Monday, October 27, 2008

Financial crisis can create economic crisis in India

The recent financial crisis that has blitzkrieged the world since Lehman Brothers & Bear Sterns turned belly-up about a month back has already netted three countries in its whirlpool. Ukraine, Hungary & Iceland are now dependent on the IMF loans of billions. The immediate symptoms that came up in these countries were
  • Almost 20% & above depreciation of their currencies to US Dollar
  • Almost 60-70% fall in commodity prices have crippled export of their economies. Ukraine, of the steel-economy fame, is already facing retrenchment, wage-cuts because of global fall in demand & prices of steel.
  • Large current account deficit because of costlier imports & shrinkage of exports.

India is struggling with the rise in demand of dollar and rupee has already depreciated by 20%. With a CRR cut of 250 basis points & repo rate cut of 100 basis point , apparently liquidity has been restored but the demon of inflation is yet to come to down. Investors are busy converting assets to cash & holding on to them . The credit squeeze will increase cost of borrowings for working capital & new projects. North America & Europe remain the largest market for any MNC. A sustained recessionary environment in those countries will put long term pressure on the profitability of the corporations directly serving those markets & more importantly the key component of the supply chain connected to these markets; BPOs,KPOs etc. The engine of economic growth is always fuelled by lower cost of capital & building of supply lines as long as recessionary conditions/demand shrinkage are absent. With a high interest rate regime in the backdrop of lack of trust in the credit market & fears of recession looming large on the horizon, we are witnessing the turn from supply-side to demand-side economics in India.

Denying the presence of economic crisis is equivalent to denying the existence of currency & rubbishing the concept of cash. The financial think-tanks of India should do well to understand that the fruits of reforms can vanish in thin air if the economic growth rate of the country falls below 5%.

No comments: