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Spreading contagion

The modified $700 billion bailout package, approved last week by the United States Congress after some initial hiccups, seemed to have faded into the background by Monday. The initiative has, thus far, not served the immediate objective of calming the financial markets and unclogging the credit flow. Though authorised to buy the toxic assets from the banks and thereby infuse liquidity, the U.S. government is hampered by the sheer enormity of the task. But its decisive move has helped in prompting governments across the Atlantic to take similar measures. In the United Kingdom, following a heavy pounding of bank stocks in the markets on Tuesday, the government came up with a £50 billion package for shoring up the capital of banks considered vulnerable. Regulators in Europe stepped in to save five banks in seven countries, although the task of keeping them afloat seems unenviable. Government intervention on a large-scale and committing taxpayers’ money will continue to be the key elements of bailout packages, with the emphasis between them varying according to the nature of the crisis in a given country. On Wednesday, acting in concert, seven central banks cut the interest rates. So far, the interventions have been more in the nature of a fire-fighting operation and found inadequate in containing the panic.

If the U.S. Treasury Secretary warned of more bank failures as the crisis permeated the real economy, the International Monetary Fund has forecast a sharp downturn in the global economy. The developing economies are unlikely to be spared. Already many countries have been hit by the contagion, and they included India, where the rupee has fallen sharply. Stock markets across the world have been sending negative signals equally loud and clear. In the U.S., stock prices slumped last week even when the legislative approval for the rescue package appeared certain. On Monday and Tuesday, the financial sector stocks were under stress — they dropped to their lowest levels since 1997. Indian markets have witnessed unprecedented volatility, with the indices crashing to a two-year low. Another defining feature of the crisis is the extreme loss of confidence in the financial markets. The inter-bank markets that have been functioning smoothly all along became frozen as banks stopped lending to each other in the developed countries. As a result, banks were forced to curtail severely their lending to companies as well as individuals — a development which, if unchecked, will have serious consequences for the developed economies and for the rest of the world as well.

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