The global financial crisis originated in United States of America. During booming years when interest rates were low and there was great demand for houses, banks advanced housing loans to people with low credit worthiness on the assumption that housing prices would continue to rise. Later, the financial institutions repackaged these debts into financial instruments called Collateralized Debt Obligations and sold them to investors world-wide. In this way the risk was passed on multifold through derivatives trade.
Surplus inventory of houses and the subsequent rise in interest rates led to the decline of housing prices in the year 2006-07 which resulted in unaffordable mortgage payments and many people defaulted or undertook foreclosure. The house prices crashed and the mortgage crisis affected many banks, mortgage companies and investment firms world-wide that had invested heavily in sub-prime mortgages. Different views on the reasons of the crisis include boom in the housing market, speculation, high-risk mortgage loans and lending practices, securitization practices, inaccurate credit ratings and poor regulation of the financial institutions. ———————————————— *Assistant Professor, DAMS, G. S. College of Commerce, Wardha, Maharashtra. **Assistant Professor, G. S. College of Commerce, Wardha, Maharashtra. The financial crisis has not only affected United States of America, but also European Union, U. K and Asia. The Indian Economy too has felt the impact of the crisis to some extent. Though it is difficult to quantify the impact of the crisis on India, it is felt that certain sectors of the economy would be affected by the spillover effects of the financial crisis.
KEYWORDS :Subprime. Real Estate. Collateralized Debt Obligations. Securitization. Speculation. Globalization *** GLOBAL FINANCIAL CRISIS AND ITS IMPACT ON INDIA *Professor SWAPNILSONY. N. SINGH **Professor K. V. SOMANADH The global financial crisis originated in United States of America. During booming years when interest rates were low and there was great demand for houses, banks advanced housing loans to people with low credit worthiness on the assumption that housing prices would continue to rise.
Later, the financial institutions repackaged these debts into financial instruments called Collateralized Debt Obligations and sold them to investors world-wide. In this way the risk was passed on multifold through derivatives trade. Surplus inventory of houses and the subsequent rise in interest rates led to the decline of housing prices in the year 2006-07 which resulted in unaffordable mortgage payments and many people defaulted or undertook foreclosure. The house prices crashed and the mortgage crisis affected many banks, mortgage companies and investment firms world-wide that had invested heavily in sub-prime mortgages.
Different views on the reasons of the crisis include boom in the housing market, speculation, high-risk mortgage loans and lending practices, securitization practices, inaccurate credit ratings and poor regulation of the financial institutions. The financial crisis has not only affected United States of America, but also European Union, U. K and Asia. The Indian Economy too has felt the impact of the crisis to some extent. Though it is difficult to quantify the impact of the crisis on India, it is felt that certain sectors of the economy would be affected by the spillover effects of the financial crisis.
Objectives of the Study * To examine the origin and causes of global financial crisis * To analyze the impact of the crisis on the Indian economy. * To examine the remedies adopted to overcome the recession Methodology of the Study The study is based on the secondary data. The secondary data has been collected from various books, journals and websites. Limitations of the Study * This study is based on the secondary data obtained from various journals, magazines and websites; where as the authenticity of the data cannot be checked out. * This study is pertaining to the recent times.
Reasons for Financial Crisis The first hint of the trouble came from the collapse of two Bear Stearns hedge funds early 2007. Subsequently a number of other banks and financial institutions also began to show signs of distress. Matters really came to the fore with the bankruptcy of Lehman Brothers, a big investment bank, in September 2008. The reasons for the crisis are varied and complex. Some of them include boom in the housing market, speculation, high-risk mortgage loans and lending practices, securitization practices, inaccurate credit ratings and poor regulation. 1.
Boom in the Housing Market: Subprime borrowing was a major contributor to an increase in house ownership rates and the demand for housing. This demand helped fuel housing price increase and consumer spending. Some house owners used the increased property value experienced in housing bubble to re-finance their homes with lower interest rates and take second mortgages against the added value to use the funds for consumer spending. Increase in house purchases during the boom period eventually led to surplus inventory of houses, causing house prices to decline, beginning in the summer of 2006.
Easy credit, combined with the assumption that housing prices would continue to appreciate, had encouraged many subprime borrowers to obtain adjustable-rate mortgages which they could not afford after the initial incentive period. Once housing prices started depreciating moderately in many parts of the U. S, re-financing became more difficult. Some house owners were unable to re-finance their loans reset to higher interest rates and payment amounts. Excess supply of houses placed significant downward pressure on prices. As prices declined, more house owners were at risk of default and foreclosure. . Speculation: Speculation in real estate was a contributing factor. During 2006, 22 per cent of houses purchased (1. 65 million units) were for investment purposes with an additional 14 per cent (1. 07 million units) purchased as vacation homes. In other words, nearly 40 per cent of house purchases were not primary residences. Speculators left the market in 2006, which caused investment sales to fall much faster than the primary market. 3. High- Risk Mortgage Loans and Lending Practices: A variety of factors caused lenders to offer higher-risk loans to higher-risk borrowers.
The risk premium required by lenders to offer a subprime loan declined. In addition to considering high-risk borrowers, lenders have offered increasingly high-risk loan options and incentives. These high-risk loans included “No Income, No Job and No Assets loans. ” It is criticized that mortgage underwriting practices including automated loan approvals were not subjected to appropriate review and documentation. 4. Securitization Practices: Securitization of housing loans for people with poor credit- not the loans themselves-is also a reason behind the current global credit risis. Securitization is a structured finance process in which assets, receivables or financial instruments are acquired, pooled together as collateral for the third party investments (Investment Banks). Due to securitization, investor appetite for mortgage backed securities (MBS), and the tendency of rating agencies to assign investment-grade ratings to MBS, loans with a high risk of default could be originated, packaged and the risk readily transferred to others. 5. Inaccurate Credit Ratings: Credit rating process was faulty.
High ratings given by credit rating agencies encouraged the flow of investor funds into mortgage-backed securities helping finance the housing boom. Risk rating agencies were unable to give proper ratings to complex instruments (Gregorio 2008). Several products and financial institutions, including hedge funds, and rating agencies are largely if not completely unregulated. 6. Poor Regulation: The problem has occurred during an extremely accelerated process of financial innovation in market segments that were poorly or ambiguously regulated – mainly in the U. S.
The fall of the financial institutions is a reflection of the lax internal controls and the ineffectiveness of regulatory oversight in the context of a large volume of non-transparent assets. It is indeed amazing that there were simply no checks and balances in the financial system to prevent such a crisis and “not one of the so called pundits” in the field has sounded a word of caution. There are doubts whether the operations of derivatives markets have been as transparent as they should have been or if they have been manipulated.. IMPACT OF THE CRISIS ON INDIAN ECONOMY:
Due to globalization, the Indian economy cannot be insulated from the present financial crisis in the developed economies. The development in the U. S financial sector has affected not only America but also European Union, U. K and Asia. The Indian economy too has felt the impact of the crisis though not to the same extent. It is premature to try to quantify the consequences of the crisis on the Indian economy. However the impact will be multi-fold. The impact has been examined in the light of following 3 Channels of Contagion: 1) Trade Channel: If an economy falls into a recession, it will also impact its trading partners as well.
A recession would imply less demand for overall products and services including import items. A recession also leads to lower investments and corporate would not be able to export their products and services. The first would affect the incomes of its export partners and second would affect the consumption levels of its importing partners. 2) Financial Channel: A crisis in an economy leads to substantial changes in its financial markets. An economic crisis usually leads to declines in equity indices, depreciation of the domestic currency and higher non-performing assets in the credit markets.
The impact on government bond markets depends on the inflation situation. In corporate bonds markets, spreads rise as concerns over health of corporates increase. The financial conditions in the crisis country could then impact other economies’ financial markets as well. This channel effects mainly through financial linkages across countries. The cross border financial linkages have increased substantially over the years. Another problem is that the correlation between assets has been rising across the world.
Hence, an impact on one large economy’s financial markets is not just transmitted to the other markets immediately; the movement is also more or less similar (decline in equity markets, rise in corporate bond spreads and currency depreciates). This channel has received substantial attention in the recent years. Not only have financial markets become more integrated in terms of volumes but also similar in terms of movement of various financial assets. Hence, this channel poses numerous challenges to policymakers. The impact via this channel is unexpected and could have nothing do with macroeconomic fundamentals. ) Trade and Finance Integrated Channel: Though, the above 2 channels impact differently, the two are quite interlinked as well. First, domestic banks can lend to companies in other economies as well. A problem in latter could lead to worsening of the conditions of domestic banks/financial firms as well (this has been seen in the case of Swede and Latin American Banks). Second, Banks are at the center of the international trade as they provide trade finance and other financing facilities that facilitate trade. A problem in financial markets will disrupt the international trade as well.
WTO and World Bank Chiefs have raised concerns over trade finance at numerous forums. This could undo a number of years of work on international trade. The Baltic Trade Index has already fallen to an all-time low and there are concerns that trade volumes might decline for the first time Hence, there are inter linkages between both the trade and finance channels and this makes the task of policymaker all the more difficult. The Indian case 1. Trade Channel: Table 1 shows both exports and imports are a crucial component of GDP.
Together they contribute about 45% of GDP and the share has risen with growth in GDP. Though, Imports are subtracted to get actual GDP, imports (especially capital goods, machinery etc) play a crucial part in development of an economy. Hence, an analysis of both exports and imports is needed. Table 1: Exports and Imports in India ?? Exports: Table 2 shows India’s export partners and their contribution in India’s exports since 2000-01. India has lowered its dependence on OECD or developed economies and the share has declined from 53% in 2000-01 to 39% in 2007-08.
Within developed economies, US has the largest share but it has declined sharply from 21% to 13%. The developed economies share has been replaced by exports to OPEC nations and developing economies. Within OPEC maximum increase is in UAE. Within Developing economies, rise in share is seen across regions- South East Asian Economies, Africa and Latin American economies. The share of China has increased from 1. 9% in 2000-01 to 6. 8% in 2007-08. However, all these growth numbers are expected to come down this fiscal year and in 2009-10 as well. This will have a negative impact on India’s exports.
As per IMF’s latest projections (November 2008), both the growth in output (Table 3) and the volume of exports (Table 4) is expected to decline in both OECD and developing economies. Hence, the overall demand is expected to decline substantially across globe and contract in developed economies. The emerging economies are still in the positive territory but it is expected to be much lower than the previous years’ growth rates. IMF has still predicted overall positive growth in trade volumes. World Bank has warned overall trade volumes might decline as well.
This would lead to lower demand for imports from other economies and as a result, India’s exports will be impacted as well. Though as India’s major export base has shifted from developed to developing economies, the impact is expected to be lesser. In terms of statistics, export market continued to be robust till August 2008 (Figure 1). The growth slipped sharply in September 2008 and has turned negative in October 2008. The growth in April-October 2008 of exports is noted at 23. 7% and cumulative export volumes are at USD 107. 80 billion (against the target of USD 200 bn).
The growth in exports between April 2008 and August 2008 was a puzzle as global growth was slipping every quarter. The main reason could be India’s dominant export partners being developing economies. The growth has been slipping in developed economies in early 2008 and in developing economies it has started only recently. As a result, the slowdown in exports is beginning to be seen now. Imports: In imports also, we see the same shift from developed to developing economies (Table 5). The maximum increase in imports has come from OPEC nations mainly because of crude oil.
In developing economies, imports from China have increased from 3. 0% in 2000-01 to 11. 3% in 2007-08. The analysis of impact of crisis on Indian imports is not clear. The imports from OPEC nations would lower as oil prices have declined substantially. This would benefit India, as it would lower the trade deficit and subsequently current account deficit. The current account deficit was so far financed by huge capital inflows but latter have dried and a decline in oil-imports will help in managing the current account deficit. ??
The imports from China would also lower as Chinese economy is expect to slow substantially (World Bank in its latest forecast puts growth in 2008-09 at 7. 5%). However, there are high chances of China dumping its products on the world shores as China has built huge capacities and would look to find demand for the same. Hence, there is some uncertainty regarding China. The impact on imports of important items for growth like machinery etc from developed economies is also expected to slow-down. It is going to be impacted from both sides demand and supply.
The demand from Indian companies for machinery, capacities etc will slow down as growth is expected to slow in India. Likewise, the developed economies would look to cut capacities and would lower supplies as well. The impact on imports is also beginning to be seen (Figure 1). The growth in both oil and non-oil imports has declined sharply in October 2008. As a result, trade deficit has also shrunk from a high of USD 13. 9 billion in August 2008 to USD 10. 54 billion in October 2008. The decline in trade deficit would help lower the current account deficit and manage it etter. 2. Finance Channel: Equity Markets: Equity Markets are the most affected (Figure 2) amongst various financial markets. From highs in 2007 the indices have declined substantially and the adverse movement happened in very quick time. This in turn is expected to impact the health of the economy further. India does not have a well-developed corporate bond market and relies on equity markets and bank financing for external capital. A decline in equity markets would lead to drying up of fresh capital raises and negatively impact the investment in the economy.
It is well-known that Indian growth story has been investment-driven and a decline in investment will impact the growth prospects. The decline in the equity indices was first seen in share prices of banks and financial intermediaries, as there were fears over the quality of their international assets. Though, Indian banks had negligible international exposure, there were concerns and fear psychosis set in. This decline was pretty severe and despite numerous statements from policymakers and corporate heads, the fear got worse.
This fear psychosis then impacted the share prices of other companies as it was expected that they would not be able to finance future investments. This then became a wide-spread phenomenon and all the companies were affected. Corporate Bond Markets: The risks of Indian corporate have increased significantly in recent months. This is common whether look at different set of companies based on ratings (Figure 3) or similar rated companies across different maturities (Figure 4). Though, the spreads have lowered in recent days because of numerous policy measures, they are still high compared to 2007 levels.
An increase in corporate spread makes further borrowing difficult as either no capital is available or it comes at a very high price. This is what we are seeing currently in Indian economy as corporate are finding it difficult on both these fronts. The corporate have expanded their capacities expecting economy to continue to grow (if not at 9% then at least 8%) and need capital to finance their expansion plans. The sources of capital have dried as both equity markets and bank financing have declined (explained below). As a result, there are concerns over unutilized capacities and losses in corporate balance sheets.
Forex Markets: The slowdown in growth has weakened investors confidence in Indian economy. The foreign investors have also withdrawn their monies to support the ailing balance sheets in their parent companies. As a result, Indian Rupee has depreciated and has touched all time lows. Another factor for steep currency depreciation is RBI’s easing of policy interest rates. The depreciation in currency has led to a different set of problems for Indian corporates. The corporates have undertaken external commercial borrowings to finance their businesses and the volumes have grown substantially over the years (Figure5).
Depreciation of rupee makes the external borrowings more expensive and poses additional concerns for the Indian corporates. Further, rolling of these liabilities has become difficult as foreign banks are in bad shape and credit risks of Indian corporates have increased. This problem of excessive dollarisation of liabilities has been seen in almost all crises in emerging markets and was an important factor that led to deepening of the respective crises. ?? Credit Markets: The growth in Indian economy led to substantial growth in bank credit as well.
Figure 6 shows that credit in the last 4 fiscal years has grown above 20% and credit-deposit ratio has increased to touch 70+ levels. This indicates credit markets have expanded manifold and banks have become more aggressive and have expanded credit portfolios. The slowdown in corporate balance sheets and personal incomes is expected to make it difficult to repay the loans. This would lead to higher non-performing assets on the side of banks. As indicated above, equity markets and bank financing are the 2 sources of external capital.
Equity markets have dried up and concerns are increasing over bank financing as well. Though like trade, bank credit continues to expand and showed growth of 27. 7% in outstanding credit at week ended 21 November 2008 and near similar growth levels are seen in every week. This is another puzzle. The corporates claim that bank financing has dried but statistics show the growth is still robust. The various media reports indicate that bulk of this credit has gone to oil companies but more evidence is needed. A detailed sectoral analysis of credit deployment is needed to understand the problem.
As banks are at the center of trade finance, latter can decline as well if NPAs in banking system rise. This will then further impact the trade channel via the finance channel. Foreign Capital Flows: The capital flows in India in form of Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII) grew tracking growth in Indian economy (Figure 7). The capital flows were so buoyant that it posed a different set of problems for Indian policymakers – appreciating rupee, sterilizing the inflows via government bonds, rising asset prices etc.
The situation has reversed now and foreign capital flows are expected to outflow from the Indian shores. Some developments are already being seen. The FII for 2008 (till November 19, 2008) in equity markets show outflow of USD 13 billion and an inflow of USD 2. 3 billion in debt markets, leading to a total FII outflow of 10. 7 billion). FDI recorded a growth in April-June 2008 quarter (compared to April-June 2007), but is expected to decline is days ahead as foreign economies slow. The ECB inflow has also slowed leading to an overall decline in Capital Account in April- June 2008 (Table 5).
The overall scenario in terms of foreign capital flows is bearish and it poses opposite concerns for policymakers – depreciating rupee, providing liquidity by buyback of government bonds issued previously to sterilize capital inflows, declining asset prices etc. Government Bond Markets: The government bond markets have been in a mixed mode getting both favorable and non-favorable drivers. The favorable development was decline in inflation tracking fall in crude oil prices, food commodities and metals. Another favorable development has been the ease in policy rates and projections of lower growth rates.
The non-favorable drivers has been concerns over liquidity being deficient and a higher than expected government borrowing program and fiscal deficit. However, the overall response has been an easing one (Figure 8) but the overall movement has been highly volatile. Summarizing the channels Overall, the summary is that the crisis has impacted the financial markets of India very adversely and an impact on trade flows is beginning to be felt (also adversely). The overall confidence in Indian financial markets has evaporated and the sentiment has shifted from euphoria to gloom in very little time. . Information Technology: With the global financial system getting trapped in the quicksand, there is uncertainty across the Indian Software industry. The U. S. banks have huge running relations with Indian Software Companies. A rough estimate suggests that at least a minimum of 30,000 Indian jobs could be impacted immediately in the wake of happenings in the U. S. financial system. Approximately 61 per cent of the Indian IT Sector revenues are from U. S financial corporations like Goldman Sachs, Washington Mutual, Citigroup, Bank of America, Morgan Stanley and Lehman Brothers.
The top five Indian players account for 46 per cent of the IT industry revenues. The revenue contribution from U. S clients is approximately 58 per cent. About 30 per cent of the industry revenues are estimated to be from financial services (Atreya 2008). The software companies may face hard days ahead. 2. Exchange Rate: Exchange rate volatility in India has increased in the year 2008-09 compared to previous years. Massive selling by Foreign Institutional Investors and conversion of their holdings from rupees to dollars for repatriation has resulted in the rupee depreciating sharply against the dollar.
Between January 1 and October 16, 2008, the Reserve Bank of India (RBI) reference rate for the rupee fell by nearly 25 per cent, from Rs. 39. 20 per dollar to Rs. 48. 86 (Chandrasekhar and Gosh 2008). This depreciation may be good for India’s exports that are adversely affected by the slowdown in global markets but it is not so good for those who have accumulated foreign exchange payment commitments. 3. Foreign Exchange Outflow: After the macro-economic reforms in 1991, the Indian economy has been increasingly integrated with the global economy.
The financial institutions in India are exposed to the world financial market. Foreign institutional investment (FII) is largely open to India’s equity, debt markets and market for mutual funds. The most immediate effect of the crisis has been an outflow of foreign institutional investment from the equity market. There is a serious concern about the likely impact on the economy because of the heavy foreign exchange outflows in the wake of sustained selling by Foreign Institutional Investors in the stock markets and withdrawal of funds by others.
The crisis resulted in net outflow of $ 10. 1billion from the equity and debt markets in India till 22nd Oct, 2008 (Kundu 2008). There is even the prospect of emergence of deficit in the balance of payments in the near future. 4. Investment: The tumbling economy in the U. S is going to dampen the investment flow. It is expected that the capital inflows into the country will dry up. Investments in mega projects, which are under implementation and in the pipeline, are bound to buy more time before injecting funds into infrastructure and other ventures.
The buoyancy in the economy is absent in all the sectors. Investment in tourism, hospitality and healthcare has slowed down. Fresh investment flows into India is in doubt. 5. Real Estate: One of the casualties of the crisis is the real estate. The crisis will hit the Indian real estate sector hard (Sinha 2008). The realty sector is witnessing a sudden slump in demand because of the global economic slowdown. The recession has forced the real estate players to curtail their expansion plans. Many on-going real estate projects are suffering due to lack of capital, both from buyers and bankers.
Some realtors have already defaulted on delivery dates and commitments. The steel producers have decided to resort to production cuts following a decline in demand for the commodity. 6. Stock Market: The financial turmoil affected the stock markets even in India. The combination of a rapid sell off by financial institutions and the prospect of economic slowdown have pulled down the stocks and commodities market. Foreign institutional investors pulled out close to $ 11 billion from India, dragging the capital market down with it (Lakshman 2008). Stock prices have fallen by 60 per cent.
India’s stock market index—Sensex— touched above 21,000 mark in the month of January,2008 and has plunged below 10,000 during October 2008 ( Kundu 2008). The movement of Sensex shows a positive and significant relation 4 A. PRASAD AND C. PANDURANGA REDDY with Foreign Institutional Investment flows into the market. This also has an effect on the Primary Market. In 2007-08, the net Foreign Institutional Investment inflows into India amounted to $20. 3 billion. As compared to this, they pulled out $11. 1 billion during the first nine-and-a-half months of the calendar year 2008, of which $8. billion occurred over the first six-and-a-half months of the financial year 2008-09 (April 1 to October 16). 7. Exports: The crisis will sharply contract the demand for exports adversely affecting the country’s growth prospects. It will have an impact on merchandise exports and service exports. The decline in export growth may sharply affect some segments of the Indian Economy that are export oriented. The slowdown in the world economy has affected the garment industry. The orders for factories which are dependent on exports, mainly to the U.
S have come down following deferred buying by big apparel brands. Rising unemployment and reduced spending by the Americans have forced some of the leading brands in the U. S to close down their outlets, which in turn has affected the apparel industry here in India. The U. S accounts for 55 per cent of all global apparel imports (Bageshree and Srivatsa 2008). The global recession will undermine other major export sectors of the Indian economy like sea foods, gems and jewellery. 8. Increase in Unemployment: One danger is of a dip in the employment market.
The global financial crisis could increase unemployment. Layoffs and wage cuts are certain to take place in many companies where young employees are working in Business Process Outsourcing and Information Technology sectors (Ratnayake 2008). With job losses, the gap between the rich and the poor will be widened. It is estimated that there would be downsizing in many other fields as companies cut costs. The International Labor Organization predicted that millions of jobs will be lost by the end of 2009 due to the crisis – mostly in “construction, real estate, financial services, and the auto sector. The Global Wage Report 2008-09 of International Labour Organization warns that tensions are likely to intensify over the issue of wages. There would also be a significant drop in new hiring (The Hindu 2008) All these will change the complexion of the job market. 9. Banks: The ongoing crisis will have an adverse impact on some of the Indian banks. Some of the Indian banks have invested in derivatives which might have exposure to investment bankers in U. S. A. However, Indian banks in general, have very little exposure to the asset markets of the developed world.
Effectively speaking, the Indian banks and financial institutions have not experienced the kind of losses and write-downs that banks and financial institutions in the Western world have faced (Venkitaramanan 2008). Indian banks have very few branches abroad. Our Indian banks are slightly better protected from the financial meltdown, largely because of the greater role of the nationalized banks even today and other controls on domestic finance. Strict regulation and conservative policies adopted by the Reserve Bank of India have ensured that banks in India are relatively insulated from the travails of their western ounterparts (Kundu 2008). Impact of previous US recessions on India It is important to look at how previous US recessions have impacted India. IMF in a report studied the impact of various US recessions in select regions (World Economic Outlook, April 2007). The results are summarized in Table 6. On a quick glance one can see that US recession does impact the other economies. The regions usually experience a negative growth in the years US undergoes a recession. However, the impact on other economies has been lesser than the US economy. There is not a definite trend as in case of some recessions certain region has slowed more than others.
In some cases the regions have actually grown. There are different reasons for the above trend. In some recession period, the growth has declined elsewhere because of common factors affecting all the economies like the 1974-75 oil crisis, 2001 dotcom crisis. Likewise, the collapse of the Savings ;amp; Loans institutions led to the 1991 recession and was limited to the US economy. The summary is that most regions do see slowing growth conditions post a US recession, but the reason is not due to US recession alone. It could also be because of the domestic conditions in the economies.
On looking at the impact on India, there seems to be little impact of the US recession on Indian economy. There have been no instances of negative growth or negligible growth. However, Indian economy has become more integrated on both trade and financial channels. The impact on financial channels is already being felt with crisis impacting Indian financial market severely. The impact on trade flows is yet to be felt but the probability has become higher with the crisis spreading widely to emerging economies. This crisis is being seen as the worst since Great Depression in 1929.
In the Great Depression US GDP had declined by nearly 30%, Industrial output by 45% and there was deflation. The Depression spread to other economies via the then fixed exchange rate system and confusions over policies. In a paper, Christina Romer points (Great Depression, 2003) the Depression also impacted Indian economy (Table7), starting in Q4 1929 (one quarter after US) and recovery beginning in Q1 1933 (one quarter before US). Hence, the impact of the biggest economic crisis was felt in India in 1929 as well! The statistics during those periods are not available and makes an exciting esearch project for future. POLICY RESPONSES SO FAR Monetary Measures: RBI’s policy rate Repo rate under LAF has been lowered by an aggregate 150 bps since October 20, 2008 from 9. 00% to 7. 50%. Rupee Liquidity Measures: * Cash Reserve Ratio has been lowered by an aggregate of 350 bps to 5. 5% since October 11, 2008. * The statutory liquidity ratio (SLR) has been reduced by 100 bps from 25 per cent of NDTL to 24 per cent. * A Special Repo facility worth Rs 60,000 cr to help liquidity problems in mutual funds (MFs) and non-banking financial companies. This will be available till March 2009. A special refinance facility has been introduced for scheduled commercial banks (excluding regional rural banks) with a limit of 1. 0 per cent of each bank’s NDTL as on October 24, 2008 at the LAF repo rate up to a maximum period of 90 days. During this period, refinance can be flexibly drawn and repaid. * A mechanism to buy-back dated securities issued under the market stabilisation scheme. The auctions under this facility have already started. * In the recent monetary policy move RBI extended the special repo facility to Housing Finance Companies. RBI also extended the time period for the various Repo facilities ??
Foreign Liquidity Measures: * RBI would continue to supply forex to agent banks in need of foreign currency * Interest Rate Ceilings on Rupee deposits and foreign currency deposits increased to LIBOR + 175 bps and LIBOR + 100 bps respectively * Trade credit less than 3 years ceiling was enhanced to 6 months LIBOR plus 200 basis points. * RBI to consider proposals to buy-back/pre-payment of FCCB and ECB prematurely ?? Credit Measures: * RBI has taken further measures to improve credit delivery. It has eased polices for trade-credit, asked banks to use special repo facility worth 1% of NDTL to give credit to micro and small enterprises.
It has taken counter-cyclical measures and has increase risk weights for sensitive sectors. For details one can see RBI’s press release dated 15 November 2008). Fiscal Measures * ?? The Government has released an advance of Rs. 25,000 crore to financial institutions under the Agricultural Debt Waiver and Debt Relief Scheme to provide additional liquidity. * ?? There have been repeated assurances by Prime Minister and Finance Minster over stability of Indian Banks and Financial System. There have been assurances that adequate measures will be taken if need arises. POLICY IN FUTURE [A] Fiscal vs Monetary:
Policy in future would depend on how worse the economic situation likely to be? The statistics aren’t conclusive of the steep slowdown but we are getting enough signs from financial markets, media and various press releases and statements from corporate leaders. There is ample news indicating labour lay-offs across sectors, build-up of inventories, increase in unutilized capacities, drying of bank financing etc. The problem with economic statistics is that it comes with a lag and in India’s case we don’t even have adequate sources of statistics that conveys a complete picture of the economic scenario.
However, both media and financial markets do indicate that things are likely to get worse. Though, financial markets are not always right but all the segments of financial markets indicate worse times ahead. The economic forecasts from various agencies are also being revised downwards with every update. The crisis was at first financial but has now spread to all segments of the economy and overall scenario is expected to worsen in 2009. In all, economic scenario looks pessimistic and policymakers would need to be proactive to prevent the crisis from becoming wide and prolonged.
This crisis has been far deeper than policymakers could ever imagine and even the most proactive policymakers (like in US) have looked passive. Fortunately, the Indian policymakers have been proactive so far and more would be needed. The policy is again going to be a mix of fiscal stimulus and monetary policy. There is substantial scope to ease policy rates and RBI is expected to ease rates going ahead. The quantum and timing of the decision will depend on Central Bank. RBI would also be looking at the level of Rupee to make its decision.
The issue is actually not as much with monetary policy (where easing is given) but with the usage of fiscal policy. India’s fiscal deficit is already on the higher side and could do away with years of hard work of lowering it (Figure 9). PM’s Economic Advisory Council in a report (Economic Outlook 2008-09) remarked: The off-budget liabilities on account of fertiliser, food and oil, along with unbudgeted liabilities arising out of the farm loan waiver and NREGA schemes and the implementation of the Sixth central Pay Commission, could amount to 5 per cent of the GDP in 2008/09, over and above the budgeted central fiscal deficit of 2. per cent. Similarly, the substantial cash losses of electricity utilities are not accounted for in budgets at the state level. The problem with off budget liabilities is that not only do they impose an additional burden that has to be extinguished when the liabilities mature, but they also have a significant servicing cost. In another paper (India’s Macroeconomic Performance and Policies since 2000, October 2008, ICRIER Working Paper No. 25), Shankar Acharya said fiscal consolidation continues to remain a priority for India: It is ironic that after the enormous success in fiscal consolidation achieved in 2002- 2008, the primary macroeconomic challenge confronting India for the medium-term is again one of restoring fiscal balance. In some ways the task ahead is harder because it may be unreasonable to expect the kind of revenue buoyancy experienced in recent years. Also, given the growing expenditure demands of recently launched populist schemes (such as the National Rural Employment Guarantee and the farm loan waiver) the prospects for expenditure compression may be limited.
The two main feasible avenues for fiscal consolidation that will need to be pursued vigorously are upward adjustment (or decontrol) of controlled prices for fuel, food and fertilizers and large-scale sale of equity in government enterprises. Hence, this position puts India into a catch-22 situation. If the crisis worsens, then monetary stimulus alone would not work and fiscal stimulus would be needed but the already high fiscal deficit would make it difficult. But the crisis might warrant a fiscal stimulus and avoiding it could further worsen the economic prospects.
How far can India go? The idea is not to advocate usage of fiscal stimulus but look at possible scenarios. In 1990-91 crisis, the fiscal deficit was 9. 4% of GDP and we had deficits around 9. 5%-9. 9% between 1999-2003. As per EAC estimates, for 2008-09 fiscal deficit could be around 7% – 7. 5% of GDP (including contingent liabilities). So, there could be a possibility of touching the previous highs. A stimulus equivalent to 1% to 1. 5% of GDP could still be provided to restore stability in economy. The next issue would be to ensure fiscal stimulus is useful and well targeted.
There are multiple options for fiscal stimulus- increase government expenditure (preferably in areas that lead to capital generation, cut taxes (direct as well as indirect) etc. The exact nature of fiscal stimulus is upto the government authorities. The authorities will also have to ensure that the stimulus is rolled back once the crisis situation eases and all possible efforts are made to go back to FRBM targets. [B] Usher Reforms across Business segments: Another suggestion for policymakers is to use this crisis time to ease the overall business scenario in the country.
As per World Banks’ Doing Business -2009 report (Table 9), it is very hard to do business in India. India ranks really low compared to other economies across business activities (In enforcing contract India ranks second last). There is an urgent need to ease the various restrictions that hinder business activity in the country. This suggestion has been espoused in many a reports but little has been achieved. It has been seen in numerous countries that it is easier to push reforms in times of crisis. Even India’s recent growth is a result of large-scale reforms undertaken in 1990-91 crises. C] Improve Economic Data: India has emerged as one of the fastest growing economies in recent times. This has led to substantial focus on Indian economy from all corners of the world. There is an urgent need to expand the set of economic data released in economy and make the data very regular. For instance, the crisis has brought the important role of housing market in an economy. But there is hardly any data on this market available in India. Likewise, Service sector is the largest component of Indian economy but there is hardly any regular data that helps track developments in the sector.
The crisis reinforces the need to have regular and large set of economic data that helps policymakers make better decisions. The policymakers can use this opportunity to improve the economic data system. CONCLUSION The above analysis is an attempt to understand the causes and impact of US originated crisis 2007-08 on India. The analysis looks at the various causes of recession and two channels of impact and points concerns are being felt widely via the financial channel. The Indian economy has hit sudden brakes after almost 5 years of acceleration at a rapid pace.
The efforts need to be made ensure the brakes are not prolonged. While the developed world, including the U. S, the Euro Zone and Japan, have plunged into recession, the Indian Economy is being affected by the spill-over effects of the global financial crisis (Chidambaram 2008). Great savings habit among people, strong fundamentals, strong conservative and regulatory regime have saved Indian economy from going out of gear, though significant parts of the economy have slowed down and there is a wide variance of opinion about how long it will continue.
It is expected that growth will be moderate in India. The policymakers can turn the crisis into an opportunity to push much needed reforms that will help India move to the next phase of growth. The most important lesson that we must learn from the crisis is that we must be self-reliant. Though World Trade Organization (WTO) propagates free trade, we must adopt protectionist measures in certain sectors of the economy so that recession in any part of the globe does not affect our country.
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