Western economic crisis: need for cautious approach
by Ashwani Mahajan on 16 Jun 2010 0 Comment

In the past two years, US and European countries have been passing through massive economic crisis. From America's financial sector leading company Lehman Brothers, to premier car manufacturing company General Motors, countless companies have declared themselves bankrupt. Their banking system is in a shambles. The crisis supposedly started with sub-prime lending, i.e. lending to those who lacked capacity to repay. To somehow deal with the crisis, trillions of dollars of government assistance program was implemented. Affected by the crisis, European governments also followed suit and implemented heavy economic assistance packages to save their respective countries.

Greece, a country of the European Union, has come into serious economic crisis in the last few months. This time the crisis has cropped up due to heavy borrowing by the government and not because of indiscriminate lending by the banks. The US crisis was mainly linked to the financial sector; the crisis of Greece was attached to bankruptcy of the government. Obviously the existence of any country depends on the credibility of the government. Greece government’s inability to repay its loans created the crisis. Currently with the assistance of the European Community to the tune 8.5 billion Euros, Greece’s government could honour its debts maturing on May 19th 2010, and crisis has been averted for the time being.


It is not only Greece

But the crisis is not just of Greece; the situation is not different in other European countries except that they are not amidst sovereignty crisis at present. A few days earlier, Germany’s ban on short selling in stock markets almost shocked the European Community. This move indicates signs of similar crisis in Germany as well. The German government says that by this move they are trying to prevent speculators to artificially increase the cost of government debt. Greece, Portugal and Ireland's public debt has surpassed 60 percent of the GDP. These countries have already announced austerity measures and fiscal cuts by freezing salaries of public servants and reduction in various perks. Clouds of economic crisis are looming large in Italy as well. Other countries are also not untouched by the crisis including England, which for the time being is looking strong.


The impact is that the European common currency has been constantly getting weaker. Exchange rate of Euro which was Rs 70 in December has come down to Rs 56 now. Its impact on other countries is also being felt and stock exchanges all over the world have started feeling the burnt. India's stock index has been declining continuously for the past few days due to depressing signals from Europe. Foreign institutional investors are trying to divert their money from stocks to gold and government bonds in search of safe havens. In the past few days, withdrawal of foreign institutional investors’ funds has weakened the rupee.

Aid package of nearly one trillion US dollars by the European Community and International Monetary Fund has been designed to find a solution to the problem. But it is believed that despite all these efforts, Europe's crisis is not going to subside. Stock markets initially welcomed and showed upward trend, but the impact did not last long and they came under pressure again and stocks started tumbling down and heavy losses were reported world over.


Investors getting attracted towards India

India's development journey is continuing unabated despite downturn in US and Europe. Though there has been a marginal impact on growth rates in India after the US crisis; whereas world’s GDP decreased by one percent in 2009-10, a growth rate of more than seven percent was recorded in India. The situation is more or less same in China, although China faced a significant decline in exports due to global meltdown. This also indicates at greater exposure of Chinese to global markets.


A situation is fast emerging in the United States, Europe, and Japan that rate of return in all these countries will be reduced to near-zero. This means investors are getting zero percent yields on their investments. Investors are turning to Asian countries in search of better options. Heavy investments in infrastructure, fast growing GDP and thus increasing demand, are pushing investors towards India. Financial institutions are buying gold in the short run in search of safer investments, but in the long run better returns on investments made in India will definitely bring them back to India and other Asian countries.


India Must Exercise Caution

But we should remember that this is `hot money 'i.e. investments which may evaporate any time, the moment investors decide to withdraw. So the country may endure heavy losses. To avoid this type of crisis, tax has been imposed on foreign institutional investors in Brazil in 2009 on buying of stocks. This move has helped Brazil in effectively controlling FIIs. For quite some time, foreign institutional investors are causing havocs in the stock markets. In India too these FIIs need to be controlled effectively. Not only a similar tax could be imposed in tune with Brazilian tax on purchases of shares by foreign institutional investors, at least three years ‘lock in period’ may be imposed. In this manner, not only an effective control would be exercised on FIIs, but the investing public may also be saved from upheavals in the stock markets.


The writer teaches Economics in Delhi University 

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