As I write this with the bright lights of Diwali just a couple of days away, the world seems very gloomy indeed with the Sensex nose-diving more than 10 per cent on Friday, October 24. It has now sunk to a five-year low. And the Sensex may have plunged even further by the time this article reaches the readers of The Telegraph since stock markets all over the world are breaking records at a pace that even Sachin Tendulkar would love to emulate. Alarming headlines appearing almost on a daily basis must be causing sleepless nights to many people. But perhaps this is also more than an appropriate time to step back and take a dispassionate view of what lies ahead in the near future.

Of course, the health of the Bombay stock exchange provides only a very noisy signal about the state of the Indian economy. I have written earlier in this column about the extreme volatility of the Indian stock market. Indian share prices seem to zoom to dizzy heights or fall steeply without any apparent changes in the fundamentals of the economy. Unfortunately, the current state of panic in Dalal Street is a very accurate reflection of the global economic crisis. But what does the global crisis mean to us? How seriously will Indians be affected?

Consider the direct impact of the dramatic fall in share prices. Only a minuscule fraction of the Indian population invest in stock markets. I vaguely recall reading somewhere that barely two per cent of Indians invest in shares. This figure may go up slightly once account is taken of Indians who invest indirectly in shares through mutual funds. Most members of this group will probably escape unscathed from the mayhem. Share prices will climb back in the long run, though it may take a couple of years to reach the levels witnessed when the Sensex reached its peak towards the end of last year. There is enough evidence demonstrating that long-term rates of return from shares are significantly higher than returns from any other form of investment. The current sharp fall in share prices will not reverse this long-term trend. Of course, this is scant comfort for those investors who are planning to retire during the course of the next couple of years — they are very obvious victims of the current crisis.

Unfortunately, the falling share prices are only the tip of the iceberg representing the global economic crisis. Indeed, the real danger facing the global economy today is no longer the frail health of stock exchanges or even the fragility of the financial sector. As a matter of fact, the concerted efforts of the major Western governments and central banks will probably restore some semblance of order to their financial sector. But, the concern is now with the ‘real’ sectors of the economy because it is now more or less certain that some of these economies will have to cope with a period of recession, defined technically as two successive quarters of negative economic growth.

Indeed, both the governor of the Bank of England and the British prime minister have in recent speeches mentioned the virtual inevitability of recession striking the British economy. The American economy is perhaps in a worse state with many of the biggest companies laying off workers. The current rate of unemployment in the country is just over 6 per cent, and some economists predict that it will rise to over 8 per cent by the end of next year. Some of the smaller European countries, particularly those in eastern Europe are also on the verge of drastic slowdowns in their rates of growth. Any long spell of recession in all these countries will have major ripple effects throughout the world, and the Indian economy cannot remain isolated from these effects.

That having been stated, it is important to have a proper perspective about the severity of the threat facing the Indian economy. The steep fall in the external value of the rupee makes Indian goods much cheaper abroad. Despite the depreciation of the rupee, it is inevitable that Indian export industries will face serious problems in finding customers abroad — it is not a coincidence that shares of the software giants such as Infosys and TCS have been particularly hard-hit.

However, it is premature to press the panic buttons immediately because the effects of the slowdown in global demand for our products need not percolate to other sectors of the Indian economy. After all, even very recent estimates suggest that the Indian economy should grow at around 6.5 per cent. While this is considerably lower than the growth rates experienced in the recent past, it is still a very healthy rate of growth. The important question is whether the economy will slow down even further. Fortunately, the export sector in India is relatively small, given the sheer size of the Indian economy. Other sectors of the economy can generate demands for one another’s products. Hopefully, this will ensure that the slowdown is restricted mainly to the export sector.

In times of perceived crisis, it is natural for there to be public clamour for government action. Conversely, the absence of government action also results in a feeling of having been let down. Indeed, the 10 per cent fall in the Sensex was largely a reaction to the Reserve Bank of India’s refusal to cut interest rates. But it is unlikely that a small reduction in the cost of borrowing will make much of a difference to companies. What is far more important is for the government to ensure an adequate supply of credit. For this to happen, an immediate step is to ensure that the there is no lack of confidence in the stability of the Indian financial sector — after all, one of the reasons for the recession abroad is that credit markets have become virtually non-existent since lenders do not know whether they will ever get their money back. Fortunately, the proportion of bad debts in the heavily-regulated banking sector in India is well within reasonable limits. In addition, the government has announced that several public sector banks will be recapitalized so as to ensure that all prudent norms of capital adequacy are met. These steps make it virtually impossible for there to be any financial crisis in our financial institutions.

Some economists have also advocated an increase in domestic money supply to stimulate aggregate demand, without quite spelling out why a mere increase in money supply will revive demand in those industries that are particularly hard-hit — namely the export sector. After all, an increase in Indian money supply is not going to stimulate foreign demand for Indian software. Thus, the bottom-line seems to be that while the heady days of double-digit growth are far behind us, the Indian economy should still be able to proceed at a stately pace quite in keeping with the sorry state of our roads. A bountiful harvest this year will be particularly useful.