The recent economic news has been worrisome, with a growth slowdown, a collapse in investment activity, fiscal stress and a weakening rupee.

The global economy also seems to have magneto trouble, a phrase used by John Maynard Keynes to describe the economic crisis of the 1930s. A quick rebound like the one we saw in 2009 seems unlikely. Unlike two years ago, no major government in the world has the fiscal firepower to support effective demand. The crisis in Europe is worsening. Fears about an implosion in China are growing. Some welcome good news from the US—strong consumer spending and better job creation—balances things out a bit.

This column has earlier argued that the roots of the current problems can be traced back to the politics of the United Progressive Alliance governments since 2004. The two governments headed by Manmohan Singh seemed to have assumed that the economy can scorch the turf without any meaningful economic reforms. The tax revenues from a dynamic economy would then be able to finance both subsidies and the ambitious social sector programmes that win votes.

These assumptions are unravelling. Government revenues have been weak this year. The subsidy bill has bloated. The fiscal deficit target is clearly unattainable. Government borrowing to fund the growing deficit is pushing up interest rates for the private sector. Further, the stimulus to consumption through revenue spending and a worsening investment climate because of the policy paralysis have led to the noxious combination of slower growth and higher inflation.

Another way to approach the issue is to look at the political economy of the ruling alliance in New Delhi. What does the state of public finances tell us? The government has not been borrowing for projects that will build new capacities. It has been busy promising entitlements and dishing out subsidies to consolidate its political base. The revenue deficit has climbed. Public investment has been muted. The politics of this government has been more about strengthening patronage networks rather than development work.

How the political system will respond to these challenges will be the key. It’s tough to tell. History offers us two possibilities. Economist Suresh Tendulkar had once pointed out the deep differences in the way the political system reacted to similar challenges in earlier decades. Indira Gandhi had responded to the first bout of stagnation of the late 1960s with radical politics, even as many other countries in the region began reforming their economies. Tendulkar pointed out that populist radicalization became a substitute for economic reforms.

It is well known that the response to the crisis of the late 1980s was very different. The rents collected by the distributional coalition that dominated Indian politics—domestic industry, large farmers, the bureaucracy and the unionized labour aristocracy—were largely responsible for a fiscal crisis in that decade. What followed in 1991 were radical economic reforms that overturned decades of economic mismanagement.

Tendulkar described the differing policy reactions to economic stress as a puzzle, one which was hard to explain. It is to be seen whether the political leadership chooses to respond to the current problems (though they are admittedly less severe than in the previous two cases) with radical politics or economic reforms. The recent record of the two main political formations in India does not inspire much confidence among those who believe that the best way to break out of the current mess is a reforms push.

One useful comparison is between Brazil and South Korea. The two countries had broadly similar average incomes by the end of the 1970s. Then Brazil stagnated, while South Korea continued to power ahead, and has now average income levels on a par with many European countries. Brazil lost two decades.

Here’s how economist Abhijit Banerjee described the situation in Brazil in a column in the Hindustan Times. “The country had been growing at a remarkable 7.5% average rate for nearly 30 years, but signs of economic stress were apparent. There had been an explosion of inequality and growing corruption. The government responded to the resultant rising discontent by launching various entitlement programmes, and borrowing heavily to pay for them. The country is not India, though it almost could be. It is Brazil circa 1979."

Will India resemble Brazil or South Korea? Will the response to the current economic stress be radical politics or economic reforms? A lot is riding on these questions.

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Niranjan Rajadhyaksha is executive editor of Mint. Comments are welcome at