Trump shock: Here’s a 4-D formula for policymakers to track it
As uncertainty rules high for companies, investors and governments, how matters move in terms of diversification, defence, debt and the dollar could help us gauge the impact of the Trump shock on the Indian economy and also guide policy.
The churn in the international economic system since Donald Trump became US president for a second time has fanned uncertainty for companies, investors and governments. As with the famous story from Indian mythology, the Samudra Manthan, in which the churning of the ocean generates nectar as well as poison, the ongoing episode will likely have good as well as bad consequences.
This column is a tentative attempt to list out four changes that are likely to cast a shadow on Indian economic policy in the years ahead. Each change alliteratively begins with the same letter: Diversification, defence, debt and the dollar.
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Diversification: There are several ways in which one can think of how countries will try to diversify their economic structures amid geopolitical uncertainty. Such rebalancing could be through bolstering the share of manufacturing, depending more on domestic demand, increasing domestic savings and restricting trade within regional economic zones.
One type of diversification could be in terms of how national income is distributed between profits and wages. In a more protectionist world, in which countries become more dependent on domestic demand, local consumer spending will have to be backed with a higher share of wages in the national income, especially if strong domestic demand for consumer goods is not to come at the cost of household savings. This is an issue that will resonate in India as well. More broadly, such vintage issues of macroeconomic strategy may get a new lease of life in our unsettled times.
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Defence: The world is becoming a more dangerous place. In 2024, global military spending increased in real terms at the fastest rate since the end of the Cold War, led by Europe and West Asia. India may also need to increase its military budget. In a recent article, retired lieutenant general H.S. Panag, after complimenting the Indian armed forces for what he described as their finest hour since 1971, called for a doubling of India’s defence budget to 4% of gross domestic product (GDP).
How this can be done while maintaining overall fiscal stability is a tricky question. A few years ago, the government had sought to examine whether a separate permanent defence fund could be carved out of tax revenues, but that was rejected as being outside our federal constitutional design. Allocating another two percentage points of GDP can come either through cuts in other types of spending or higher taxes, at a time when a new Pay Commission will push up government salaries.
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Debt: After a long hiatus, bond markets are once again threatening action against countries that have very high levels of public debt. Even countries such as Japan and the US have not been spared in recent weeks. “The pre-pandemic era, when too much savings chased too few bonds, is over. Governments everywhere must pay up, and big budget deficits are more dangerous," economics writer Greg Ip said in a recent article.
India is somewhere in the middle of the pack as far as the ratio of public debt to GDP goes, and International Monetary Fund projections suggest that it will be one of the few major economies in the world that will bring down its public debt ratio—albeit only marginally—between 2024 and 2030. India has the added advantage that most of its government debt is held by domestic investors. Even though public debt dynamics do not look too worrisome for India on a consolidated basis—though a few states seem to be inching towards a fiscal cliff —the financing of debt may get tougher on a global basis.
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Dollar: The US currency has been the pivot of the global financial system. It was so by design in the new international monetary order that emerged after the Bretton Woods conference in 1944. The system worked well till the US dollar came under stress because of its huge spending on the Vietnam War. The system fell apart in two acts—first when US president Richard Nixon ended the convertibility of the currency into gold in 1971 and then when fixed exchange rates were replaced by flexible exchange rates in 1973.
The US dollar continued to be the global reserve currency even after 1973. Economists around Trump seem to believe that this has imposed costs on the US economy as global demand for US assets has led to currency overvaluation, hurting the competitiveness of US firms.
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Concerns about the sustainability of US public finances is another important factor. If the US dollar is toppled from its perch as the global reserve currency—either by government policy or by market behaviour—then it will have an impact on every open economy that uses the US dollar as its main currency for international trade, whose central bank holds its reserves primarily in US dollar assets and whose exchange rate is maintained in some fixed or crawling leg to the US currency. India is one of those countries.
How matters move in terms of these four Ds—diversification, defence, debt and the dollar—can be a useful way to track the impact of the Trump shock on the Indian economy over the medium term and can influence economic policy choices as well.
The author is executive director at Artha India Research Advisors.
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