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Forget Hurricanes Ike and Gustav, the Category Five storm that hit Wall Street over the weekend, in the form of the collapse of Lehman Brothers and the sell-out of Merrill Lynch, has spread panic across the global financial system. The shock waves from a collapse that was assumed will never be allowed, sent markets on a tailspin across the world. The crisis will be dissected in detail in the days to come, especially the stubborn refusal of the US Treasury Secretary, Mr Henry Paulson, to fund even a partial bail-out of Lehman, which left the 158-year old firm with no option but to file for bankruptcy. Clearly the US markets and the global financial system are entering uncharted terrain. The possible repercussions of this crisis, that has now been unleashed, is unclear and it is this uncertainty that is causing nervousness in global markets. Even so, by refusing to bail-out Lehman using tax-payer funds, Mr Paulson appears to have taken the right decision. The poison has to filter down the system and take out the vulnerable players before it stabilises.

For India, the precipitous 850-points mid-session dip in the Sensex (it closed down 469 points or 3.35 per cent) is yet another sharp reminder of the global linkages of the domestic markets and will hopefully drive the last nail in the coffin of the “decoupling” theory. Any trouble in the US will wash into the Indian shores and the markets and the economy will have to be prepared to deal with the fall-out. The Lehman crisis is bound to have an impact much beyond the stock markets. The rupee weakened during the day, and but for support from the central bank, would have weakened even further. Indeed, central banks across the world were helping calm nerves in the markets by either injecting liquidity or giving statements of support. The new RBI Governor, Dr D. Subbarao, faces a challenge right away with the turmoil in the financial markets coming at the wrong time. The economy is just beginning to show some positive signals with inflation steadying and industrial growth bouncing back.

The Lehman hurricane is also bound to badly dent sentiment in the stock market. It is not so much a question of Lehman’s exposures in the market, which does not appear significant anyway, as the impact that the collapse will have on prospective FII investments. Given the turmoil in their home stead, it is likely that major FIIs will slow down their investments in the Indian market. Given that FIIs still form the backbone of the market in terms of generating liquidity, any slowdown in their activity cannot but affect valuations, irrespective of strong domestic fundamentals.

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