The deadly ‘Recession’ fears are far from over. Just when the world heaved a huge sigh of relief with many larger economies showing recovery signs, the Euro crisis hit them like a thunder bolt. The stocks across the world are melting yet again. The danger, perhaps, may not be that much bigger, but the Recession threat is clearly far from over.
After recovering from the global economic slowdown triggered by the collapse of Lehman Brothers in September 2008, the Indian IT sector, like many other sectors, is clearly concerned over the European crisis which may lead to cancellations of many big orders. There are concerns that the USD 1-trillion European crisis fund, raised by European countries to fight crisis and austerity measures, may in fact, further slow down their economies which may result in cancellation of many projects, lead to price-cuts and consequent pressures.
How it all started:
The ‘Euro crisis’ as it is being called now, has its origins from the ancient civilisation land Greece, which defaulted on its payments triggering the crisis. The European countries reacted rather slowly to avert this. And, by the time, they announced the bailout package, the damage had been done. Markets are reacting with skepticism to the largest bailout package announced by the European nations in an attempt to prevent the bankruptcy of Greece.
The turn of events look really surprising for many. Former Eastern Bloc countries, such as Slovakia, are expected to bailout Greece now! The International Monetary Fund (IMF) and 15 other Eurozone countries – the member states of the European Union (EU) which, together with Greece, use the euro as their common currency – agreed to bail out Athens with bilateral loans totaling €120bn ($160bn) over the next three years. Many of these 15 countries, however, have huge debts for themselves. They have all agreed to extend their helping hand to bail out Greece hoping against hope that some big country like Germany, would come to their rescue, too!
In fact, many Germans are opposed to the bailout package offered to the Greeks. Reason: Germany has to pay €22bn of the €120bn – the largest share apart from the IMF, which pays €40bn in this package deal. Nevertheless, 76% of the Germans expect that Greece would not be able to pay back the loans it receives. The German political establishment, however, feels it has no other choice but to come to the rescue of the Greeks.
German Chancellor Angela Merkel long resisted the plans to bail out the Greeks for long. But she changed her mind in the last moment. Reason: One of the people who rang her to ask her to bailout Greece was US President Barack Obama. Merkel insists, however, that the Greeks implement harsh measures, “not just for one year but for several years.”
In exchange for the bailout, Greece must introduce draconic austerity measures. The IMF and the EU demand €22bn in new budget cuts over three years, on top of cuts already announced. Greece would increase its retirement age from 62 to 67 years, salaries and pensions in the public sector would be frozen, annual holiday bonuses would be capped and scrapped for higher earners, VAT would rise from 21% to 23%, and there would be a 10% hike in fuel, alcohol and tobacco taxes.
The Greeks trade unions have rejected the austerity plan. A general strike hit the country with chaos prevailing every nook and corner. There were reports of severe rioting everywhere. Anarchists threw petrol bombs, attacked banks, shops and hotels, and clashed with riot police outside the Finance Ministry in Athens, while thousands of Greeks, mobilised by the trade unions and left-wing parties, demonstrated against the austerity plans of the government. Polls suggest that more than 50% of the Greeks are prepared to take to the streets to stop the government plans. Greek Prime Minister George Papandreou has promised the IMF and EU that the cuts would be implemented
The markets, however, are not impressed. In early February, Papandreou promised similar austerity measures, but did not live up to his promises. French Foreign Minister Bernard Kouchner warned that there are no guarantees that the massive bailout for Greece would prevent fallout from spreading to the other countries of the eurozone.
The Greek crisis threatens to bring down the entire 16-nation monetary union. Contagion has already spread to Portugal and Spain, whose bonds were also downgraded by international rating agencies. Spain, meanwhile, is trying to convince the markets that it would be able to solve its budgetary problem independently. “Spain is able to pay its debts. We would not need help,” Elena Salgado, the Spanish Minister of Economics, said last week, assuring that Spain would cut its deficit from 11.4% to 3% by 2013. The general expectation is that if the Greek and Portuguese dominos fall, Spain would follow. The irony of the situation is that Portugal is expected to contribute about €2bn of the €120bn in bilateral loans to Greece, and Spain some €8bn. Italy and Ireland, who are also burdened with debts, are to contribute some €12bn and over €1bn respectively.
It is clear that the euro is doomed.
Impact on Indian economy:
Now, the most asked question in Indian financial market is: What impact the Euro crisis is likely have on Indian economy, since the epicenter of the crisis is far away in Greek capital Athens. Perhaps, there may not be any direct impact on the Indian economy from the European crisis. However, with the increasing integration of the world economies, in the current global scenario, any minor blip would have its impact on the Indian economy as well. Despite the assurances, the markets are reacting sharply, showing huge decline. The recent events show the situation is quite severe.
Given this global uncertainty, it puts Indian policymakers in a peculiar situation. No doubt, the Indian economy’s fundamentals look quite strong. GDP growth is expected to be around 8.5% in 2010-11, IIP is increasing in double digits, credit growth has increased to 17%, export markets are picking up and capital inflows have been robust.
However, because of the global uncertainty all these calculations can easily go wrong. In fact, sentiment has already reversed in some cases: The investments might not increase seeing the global uncertainty. Investment was a key driver in Indian 9% growth period (2003-08). Again it is expected to play the key. We have seen business confidence evaporating in thin air quick time. IIP could again decline as it did post-September 2008 crisis. Credit growth could decline both because of banks becoming uncertain and business not demanding credit
Foreign capital inflows could reverse to an outflow position. In fact, this has already started to happen with FII showing outflows worth USD 1.65 billion in May from equity markets. Till April 2010, we had nearly USD 6.65 billion of capital inflows. The decline in inflows along with global uncertainty has led to decline in equity markets. The expectations of BSE Sensex reaching soon to 21,000 levels are being revised downwards.
The volatility is again increasing. If we see the National Stock Exchange (NSE) index, it had increased from 20 levels in Jan 2008 to 85 levels in Nov-08. It then declined to pre-crisis level of 17-18. It has again started increasing to touch 34 levels now. Yields in bond markets have eased considerably to 7.35% levels looking at the global crisis. This is quite a turnaround as most market participants expected yields to touch 8-8.25% levels after April Monetary Policy. The market participants were also expecting RBI to increase interest rates even before its monetary policy in July 2010. This crisis has reversed the sentiment and most now expect RBI to keep interest rates unchanged in July policy.
Export markets could also decline for reasons explained above. If the crisis situation worsens, Indian government might again have to intervene to ease the crisis situation. Though the probability is remote, but it is till there. There are expectations that fiscal deficit and government borrowing programme could be lower than budgeted amount. This is because of the higher than expected proceeds from 3-G auctions. If crisis worsens, the government borrowing and fiscal deficit could get worse. Oil and commodity prices have declined as well. This could be a positive factor as inflation might just become lower.
The above is a worse-case scenario and all would depend on the nature of European crisis. We still do not know where the crisis is headed. Comparisons have been made on how the crisis is similar to earlier US crisis but we have a far more complex problem here. In US you have one government and here you have 16 governments who are trying to resolve the issue. The recent events show the situation is quite severe. There is little coordination between European policymakers. Germany was seen as the economy which could support falling Eurozone but its government has been severely criticised for a dilly-dally approach. So, overall it is very chaotic and complex at the moment.
Before the Recession hit the world economies in 2008, the Indian financial experts insisted that it would not have any impact on our country. And then the crisis hit and hit them hard with equity markets declining from 21,000 levels to 8,000 levels. As the Euro crisis started to show its impact, the Indian experts once again laughed off when asked whether we could be impacted. And now we are seeing some strains on equity markets, capital inflows etc. We may not be impacted by the European crisis as much as previous crisis, but forgetting history so quickly is a crime. Who knows what’s in store for you!