Contagious Financial Crises in the Recent Past and Their Implications for India

The phenomenon of financial market crises—the lasting disturbances in the capital markets—emerges in the form of banking crises, external debt crises and currency crises or in all of these at more or less the same time—these different forms are interlinked with one another which have their origin in one particular country and tend to spread to other countries. This is not a new one and is called in modern terminology ‘contagion’ a term that has been re-coined from the earlier ‘international propagation’ as coined by Charles Kindleberger in his classic of 1978, Manias, Panics, and Crashes. The more the interdependence among the countries in trade or exposure to common macroeconomic factors, the greater will be the contagion, while the main sources of it can be traced in common financial linkages, pathologies in the diffusion of information among the agents and, finally, financial fragility that underlies international contagion: rapid inflows of capital, macroeconomic shocks that occur too rapidly for gradual portfolio rebalancing and a leveraged common creditor. The present chapter in this context endeavours to have a look back and forward into the generation of so many financial market crises. Capital flows into emerging economies have grown twice as fast as those into developed economies since the 1990s. Over time, there have been notable changes in the form and nature of international capital flows. The first important trend is that the vast majority of these flows are driven by portfolio investment. A second trend is the rise in private capital flows. Private capital flows represented more than 80 % of all flows in 2011. A third trend is the increasing integration of developing states into global financial markets. These states have become an important destination for global capital. Larger capital flows meant larger current account deficits, given the difficulty of sterilizing these inflows, and real exchange rate appreciation. Both the deficits and the large real appreciation are sources of vulnerability when financial market conditions are disturbed. In the first place in this chapter, we recall early financial market crises in economic history which helps us to understand more about the contagion processes observed in more recent years. In the following section, our aim is to picture the important events that occurred in Chile in 1982, crisis of the exchange rate mechanism (ERM) during the early 1990s, the Mexican crisis of 1994–1995. Last of all, we provide a chronicle of the more recent crisis of 1997–1998 in Thailand and the subsequent turmoil in many Asian economies as well as global economic meltdown and the Eurozone crisis of recent years and their implications for India. The chapter ends with a conclusion.