Global markets rallied magnificently on Monday in response to the trillion-dollar bailout package cobbled together by the European Union and the International Monetary Fund (IMF) to support the faltering Greek economy. The help came in the nick of time, since Greece has €8.5 billion of debt maturing on 19 May and there were high chances that it would not have been in a position to repay bond investors. The cost of insuring against a Greek default had soared in the credit default swaps market, as the solvency of the Greek government was in question.

Lest we forget, we have seen many relief rallies of this sort over the past three years in response to emergency liquidity support to the markets. But the road ahead will continue to be rocky. There are many fundamental problems with Western economies, and fixing them will take more than an (admittedly impressive) infusion of liquidity.

India has been in a similar position. The statement last week by Greek finance minister George Papaconstantinou that Greece was a mere fortnight away from defaulting on its loan payments brought back memories of the harrowing months of 1991 when India had barely enough foreign exchange to buy 15 days of imports.

The 19 years since then have been the longest crisis-free period for the Indian economy after independence. What the combination of Narasimha Rao and Manmohan Singh did to steer the economy out of the crisis—IMF loan, rupee devaluation, fiscal stabilization and structural reforms—offers some clues about what so many fiscally stressed and indebted European economies need to do.

The Indian experience clearly shows that the first defence against a crisis of confidence is liquidity support, a role that IMF has so far been best placed to do despite the unpopularity of its loan conditions. The IMF loan to India did much to assuage investor fears. That is what the weekend package for Greece also does.

But liquidity support was only the beginning. One of the first steps Manmohan Singh took after he became finance minister in 1991 was to devalue the rupee to make the economy more competitive. A flexible currency policy is important in a crisis because it allows economies to adjust. Even subsequent crises, such as the one that rocked Asia in 1997, showed that countries running fixed exchange rate regimes were needlessly painting themselves into a corner. Greece has outsourced its monetary policy to the European Central Bank and cannot devalue its currency because it does not have one. The other option to regain competitiveness is to reduce wages, a move that will surely ignite the Greek tinderbox.

The Chandra Shekhar and Narasimha Rao governments had to announce credible austerity measures and a medium-term plan to stabilize public finances. India has not been a paragon of fiscal virtue over the past few decades. However, strong growth in the underlying economy has allowed governments to be profligate without completely wrecking public finances, though fiscal deficits and levels of public debt have been too high for comfort.

Low-growth countries such as Greece do not have this option. The only way that Greece can get its debt-gross domestic product level down to safe levels is to run a primary surplus for many years. In other words, many European governments will have to earn a budget surplus, not including interest payments on the debt they have. The softer option of allowing public spending to grow but at a slower pace than the economy is not available to Greece and the others right now.

After getting liquidity support from IMF, devaluing the rupee and agreeing to fix the fiscal problem, the Indian government introduced structural reforms that eventually created the conditions for the acceleration in economic growth. This meant upsetting the coalition of special interests—large farmers, industrialists, government bureaucrats and politicians, according to economist Pranab Bardhan—that defined Indian political economy in the preceding decades.

In a sense, the old social contract based on protected markets and heavy subsidies had to be torn apart. There is no doubt that much of Europe will have to do the same. The welfare state that was built in the post-war decades helped establish social democracy in Europe, but the system is now broken given the ageing population, economic stagnation and pressure on wages because of the competition offered in the global market by more than two billion Chinese and Indians. Europe will have to replace this with a new social contract to replace the old one, a politically combustive task even at the best of times.

In short, what we have seen this month is a mere first step in fixing what is a deep-rooted problem in Greece and other European economies. The immediate fears have lifted, but the more intractable problems remain. Tackling them will necessarily mean tough political choices and hard economic reforms.

Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at