March 29, 2011 ☼ Economy ☼ Foreign Affairs ☼ geoeconomics ☼ India ☼ Middle East ☼ Public Policy ☼ Takshashila
This is an archived blog post from The Acorn.
Why is this important?
India is much more linked to the global economy today than it was a decade ago. As compared to 2001, today a majority of India’s manufactured output is exported. External demand drives exports and newer exports like services and engineering goods have a higher demand elasticity. If global economic growth is hit, investment, income from exports and remittances will be impacted, hurting India’s own economic growth.
In such a situation, an Indian government will face the need to cut its expenditure. It is more likely to cut down on capital spending (infrastructure) than on revenue spending (entitlements and social programmes). This, in turn, will not only cause macroeconomic problems (like inflation) to worsen in the short term, but also constrain the sustainable growth prospects of the Indian economy.
There is, therefore, a greater need for India’s policymakers to pay attention to the economic implications of the developments in the Middle East.
It’s the Gulf that matters more
So far, other than Bahrain and Yemen, the political unrest has largely taken place in North Africa and the eastern Mediterranean. These have limited oil and host relatively fewer Indian expatriate workers. If, however, the unrest spreads to the Gulf Cooperation Countries—Saudi Arabia, Kuwait, Oman, Abu Dhabi/UAE—and Iran, the implications will be of an altogether higher degree of seriousness. While the United States is unlikely to encourage regime change in the GCC countries—which are among the biggest purchasers of US arms—there is a risk that the Saudi-Iran dynamic could take a destabilising turn.
These developments impact India directly and indirectly through their effect on the global economy, through three main channels: by affecting the oil price, investment and remittances.
Oil price
Even if a Gulf state undergoes regime change, it will still have to continue to export oil and gas. However, the risk of unrest, potential increase in demand in Japan and speculation are likely to continue to cause oil prices to rise further. Rising oil prices affect India by hurting the balance of payments, worsening the fiscal deficit (due to oil subsidies) and by damping global economic growth.
(According to one estimate, visible and hidden oil subsidies would amount to between 2.2% of GDP to 3.6% of GDP at crude oil prices of $100/barrel and $120/barrel respectively. )
A closer economic relationship with Russia might be a way to manage the oil-price related risks emanating from the Middle East.
Investment
Lower global growth is likely to hurt inward investment. However, some participants also felt that India could buck this trend if the Indian government carries out measures that can convince investors of India’s long-term growth potential. This calls for the urgent and bold introduction of the so-called second-generation reforms. (Prime Minister Manmohan Singh’s statement at the Business Standard awards ceremony were mentioned in this context, although his ability to carry these out remains in question.)
The move by some GCC countries to provide fiscal handouts to their citizens, in an attempt to stem the unrest, could turn out to be a positive for India. Some of it will translate into revenues for Indian exporters and some into higher remittances by Indian expatriate workers. Also, to the extent that Gulf sovereign wealth funds have lower sums to invest in a discretionary manner around the world, it is to India’s benefit.
Remittances
India is one of the world’s largest recipients of remittances, a significant fraction of which originate from the Middle East. However, to the extent that the unrest does not affect the GCC countries, remittance flows will not be significant impacted.
The relationship between oil price and remittances suggests that the “sweet spot” for India is when the oil price is around $50/barrel. At this level, there is robust economic activity in the GCC countries and a corresponding robustness in the remittances to India. But this equation falters when oil prices go upwards of $90/barrel, after which the impact on economic activity and remittances turns negative.
Impact on India
First, the primary risk to India is of political upheavals in the region causing a global economic slowdown and, in consequence, slowing down the pace of India’s economic growth. According to one estimate, these events could reduce India’s GDP growth rate by up to 2 percent. This is likely to disproportionately hurt the poorer segments of society, especially in urban areas, more than others.
Second, the evacuation and resettlement of Indian expatriates might not be smooth and could generate some short-term political problems. This would be harder to manage if there is a surge of evacuation as a result of a precipitate crisis, the risk of which is estimated to be low. Also, the return of Indian expatriate workers could turn out to be beneficial in the medium- and long-term due to the infusion of new ideas, skills and innovation.
Open questions
Three questions were raised: To the extent that the rise of Islamic radicalism and militancy is, in part, backed by money from the GCC countries, would a sustained increase in oil prices and fiscal measures by their regimes lead to an increase in funding for extremist groups operating in India?
What would be the impact of lower remittances on Pakistan’s domestic politics, and how might that affect India?
What might be the relative impact of these geopolitical developments on India, China and the United States?
If you would like to share or comment on this, please discuss it on my GitHub
Previous © Copyright 2003-2024. Nitin Pai. All Rights Reserved.