Moneycontrol
Mar 20, 2017 07:57 PM IST | Source: Moneycontrol.com

COMMENT: US economy is in top gear: Is it good or bad news for Indian investors?

India’s software exports to the US are well regarded and in the long run should benefit from the strength of the US economy.

The US Fed’s decision did not hold much by way of surprises – the 25 basis points rate hike, the second in three months, had all the expected adjuncts in the accompanying statement. The Fed communicated the following to the financial markets: steady economic growth in the US, strong job gains and inflation gradually picking up to the central bank's target level of 2 percent. The bank also alluded to a rise in household spending and firming up of fixed investment. In sum, the American economy is already “doing great”. Markets also took comfort from the guidance that further rate increases would only be "gradual", with expectations of two more rate hikes this year and three more in 2018.

For an emerging economy like India, the immediate reaction was expected to be one of caution as the attractiveness of US markets and of the US dollar should result in outflows from emerging markets, depreciation of their currencies, pressure on balance of payments and an upward pressure on domestic interest rates. However, the reaction so far has been overwhelmingly positive, and there are plenty of reasons for this.

Contrary to popular perception, if we closely look at the previous rate hike cycle in the US (2004-2006) when FIIs (foreign institutional investors) were active in Indian bourses, the correlation isn’t a strong negative. In fact, the correlation coefficient between US rate action and FII flows to Indian equities is 0.5 in the period 2003-2007. Hence, it wouldn’t be wrong to conclude that after the initial hiccups, money eventually follows fundamentals and relative valuations.

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The big takeaway from Fed’s latest policy statement is the underlying strength of the US economy. Is it a cause for cheer or despair?

The value of total US- India trade (goods and services together) was estimated at USD 109 billion in 2015 – exports of US to India at USD 39.6 billion and imports of US from India USD 69.5 billion, resulting in trade deficit of USD 30 billion for the Americans. India is the 9th largest trading partner of the US for goods. It ranks 18th in the terms of exports of goods from US and 9th in the list of imports of goods to US thereby running a trade surplus with US valued at USD 24 billion in 2016.

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In the first nine months of the current fiscal, India’s goods exports to the US were USD 31.5 billion (16 percent share in total exports) and hence assumes significance. India’s goods import from the US at USD 16.1 billion was a relatively smaller portion of total imports (5.8 percent). So the American economy’s journey from good to great should be music to the ears of our exporters despite the looming threat of Trumpism.

So, which are the commodities/sectors that dominate our exports basket to the US?

India’s software exports to the US are well regarded and in the long run should benefit from the strength of the US economy. However, the key beneficiaries would be the ‘smart boys’ who will succeed in responding to the technological changes ahead of the competition.

Our deep dive into India’s exports basket to the US suggests that the top fifteen products contribute nearly 79 percent and categories like Gems & jewellery, textiles and variants, pharmaceuticals and chemicals clearly dominate the list.

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Comparative analysis of the top categories imported by US with top categories exported by India to US suggests that five product categories exported from India figure in the top 10 list of US imports. Hence, in the event of extreme protectionist policies, these might feel some heat. However, other than gems & jewellery, where India is a dominant exporter (double-digit market share) and enjoys comparative advantage, in the other categories India isn’t a dominant supplier and hence unlikely to be singled out like a China or a Mexico.

As the exhibit suggests, many of the predominantly labour-intensive industries like textiles, garments, chemicals etc. have already made inroads into the US markets and in the long run should gain from the strength of the US economy, whatever be the near-term Trump rhetoric.

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