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July 30, 2018

Indian Economy: This time, it's complex

The Indian economy is facing headwinds arising from the emerging globalgeopolitical and economic scenario. Oil, end of quantitative easing, and tradewars are the three perils that the world faces. While crude oil price surge is theleast complex of the shocks, the other two shocks – monetary policynormalisation in most of the advanced economies and intensification of tradewars – take us to unchartered territory.


Elevated crude oil prices are has the most perceptible impact on currentaccount deficit (CAD) and inflation. However, crude prices are expected toease in 2019 on easing global demand and structural shift to nonconventionalfuel alternatives, suggesting that its impact will betransitionary, unless oil prices stay elevated longer than expected, in whichcase the pressure on inflation and fiscal deficit can mount.


The retreat of the central banks of advanced economies – the United States(US) Fed and European Central Bank (ECB) from unconventional monetarypolicies can impact emerging markets such as India through interest ratechanges and currency exchange rates. Research shows that US interest ratehikes plus quantitative tightening will have a greater impact on globalfinancial conditions than the actions of the ECB and the Bank of Japan.Therefore, a faster-than-expected catch-up in inflation in the US can result inimpulsive tightening, which would roil emerging markets.


Trade wars are intensifying and getting more complex. While US tariff wallswith other economies are rising and facing retaliatory action, within Asiathere has been an attempt to lower them for each other. The endgame of tradewars is hard to fathom, but they certainly have injected uncertainty intoglobal policy direction and their impact will play out via trade, investment,supply chain disruption, and the confidence channel. The tariffs imposed bythe US so far impact 5.7% of India’s total exports to the country. The impact ofthe tariffs imposed thus far is rather limited with the tariffs on thesecommodities collectively working out to ~0.02% of India’s gross domesticproduct (GDP) and 1.2% of India’s CAD.