How safe are we from catching the cold?

The bankruptcy of the US investment giant, Lehman Brothers. The sale of Merrill Lynch. The turmoils of insurance giant AIG. These three back-to-back upheavals indicate that the global financial crisis has far from bottomed out. Barely six months after the loss of Bear Stearns, the growing list of investment banks going under reverberated in Indian stock markets. The Sensex fell by 469.54 points on Monday. Jittery foreign institutional investors (FIIs) have withdrawn $ 8 billion from the market so far this year. Sentiment will remain subdued for the rest of the week in the bourses due to these adverse developments.

The big question on investors’ minds: what sort of impact will the global financial crisis have on the Indian economy? Reports have detailed huge job losses as the affected US investment banks have expanded their operations in India. Lehman has about 2,500 employees while Merrill about 600 employees who face uncertain prospects. The market valuation of the companies in which Lehman has made investments has taken a hit. A shadow also hangs over AIG’s insurance business. At a different level, these developments are also bound to affect the campus recruitment of management graduates.

However, the biggest impact on India will be when this crisis triggers a global recession. According to former US Treasury Secretary Larry Summers, four vicious cycles are simultaneously underway: falling asset prices forcing leveraged holders to sell, driving prices further down; losses at financial institutions reducing their ability to finance investment, which, in turn, reduces asset values causing further losses; the weakness of the financial system reducing growth, and thus weakening the financial system; and falling output hitting employment, which reduces demand for output.

With unemployment already spiking upwards in the US and Europe, the dreaded R-word has already kicked in. All of this is bad news for our growth prospects that will be seriously affected in 2009. We cannot remain an island unto ourselves when the financial fragility that is integral to modern capitalism takes the world economy down.