Wednesday, April 3, 2013

They say there is a silver lining to every cloud. No place better than the financial markets to get reassurance about this. Every asset bubble burst has led to messy state of affairs and losses running into millions. Every stock market crash sees speculators running for cover. Every sovereign crisis brings in reluctant bailouts. But each one of them teaches some important lessons. The latest one, concerning a tiny economy, has brought a massive problem into the spotlight.

Cyprus' bailout may not have caused too many creases on the global economic landscape. However, it was a notable one. It was the first time the euro zone penalized bank depositors for the government's poor fiscal management. To put things in perspective, consider these statistics. Cyprus had fiscal deficit of 4.9% and bank assets comprised 716% of its GDP in 2012. But don't make the mistake of thinking that Cyprus is a one-off case! There are many others, big and small economies, whose economic profile is as delicately balanced as in the case of Cyprus. Fingers are already being pointed at Luxemburg, Malta, Estonia, Slovenia and Slovakia. As seen in the chart, the first two have bank assets that are ridiculously higher than GDP. For Luxemburg, the bank assets are 2107% of GDP! The risk of a country's growing dependence on bank debt is that it becomes more vulnerable to economic and financial shocks. An economy with higher leverage is likely to see more business failures and loan defaults in a recession or steep rise in interest rates, all else remaining same. Slovenia and Slovakia are also on red alert as their fiscal deficits are 4.2% and 4.8% respectively. 
 
Data source: World Bank, WSJ, IBT, Equitymaster

 
That makes us wonder how safe is India with fiscal deficit of 5.2% in FY13. Or for that matter, Ireland, Japan, US and China that have bank assets at 718%, 341%, 235% and 146% respectively. India' bank assets at just 75% of GDP assuage some concerns. For China too the robust fiscal position makes things look brighter. But the Cyprus debacle is a warning for every nation, big and small, to pay heed to. Unless the governments put their fiscal management in order and curb indiscriminate bank lending, a much bigger global crisis cannot be ruled out.