INDIA AND THE GLOBAL

FINANCIAL CRISIS

INDIA SHINING: GROWTH STORY

2001-2007

Entrepreneurial spirit, rise in productivity and increasing savings.

Unprecedented nine per cent growth

Rising forex reserves

Well performing services sector

Strong fundamentals

GLOBAL FINANCIAL CRISIS OF

2009

EVOLUTION OF THE CRISIS

Subprime mortgage crisis: rising interest rates, falling home prices leading to widespread default and foreclosures.

Securitized mortgages labeled investment grade turn illiquid on back of loose regulations and irresponsible financial innovation.

Host of institutions in US and Europe effected badly.

Financial markets freeze, recession sets in.

DECOUPLING THEORY

Holds that emerging economies will remain unscathed if advanced economies went into a downturn because of their substantial foreign exchange reserves, improved policy framework, robust corporate balance sheets and relatively healthy banking sector.

However, once the crisis hit, capital flow reversals, sharp widening of spreads on sovereign and corporate debt and abrupt currency depreciations , invalidate the theory.

INDIA: SAFE FROM THE CRISIS?

The Indian banking system had had no direct exposure to the sub-prime mortgage assets or to the failed institutions.

It has very limited off-balance sheet activities or securitized assets.

India's recent growth has been driven predominantly by domestic consumption and domestic investment. External demand, as measured by merchandize exports, accounts for less than 15 per cent of our GDP.

So the question is, why were we effected?

ANS: GROWING INTEGRATION WITH

THE GLOBAL ECONOMY

Increased globalization.

India's two-way trade (merchandize exports plus imports), as a proportion of GDP, grew from 21.2 per cent in 1997-98, the year of the Asian crisis, to 34.7 per cent in 2007-08.

Increased financial integration.

Ratio of total external transactions (gross current account flows plus gross capital flows) to GDP, this ratio has more than doubled from 46.8 per cent in 1997-98 to 117.4 per cent in 2007-08.

Increased reliance of corporate sector on external financing

In 2007-08, India received capital inflows amounting to over 9 per cent of GDP as against a current account deficit in the balance of payments of just 1.5 per cent of GDP, which shows the importance of external financing.

HOW INDIA WAS HIT?

Financial Channel

Confidence Channel

Real Channel

FINANCIAL CHANNEL

Overseas financing dried up

Corporate demand shifted to domestic banking sector

Corporates withdrew investment from NBFCs and MFs, putting redemption pressure

Capital flows reversed, corporates converted domestically raised money to foreign currency to meet foreign obligations

Rupee depreciated

REAL CHANNEL

Slump in demand for exports (US, ME, EU in

downturn)

Fall in outsourced services demand as overseas firms

face restructuring and downsizing.

RESPONSE TO CONTAIN THE CRISIS

PHASE 1: CRISIS MANAGEMENT

(OCTOBER 2008-APRIL 2009)

Monetary measures

Lower interest rates, CRR, SLR, repo and reverse repo rates

Expansion of refinance facilities for export credit

Relaxation of ECB rules for corporates, NBFCs and HFCs

Fiscal Stimulus packages of Dec ‘08 and Jan ‘09

additional public capital expenditure

government guaranteed funds for infrastructure spending

cuts in indirect taxes

expanded guarantee cover for credit to MSEs

additional support to exporters

PHASE 2: RECOVERY MANAGEMENT

(MAY 2009-DECEMBER 2009)

Strong rebound in investment demand

Domestic private demand remained dampened

Inflation started increasing due to high liquidity and money supply

Monetary measures withdrawn; SLR, export credit refinance limit, etc., restored to pre-crisis levels.

PHASE 3: INFLATION MANAGEMENT

Sustained increase in food prices and manufactured goods

CRR raised to contain excess liquidity

Repo and reverse repo rates were increased

Risks from sluggish global economy, rebound in global commodity prices, volatile capital flows and high domestic food prices remaing significant.

BREWING ECONOMIC CRISIS

AFTERMATH OF CRISIS 2008-09

Large erosion in asset value

Failure of financial firms

Contraction of output

Slowdown in growth

Widespread unemployment

Fiscal burden on countries, world-wide.

HIGH LIQUIDITY ACROSS THE

WORLD

Across the globe, central banks are pegging their lending rates at near zero levels, leaving scope for another asset bubble to take down the global financial system.

US Fed has pledged to keep interest rates low till 2014.

US treasury bonds have become the investment of choice instead of lending to small businesses.

EUROPEAN DEBT CRISIS

Euro-zone’s ‘Sovereign Debt Crisis’, threatens to derail the recovery process and plunge the world into a fresh financial crisis.

Some of the countries in the Euro-zone, namely, Portugal, Ireland, Italy, Greece and Spain (PIIGS) are finding it difficult to even service their debts.