It will be a year this week since investment bank Lehman Brothers fell with a thud, sending financial markets around the world into a panic not seen since 1929 and presaging a brutal contraction in world economic activity.
India has proved to be one of the most resilient economies in these past 12 months. The initial impact was severe. As global investors pulled money back home, the rupee tumbled and local short-term interest rates shot up. In that sense, what happened in the last three months of 2008 was a wake-up call for those who believe that India is insulated from global financial shocks. The global panic was instantaneously transmitted to India.
Illustration: Jayachandran / Mint
The real economy, too, had to withstand several shocks. Exports tumbled and jobs were shed in many areas such as garments that are dependent on global demand. Companies that had taken on too much debt to fund expansions and expensive acquisitions found they could not roll over these debts. Stock market funding dried up. Companies put spending plans on hold.
The panic of those months has subsided and the damage to the Indian economy has been contained, thanks to aggressive interest rate cuts by the Reserve Bank of India and a surge in government spending. These quick and commendable policy responses bring significant future risks: high inflation and a huge public finance mess. Both the government and the central bank will need to chalk out a plan to exit their aggressively expansionary policies soon, perhaps over the next two quarters.
The fact that India is more dependent on domestic demand rather than foreign demand also helped, but we should realize that India today is more of an open economy rather than an autarchic one. That’s good for growth and we need to strengthen our links to the global economy rather than overreact to the recent problems and withdraw into a shell. The strong empirical evidence that open economies tend to grow faster than closed ones cannot, and should not, be ignored.
India’s prestige is running high because of its record of economic management in the past 12 months. It should engage with the outside world on its own terms. The constructive role played by India in reviving the Doha Round of global trade talks and its active role in the Group of Twenty negotiations on how to make the global regulatory system more democratic are early signs of growing clout, at least in the economic sphere.
In that sense, the chaos after the collapse of Lehman is an opportunity for India.
Has India responded well to the post-Lehman shock? Tell us at firstname.lastname@example.org