US downgrade - another blow to Indian economy

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Bikky Khosla | 09 Aug, 2011
When the US sneezes the rest of the world catches a cold -- the recent shock-wave across the global financial markets triggered after the rating agency Standard & Poor's had downgraded the United States government's credit rating from AAA to AA+ reminds us again of the saying.

The move by S.&P. seems symbolic as the decision is based highly on political analysis. Some economic experts have already questioned the validity of the rating, and two other major rating agencies, Moody's and Fitch have yet to take a similar decision. Also, immediately after the release of the report, the US Treasury Department pointed out "a $2 trillion error", which later forced S.&P. to come out with a revised release but the same conclusion.

But still I feel, the rating is not fully void of real financial implications to the US economy. First of all, the move could result in higher borrowing costs for the federal government, resulting in higher costs for businesses and consumers; secondly, S.&P. could move further to downgrade ratings of some government-controlled financial entities; and finally, the US economy is clearly struggling at this moment with almost all of its major economic measures - stock prices, growth, housing, manufacturing and employment still dull.

Keeping aside the above possibilities, what is certain is that the recent development will impact the global trade, including India's exports, at least in the short-term. Combined with the slowing down China and the tsunami ravaged Japan, the US turbulence will further worsen the level of global trade activities as well as India's international trade.

Exporters' body FIEO has cautioned that the downgrading is "certainly not good for Indian exports" as it may lead to Rupee appreciation and higher taxes in the US shrinking disposable incomes of its citizens. Besides IT, it added, some labour-oriented sectors like leather, gems and jewellery would be hit hard. The industry lobby demanded booster packages for the export sector in the form of interest subvention and reduction in transaction costs.

In addition, I feel, Indian manufacturing needs to be taken care of at this moment as the sector has been reeling under higher prices and borrowing costs. Issues like power shortage and green concerns need immediate attention while the government should also push policy reforms, particularly in taxation, and renovate the poor infrastructure, which would help not only to strengthen the domestic industry but also to woo foreign investors most of whom still consider India's infrastructure very unfriendly.

As far the Indian economy is concerned, it seems, despite the recent volatility in the Sensex (and all major stock market indices across the world), the US credit rating downgrade would have only temporary impact on the nation's domestic consumption-based and service-led economy. Finance Minster Pranab Mukherjee recently termed the current volatility as "temporary" and the RBI has also assured that adequate rupee and forex liquidity would be maintained in the coming days.

But still it is too early to be complacent; while the Indian economy, with high inflation, rising interest rates and falling industrial production, is still far from being healthy, the effects of the US crisis would be clearer only in the coming days. If the situation worsens, prospects of the economy, the industry, and exports will largely depend on the policymakers' ability and efficiency to tackle such challenges arising from the external factors.