After Shock Within, Comes External Shock Wave

Apart from demonetisation worries, Donald Trump’s victory in the US has added new risk variables for equity, bond and currency markets

The government’s demonetization contretemps has focused attention on the short-term havoc it will inflict on the domestic economy. There’s another worrisome front opening up which could exert additional pressure on the stressed economy: the external sector.
Donald Trump’s unanticipated election victory in the US and his scattergun statements on trade, visa control and general economic policymaking have added new risk variables for equity, bond and currency markets.
In addition, markets sense that the Federal Reserve might be on track to increasing interest rates in December. Consequently, investors are headed for dollar-denominated assets which, in turn, has adversely affected emerging market assets.
In India, foreign portfolio investors sold close to Rs32,000 crore of securities in November (till 25 November) alone. Predictably, the Indian rupee also depreciated by over 2% in November.
It also raises questions about the Reserve Bank of India’s (RBI) surgical strike: There’s speculation that the sudden and inexplicable 100% incremental cash reserve ratio announcement is aimed at stopping the deposits deluge from bringing down bond yields further and staunching outflow of foreign exchange.
But, that’s not the main problem; it only adds to the underlying weakness. The problem lies on the current account front.
The mainstay of India’s export basket— services—is slowing down. According to RBI data, services exports between April-September 2016 increased only 2% over the same period in 2015, while services imports are up 7%. And, though India enjoys a positive trade balance in services exports, slowing export growth has shrunk the surplus trade balance by 50%.
There’s more. The performance of software and IT-related services exports, the largest contributor to services exports, is expected to deteriorate progressively. Leading infotech companies are revising their FY2017 estimates downwards.
For example, Infosys has marked down its top-line growth expectation to 8-9% for FY17; the lowered guidance comes a second time this year.
Nasscom, the industry association for the information technology and business process management companies, expects IT industry’s exports to grow at 8-10% for the financial year ending March 2017, against its earlier estimate of 10-12%: from $119-121 billion estimated earlier to $116-118 billion now.
The drop in the IT sector’s revenue generation is a direct fallout from US-based companies holding back, or deferring, their spending till the political drift becomes clearer. Trump is expected to take over in January; meanwhile he has revealed his business agenda which, if followed through, is likely to spell trouble for India’s IT sector.
For example, he has promised to review the US visa programme and reform “abuses of visa programmes that undercut the American worker”. Read that as targeting the H1B visa programme, a non-immigrant visa that allows US companies to hire foreign workers in specialized roles for short periods. In IT-speak, it’s a special window which allows Indian software coders to work on client sites in the US.
Trump seems to be following through on his promise: his pick for advocate general, Alabama senator Jeff Sessions, is a long-time H1B opponent who has tried to legislate a reduction in H1B annual quotas and sought federal investigations into alleged H1B visa frauds.
So, till the picture gets clearer, most US companies have put their IT spends on hold. This hurts because the US accounts for about 60% of India’s software exports. Add to this Brexit and the uncertainty caused earlier in year, and that’s another negative mark against the rupee. Expect further changes over the next few months as the picture becomes clearer.
There’s additional pressure on the horizon. Goods exports have been in steady decline, affected by a mix of cyclical and structural factors. Merchandise exports between April-October 2016, in dollar terms, were stagnant (actually marginally down by 0.17%) over the same period in 2015.
The trade balance might look redeeming, with the negative spread between imports and exports having narrowed but hides another source of worry: goods imports during April-October contracted 10.85% in dollar terms.
Apart from the impact of lower oil prices, this reflects two trends: waning global demand squeezes items imported for re-export (such as precious stones, or other jewellery inputs), and decline in domestic demand affects imports of raw materials or intermediate goods.
The bad news doesn’t end there. One of the pillars of India’s current account— remittances sent by Indian workers overseas—has also been steadily coming down. Net remittances during April-June 2016 amounted to $8.82 billion, down 3% from $9.1 billion in the same period of 2015.
It can be argued that the external economy has been under stress for a while. What’s changed is the effect of demonetization on the economy.
The sudden liquidity withdrawal will have a shock effect on the economy, disrupting supply chains, dampening an imminent consumer-led economic revival, deterring capex impulses and lowering overall GDP growth.
How long that will last is still uncertain. But what is certain is that the added burden of a shrinking external economy—gripped by a decade-long slowdown and buffeted by systemic shocks like Brexit or unexpected sharp turns in US economic policy—will only aggravate the systemic shock.

This article originally appeared in Mint newspaper on November 30, 2016, and can be also be read here

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