Business Standard
May 6, 2013
Abstract
In mid-1994, Rudiger Dornbusch and Alejandro Werner warned that Mexico was heading into a crisis. Few academic papers have been so prescient. Not only was there a crisis later that year, but it followed the playbook that the paper outlined.
The late Professor Dornbusch and Mr Werner (now a senior official at the International Monetary Fund, or IMF) were worried on three counts. The exchange rate was substantially overvalued, economic growth had stalled, and the financial system was under stress. A loss of confidence, they warned, would lead to a sharp depreciation of the exchange rate, a collapse of foreign funding, and a seizure of the banking system. Together, these would cause a severe contraction in output.
Leo Tolstoy said in Anna Karenina that "… every unhappy family is unhappy in its own way". Yet, the Indian macroeconomic constellation today has an eerie feel of Mexico in 1994. The exchange rate is overvalued, economic growth has slowed to a crawl, and banks, with accumulating balance sheet strains, may struggle to withstand a large shock. If the horizon for continued inaction is the next general election, there is enough time for these vulnerabilities to morph into a full-blown crisis.
Citation
Ashoka Mody, and Michael Walton. "What Type of Crisis for India." Business Standard, May 6, 2013.