An Italian bank's boss recounts a joke of two hikers picnicking when a bear appears. When one laces up his boots to run, his friend scoffs that he can’t outrun a bear. The shod hiker retorts that it is not the bear he needs to outrun, merely his fellow hiker. “We’re sitting at the picnic with our boots still on,” says the bank boss.
As the ‘Grexit’ scenario looks inevitable, banks and investors have already started taking precautions by pulling out their money from the fragile markets like Portugal, Ireland, Italy, Greece and Spain. Spain and Italy have alone lost foreign bank deposits of about €45 billion and €100 billion respectively from their peaks. On the other hand sales of government bonds by foreigners and capital flight is probably equal to about 10% of GDP in those countries. So the sound of credit crunching can be heard in these countries loud and clear.
Though there are many prominent differences between India and Europe in their economic structures but still there are two apparent similarities with Europe which brings to fore the riskiness of the present volatile economic situation. First is the India’s debt to GDP ratio which has already been unacceptably high, declared by the international financial standards and the soaring Fiscal deficit coupled with the bloated Current Account deficit. And the second similarity lies with the large presence of international investors and creditors which not only increases the volatility but also causes economic instability because the sudden influx and exodus of these investors shocks the economic momentum and leaves it gasping.
Undoubtedly there are external factors which have impacted the domestic economy to a large extent but it should also not be forgotten that the government failed to protect the economy from these shocks through its inaction. Even when confronted with the low growth, the government tends to adopts austerity measures that trap the country in a recession. And this is what happened in Europe and so it can also become a reality for India.
Paul Krugman in his latest article in a leading newspaper describes this situation by saying that the economy is a unit where one’s spending becomes the other’s income and vice-versa. So what happens if everyone simultaneously slashes spending in an attempt to pay down debt? The answer is that everyone’s income falls and it worsens the debt problem.
The way out of this vicious cycle as clarified by economists is to expand the spending and find other alternative way to address inflation or balance of payments difficulties which can only be possible if the government takes on the challenges head on at least now in these dire situations.