This initial assessment was based on misplaced assumptions. It was believed in India, as in the US, that the crisis could be confined to financial markets and could be tackled by identifying and fully providing for lending and other risks. In the US, however, confidence couldn’t be restored by takeovers by solvent institutions; not even by reasonably reassuring half yearly results. Injecting supportive federal funds won’t be sufficient: a crisis of confidence, leading to refusal of credit by depositors, investors and their institutions, has meant economic activity has contracted. Major financial institutions are deleveraging — reducing their dependence on borrowing and calling in their own funds - implying a drastic depletion of liquidity. So speculators have no money to dabble in commodity markets and push up oil and other commodity prices, bankers cannot raise capital to shore up written-down assets, share indices are hitting rock bottom and producers are unable to access working capital for existing activities — let alone pay for new projects.   

Further de-leveraging is unavoidable: European banks like Barclays, Deutsche, UBS and BNP Paribas have leverage ratios in the forties and fifties. With the demise of investment banking, there is also no scope for restoration of previous liquidity levels in the near future. It will certainly take time for ingenious financial innovators to discover fresh ways of breaking through regulatory controls. Till then, global business activity will necessarily have to operate at a much lower level than hitherto.

The Prime Minister’s concern over the financial meltdown is appreciable. Dr Singh warned of economic slowdown almost 18 months ago. Now, he has suggested we isolate specific areas where our economy would be most vulnerable, so we can react effectively. Also, we need to ensure that our policies gel with global action for sustaining demand and investment.   

... contd.