A financial contagion is the negative spillover effects of a financial crisis that is initiated in one part of the country or the world which spreads over to the entire country or various parts of the world (global contagion); there could be positive effects as well, when there is a boom associated with certain markets and the spillover effects drive co-movement of prices across several countries. We have seen a negative contagion happening during the 2008 crisis when the housing crisis in the US found spillover effects in many parts of the world and it worsened in form of a full-fledged financial meltdown when credit markets almost fell off the cliff across large parts of Americas and Europe, impacting business growth severely .
Thankfully the financial contagion that initiated in the housing markets of the US in 2008 did not cross over to India and virtually India was left unaffected in every possible way. In fact when the GDP of the rest of the developed world went through a drop of 2 to 3 per cent, India showed resilience to grow at 7 per cent plus in 2009-2014.
It was a rare event, to find India completely insulated from a global financial contagion; some of the reasons (some could be for the wrong reasons) why this could be explained is that India did not have a large inter-connected financial sector with sophistication and also the dependence on global trade was lower in initiating economic growth; the total size of the Indian banking sector is very low, even now it is $270 billion in assets which is equal to the net income of the banking sector in the US with assets of $17 trillion. The lending standards in 2008 were good, with prudential norms and bank NPAs were far too low even by global standards. The housing sector was also mildly expansionary and chances of toxic assets either in the banks or in the rest of the shadow banking system was low. The growth rates were actually quite high and a drop even up to 2 per cent could have been absorbed by the economy.
If we look at the global contagion driven by the Covid-19 meltdown now, it may not be the same resilient economic system in India that we are standing on. First of all the growth rate itself is closer to 4 than 5 percent, which by Indian standards could be really low to weather any impact of drop in trade, exchange rate, demand and most importantly supply disruption, where alternate supply chains would take years to be developed. The bank balance sheets still need a clean up as NPAs are way too high even after RBI actions, leaving a lot to be desired on credit growth. The biggest issue is that India is already suffering from the low demand that came from a consumption slump it has not seen in many decades.
The other more crucial factor is that the ability of the RBI to lower interest rate is stunted now due to already prevailing inflationary forces that drive agricultural commodity prices to still stay higher than expected.
All these factors limit India’s ability to face a financial contagion now as the need of the hour is to have massive stimulus from fiscal actions which tends to crowd out private investment as it further raises the cost of borrowing for the rest of the financial system.
But India will do what needs to be done, drive infrastructure, manufacturing and agriculture as three fundamental pillars of growth. All this would bode well with the current underlying conditions of global supply chains, which must reconfigure, re-orient from complete end to end chains to a more balanced clustered chains that are bound with enough checks and balances both horizontally and vertically.
ABOUT THE AUTHOR:
Procyon Mukherjee works as Chief Procurement Officer at LafargeHolcim India. The ideas presented are his personal and have no connection to the beliefs of the company where he works.
