Should India help the euro? We're most exposed there

Brazil’s recent initiative to get the BRIC economies to come together to aid the beleaguered eurozone might have met with a lukewarm response so far, but that does not mean the eurozone is not significant for the Indian economy.

In fact, the economic significance of the eurozone is actually far higher than that of the US for India today. Long term investments and earnings originating from the eurozone are 2.2 times and 1.4 times the size of those from the US to India.

Moreover, barring a complete collapse of the euro, deeper economic relations with the euro area countries offers risk diversification for India. While countries like Greece, Ireland and Spain reel under the pressure of high external debt, other countries such as Germany - the largest economy in the monetary union - remain steady.

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This neutralises the negative impact on trade and capital flows due to their depressed economies. This flexibility is not available to a standalone economy such as the US. Perhaps as recognition of this fact, the Reserve Bank of India’s (RBI’s) holdings of eurozone bonds exceed those of US treasury debt at 20 percent and 13 percent of its total holdings respectively. (Note: These figures do not include investments in commercial paper and some other avenues, and hence present a partial picture).

Here’s a detailed look at some of the major data trends that underline the significance of the eurozone economy for India, particularly in comparison to the US.

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1. Export earnings: India has exported at least $35 billion worth of goods to the eurozone in 2010-11. The actual number will most likely be higher, since full year data is not yet available for some of the smaller eurozone economies. Even so, earnings from exports to the eurozone are 1.4 times that of earnings originating from the US, as the region’s largest economies like Germany and France (and Belgium) showed continued pickup in demand for Indian products for the second straight year after slipping sharply in 2008-09. This more than made up for the depressed demand in Spain, Greece, and Ireland, among others.

2. Eurozone investments: Long-term investments from the eurozone also far exceed those from the US over the past decade. At over $21 billion, foreign direct investment (FDI) inflows from the eurozone are more than double the $9.8 billion inflows during the April 2000-June 2011 period. While the US has made more direct investments into India than any of the eurozone countries individually, the sheer size of the eurozone, along with a growing preference among these countries to invest in India, has resulted in a substantial share in total FDI into India. Netherlands, Germany and France feature among the top 10 investing countries into India, alone accounting for about $13 billion of the total eurozone investments.

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3. Euro debt holdings: Despite India’s tentative stance with respect to playing a knight to the eurozone, India holds an appreciable portion of its reserves in eurozone debt. Reported to be about 20 percent of India’s total foreign exchange reserves, this means that the absolute amount stands at as much $63 billion. In comparison, it has a relatively lower 13 percent in US treasuries, according to reports, which amounts to $41 billion as per total reserve data for the week ended 9 September 2011. Moreover, a finance ministry official has recently stated that holdings in EU currency assets will be maintained at 20 percent, suggesting a natural absolute increase in euro- denominated assets overtime.

Of course, the actual importance of the euro to India is even higher as a substantial amount of India’s imports also come from the eurozone (estimated to be at least $32.5 billion in 2010-11). Moreover, events in the eurozone have a sentimental impact on equity market investments, and demand conditions in the eurozone impact commodity prices worldwide. All of these will impact the Indian economy.

While these trends without fail underline the high significance of the eurozone to India, the real question for India is not so much whether it ‘should’ aid the euro as much as whether it ‘can’ actually aid it. The BRIC (Brazil, Russia, India and China) economies already have a proportion of their reserves in the euro. And the magnitude of the eurozone crisis does not lend itself to an easy resolution through extension of limited aid by BRICs.

A meeting of the BRICs on 22 September 2011 to discuss the issue will finally determine whether and how far they aid the eurozone. But at any rate, despite its importance to India, it is unlikely that it can affect the fate of the eurozone in a meaningful manner.

Manika Premsingh is the promoter of Orbis Economics, which provides research on the economy.