Europe, again

This time, even Germany is slowing

If investors who contributed to the soaring stock indices on Monday had paid closer attention to recent events in the euro zone, their euphoria may well have turned to despair. Three recent developments in that region suggest that India's GDP growth may not easily be able to sustain the satisfying 5-plus per cent printed in the April-to-June quarter. First, the French Prime Minister Manuel Valls dramatically resigned following a disagreement with President François Hollande over a fresh German-imposed austerity package just as France's GDP growth flatlined. Then came seemingly invincible Germany's own unpleasant surprise of shrinking second-quarter growth. Together with a similar performance in Italy, Europe's three largest economies have shrunk in the second quarter. Topping it on Monday was news that Markit's Manufacturing Purchasing Managers' Index (PMI) for the euro zone dipped to 50.7 in August, down from 51.8 in July, teetering at the 50 limit that indicates expansion.

Taken together with inflation below one per cent and dismal bond yields, there is little doubt that the euro zone is emphatically not out of crisis. Sanctions against Russia, the proximate reason for the contraction of Europe's Big Three economies, are only an immediate cause of the problems. In much of the euro zone, the toxic combination of high public debt (it is over 100 per cent in large parts of the region) and high unemployment (persistent in the "Club Med" economies) persists, suggesting that the old, unpopular austerity formula imposed by German Chancellor Angela Merkel has had limited success at best. But the structural rigidity imposed by the demands of a single currency without the flexibility of federated polities like India and the US mean that European economies have limited scope to deflate the currency and spend their way out of stagnation. The euro is also weakening, reflecting sentiments across the money markets as more and more commentators are suggesting that Europe bids fair to emulate Japan in the 1990s and head for a decade of lost growth. Events on the border between Russia and Ukraine do not indicate an abatement of hostilities anytime soon.

The reason investors in the Indian stock markets need to be worried is that this impacts India too. Despite the determined "Look East" policy pursued by several Indian regimes since the mid-1990s, Europe's lacklustre growth has been a major cause of concern. Europe accounts for 20 per cent of Indian exports, a fair portion in high-employment sectors like textiles and readymade garments where India is already a laggard in terms of price competition from countries like Bangladesh and Vietnam. Prime Minister Narendra Modi is predicating India's economic revival on getting stalled projects, investment and employment going once again. His reaching out to Japan, China and the US are transparent steps in that direction. The problem is that these initiatives take time to transmit themselves through an Indian system mired in the sludge of endemic corruption and poor implementation. So Europe's fortunes will continue to play a part in determining India's growth in the near term. India's economic planners need to be prepared for that.