I have been planning to write this article for quite some time to put my views on why should India (and obviously Indians) care about the health of foreign countries, specifically speaking of our western counterparts such as Americas, Europe, etc. Why do Indian stock markets drop several percentage points if European economies declares their adverse GDP or employment numbers ? Why does it matter to observe America’s government elections or policy decisions of European Union ? Why do we care if Greece goes bankcrupt and EU breaks ? The list of questions can go on and on – and probably I can answer all these questions in just one word – ‘GLOBALISATION’. I don’t intend to elaborate on what Globalisation is in this whole article, hence let me quickly explain it in a few sentences.
What is Globalisation ?
Lets understand it with a very simple example. Let us say that you produce milk at your home by employing a cow. Hence, you do not care if the next door milk man or the entire market is selling the milk at x, y or z prices. Now, if you decide to sell your cow and end up buying your household deman for milk from a neighbouring milkman as he promises to give you a better quality milk supply. Suddenly you become reliant on an external factor for your milk supplies. If the milk man’s cows do not give sufficient milk or if the cow’s fodder becomes more expensive, he would eventually end up increasing the price of milk. An increase in price owing to decrease in supply of milk or owing to increase in cost of producing milk would eventually end up affecting your family budget. Hence you may be closely monitoring the supply and cost factors affecting your milkman – won’t you ? This in very simple term explains what globalisation has done to India.
India is no longer an economy as it used to be in 1970s upto 1990s where its trading relationship with external countries was limited and stringently controlled. Globalisation has resulted in India opening up its trade barriers and to a big extent it has benefitted us ! Inflow of foreign capitals, MNCs, services resulted in creating a lot of jobs and kicking India’s growth rate on an over drive. A lot of quality products became accessible to Indians, which were earlier a dream. On the other hand, it resulted in Indian economy being postively correlated with other countries as now India became dependent on other countries.
India’s External Trading Relationship
Let me now quantify the extent of India’s relationship on external countries with a help of a few numbers summarising India’s export / import trading activities – apologies if it sounds a bit boring, but it really gets things into perspective. If you refer to the table below, you would realise that how much of our external trading business is dependent and concentrated upon top 25 countries and hence a slight shift in the policies and economic situations of these countries may affect our economic well being. The statistics are soured from Export Import Data Bank. Our exports comprise of 25% of India’s GDP which gives a big perspective that if our foreign traders don’t trade with us or if they trade less with us, our growth is going to be severely impacted as 1/4th of our growth is dependent upon our foreign trade.
We are aware that India is a major exporter of Technology services and hence the following statistics provided by Nasscom would be particularly interesting :
- IT sector is a net employment generator – expected to add 230,000 jobs in FY2012, thus providing direct employment to about 2.8 million, and indirectly employing 8.9 million people
- As a proportion of national GDP, technology sector’s revenues have grown from 1.2 per cent in FY1998 to an estimated 7.5 per cent in FY2012
- The industry’s share of total Indian exports (merchandise plus services) increased from less than 4 per cent in FY1998 to about 25 per cent in FY2012
The above statistics clearly reflect on how much India’s growth story is reliant upon our external trading partners.
Global Banking Industry – FIIs
You may have often heard on the street that the recent surge in stock markets is probably attributable to foreign fund flows coming into India – this is to an extent true ! The banks outside India, particularly in US, UK & Europe are flush of liquidity. They can borrow money at an interest rate close to zero percent from their respective central banks and can use this liquidity to invest in profitable venues. This is closely reflecting another link-pin : The global interest rate scenario commands the level of liquidity which is available at the disposal for the investors. If the interest rates go up, it would reduce the level of funds which the banks can play with and hence resulting in lesser funds flowing into India.
US Politics and Indian Growth Relationship
This flashes so often in the news – whereby US politics (for all fair reasons) is trying to improve the financial & economic situation of their countrymen by creating more jobs and preventing as much as possible flow of jobs outside US. Unfortunately, in order to be successful, US politicians would need to clamp down on the overall outsourcing of jobs outside of US. Fortunately, India is the market leader when it comes to getting the market share of the outsourcing business. India proudly commands 58% of global outsourcing’s market share in 2011 (source – Nasscom). Any change in political stance to reduce the level of outsourcing hence affects Indian companies which are into the outsourcing business and hence affecting India’s growth story.
Reduced Private Equity into India
If you have limited funds or if you forecast that your future financial position may be under risk, would you go ahead and invest in uncharted territories or take long term investment risks ? Probably not. This in simple terms defines the relationship of private equity funding into India. With a downturn scenario posing upon our western counterparts, any prospective funds from these countries into India becomes limited. And without adequate funding, new investment projects in India may not pickup which hampers our longer term ability to grow on a sustainable basis.
As we know, employment is generated by industries and service sectors (plus agriculture). However, if the industries / services are not doing well, their scope to generate further employment or sustain current employment levels becomes very limited. With industries & service companies in India becoming heavily dependent on external countries, any policy decision on outsourcing, reducing of imports, reduction of growth of foreign countries results in reducing the scope of Indian entities to make more progress and hence hampers the employment prospects in India.
Balance of Payments & India’s Credit Rating
By above points it would be evident that economic health of India is dependent upon the economic health of our western counterparts. Yet another impact point is the impact on India’s Balance of Payment (BOP). BOP in very simple terms means Total Foreign Exchange Inflows Less Total Foreign Exchange outflows. It is represents debits / credits in India’s bank account. If we have a deficit (net outflows), then India’s financial situation goes down and vice-versa. You would realise that net outflows would be dependent generally on imports being more than exports. Hence if we export less than imports and we receive less foreign fund inflows in the country (or have fund outflows), then it would result in a deficit on our BOP. A consistent deficit in BOP would surely result in degradation of India’s credibility – just like a person’s bank account having more outflows than inflows. Eventually it may lead to a credit rating downgrade for India, resulting in a whole set of negative cascading effects. You can read my article If India’s Credit Rating Gets Downgraded for more details on this topic.
Economic health of a country in the current era of globalisation is now open to whole load of factors, many of which are not within the control of an individual country. A series of linkages have been estabilished whereby the infection of poor economic growth can easily spread from one country to another making it very difficult to quarantine poor performing countries from better performing ones. Perhaps it has created a systemic risk which explains why the current crises sprang up from one country to engulf the complete Eurozone, Americas and has started affecting the growth tragectory of Asia. How long would this last – perhaps 5 years, decade ? Your guess would be as good as mine. But perhaps if we know the economic linkages between different countries, we can be better geared to handle both opportunities and threats that arise out of such testing times and emerge out as a winner (rather than just blaming our politics) !