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Strong Dollar and Weak Trade Bode Ill for India

The year 2008 is unlikely to be forgotten soon, though most Indians are happy to see its back. Few years in living memory have seen such wide swings in fortunes of the economy.

Commodity prices and equities soared in the first half and collapsed in the second, throwing businesses, investors and even the government out of the gear.

A durable lesson of 2008 for India’s businessmen and policymakers is that there is no such thing as decoupling, that Indian economy is firmly tethered to the world economy dominated by the advanced countries and that what others do matters to India.

The year 2009 is likely to be dominated by issues related to international trade. There are three developments which would have a substantial influence on the Indian economy: the strength of dollar, the growing threat of protectionism in large economies and the collapse of the global trade negotiations.

The dollar has appreciated against major currencies since the financial crisis erupted. This is bad news for free trade. A strong dollar worsens recessionary pressures in the US by discouraging exports. And as local industries begin to feel the heat from imports made cheaper by a strong dollar, they yearn for protectionist measures.

The rich countries collectively face the most severe recession in several decades and the World Bank has predicted a 2 per cent fall in global trade volume in 2009. There is a real risk that the governments would be tempted to prop up domestic jobs and incomes with export subsidies, tariffs and cheaper currencies. US, EU, Brazil, Russia, Indonesia and yes, India too have either imposed or are contemplating some trade restrictive measure or the other. However, any obstruction to the transnational flow of goods and services can only deepen global recession and reduce exports.

That brings us to the third development: the collapse of the Doha Round of trade negotiations. The breakdown of the talks has not evoked any strong reactions indicates lack of interest. The fact that until the recent slowdown, global trade had been growing like never before gave people and governments less incentives to strike difficult political bargains.

Moreover, researchers like Aditya Mattoo and Arvind Subramaniam have pointed out that the Doha Round has become nearly irrelevant because of its inability to move beyond the well-known sticking points like SSM and sectroal tariffs and address the new challenges being thrown up. The Doha Round, for example, has nothing concrete on critical issues like food security and food prices, distortion of trade by banning of exports or biofuels and diversion of food crops. Multilateral trade talks need to discuss energy (and oil prices) as well as the problem of undervalued currencies. Without a new paradigm, the WTO will surely continue its journey to oblivion.

Where do all these developments leave India? Indian policymakers and businessmen have been operating under the assumption that markets in the major industrial countries, including the US, will remain open regardless of what India does. They rightly thought that there never was any serious risk of Indian software or textiles attracting restrictions from other countries.

However, if the global recession deepens and the dollar remains strong, that assumption may have to be reconsidered. There is a real possibility that markets for exports of India (indeed all emerging markets) may become less open. To keep them open, India may have to open up its own market a little more. The days when India could unilaterally decide its trade policy, without assessing how other countries would react, may end soon.