For the March 2020 quarter, the United States reported the worst quarterly growth since the peak of the Lehman crisis when the US economy had contracted at (-8.4%) in Q4-2008. Almost 12 years later, the US economy has contracted by (-4.8%) in Q1-2020. This time around, the negative growth has been largely driven by the collateral damage of COVID-19.
How the US dipped into negative growth?
Exactly one year back, the US economy had shown positive growth of 2.1% and the only concern at that point of time was whether the trade war would damage the growth trajectory. The trade war did get relegated on the back of a Sino-American truce but the COVID-19 pandemic came as a big blow to the US economy. The US Commerce Department has underlined that the pandemic forced closure of businesses and virtually halted purchases and even investments. Macro analysts are expecting growth in the June 2020 quarter to dip to beyond (-10%) as the full economic effects of the virus are expected to sink in. The jobs data shows that nearly 26 million jobs have been lost to the pandemic.
The biggest hit was on personal consumption, which literally drives the US economy. For example, personal consumption fell by (-7.6%) in the first quarter due to spending cuts in a plethora of sectors like healthcare, automobiles, oil and financial services. US banks have already warned that the recovery in growth, if any, will be gradual and spasmodic.
US Federal Reserve draws a blank cheque
The Americans refer to it as a check rather than cheque but they could afford to be different for a variety of reasons. Being the largest and most powerful economy, the US always set the standards; at least in the last 100 years. One factor that has supported the US in this journey is the exorbitant privilege of having the dollar as the pivotal currency of global trade and finance. That enabled the US to boost the economy with unlimited money supply and liquidity. The US Fed exhibited that in 2008 and has again shown that in 2020.
In the Fed meeting on April 29, 2020, coming just a day after the GDP contraction announcement, the US Fed again committed to keep the interest rates anchored near zero till the time the economy recovers with conviction. In fact, the Fed has committed to keep rates at near-zero and liquidity abundant till the time the US economy returns to 2% inflation and full employment. That surely looks a long time away for now. The Fed, in its statement, also avoided any reference to bond purchases; hinting that liquidity infusion will also be virtually unlimited till the time the economy recovers substantively.
What does this US contraction mean for India?
Clearly, the growth slowdown in the US is going to hit the Indian economy and its recovery in multiple ways. To begin with the US still accounts for a whopping 16.8% of India’s total exports to the world; and that is quite a lot.
It is not just about the share of US exports that is material. What is more important is the composition of trade with the US in contrast to India’s trade with China. Consider these numbers.
For the fiscal year 2018-19, total Indo-US trade was to the tune of $88 billion as compared to $87 billion with China. This was the first time in 6 years that Indo-US trade had surpassed China. But what is more critical is that India runs a trade surplus of (+$16.85 billion) with the US while India runs a huge trade deficit of (-$53.56 billion) with China. That is why US trade becomes so central to India. This is just the merchandise trade and we are not even talking about the billions of dollars that India earns from the US via software exports.
India will also benefit from a dovish stance by the Fed
The real takeaway for the Indian markets, however, would be on the liquidity front. With the Fed committing to keep global liquidity abundant and rates near zero till growth in the US recovers, there are 3 clear benefits for Indian markets.
The RBI will be able to persist with its low interest rate policy and can even afford to get more aggressive on rate cuts.
Indian bonds will continue to attract FPI interest as the Fed policy will hold US 10-year yields closer to 0.60% and the yield spread on Indian bonds will be comfortable.
Lastly, abundant global liquidity was a driver for Indian equities in the last 10 years and that looks set to continue; at least in the foreseeable future.