Govt girds up for possible breakout in eurozone

Written by Sunny Verma | New Delhi | Updated: May 16 2012, 08:22am hrs
The finance ministry is mulling some policy interventions to address the eventuality of a breakout in the eurozone. In contrast to the 2008 crisis when the government gave a hefty fiscal stimulus, the Centre would rely on non-budgetary measures this time. This approach is also necessitated by an already bloated fiscal deficit, and it leaves the government with certain administrative relaxations and monetary policy interventions to protect the economy from any severe downturn.

R Gopalan, secretary, department of economic affairs in the finance ministry, and his team of senior officials have discussed the likely impact of a full-blown Eurozone crisis on India, official sources said. These officials have prepared policy actions over the past couple of months, which have been discussed in meetings of the Financial Stability and Development Council, headed by RBI governor D Subbarao.

"We have done an internal assessment of the likely impact of a breakdown in the Eurozone. We did some simulations to ascertain, which sectors will be affected immediately in the wake of a crisis," a senior official privy to matter said. Direct exposure of Indian companies and banks to the Eurozone banking sector is about $60 billion, Subbarao had said.

"Since the fiscal deficit is already high, the government would not intervene through the budgetary channel. There are other ways to stimulate the economy," the official said, indicating that the government will have to rely on the monetary policy in case there is a breakdown in the Eurozone, including a possible crash in the banking system. The official said this exercise was to prepare a back-up plan to counter adverse effects of a possible recession in Europe and its resultant impact on India.

The immediate impact of such an event would be drying up of liquidity, while capital inflows would choke. "We need to prepare for crisis two," HDFC Bank chief economist Abheek Barua said, while speaking at a seminar on Monday. Regulatory communication and signaling has to be more forceful in light of the imminent risk, Barua said, adding that he was far more uncomfortable with the global environment.

The eurozone sovereign debt crisis have rattled financial markets across the globe, with possibility of Greece exiting the Eurozone only adding to the woes. Countries including the UK and Spain are also battling double-dip recession.

Prime Minister's Economic Advisory Council Chairman C Rangarajan said both exports and imports will be impacted in an event of a Eurozone crisis, while commodity prices especially crude oil prices may not fall sharply. Most analysts agree that the monetary policy will play a key role, in case there is a repetition of a crisis similar to one witnessed in 2008.

With the projected fiscal deficit at 5.1% of GDP in 2012-13, there is little headroom available for the government to go in for tax cuts and for boosting expenditure. The RBI raised its policy rates by 375 basis points since March 2010, before cutting its short-term lending rate by 50 basis points in April 2012. IGIDR economics professor Ashima Goyal said there would be need to pump in massive doses of liquidity in an event of a sudden disruption.