India Broadband Forum

saurav_k

Effect of the Financial Crisis on India

When experts chose to quell fears of the subprime crisis spreading to India, they cited the following reasons.

• India had not invested heavily in US subprime mortgages.

• Lending organizations in India followed a more conservative approach. Zero-interest lending and lending without proper documents were almost unheard of in India.

• The Reserve Bank of India was a strict regulator. At no point did it cut interest rates to near zero, as the Federal Reserve in the US did when the real estate boom was at its peak.

Considering that the situation in India was so different from that in the US, it was only natural for many experts to express a rather optimistic view of the situation.

But, following the collapse of the financial system in the US, the same experts are no longer feeling so smug because there is no doubt that India has taken a hit. One has to only study the dramatic fall of the Sensex from its peak to realize this.

Another indicator of the brewing crisis is the bursting of the housing bubble in some major cities, where home prices are rapidly on the decline.

When Indian monetary policies were supposedly far sounder than the ones that precipitated the subprime crisis in the US, why are we suffering some of the ill effects? Does this mean that the causes of the subprime crisis are not just the ones that are commonly cited, but also some that lie hidden, waiting to bring the global economy to its knees?

The fate of economies around the world is decided by the swings in consumer confidence. Let us explore how the dramatic swings in consumer confidence affected the US economy and then went on to kick the rest of the world in the guts.

• The upswing in the stock market and the subsequent boom in the economy fuelled consumer confidence in the US at the turn of the millennium.

• In turn, the buoyed consumer confidence propped up the economy further. In short, customer confidence and the economy fed off one another.

• Recently, consumer confidence in the US has shown a downward trend. Due to its close links with consumer confidence, the economy is also on its way down.

• The financial trouble brewing in the US has made its presence felt across the globe in the form of drying credit markets.

• Since there is hardly any money available in the markets, there are fewer consumers and a general collapse in prices.

The poor lending practices in the US were also a result of overconfidence in the belief that housing rates would only go up and that, therefore, there was no risk in lending with very little protection. The overconfidence was so high that financial experts failed to recognize the housing bubble they were sitting on.

But, isn’t this something that the US needs to deal with? What has India got to do with it?

India and China are the most spectacularly growing economies in the world today. The fallout is that this tremendous economic boom has raised unrealistic expectations for investments in these countries. There was a time when investing in stocks was considered the best option. But, the poor performance of stock markets across the world has dented this belief. India is no exception. The falling stock market in India has triggered a parallel fall in consumer confidence.

Investing in real estate was always considered a safe bet in India. Like in the US, the belief that housing prices would only head skywards was also firmly entrenched in the minds of Indian investors. People failed to understand that the apparently dramatic difference in the price of a house over the years was mainly due to inflation. They paid little attention to the fact that consumer prices had also shot heavenwards in the same time. Now, with the falling prices of houses around the country, people are beginning to reconsider real estate as a sound investing option. Even here, it is clear how economies are affected by swinging consumer confidence.

Any turbulence in speculative markets like stocks and real estate will affect a rapidly-rising economy like India more than a country with a relatively stable economy. It is in vibrant economies that speculative turbulence wrecks the greatest havoc on traditional thinking.

India is as likely to be affected by the economic crisis, which has the world in its grip, as any other country. Urgent action needs to be taken on lines similar to those being taken in the rest of the world. More regulation needs to be introduced into financial markets and more policies adopted to ensure consumer protection.


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