All that the Finance Minister of the world’s tenth largest economy had to say after the downgrading of the US sovereign credit rating to AA+ by Standard & Poors was: “The situation is grave – we need to analyze”. I could have done better.
S&P cut the US credit rating for the first time in history, from the first-class AAA to one notch below at AA+. The rating’s agency said that the US politicians were increasingly unable to handle the country’s huge fiscal deficit and debt load. Going from bad to worse, it added a negative outlook, saying there was a chance the rating could be downgraded further within two years if progress is not made in cutting the huge government budget gap. S&P said the “political brinksmanship” of recent months shows that governance in the country is becoming “less stable, less effective, and less predictable,” raising the risks that one day it might not honour its debt. The move - which came late Friday after US markets closed, allowing the world to digest the news over the weekend - was the first time the US was downgraded since it received an AAA rating from Moody’s in 1917. Predictably, the White House called S&P’s analysis of the economy deeply flawed and politically-based. A Treasury spokesperson alleged that there was a “two trillion dollar error”, arguing that S&P admittedly used the wrong baseline and erred on spending plans and debt projections.
S&P had first warned Washington of a possible downgrade in April. Then in July, during the protracted political standoff over raising the government’s debt ceiling, S&P placed the United States on credit watch and warned of a possible cut within 90 days. The White House, Democratic and Republican lawmakers battled for months until the country was on the precipice of default last week before they finally agreed to a deal to raise borrowing limits and slash the deficit. The fiscal consolidation plan finally agreed calls for $US917 billion in cuts over 10 years, but also mandates an as-yet unnamed Congressional panel to come up with another $US1.5 trillion in cuts by the end of the year. That fell short of what S&P has been saying would merit retaining the AAA rating: $4 trillion in deficit reduction over 10 years that includes both cuts and revenue increases, which Republicans refused to accept.
Let’s put these numbers in perspective – using the present $14.772 trillion US economy as the baseline, an average annual expenditure cut of $91.7 billion is about 0.6% of the total size of the economy. With the projected GDP growth as 2.8% and inflation at 2.1%, in my “simple” model this ipso facto means a stagnant US economy (with all else being constant). Of course, I am willing to reconsider my figures once the Congressional panel figures out what to do for its $1.5 trillion in cuts.
And for those who wish to trash my “simple” model, let me digress a bit. Milton Friedman defended models with untrue premises by suggesting that it does not matter how unrealistic the assumptions of a model are, as long as those models predict accurately. An analogy might be Newton’s laws of motion which depend on false assumptions about how the world works compared to quantum mechanics. Nonetheless Newton's laws of motion are practically useful for some applications, especially since those are much easier to intuitively understand and use rather than quantum mechanics. What matters, or so argues Milton Friedman, is the truth of the predictions produced by the model more than whether the premises built into the model are true.
Now what effect would this 0.6% spending cut have on India’s trade figures with the US?
The final figures on Indo-US trade in merchandise goods for 2010, which were released recently, are both encouraging and sobering at the same time. But, first, the hard, cold statistics: the volume of trade in goods between the world’s richest country and the 10th largest economy was worth $48.8 billion last year; US exports to India accounted for $19.2 billion and its imports from the country totaled $29.5 billion. Exports to the United States comprised roughly 14 percent of India’s exports last year, and its imports from the United States were just under 7 percent of its overall imports. Significant numbers, but yet not large enough for India to press the panic button.
Now whilst the much anticipated $50 billion milestone was missed by a whisker, 2010 turned out to be the best year for bilateral trade in goods. This $48.8 billion was a 30 percent increase over the previous year, when for the first time in many years the bilateral trade declined mainly because of a nearly $5 billion dip in US imports from India, in the aftermath of the financial meltdown. The good news is that Indo-US commerce is more or less a two-way trade, with the balance of trade – which is in favor of India – a manageable $10.3 billion.
Trade with India accounted for 1.5 percent of all US trade in goods, which totaled $3.2 trillion. In comparison, its trade with China accounted for 14.3 percent of America’s overall trade in goods. In November last year alone, the United States and China traded in goods worth $45 billion, close to a whole year’s worth of India-US trade. Last year, India was America’s 12th largest goods trading partner, sandwiched between the Netherlands at 11th and Singapore at 13th, both much smaller economies. The Dutch GDP is approximately half the size of India’s and Singapore’s less than a sixth. I suspect the Dutch and the Singaporeans should be worried more than the Indians.
Trade in services with India (both exports and imports) totaled $22.3 billion in 2009 (latest data available for services trade). Services exports were $9.9 billion, with imports of $12.4 billion. The US services trade deficit with India was $2.4 billion in 2009, again manageable.
The sobering aspect of last year’s trade data is that, while the Indo-US merchandise trade is on the upswing, the two countries have not been able to put it on a fast track. Though India recognizes the importance of the US market, its size and scope for the expansion of exports, it is struggling to meet even the modest goal of increasing its market share to 2 percent. Ironically (and possibly perversely) this is good news today.
Some other numbers: India received the maximum FDI from Mauritius, Singapore, and the US pegged at $56.31 billion, $13.25 billion and $ 9.71 billion, respectively, during April 2000-May 2011. In the last year, about 36 per cent of FDI came via Mauritius – mainly because most of the investors want to take advantage of the double taxation avoidance agreement between Mauritius and India and Mauritius-based investors do not have to pay capital gains tax in India. Singapore was the second largest contributor of FDI after Mauritius, accounting for nearly 9 per cent of the investment during the same period. Japan came in third with 8.3 per cent, followed by the Netherlands and the USA with 6.1 per cent each, and Cyprus with 4.5 per cent. So what are we looking at for the US? Just about $1.1 billion of the total FDI inflows of about $27 billion.
Yes indeed, I agree one can never overestimate the role of US consumers in underwriting Asia’s rise as a global, should I say, production house. And oh, I also do know about globalization and free markets and financial debris cascading across borders et al, but I daresay tongue-in-cheek, India needs to focus on S&P’s rating for Mauritius and Singapore, and not lose too much sleep over America’s (alphabet) soup! That’s for the Chinese.
Any thoughts Mr. Finance Minister?