“ US sneezes, India catches a cold ”

Before the financial crisis broke out, it was generally believed that the corporate sector was in the pink of health. As the credit and liquidity crunch has intensified, the vulnerabilities have come trembling out.

To a great extent, the current economic turmoil is a fall out of the global economic crisis, which in turn, is the outcome of US sub prime crisis. However, what had begun as a financial crisis is now a crisis in real economies of the world and India is no exception. Contrary to what was believed earlier, the Indian economy is not immune from development in the global economies.

There is no panic, but it cannot be denied that a lot of uncertainties have been created with the sharp reduction of the GDP and industrial growth rates, steep and continuous fall in stock prices, erosion of export growth and depreciation of the rupee. All this has created a crisis of confidence.

Elaborating on the fall out of crisis for countries in Asia, Mr. Manmohan Singh, Prime minister of India said that the anticipated economic slow down in the US and Europe would affect exports and lending. “The growth rates in these countries are likely to be affected. This will affect exports of developing countries”– he said. He further said that international financial institutions were reluctant to lend and that this would cause problems in the balance of payments and flow of funds, from developed to developing countries.

A comprehensive policy response is required to prevent such a collapse and limit the damage to the Indian economy. The response so far has been to loosen the monetary tap and to get banks to lower the lending rates. This slowdown has hit the mid and small sized companies harder compared to the bigger firms. When the latest financial results for the quarter ending September 2008 has been disapproving for Indian Inc. as a whole, an ETIG study reveals that it is only the larger companies that have managed to register growth in profits.

The Prime minister and Finance minister have been busy meeting captains of Indian industries. The message from the government seems to be that everything will be done to ensure funds for industries. In return, Indian industries must refrain from effecting big layoffs. This approach makes sense only if the government thinks that the crisis will blow over in six months or so. This is a dangerous approach to take, because half hearted measures could result in crisis taking more than two years to play out. And action to arrest a fall in confidence cannot be confined to monetary policy.

We need a strong fiscal response. This does not imply a cut in indirect taxes only. That can only have a limited impact on the economy. People may have the money but they lack the confidence to spend. Confidence can be bolstered only through massive government spending and the creation of new jobs. This means spending on infrastructure. We are not just talking about airports, but rural roads etc., that create employment and can be planned and executed.

According to Montek Singh Ahluwalia, deputy chairman of the Planning Commission, for the current fiscal growth may even fall below the RBI estimates of 7.5 to 8.1, “we should be planning for as low as 7% this year. However we can expect inflation to come down further. This would give greater flexibility in monetary policy. Infusion of liquidity would ease interest rates and spur investment and growth” he said.

The present crisis poses a challenge, but it also creates a major opportunity- to address the long neglected issues of the financial structure. If tackled properly, the present crisis could turn out to a blessing just as the balance of payments crisis in 1991 was. It could lay the foundation for much stronger growth once the crisis is resolved.
Shruti Kapoor

[Image source: http://www.abc.net.au/reslib/200708/r166723_619985.jpg]