Tuesday, November 4, 2008


According to Percy Mistry who was writing in the Business Standard, the world financial crisis has turned into a global economic slump. Fear about future job and income security has spread more rapidly in all countries than anyone thought possible.

In a few days, people have reined in spending, more swiftly than central banks had contemplated. So have companies. Volvo reported that its total global orders for new trucks in Q3-08 were 115, vs. 42,000 for Q3-07, when things were turning bad. Auto firms are gearing for a 25-40 per cent fall in global demand. So, steel mills are shutting down furnaces across Europe.

The UK economy shrank by 0.5 per cent in Q3-08. The US economy has shrunk likewise. It would be surprising if numbers for continental EU and Japan did not look similar or worse. Contrary to expectations, China will be lucky to register a growth of 8 per cent in 2008-09. India will be fortunate to hit 7 per cent.

But the issue is not whether growth in OECD in the next few quarters is minus 0.5 per cent or minus 2.0 per cent, or whether Indian growth turns out to be 7 per cent or 8 per cent.

The Reserve Bank of India's [Get Quote] latest credit review suggests that the authorities are in denial about how rapidly unwinding could occur with a change in public sentiment, despite our robust domestic market.

The issue right now is whether governments and central banks realise the magnitude of the economic implosion they risk (through complacency or fright, even in relatively robust economies like India) without decisive action; even if it seems to traditionalists to be over the top.

The facts have changed dramatically. Governments and central banks must respond accordingly. Right now, perception and signalling are even more important than reality in ensuring that the public's fearful sentiments are allayed.

But governments and central banks seem in denial about the ineffectual impact of their Herculean exertions last month, which saw unprecedented financial rescue and liquidity pump-priming packages being put in place.

Yet, despite these efforts, which were necessary (if too little too late), the second shoe has dropped. The effects of that are likely to be large and contagious, as sudden concern about the vulnerability of ALL emerging markets suggests.

The financial crisis of 2007-08 required bank balance sheets to be propped up through measures unimaginable two months ago. But those rescues were based on harm done by sub-prime debt, toxic securitisation, and uncertainty about coverage in the credit-default swap market, which unzipped after the demise of Lehman Brothers and (virtually) of AIG.

With a full-blown global recession now under way for 2008-10, even prime loan portfolios will turn sour until economies turn around. That will result in increasing non-performing assets in portfolios that were until two months ago regarded as secure.

So banks will go into a second round of provisioning, write-downs and reserve accretion, requiring more capital. But government rescues have exhausted the ammunition available to fight this new scourge. The Brown Plan will make it more, not less, difficult to raise more bank capital.

National governments, having mutilated their budgets with financial rescues, are now talking up plans to launch counter-recessionary public capex programmes; even as demands on social security safety net financing increases with rising unemployment.

But, as Japan showed in 1990-2005, large public capex can be ineffectual, even counter-productive. What may be better is inducing private consumption through direct and indirect tax cuts, along with expenditure incentives, to ensure that private consumption does not fall through the floor.

But, with governments having stretched their fiscal deficits beyond tolerable limits, those measures seem counter-intuitive and dangerous. If a first-order problem has been created by spending and borrowing too much (whether by individuals, families, banks, companies or governments), can it be solved by spending and borrowing even more?

The answer intuitively is NO. But the consensus among global policymakers seems to be YES - at least until panic subsides and normalcy returns. Even if one agrees, it cannot be without deep concern about mortgaging the future.

The WORLD BANK takes a more optimistic view:

The World Bank report on "Global Financial Crisis: Implications for South Asia" released on Thursday shows that even as India is relatively more exposed to the contagion effects of global financial markets, risks associated with it are countered by a fundamentally strong macro economy including prudent foreign debt management, high savings rate, solid financial sector health, and a pro-active monetary policy management.

These steps will allow India to ride the crisis without destabilizing the financial sector. Further, the report indicated that the main effects of the global financial crisis will be to reduce the availability of funds leading to higher interest rates and lower public and private investment that will hurt growth.

According to the report, "The largest economy, India, is relatively more exposed to the contagion effects of global financial markets through adverse effects on capital flows from portfolio and direct foreign investments, and also through exposure of domestic financial institutions to troubled international financial institutions and to contracts-including derivatives-that have undergone large value changes. The evidence so far shows significant losses in the stock market and a reduction in the flow of foreign capital.

RBI has already responded by letting the exchange rate depreciate to stem the outflow on the current account, by providing extra liquidity to the financial sector, and by raising the limit on private foreign borrowing. The nature and depth of the global financial crisis is still evolving and there is a significant downside risk of further slowing down of net capital flows and a hardening of terms. But these are countered by an overall healthy banking sector with low non-performing loans and a comfortable capital base and a pro-active monetary and exchange rate management. Foreign debt and debt service is low, and reserve cover ($274 billion) is still substantial. The high domestic saving rate (34% of GDP) provides added cushion."

Given that an election year is around the corner, Government is pulling all stops to ensure that there is no "blood on the streets". The roll back of the Jet Airways layoff and the instruction to the Industry captains to avoid "pink slips" is aimed in this direction. LIC and public institutions stepping in to improve liquidity is part of the symphony being played by the Government orchestra. No wonder Karl Marx has suddenly emerged as the best ing author of the week!!!

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