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Countering the slowdown

Prime Minister Manmohan Singh’s statement in Parliament on the fallout of the persisting global financial crisis is timely. In the first place, he has acknowledged realistically that the domestic economy, though not fully exposed to the turmoil abroad, will still face an indirect impact that will slow down economic growth. In all developed countries, the financial crisis, especially the falling stock markets and the freeze in credit markets, has already taken a toll on the real economy. In Europe and the United States, aggressive intervention by the governments to stave off a financial meltdown has taken the form of a massive recapitalisation of mainline banks with public money and guaranteeing short-term transactions in the inter-bank money markets. In India, although there have not been serious concerns over the stability and solvency of banks and financial institutions, the Prime Minister’s assurance on the safety of bank deposits is welcome. The overall policy response recognises that the inadequate flow of credit to the real economy is the issue, not solvency of financial institutions. Thus what needs to be addressed is the prospect of slower economic growth in the wake of the global meltdown. The recent cut in the repo rate that has come on top of major reductions in the CRR over the previous two weeks and other monetary measures is intended to stimulate liquidity and lower the cost of credit. The implication is that even the admittedly slower growth momentum calls for extra credit infusion.

Inflation though tapering off still remains a threat. It is not clear whether the sharp reversal in the RBI’s monetary stance is guided by the falling commodity and oil prices or by the imperative of meeting the needs of the real economy. However, as has been the case in the U.S, enhanced liquidity in the system need not translate into increased lending by banks that have now developed a higher degree of risk aversion. To add to the problem, the global financial crisis has triggered massive capital outflows, with foreign institutional investors pulling out funds. With the current account deficit already widening and the exports very likely to suffer because of the global slowdown, there is concern over the balance of payments. The rupee has depreciated sharply and there has been a $26 billion drawdown in foreign exchange reserves between March and early October. Most of India’s high growth software exports are to the U.S. financial sector and are unlikely to regain their robustness in the immediate future. One hopes the government will act quickly on the Prime Minister’s assurance of policy measures to minimise the negative impact of the global crisis.

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