A year-and-a-half after Lehman Brothers up-ended the world economy, a similar tragedy is unfolding in Europe. If the Americans were widely blamed for poorly regulating buccaneer capitalism and excessive risk-taking, this time it is the European Union (EU) that should take the rap for letting rogue borrowers like Greece to join the eurozone. Despite a 110 billion  euro ($140 billion) bailout package, Greece looks set to threaten the political and economic basis of the European Union. The size of the bailout — for a country with 1 per cent of India’s population and one-quarter its economic size — is larger than India’s current GDP by a wide margin.

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How can a country as tiny as Greece rock the EU, which is bigger than the US economy? The answer: in an integrated world, market confidence is key. Greece had to be rescued from a debt default to prevent a domino effect. If it had gone under, the markets would have started dumping the bonds of other problem countries like Spain, Portugal, Ireland and Italy. Once panic sets in, the EU cannot survive.

But the price of the Greek bailout is extremely stiff — and it could still come unstuck. In return for loans of $140 billion, the country will have to raise taxes and reduce expenses dramatically. Worse, it will have to reduce public sector wages and pensions and hold them at low levels for years. Net result: even while its debt will continue to bloat from 115 per cent of gross domestic product (GDP) to 150% over the next four years, the economy will be contracting for the next three years. All burden of this austerity is going to be borne by the Greek people — with untold consequences for political stability.

What if the EU had let the Greeks default? Not an easy decision, for Greece is part of the eurozone. A default would have had the same consequences in Europe that a default by a state government would have had in India. If, say, Maharashtra or Karnataka were to default on debt, the centre would have had to pick up the bill. If it doesn’t, all state government debt in any part of India would become suspect — and the centre would have had to step in anyway. Reason: all Indian states are part of the rupee area. An internal rupee default has huge implications for people who hold any kind of rupee debt. In the case of Greece, it would be tantamount to a euro default — and the euro’s future as a common currency would have come under a cloud.

This brings us to the first lesson for India, which is actually an economic union of many linguistic states, just like the eurozone: don’t let central or state debt grow to unsustainable levels. For the last few years, the UPA government has been squandering the fiscal prudence achieved in the NDA years through profligate spending. The public debt-to-GDP ratio is a high 82 per cent for centre and states — and rising.

To be sure, it is not the raw ratio that matters, but demographics. High ratios are tougher to sustain in slow-growth, ageing countries. What’s saving us is favourable  demographics. Thanks to steady rise in working age population, the Indian economy is in that sweet spot where growth impulses are very strong. So it is possible to cover rising deficits through higher tax collections. But if the debt rises any further, there could be hell to pay. It’s worth recalling that the 13th finance commission wants to the debt-GDP ratio to fall to 68 per cent by 2014-15. That calls for tough curbs on spending, of which there is no sign as yet.

The second lesson for India is to tread cautiously on economic integration within Saarc. The Greek crisis is very likely to call into question the very concept of having a common currency when economic policies diverge so much. If it had stayed outside the eurozone, Greece would have been able to devalue its currency and ease the pain of debt by stoking inflation, which is a way of reducing the real value of debt. Britain, which has also seen debt levels rising after the financial meltdown, has been saved from a Greece-like situation since it is out of the eurozone.

It is just as well that Saarc has been a non-starter in terms of economic integration. As the largest economy in south Asia, any country going under (Bangladesh, Sri Lanka, etc) would have become our responsibility. In fact, the best way forward is to do a lot of bilateral opening up with the smaller countries in Saarc to give them greater access to our markets. This will improve our ties with them and also make our economy more competitive. Pakistan can be left for later. When the generals are out and there is a genuine demand for peace, we can always do a deal with them. Till then, we should deal with Saarc like a sum of the parts rather than the whole.