A long,rough patch

Global financial and currency markets are in turmoil. As news comes in of some steps by the US Fed,slowdown in the US economy and the fiscal crisis in Europe,markets are reacting sharply. By contrast,now the Lehman crisis appears to have been one that could be solved in a short time,as governments were able to step behind firms and markets and bail them out. Now the situation is much more severe. Governments themselves are in trouble. The euro,an attempt to creating a monetary union of countries that do not have a fiscal union,is running into difficulties not anticipated in its design. Different political and economic conditions,such as in Germany and Greece,make the task of coordination politically very difficult. As markets see these difficulties rise and start expecting a move towards either a breakdown of the system or the exit of one or another eurozone member,confidence in the euros future becomes more uncertain. There seems to be no imminent political solution to Greeces sovereign debt problem,and until then,Europe may continue to witness high economic uncertainty.

The solution to the US economys problems is political. The lack of consensus among Democrats and Republicans on issues relating to the size of the state,income taxes,social security and benefit programmes is caused by a deep ideological divide and will not be easy to resolve. There appears to be no quick solution to the problems being faced by the world economy now.

In the long run,there are key lessons for India from the present European and US crisis. One,we need to be wary of building a large welfare state,as in some European economies. Welfare programmes are hard to pull back,and when the need arises,the political will to do so can be sorely lacking. Two,the size of the fiscal deficit and government debt matters. In the last few years,many people argued that,while the fiscal deficit was high in India,its rise overlapped with years in which growth was rapid,and so there was no need for fiscal consolidation. In normal times,large public debt may not seem a serious issue; but in crisis times,it blocks any large increase in government spending as a way out of the recession. For Indian markets,the turmoil in global markets has come at a particularly bad time when the country is struggling with its own governance issues.