The Effect of Euro Crisis on India

Topics: European Union, European Central Bank, Euro Pages: 6 (2405 words) Published: December 7, 2012
Effect of euro crisis on India
EURO CRISIS: The European debt crisis is the shorthand term for Europe’s struggle to pay the debts it has built up in recent decades. Five of the region’s countries – Greece, Portugal, Ireland, Italy, and Spain – have, to varying degrees, failed to generate enough economic growth to make their ability to pay back bondholders the guarantee it was intended to be. Although these five were seen as being the countries in immediate danger of a possible default, the crisis has far-reaching consequences that extend beyond their borders to the world as a whole. As the world braces for a probable Greek exit from the Eurozone as part of the latest development in the Eurozone sovereign debt crisis, it is prudent to take stock of the situation and of the effect it might have on India. It is only wise to be prepared for the worst after the unsavoury experience of 2008 and 2009 during which many professionals were laid off in different parts of the country though the economy was not significantly affected. The resilience of the Indian economy is very often cited by many in advocating the 'India is insulated from the Eurozone crisis' theory. In my view, that is a myopic view. The 2008-09 global meltdown was a fallout of corporate greed, malpractices and lack of government control. Banks and companies collapsed for their own fault. While the band-aid came in the form of government bail-outs or, in simple terms, socialising private losses, one has to bear in mind that we are no longer looking at the prospect of failing companies or banks. We are looking at prospects of collapse of countries altogether. If Greece exits Eurozone, the Euro area national central banks and the European Central Bank would stomach big losses, threatening their solvency. Greek debt to these entities total almost 57 billion Euro. There will be a sudden flight of capital from Spanish and Italian banks. Both Madrid and Rome have repeatedly issued fresh government bonds with the promise of high returns (ranging between 5 and 7 per cent). With their economies supposed to experience de-growth (and officially Spain is in recession now), pre-mature exits from the bonds will be the most obvious panic reaction as most of these bonds are held domestically. So, rescuing the European banking system will involve pouring more money into Greece even after the Euro is out and the severely devalued Drachma is in. The European Financial Stability Facility, the instrument for fixing the European liquidity crunch, is authorised to borrow up to 440 billion Euro, of which 250 billion Euro remained available after the Irish and Portuguese bailout. A separate entity, the European Financial Stabilisation Mechanism (EFSM), a programme reliant upon funds raised on the financial markets and guaranteed by the European Commission using the budget of the European Union as collateral, has the authority to raise up to another Euro 60 billion. But with negligible growth in two of the 'most developed countries' (Germany, France, Italy and Spain which shoulder most of the guarantee commitments) and two of them in deep trouble themselves, such an eventuality seems remote if not impossible. In such a situation, the US Dollar will emerge as the most secure currency. With the collapse of the Euro, Dollar's rise against the Indian Rupee, which has already fallen to historic lows, will be meteoric. This will lead to less capital inflows as foreign institutional investors would tend to be more conservative. The fall of the rupee will make exports and services theoretically cheaper. But since India depends on imports to meet its fuel demands (generally paid for in US Dollars), fuel prices would go through the roof, making everything costlier. As forex reserves will dwindle fast, input costs will continue to rise and margins will drop drastically. Trade deficit with China, which in all probability will keep the Renminbi at an artificial low, will increase and manufacturing could...
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