India and Europe’s tribulations

The past month has been eurocentric , and it continues to be so. It is an unfortunate case of delayed effect. After all, the Greece fiscal imbroglio was uncovered by the newly-elected government shortly after it came into power in October 2009. That is, by the standards of the day, a long time ago. So, why is it causing tremors now?

One may recall that there was a major fracas about Dubai in late November 2009, but once cousin Abu Dhabi stepped in and bailed Dubai out, it was over. The problem with Europe is that unlike the emirates, blood runs thinner than water.

It is well understood that when the question of confidence is raised, the best and the only way to respond is immediately . If you let the problem fester, it gets worse and contagion begins to spread.

Why, one wonders, were the authorities in the eurozone so slow in sorting out the problem in Greek? It was a fairly straightforward issue.

The country had borrowed well beyond its means, concealed it, and is now facing a payment crisis. Either other members collectively pay out the cash needed to make Greece solvent for the moment, or suspend it from the eurozone and leave it to the care of the IMF, whose mandate it is to deal with external payments crises.

But the eurozone did not have a provision of extending collective assistance, nor was it willing to face the consequences: question mark on the credibility of the euro likely to flow from suspension of Greece from the monetary union.

Further, as the markets caught on quickly, Greece was not the only one that had lived beyond its means and the idea of bailing out wholesale nearly half of the membership was simply beyond the capacity of the solvent few. Finally, the public in the member countries perceived to be solvent by the rest — most prominently Germany — seemed to be understandably, vehemently opposed to the idea of such bailouts: which were not just massive, but also potentially openended , that is a continuing feature.

Greece joined the eurozone in June 2000. In 1998, its current account deficit (CAD) had been 2.8% of GDP, which jumped to 7.8% in 2000 and remained close to this level till 2005. In 2006, it soared to 11.3% and to 14.6% in 2008. In the nineties, the average CAD had been 2.5%, but it was 9.3% in the next decade. But Greece was not alone.

Portugal had an average CAD of 1.6% till 1997, the year before it joined as a founding member of the eurozone.
Thereafter, this number averaged over 9%. Spain, a comparatively large economy, had an average CAD of 1.7% between 1990 and 1997; thereafter, it was 5.4%.

In the boom years of 2005 to 2008, the CAD that these countries ran up was staggering: Greece 14% in 2007 and 2008, Portugal 10-12 %, Spain 10% in 2007 and 2008. Spare a thought for those lined up to join the eurozone: Estonia with CAD of 18%, Latvia 22% and Montenegro 52%.

Basically, the less industrialised members of the monetary union went on an unprecedented shopping spree fuelled by the magic that the euro bestowed on their ability to borrow and attract equity.

The policymaker was untroubled since they could argue that the liabilities and the assets were mostly in the same currency, i.e., the euro. But this pre-supposes that there is effective fiscal unification; that if one constituent turned insolvent vis-a-vis another, some federal authority would pay.

But in the eurozone, there is no such federal capability, since this function was supposed to flow from everyone observing the Stability Pact whose strict observance, the mantra said, would keep all members of this club equally solvent. Europe now has to make up its mind on what to do, and it is quite a struggle.

It has been made worse by the unexpectedly jejune statements by people in high office who should be expected to know better.

So, is this a new crisis in the making? Another subprime mess, with a Lehman coup de grace down the road? Hard to say, though one may note that in a recently reported poll, a staggering 53% of French respondents opined that their country could default over the coming decade.

Such is the faith of the European citizens in their governments today. Of course, it could be argued that disillusionment is not restricted to Europe, as the same poll reported that 46% of Americans feel that their country could default too.

It is my take — and indeed my hope too — that this time round, the troubles will be much less severe than they were in 2008. For one, in 2008, many people had felt that their world was about to end in a bottomless abyss of disorder. Having survived, they have been inoculated to an extent.

Then again, the centre of the financial world is not in Europe , so what happens there affects the continent more than it does others. Finally , in this crisis of solvency, major European governments have enough strength to slow the decline, even if halting it may be beyond their power now.

For India, the European mess is not good news. The EU may enter into recession-like conditions and our exports to that region will suffer.

The cost of credit is likely to rise for everyone and portfolio investors may become cautious , factors that can make the cost of financing new fixed assets in India higher than it may have been otherwise .

On the positive side, the experience of recovery in Asia will, sooner than later, generate a kind of discrimination in favour of this region that will be advantageous to us. In India, the government has to shape domestic business confidence so that it can offset the adverse fallout of the troubles in Europe and that it can do by moving boldly on infrastructure and other developmentalfronts .IfthecrisisinEuropepersists , commodity prices will ease, which will also be a silver lining for us.

In summary, our destiny is in our hands. We can grow rapidly and strengthen our economic base, even if the advanced world is facing difficulties. To do this, we need to aggressively address the infrastructure, regulatory and other deficits, and focus on international trade and investment in the Asian and African regions.

(The author is a member of Planning Commission)