The Telegraph
Thursday , December 13 , 2012
Since 1st March, 1999
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The largest Swiss bank and a major global player, UBS, has announced that it would cut 10,000 jobs (16 per cent of its workforce) worldwide by 2015 owing to a restructuring of its investment banking division. So the European recession brought about by reckless lending by its banks to private parties and German obduracy regarding austerity (cuts in wages, pensions, public spending) is now spreading to even the strongest of banks after having engulfed Greece, Portugal, Spain and Ireland.

For India, this is a double blow. Apart from the loss of the large European export market (14 per cent of its total exports), the colossal outstanding claims held by the European banks in India — which have grown from $42.7 billion to $150.6 billion, a direct result of financial liberalization, between the first quarter of 2005 and that of 2012 — pose a grave problem since there could be a return flow of capital. The exposures of these banks are about half of the total foreign claims on us and the non-banking private sector has been the largest recipient of such exposures.

Apart from the credit provided to the local institutions, the exposures of the foreign banks take various forms, such as derivatives contracts, guarantees extended, credit commitments and other potential exposures. These exposures can be substantial, and can even exceed the formal claims on India. Intriguingly, the ambiguously defined category, ‘other potential exposures’, dominates the other sections. This makes India’s situation qualitatively worse than the one in late 2008 because India does not know the precise terms and conditions of the loans and their legal implications besides the sheer scale of the claims.

Old issue

The crisis deepens as the recession continues since the European banks could reduce their exposure to cover the losses and/or to meet commitments at home. Such return flow of capital took place after September 2008 with disastrous consequences for the economy and it will happen again. As foreigners withdraw their funds, India’s foreign exchange reserves fall and so does the rupee, increasing the inflationary pressures on the economy, thanks to India’s huge imports that far exceed exports. It is not just oil imports but also non-oil imports that matter. Of late, the latter have become substantial as the import-intensity of the manufacturing sector has grown over time, making India far more import-dependent than before. This is a structural change that has occurred in India due to globalization, and the process goes on making the nation increasingly vulnerable to what happens abroad. With retail inflation already in the double digits, additional inflation will ruin the aam admi and interest rates will rise, hitting investment and industrial output. Contrary to the claims of the exporters, a drop in the exchange rate of the rupee cannot help much. For as Europe falters while the United States of America grows slowly and China’s demand remains below expectations, it is unlikely that export earnings would grow.

Moreover, India’s stock markets could crash since the foreigners might offload their huge stock holdings as they did in late 2008. Given the ‘herd mentality’, the moment they unwind their stocks, we shall follow suit and the result will be there for all to see. In no time, this will destabilize the financial markets and adversely affect the middle class, thereby lowering its demand for housing and consumer durables.

This is nothing new. All these things happened in 2009 and in 2010, beginning from October 2008. But the powers-that-be don’t bother, except for the Reserve Bank governor who has voiced concern for the high retail inflation and has followed it up by refusing to reduce the benchmark interest rate despite strong pressure from the finance minister and private-sector bosses.