The financial sector is under a bear attack. Over the past few days, Wall Street (the financial nerve centre of the US) has been reeling under a severe financial crisis. World’s biggest financial services firms are facing the heat. Lehmann Brothers, Bear Stearns, AIG, Meryl Lynch, Freddie Mac and Fannie Mae have already gone down. Morgan Stanley and Goldman Sachs are holding on, although Morgan is also talking to a couple of banks for a possible merger. What caused this huge crisis in the first place? The answer probably lies in too much freedom. US is the world’s biggest free market economy. But at times, it is “too free”. And this possibly caused it, this time. Banks and financial institutions gave huge loans to sub-prime segment or people with dubious credentials. They defaulted and triggered this vicious cycle. Also, big investment banks bought these risks in anticipation of reaping profits but had to pay a steep price.
India, being a free market economy itself, isn’t insulated from this turmoil. It is evident in the sharp depreciation of rupee against the dollar and the fall in BSE sensex. FIIs are pulling out their money in huge numbers. Companies which had exposure to risks associated with Lehmann or Meryl will be facing losses. ICICI is an example, which will face a possible Rs 375 crore loss. Thousands of jobs also will be lost and pay cuts and pink slips will be the order of the day.
Despite all this, India has been able to avert a major disaster. And this is only because of those very regulations which we have been denouncing as being anti-liberal. Financial sector has been advocating reforms for a long time now which means easing up of these regulations and policies. However, this time, these very policies have helped in thwarting the crisis. Take for instance, the unsecured loans. In India, they aren’t easy to get. And these loans are the possible trigger of sub-prime crisis in the US.
It doesn’t stop there only. Reserve Bank of India has been favouring inflation control over economic growth for a long time now. This has resulted in tightening of liquidity in the market and steep rise in the interest rates. This has caused a slowdown in demand in the real estate sector as well as some others. RBI’s non-reformist approach also included measures such as controlling inflow and outflow of equity into the Indian markets. A prime example lies in the fact that we received an inflow of about $100 billion last year, which in many opinions, is probably about $30 – $50 billion less than what could have been there had RBI been more reformist. This approach on RBI’s part deterred extra hedge funds from entering India and in process, saved us the blues which Wall Street is suffering from. Most of these hedge funds would have been managed by biggies such as Lehmann or Meryl. And with their going down, our markets could have crashed further had these funds not being restrained. One just shudders thinking about the outcome had these funds been invested in real estate or some other sector? We could have been sitting on a financial disaster ourselves.
This financial crisis has also brought down oil prices. Prices crashed to $89 from $100 last Monday morning when New York Mercantile Exchange [Nymex] opened up for trading. Oil is still reeling from the aftershock. This, in a way, has helped our economy. Although as caution, government has rightly refused to cut domestic crude prices for now.
Every financial crisis brings with itself a sense of prudence. The oil shock of 70s witnessed a rise in globalization. Current meltdown will force countries like US to put in place certain regulations on the market. You cannot allow capital to run freely if you want free market to survive. Too much free money can be harmful. Western economies can take a lesson or two from countries like India. We may have imperfect regulations and policies and we may not be fully developed as an economy but we do know how to survive a bear attack. Our financial institutions such as RBI etc. are robust so are our economic fundamentals. The finance ministry, IRDA [insurance sector regulator], SEBI and RBI have all been doing hard work and its showing.
Every country faces a choice between a real economy and a bull-run driven one. Commonsense favours the former. I will not say that we chose to be real based only upon reasoning. There have been political compulsions also. Inflation control over growth is a policy that government had to follow keeping in mind, the elections. But I do say that we have successfully thwarted a complete financial meltdown in our country. Hopefully, the crisis in US will result in saner policies.