Federal Reserve hikes interest rates by 75 basis points to tackle economic inflation in US. Will it help?

India is not immune to a US recession and domestic growth has slowed by 1.5-2.5 per cent even in normal Fed-led recessions. Assuming a mild US recession and GDP growth of 7.5 per cent in FY23, Nirmal Bang believes that GDP growth could slow to 6 per cent in FY24 (revised down from 7 per cent earlier. Stable domestic fundamentals in terms of strong financial sector and non-financial sector balance sheets, high forex reserve and some amount of counter-cyclical fiscal policy ahead of elections in FY24 will limit the growth slowdown to 1.5 per cent.

US market share in India’s merchandise exports declined from 22.8 per cent in FY2000 to 10.1% in FY2011, which has since increased to 18.1 per cent in FY22. The rise of US market share in India’s export basket has obviously increased India’s vulnerability to a US recession. Moreover, other key export markets, particularly Europe, are also likely to face recessionary conditions at the same time.

In FY21 and FY22, software exports recorded the fastest growth since FY11. In FY21, the US was the major destination for software exports, accounting for 54.8 per cent share; Europe had 30.1 per cent share, nearly half of which was contributed by the UK. A US recession is bound to have some adverse impact on India’s software exports at the margin.

The domestic rate cycle has never moved counter to the US Fed rate action, but episodes of extended pauses are common. Eventual moderation in crude oil prices and a weakening US dollar, which usually accompany a US recession, support domestic macro stability and a return of flows into EMs, including India. In the event of a US recession, Nirmal Bang expects a decline in yields, rupee trading with a marginal depreciation bias against dollar and muted but positive equity market returns in its base case.

The current account deficit (CAD) may be contained while the rupee may be flat or trade with a slight depreciation bias or at best see marginal appreciation if FPI inflows are very strong, Nirmal Bang said. In our view, the worst of FPI outflows from Indian equities may be largely over. The brokerage said FPI flows are likely to resume gradually, that may limit the depreciation pressure on rupee. A recession imparts a downward bias to equity market returns, but this is likely to be offset by the gradual return of FPIs, it said.

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