The so-called resilience that India’s economy demonstrated in 2009 and 2010 did not so much reflect a minor initial impact as it did the fruits of nimble fiscal and monetary policy.

The Congress-led United Progressive Alliance (UPA-I) coalition government in power at the time had available to it four shock absorbers that had been assiduously built up in the ‘fat’ years before the crisis. These were: a strengthened fiscal position; a large stock of international reserves; relatively high nominal interest rates; and national confidence in its economic management, symbolised by sustained fast growth. Two other ‘structural’ features of the policy framework were the banking system’s insulation from volatile capital movements via the Reserve Bank of India’s (RBI) creative Market Stabilisation Scheme and well-honed skills in operating a managed but broadly market-determined nominal exchange rate.

While the authorities demonstrated considerable foresight in developing this framework for managing risk, it still required nerve to use these assets to counter the slump. Based on the experience of past crises in emerging markets, the dominant view in the international financial press was that adopting expansionary, counter-cyclical policies in times of financial stress and uncertainty would aggravate, and not alleviate, skittishness. There was real uncertainty as to how the markets would react to an actual reduction in the stock of foreign exchange reserves. But as often happens, fortune favoured the brave, and the government was not only rewarded by the markets, it also succeeded in winning re-election in May 2009 with an enhanced majority. The successor coalition government, the UPA-II, led again by Congress (which improved its own position), remains currently in power.

This experience is worth recounting, both for the international parallels with 2008-09 and for the domestic differences. On the international front, the euro crisis is temporarily off the boil, but few knowledgeable commentators are convinced that a durable solution has been found. Reports in the international press, as well as comments from the Asian Development Bank, suggest that Asia will be substantially affected as European banks retrench so as to build up their capital ratios, and that India’s corporate sector is among those likely to be most affected. India’s domestic banks have already experienced a sharp increase in gross non-performing assets, while those owned by the state have to wait in a queue to receive infusions of government capital, one of the factors that led Moody’s to downgrade the State Bank of India’s stand-alone credit rating. Perhaps as damaging as any of these technical factors is the severe blow to the government’s reputation for economic and political management resulting from ever-widening corruption scandals, sharp rebukes from important constitutional bodies such as the Supreme Court and the Controller and Auditor-General of India, and discord within Congress and between Congress and important allies on important policy issues.

So what might the government’s ‘playbook’ be if, once again, the global financial system hurls its thunderbolts at India? In particular, under these changed domestic circumstances, will the government once again have the option of counter-cyclical easing, or will it have to follow a more conventional path of fiscal and monetary tightening? There is, unfortunately, no easy answer.

In 2008, the world’s financial institutions were themselves so scared and battered that the risk of a speculative attack on the rupee was slight. But we should not be quite as sanguine this time round. With its large current account deficit and substantial external financing needs, India would very much be in the sights of global hedge funds. From this perspective, a recent swap line concluded during a recent visit by Japan’s Prime Minister Noda to New Delhi is a useful additional line of defence. But in general, India would need to be more cautious in throwing reserves at the problem.

In this respect, I am one of the few commentators to endorse the RBI’s logic in remaining on the sidelines in the plunge of the rupee in late 2011, since significantly reversed. Irrespective of the proximate cause of the depreciation, it has been effective in signalling that, in a turbulent global and domestic environment, the RBI is willing to allow the nominal exchange rate to take the burden of adjustment. The correlation between the value of the rupee and the level of the stock market became uncomfortably clear to many corporate houses late last year as they faced the challenge of meeting redemptions on foreign currency convertible bonds coming due. These were a favoured means of raising overseas funding in the bull market, but have revealed their hidden costs in the present environment.

A harder question is whether it can now afford to ease up on interest rates given a slowing economy. In its monetary policy statement at the end of January, the RBI’s focus was on liquidity management rather than monetary easing; indeed, the occasion was used to rebuke the government on its fiscal looseness. The contribution we can expect from monetary policy this time round will be less than in the past.

What, then, of fiscal policy? Again, unfortunately, 2012 is unlikely to permit a repeat of 2008-09. India’s fiscal ‘marksmanship’ and its reform credibility are severely challenged, and an attempt to replace foreign demand with domestic stimulus is likely to go down badly with the markets. The conclusion is that India is in for a period of consolidation, and that it will take time — and a stronger global economy — before the halcyon days of 9 per cent growth once again become likely.

Suman Bery is Country Director of India Central at the International Growth Centre, New Delhi.