to a potential slowdown in job creation.
| Note: Venture Capitalists are investors who provide capital to startups or small businesses with long-term growth potential, often in exchange for equity. |
Impact of US Recession on Remittances
- Remittances, the money sent by the Indian diaspora to their families in India, play a crucial role in the Indian economy. For many families, remittances are a primary source of income, contributing to household spending and driving demand for goods and services. This inflow not only boosts economic activity but also strengthens India’s foreign exchange reserves. The Indian diaspora, globally, contributes around 3.4% to India’s GDP through remittances. Indians abroad, particularly in the US, contribute around $125 billion annually to India’s economy.
- Indian Diaspora in the US: The US hosts the largest portion of the Indian diaspora. According to 2021 US immigrant data, Indians are the second-largest immigrant group, with approximately 2.7 million individuals residing there.
- Possible Effects of a US Recession: If the US economy goes into recession, many Indians working there could face job losses. This would lead to a reduction in the amount of money sent back home, potentially decreasing remittances by 1-2%. This decline could negatively impact India’s GDP, as remittances are a vital source of income for many Indian households. Moreover, returning diaspora workers would add pressure to India’s already stretched job market, making it harder to absorb them. A similar challenge was observed during the COVID-19 pandemic and the Gulf crisis when returning workers struggled to find employment back in India.
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Investor Behavior During a US Recession
When the US economy enters a recession, it triggers a ripple effect across global financial markets, including India. Typically, during such times, investors tend to become risk-averse and look for safer investment options. This will led to:
- Withdrawal from Markets: Investors often start pulling their money out of riskier markets in favour of safer alternatives such as gold, government bonds, and other low-risk assets.
- This could result in a significant outflow of foreign investment from India.
- Stock Market Decline: As foreign investments exit, the Indian stock market may see a decline in stock prices, exacerbating market volatility and uncertainty.
- Reduced Foreign Investment: The withdrawal of foreign capital could lead to a reduction in future investments, slowing down India’s economic growth in the short to medium term.
Can India deal with Such Crisis?
India’s economy demonstrates notable resilience due to several factors, helping it withstand external shocks like global recessions as evident during the 2008 recession. Some key strengths include:
- Diverse Economy: India’s economy is socially and economically diverse, encompassing multiple sectors that contribute to its stability, reducing dependence on any single industry.
- Unorganised Sector: With 90% of employment in the unorganised sector, India’s economy is less vulnerable to global economic disruptions. This sector provides a cushion against the direct impact of external shocks.
- Domestic Consumption: A large domestic population ensures significant internal consumption, minimising dependency on exports. In India, this internal demand plays a crucial role in sustaining the economy.
- For example, during the 2008 financial crisis, domestic consumption and agriculture helped India absorb the economic shock, allowing companies to continue production despite global downturns.
- Digital Revolution: India’s IT sector has shown remarkable growth and stability, even during global economic slowdowns.
- Companies like TCS and Infosys provide digital services to corporations and governments globally, which are in demand regardless of recessionary trends. Thus, continue to thrive even in such situations.
- This was a key factor in India’s resilience during the 2008 crisis.
- Strict Financial Regulations: India’s financial regulations are more robust compared to other countries like the US.
- The RBI and SEBI play pivotal roles in maintaining financial stability.
- During the 2008 financial crisis, India’s stricter financial oversight helped mitigate the impact of the global meltdown.
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Conclusion
Drawing from the experiences of the 2008 financial crisis, it is clear that proactive measures are essential to mitigate the potential effects of another global downturn. The government needs to adopt a preemptive approach, preparing in advance to safeguard the economy. This includes strengthening financial regulations, supporting vulnerable sectors, and enhancing domestic consumption to buffer against external shocks. By taking these steps, India can be better positioned to navigate future economic challenges.
September 17, 2024
