This post was written by Rishi Dutta
The global financial crisis originated in the US and then spread to Europe. While the global growth has recovered from the trough of 2009, Europe has lapsed into recession again. The continuing uncertainty in the euro area poses a major risk to the global economy today. Given the interconnectedness of global financial markets, the principal risk to emerging markets and developing economies (EMDEs) like India arise from ‘risk on’ and ‘risk off’ behaviour of global financial market.
This volatility in behavior affects the economies India and other South Asian countries.
The euro area crisis first surfaced in 2009 when Portugal, Ireland, Greece and Spain slipped into recession with exceedingly high budget deficits. The crisis deepened further in 2010 with credit rating agencies downgrading the sovereigns and banks in the peripheral Europe. This significantly dented confidence, even threatening the very existence of the euro. Consequently, the risks to the global economy rose.
The problems in the euro area are largely structural in nature and existed even prior to the crisis. The global crisis only amplified the weaknesses in the system.
Indian economy is significantly integrated with the euro area. The impact so far has been mainly through trade and finance channels. As a result of slowdown in euro area, India’s merchandise exports to the region declined by a full 1%. Europe accounts for more than one-third of total tourist arrivals in India. Travel receipts have also suffered because of lower tourist arrivals from the euro area, particularly from the affected countries.
The uncertainty about the duration of the euro area crisis persists as there has not been much improvement in its real economy despite a string of policy steps. While reforms are being initiated, fresh concerns are surfacing: for example, recent downgrade of both Italy and France.
The immediate concern for India is to reduce the current account deficit from its present high level. Oil and gold are the two major items of our imports. With regard to oil, the domestic pricing has increasingly been made market determined. It is expected that this will help economizing the domestic oil consumption. Recently import duty on gold has been raised and bank finance against pledge of gold has been restricted. The efficacy of these measures, however, is yet to be tested. Inflation Indexed Bonds have also been introduced, which should help contain gold demand to the extent these bonds are used as an investment hedge against inflation.
To sum up, while national authorities are taking steps, international financial institutions like the IMF need to be more proactive to suggest ways to limit the spillover and prompt actions to be taken to arrest further deterioration in global economic condition.
What is your take on this entire situation? Should we look for an immediate solution or should we look at the long-term perspective?
What, in your opinion could be other possible policy reforms that could help India nullify or reduce the impact of the Euro Area Crisis?