Six ways a Western economic slowdown will impact India

Earlier this month, the Federal Reserve of the United States and the Bank of England raised their key short-term interest rates by 75 basis points, or by 0.75 per cent. This is because the rich-world central banks are currently struggling with multi-decadal high inflation, or the rate of price rise. Hence, higher interest rates in order to control inflation is the order of the day. These higher interest rates in the West are already having a negative impact on the Indian economy.

Further, the higher interest rates are expected to lead to an economic slowdown, if not a recession, in large-parts of the Western world. This will also impact the Indian economy in various ways.

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First, higher interest rates in the US leads to money moving from other parts of the world to the US. This leads to the dollar gaining value and currencies of many other countries, including the Indian Rupee, losing value. A weaker currency feeds into retail inflation, as imports become expensive. In that sense, as the US raises its domestic interest rates in order to control inflation, it ends up exporting inflation to other parts of the world. This has been happening over the last few months.

Second, higher interest rates in the US mean lesser money moving to other parts of the world in search of higher returns. This has led to a situation where capital has become more precious for India’s unicorns and start-ups, leading to a situation where they cannot continue to burn cash in order to build scale, at least not at the same pace as they were doing earlier.

This implies that they have had to control costs like never before, leading to many unicorns having to fire a significant proportion of their workforce. In fact, the news reports on unicorn firings just won’t stop. Some start-ups have shut down as well.

Third, higher interest rates in the US and other parts of the rich world, is leading to the real estate bubbles in these countries popping. In fact, individual homes are the biggest source of household wealth. Hence, when real estate bubbles pop, the overall wealth of people comes down. This has a negative psychological impact. People feel poorer and, at an aggregate level, they spend less money than they used to. Private consumption is the biggest part of Western economies. As the real estate bubbles keep deflating, lesser spending will further slowdown these economies. This will also impact imports that these countries carry out. India’s non-oil goods exports in October were at $25 billion, around 18 per cent lower than October 2021 and 28 per cent lower than the highest monthly goods exports of $34.7 billion in March 2022. Services exports remain strong.

Fourth, the high chances of an economic slowdown, or perhaps even a recession, in the US has led to even profitable American technology companies deciding to fire a significant number of employees. A recent report on the website of National Public Radio (NPR) in the US points out that “more than 35,000 tech workers across 72 companies have been laid off this month”. Companies like Amazon, Meta and Twitter are also firing employees. If this continues, it is bound to spill into other sectors, impacting private consumption and, in turn, imports from other countries. It will also have some impact on India’s IT sector.

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Fifth, if the Fed and other rich world central banks continue to raise interest rates, as they have indicated, the RBI will also have to keep raising interest rates in India. This is primarily because the US Fed decides the direction of global monetary policy. In this scenario, higher interest rates will make things difficult for those who have already taken on loans, that is, individuals who have home loan EMIs to repay and firms which are repaying business loans, in particular the smaller firms. While the recent growth in bank loans has been very strong, if interest rates continue their upward trajectory, it is bound to slow down.

Sixth, if the rich parts of the world actually get into a recession, oil prices will fall from their current levels. The price of the Indian basket of crude oil as of November 16 stood at $89.1 per barrel. Lower oil prices will provide some relief to the Indian economy.

These are the likely impacts of a slowdown in the Western economies. As the cliché goes, when America sneezes, the world catches cold.