It was the summer of 1997. What was to become known as the Asian financial crisis had just got rolling, knocking Thailand's currency off its peg. Over dinner in Singapore, an investment banker predicted to me that the country least likely to be affected by the spreading virus was Indonesia.
It seemed a reasonable statement to make at the time: unlike Thailand, Indonesia had good macro-economic fundamentals -- low inflation, a comfortable trade surplus and large foreign exchange reserves, plus strong banks. Confident about their future, some Indonesian companies had been borrowing in dollars, which had been falling against the Indonesian rupiah. Nothing on the horizon suggested the wholesale collapse that was to come, resulting in not just economic crisis but widespread riots, a pogrom that targeted the minority Chinese business community and the collapse of the Suharto government.
Financial contagion is dangerous precisely because you don't know where it will hit, and how hard. What is getting the financial world into a tizzy today began with the US sub-prime housing market, hit Bear Stearns in New York, then Macquarrie in Australia, and now BNP Paribas in France and a Dutch bank, as well as our own Tata Steel. The central banks in Europe, the US and Japan are scrambling to pump in liquidity so that credit does not dry up and trigger a recession.
Those in charge are trying to calm things down, in the US (where President Bush has spoken out twice, underlining the health of the economy) as well as in India (note what Mr Chidambaram and Mr Damodaran have said in the past couple of days). But the nervousness is spreading. Not because of what has happened (which in India is very little) but because of what might come to pass.
India's stock market is still ruling only marginally lower than a month ago. The rupee has dropped a bit as some of the foreign institutional investors pull out, but this is a blessing when everyone has been fretting about how the rising rupee has hit exports.
FII holdings at the peak of the stock market were close to the country's foreign exchange reserves, but any significant sell-off will drop both stock prices and the rupee, so the system can be self-correcting. Also, some long-term investors are still keen on India and will come in if they see attractive share prices. Which is not to say that stock prices will not fall, merely to argue that if the market falls to no lower than where it was in January (when the Sensex was about 14,000), or in March (12,500), it will not be an earthquake.
As for currency exposure, India was not affected very much by the 1997 crisis, though the rupee did fall 9 per cent against the dollar. This time round, the country's defences are stronger, with foreign exchange reserves in excess of $200 billion (they were $26 billion a decade ago).
The Reserve Bank can also prevent a flight of international money from provoking a domestic liquidity crisis, of the kind that central banks elsewhere are fighting to prevent, because it has ample reserve liquidity (all those market stabilisation bonds which can be bought back, the cushion provided by a high cash reserve ratio that can be slashed, plus excess money that the RBI is taking in through the repo market -- the total cushion is in excess of Rs 200,000 crore or Rs 2,000 billion). That should help to keep interest rates under control. Finally, while Indian companies have borrowed abroad quite a lot in the last couple of years, they should not be in trouble so long as the rupee falls no more than the 9 per cent of 1997. In fact, many today would welcome that kind of fall.
The key issue is to prevent the real economy (exports, domestic sales, jobs) from getting hit by the turmoil in financial markets, and the underlying factors here are confidence and trust -- in institutions, markets and policies. It is only if these come into question in people's minds and they stop spending, or if the world plunges into a recession, that we will have a crisis on our hands.