How ‘Cold War II’ Will Impact Indians’ Wealth

Over the past five years, we have grown accustomed to China and America squaring off on trade restrictions and Covid-19 even as the Americans had grown habituated to the Russians meddling in American elections. With Russia’s assault on Ukraine, these smouldering hostilities have now been escalated to what is effectively Cold War II. The sanctions on Russia which have followed the assault on Ukraine, and China’s support for Russia in the midst of all this is likely to reverse much of the globalisation dynamic which was set in motion after the fall of the Berlin Wall in 1989.

India Impact

Given China’s increasingly menacing behaviour vis-a-vis Taiwan, India, and Australia, India is strategically inclined towards the democratic bloc led by the United States, along with the European Union, United Kingdom, Japan, and Australia.

This could lead to the creation of a 21st-century strategic equivalent of an Asian version of NATO. In any case, an economic quid pro quo between the countries in the democratic bloc and India seems to be on hand. This essentially would be in the form of increased foreign direct investments, foreign portfolio investments, and trade inflows (largely in the form of the western world outsourcing much of its white-collar office work in information technology services, finance, human resources, payroll, and marketing to India) in return of continued allegiance with the democratic bloc.

The implications of these capital and trade inflows for India’s economy are significant. Services currently account for $1.3 trillion of India’s $2.6 trillion economy. India’s total export of services currently stands at $250 billion trillion or around 9% of GDP. The combined services sectors of the U.S., E.U., and U.K. stood at nearly $30 trillion at the start of the pandemic. Even assumed to stay constant, if a mere 5% of this is assumed to get outsourced to India, India’s services exports to just this group say a decade hence could be around $1.5 trillion. To get to this number organically would imply a ten-year CAGR of 20%.

Such a blast off in services exports in turn would become a strong driver of formal sector job creation in India. EPFO and CMIE data already point to a rapid surge in formal sector job creation over the past three years. The first chart shows that India added 33 million jobs in the formal sector over FY20 and FY22.

Thanks to the surge in formal sector job creation in India alongside the boom in the services sector in India, wage inflation is likely to sustain in the mid-teens over much of the next ten years. This alongside: (a) China’s increasing reluctance to be the manufacturing centre of the world for cheap chemicals, cheap toys, electronics, low-end synthetic textiles, etc; and (b) the disruption of global supply chains as the democratic bloc brings stuff back home that was hitherto imported from China, is likely to result in CPI inflation in India staying well above 6% (i.e., the upper end of the RBI’s comfort range) for much of the next decade.

In addition, Indian investors routinely fret over rising commodity prices and especially, rising oil prices. However, if we analyse the link between crude oil prices, the Indian economy, and the Sensex, a far less worrisome picture emerges.

The next chart shows an initial positive relationship between the crude oil price change and the real GDP change for India. Understandably, however, once the oil price rise exceeds 100% year-on-year, the relationship becomes negative i.e., the rise in oil prices begins to hurt economic growth.

Presently, according to the red dot in the chart, we are well within the rising phase of the chart, meaning that the surge in crude oil prices that we have seen so far is unlikely to materially impact economic growth. Interestingly, when it comes to the relationship between crude oil prices and the Indian stock market, the relationship is positive i.e., a rise in oil prices correlates with a rise in the Indian stock market – see the next chart.