my final res.global crisis

8/2/2019 My Final Res.global Crisis

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A PROJECT REPORT ON

BY

DIANA HARRIS

In partial fulfillment of

M.A in ECONOMICS .

NOWROSJEE WADIA COLLEGE

ROLL NO . 316

2011- 12

CERTIFICATE


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This is to certify that Miss DIANA HARRIS of M.A

ECONOMICS has

Successfully completed her project entitled on a

Research on

GLOBAL FINANCIAL CRISIS &

ITS IMPACT ON INDIA

Under the Guidance of Dr.MANJUSHA MUSMADE

DR.MANJUSHA MUSMADE DR.B.B THANKUR

RESEARCH GUIDE PRINCIPAL

HEAD OF ECONOMIC DEPARTMENT

NOWROSJEE WADIA COLLEGE

PUNE- 411001

ACKNOWLEGEMENT


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A project is Golden opportunity for learning & self-development. I

consider myself very lucky & honored to have wonderful people

lead me through in completion of this project.

My Grateful thanks to my HOD (Dr.Mrs.M.Musmade) who in spiteof being extraordinarily busy with her duties took time to hear,

guide & keep me on correct path. I dont know where I would

have been without her. A humble Thank You madam.

Dr.Mrs.M.Musmade monitored my progress and without her

encouragement I would have not been able to complete this

project. I choose this moment to acknowledge her contribution

gratefully.

Last but not the least there were so many who shared valuable

information that helped in the successful completion of this

project.

DIANA HARRIS

OBJECTIVE:-

TO study the role of cause of Recession

TO study the impact of Recession on India for the period 2007-10


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To analyze the opportunity created by recession before India

Policy responses of the Government to tackle the Crisis

Main aim of study is to find relevant answers to questions like why &

how India has been hit by the Crisis & how the Indian economy & theRBI have responded to Crisis

HYPOTHESIS:

Global financial Crisis affects credit & confidence of the banking &

financial market

The capital market Capital has become more expensive as banks are

lending to each other at higher rates

The stock market- fall in value of stocks& real estate as a result of

credit, assets & investment bubbles

Service sector, particularly the IT sector. Companies in the IT &

financial sectors continue to downsize & cut costs & will not likely hire

more people

Impact on employment & poverty

METHODOLOGY:-

For the requirement of this research & for the collection of material,

Secondary data has been used, E-books, websites & E-newspaper, reports,

periodicals, journals.

LIMITATIONS:-

Due to time constraints more issues have not been detailed

The accuracy & reliability of the data collected data across different

sources may vary slightly

The measurability of the crisis across a global scale may not be

through- considering all the factors would not be a feasible option

Option biasness may also exit.

Apart From internal factors that have affected Global economies, there

are critical external factors & trade behavior that dicate the nationsacross the globe to resort to measures to help themselves. The


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discussion of such issues in detail hasnt been made a part of report at

hand, though a significant amount of information has been analyzed &

studied for the same.

The Study of Global Financial Crisis is inexhaustible, & it will continue

as long as the world economy doesnt become self-sustainable again.

INDEX:-

I. CHAPTER 1

Introduction of Global Economic crisis

Understanding Business Cycle

II. CHAPTER 2

Background of crisis

Causes of Crisis

GENESIS & DEVELOPMENT OF CRISIS :-

Subprime Mortgage

Securitization & Repackaging of loans

Mismatch between financial innovation & regulation

Complex interplay of multi-factors

III. CHAPTER-3IMPACT OF GLOBAL CRISIS

Impact on India

i) Off Shoot of Globalized economy

ii) Aspects of financial turmoil in India

Capital outflow

Impact on stock forex market

Impact on Indian Banking system

Impact on Indian Sector & export prospect

Impact on employment

Impact on poverty


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IV. CHAPTER -4 INDIA & THE FINANCIAL CRISIS

Global liquidity crunch & Indian economy

Decreased consumer demand affecting exports

Financial crisis & Indian IT industry

Indian financial Markets

BAILOUT PACKAGES & RBI INITIATIVES

Indias response to crisis

Policy response i) fiscal stimuli ; ii) monetary policy response

Option Ahead

RECOVERY:-

Recovery of Indian economy

Some reasons of recovery

V. CHAPTER-5

Outlook for Indian economy

VI. CHAPTER-6

Summary

Conclusions

Bibliography


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CHAPTER 1

INTRODUCTION OF GLOBAL ECONOMIC CRISIS:-

The Indian economy is experiencing a downturn after a long spell of growth.

Industrial growth is faltering, the current account deficit is widening, foreign

exchange reserves are depleting, & the rupee is depreciating.

The crisis originated in US but Indian government had reasons to worry

because there was potential adverse impact of the crisis on the Indian Banks.

Lehman Brothers & Merril Lynch had invested a substantial amount in the

Indian banks. Who in turn had invested the money in derivatives, leading to

exposure of even the derivatives market to this investment bankers.

The present financial crisis which has its deep roots in closing year of the

20th century became apparent in July 2007 in the citadel of global neoliberal

capital, the United States, when a loss of confidence by investors in the valueof securitized mortgages resulted in a liquidity crisis. But the crisis came to

the forefront of business world and media in September 2008, with the

failure and merging of many financial institutions.

Added to this, in previous times of financial turmoil, the pre-crisis period was

characterized by surging asset prices that proved unsustainable; a prolonged

credit expansion leading to accumulation of debt; the emergence of new

types of financial instruments; and the inability of regulators to keep up

(ADB, 2008)

The immediate cause or trigger of the present crisis was the bursting of

United States housing bubble3 (Also known as Subprime lending crisis),

which peaked in approximately 2006-074. In March 2007, the United States'

sub-prime mortgage industry collapsed to higher-than-expected home

foreclosure rates, with more than 25 sub-prime lenders declaring bankruptcy,

announcing significant losses, or putting themselves up for sale. As a result,

many large investment firms have seen their stock prices plummet. The

stock of the country's largest sub-prime lender, New Century Financial

plunged 84%. Liquidity crisis promoted a substantial injection of capital intothe financial markets by the US Federal Reserve.


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Public sector Unit (PSU) banks of India like Bank of Baroda had significant

exposure towards derivatives. ICICI faced the worst hit. With Lehman

Brothers having filed for bankruptcy in the US, ICICI (Indias largest private

bank), survived a rumor during the crisis which argued that the giant bank

was slated to lose $80million (Rs.375crs) invested in Lehmans bondsthrough the banks UK subsidiary.

UNDERSTANDING BUSINESS CYCLES:-

Business Cycle or Economic Cycle refers to economy wide fluctuations in

production or economic activity over several months or years. These cycles

are characteristic features of market oriented economies whether in the

form of the altering expansions & contractions which characterize a classic

business cycle, or the altering speedups & slowdowns that mark cycles in

growth.

A recession occurs when a decline- however initiated or instigated occurs in

some measure of aggregate economic activity & causes cascading decline in

the other key measures of activity. Thus, when a dip in sales causes a drop in

production, triggering declines in employment & income, which in turn feeds

back into a further fall in sales, a vicious cycle results & a recession ensues.

This domino effect of the transmission of the economic weakness, from sales

to output to employment to income, feeding back into further weakness in all

of these measures in turn, is what characterizes a recessionary downturn.

The phases of the business cycle are characterized by changingemployment, industrial productivity & interest rates.

In the Keynesian view, business cycles reflect the possibilities that the

economy may reach short run equilibrium at levels below or above full

employment. If the economy is operating with less than full employment, i.e.,

with high unemployment , then in theory monetary policy & fiscal policy can

have a positive role to play rather than simply causing inflation or diverting

funds to inefficient uses.


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CHAPTER 2

BACKGROUND OF CRISIS:-

A disorderly contraction in wealth & money supply in the market is the basic

cause of a financial crisis, also known as a credit crunch. The participants in

an economy lose confidence in having loans repaid by debtors, leading them

to limit further loans as well as recall existing loans.

Credit creation is the lifeblood of the financial/banking system. Credit is

created when debtors spend the money & which in turn is banked & loan to

other debtors. Due to this, a small contraction in lending can lead to a

dramatic contraction in more supply.

The present global meltdown is a culmination of several factors, the most

important being irrational & unsustainable consumption in the West

particularly in United States disproportionate to its income by consistent

borrowings fueled by savings & surplus of the East particularly China &Japan.

The Second important factor is the greed of the investment bankers who

induced housing loans by uncontrolled leveraging in an optical illusion of

increasing prices in the housing sector.

The third important factor is the failure of the regulating agencies who

ignored the warning signals arising out of the ballooning debts, derivatives &

financial innovation on the assumption that the Collateral Debt Obligation

(CDO), the credit Default Swapping (CDS) & Mortgaged Backed Securities(MBS) would continue to remain safe with the mortgage guarantees provided


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by Government Sponsored Enterprises (GSEs) namely Fannie Mae & Freddie

Mac which had enjoyed the political patronage since inception.

There are other several factors including shadow banking system, financial

leveraging by the investment bankers & lack of adequate disclosures in the

financial statements leading to fallacious ratings by the rating agencies.

The global financial crisis is the unwinding of the debt bubbles between 2007

&2009. On Dec1, 2008 the National Bureau of Economic Research (NBER)

officially declared that the U.S economy had entered recession in Dec, 2007.

The financial crisis has moved into an Industrial crisis now as countries after

countries are sharing negative results in their manufacturing & service

sectors.

CAUSE OF THE CRISIS: The Financial Crisis: How it happened

The current crisis has been linked to the sub-prime mortgage business, in

which US banks give high risk loans to people with poor credit histories.

These & other loans, bonds or assets are bundles into portfolios or

collateralized Debt Obligations (CDOs) & sold to investors across the globe.

Falling housing prices & rising interest rates led to high numbers of people

who could not repay their mortgages. Investors suffered losses & hencebecame reluctant to take on more CDOs. Credit markets froze & banks


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became reluctant to each other, not knowing how many bad loans & non-

performing assets could be on their rivals books.

The crisis began with the bursting of the United States housing bubble & high

default rates on subprime mortgages & adjustable rate mortgages (ARM).

The foreclosures exceeded 1.3 million during 2007 up 79% for 2006 which

increased to2.3million in 2008, an 81% increase over 2007.

Financial product called mortgaged backed securities (MBS) which in turn

derive their value from the mortgage installment payments & housing prices

had enabled financial institutions & investors around the world to invest in

U.S housing markets. Major banks & financial institutions which had investedin such MBS incurred losses of approx.The value of all outstanding residential

mortgage owned by US households was US$10.6 trillion as of Mid-2008 of

which $6.6 trillion were held by mortgaged pools Consisting of Collectivized

debt obligation(CDO) already mortgage backed securities (MBS)(CDO & MBS)

and the remaining US$3.4 trillion by traditional depository institutions.

The owners of Stock In US Corporation alone have suffered loss of about

US$8trillion between 1Jan & 11Oct 2008 as the value of their holding decline

from US$20 trillion to US$12trillion.

The first catastrophe took place when Bear Stearns was sold to JP Morgan at

a throw away price in April 2008.

The biggest adverse impact was on Freddie Mac (the Federal home loan

Mortgage Corporation) the two Governments sponsored Enterprises (GSEs)

were granted a very quick bailout package by the US Treasury. A record

breaking level of mortgage foreclosures took place for the subprime

mortgages. Most of the investment bankers including Fannie Mac & Freddie

Mac reached to the brink of bankruptcy.


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When homeowners default, the payments received by MBS & CDO investors

decline & the perceived credit risk rises. This has had a significant adverse

effect on investors & the entire mortgage industry. The effect is magnified by

the high debt levels (financial leverage) households & business have incurred

in recent years. Finally, the risks associated with American mortgage lendinghave global impacts, because a major consequence of MBS & CDOs is a

closer integration of the USA housing & mortgage markets with global

financial markets.

GENESIS & DEVELOPMENT OF CRISIS:-

(i) Sub-prime mortgage:The current global economic crisis has originated in the sub-prime mortgagecrisis in USA in 2007. With easy availability of credit at low interest rates, realestate prices in US had been rising rapidly since the late 1990s andinvestment in housing had assured financial return. US home-ownershiprates rose over the period 1997-2005 for all regions, all age groups, all racialgroups, and all income groups. The boom in housing sector made both banks

and home buyers believe that the price of a real estate would keep going up.Housing finance seemed a very safe bet. Banks went out of their way to lendto sub-prime borrowers who had no collateral assets. Low income individualswho took out risky sub-prime mortgages were often unaware of the knownrisks inherent in such mortgages. While on the one hand, they were everkeen to become house-owners, on the other, they were offered easy loanswithout having any regard to the fact that they were not in a position torefinance their mortgages in the event of the crisis. All this was fine as longas housing prices were rising. But the housing bubble burst in 2007. Homeprices fell between 20 per cent and 35 per cent from their peak and in some

areas more than 40 per cent; mortgage rates also rose. Sub-prime borrowersstarted defaulting in large numbers. The banks had to report huge losses.

(ii) Securitization and Repackaging of Loans:The mortgage market crisis that originated in the US was a complex matterinvolving a whole range of instruments of the financial market thattranscended the boundaries of sub-prime mortgage. An interesting aspect ofthe crisis emanated from the fact that the banks/ lenders or the mortgageoriginators that sold sub-prime housing loans did not hold onto them. Theysold them to other banks and investors through a process calledsecuritization. Securitization, as a financial process, has gained wide

currency in the US in the last couple of decades.


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In the context of the boom in the housing sector, the lenders enticed thenaive, with poor credit histories, to borrow in the swelling sub-primemortgage market. They originated and sold poorly underwritten loanswithout demanding appropriate documentation or performing adequate duediligence and passed the risks along to investors and securitizers without

accepting responsibility for subsequent defaults. These sub-prime mortgageswere securitized and re-packaged, sold and resold to investors around theworld, as products that were rated as profitable investments. They had astrong incentive to lend to risky borrowers as investors, seeking high returnsand were eager to purchase securities backed by subprime mortgages. Thiskind of dangerous risk-shifting took place at every stage of the financialengineering process.The booming housing sector brought to the fore a system of repackaging ofloans. It thrived on the back of flourishing mortgage credit market. Thesystem was such that big investment banks such as Merrill Lynch, MorganStanley, Goldman Sachs, Lehman Brothers or Bears Stearns would encouragethe mortgage banks countrywide to make home loans, often providing thecapital and then the Huge Investment Banks (HIBs) would purchase theseloans and package them into large securities called the Residential MortgageBacked Securities (RMBS). They would package loans from differentmortgage banks from different regions. Typically, an RMBS would be slicedinto different pieces called tranches. As it was hard to sell some of lowerlevels of these securities, the HIBs would take a lot of the lower leveltranches and put them into another security called a collateralized debtobligation (CDO). They sliced them up into tranches and went to the ratingagencies and got them rated. The highest tranche was typically rated again

AAA. The finance investment banks took sub-prime mortgages and turnednearly 96 per cent of them into AAA bonds.The outstanding CDOs are estimated at $ 3.9 trillion against the estimatedsize risk of the sub-prime market of $1 to $ 1.3 trillion. This is a revealingindex of the multiplier effect of securitization structures and CDOs.

(iii) Mismatch between Financial Innovation and Regulation:It is not surprising that governments everywhere seek to regulate financialinstitutions to avoid crisis and to make sure a countrys financial systemefficiently promotes economic growth and opportunity. Striking a balancebetween freedom and restraint is imperative. Financial innovation inevitably

exacerbates risks, while a tightly regulated financial system hampers growth.When regulation is either too aggressive or too lax, it damages the veryinstitutions it is meant to protect.In the context of this crisis, it would be pertinent to know that in US, thefinancial institutions, during the past forty years, focused considerableenergy on creating instruments and structures to exploit loopholes in theregulation and supervision of financial institutions. Financial globalizationassisted in this process by enabling corporations and financial institutions toescape burdensome regulations in their home countries by strategicallybooking their business offshore. Regulatory authorities proved ineffective in

acknowledging that large and complex financial institutions were usingsecuritization to escape restrictions on their ability to expand leveraged risk-


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taking. Central Banks in US and Europe kept credit flowing to deviousinstitutions that as originators of risky loans or as sponsors of securitizationconduits had sold investors structured securitization whose highest qualitytranches were so lightly subordinated that insiders had to know that theinstruments they had designed were significantly over-rated. It is important

to understand that the goal of financial regulation and supervision is not toreduce risk-taking of the financial institutions, but to manage the safety net.This goal implied that supervisors have a duty to see that risks can be fullyunderstood and fairly priced by investors. The loopholes in supervisionclearly sowed the seeds of the current crisis. In tolerating an on-going declinein transparency, supervisors encouraged the very mis-calculation of riskwhose long-overdue correction triggered the crisis. Financial markets did wellthrough capital market liberalization. Enabling America to sell its riskyfinancial products and engage in speculation all over the world may haveserved its firms well, even if they imposed large costs on others. Today, therisk is that the new Keynesian doctrines will be used and abused to servesome of the same interests. The crisis has taken by surprise everyone,including the regulators. The regulators failed to see the impact of thederivative products which clouded the weaknesses of the underlyingtransactions. The financial innovation two words that should, from nowon, strike fear into investors hearts... to be fair, some kinds of financialinnovation are good. ... but the innovations of recent years were sold onfalse pretences. They were promoted as ways to spread risk. Quite clearly,there was a mismatch between financial innovation and the ability of theregulators to monitor. Regulatory failure comes out glaringly.

(vi) Complex Interplay of multiple factors:It may be said with a measure of certainty that the global economic crisis isnot alone due to sub-prime mortgage. There are a host of factors that led toa crisis of such an enormous magnitude. The declaration made by the G-20member states at a special summit on the global financial crisis held on 15thNovember 2008 in Washington, D.C. identified the root causes of the currentcrisis and put these in a perspective. During a period of strong global growth,growing capital flows, and prolonged stability earlier this decade, marketparticipants sought higher yields without an adequate appreciation of therisks and failed to exercise proper due diligence. At the same time, weakunderwriting standards, unsound risk management practices, increasingly

complex and opaque financial products, and consequent excessive leveragecombined to create vulnerabilities in the system. Policy-makers, regulatorsand supervisors, in some advanced countries, did not adequately appreciateand address the risks building up in financial markets, keep pace withfinancial innovation, or take into account the systemic ramifications ofdomestic regulatory actions. Major underlying factors to the current situationwere, among others, inconsistent and insufficiently coordinatedmacroeconomic policies, inadequate structural reforms, which led tounsustainable global macroeconomic outcomes. These developments,together, contributed to excesses and ultimately resulted in severe market

disruption.


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CHAPTER 3

IMPACT OF THE CRISIS:-

The global financial crisis is already causing a considerable slowdown in most

developed countries. Governments around the world are trying to contain the

crisis, but many suggest the worst is not yet over. The continuous

development of the crisis had promoted fears of a global economic collapse.

Quoting US Economist Paul Krugman, as noted in New York Times column,

Rate of unemployment hikes to 8.9% in the US: 539,000 jobs lost

US GDP shrinks by 8.1% in the first Quarter

US foreclosures spike 32% in April, 2009

US Home Prices fall 14% in first quarter

These financial losses have left many financial institutions with

too little capital too few assets compared with their debt. This

problem is especially severe because everyone took on so much

debt during the bubble years.

Financial institutions have been trying to pay down their debt by

selling their assets, including those mortgage backed securities,

but this drives asset prices down & makes their financial

condition even worse. This vicious cycle is what some call the

paradox of deleveraging.


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IMPACT OF ECONOMIC CRISIS ON INDIA -

(i) Offshoot of Globalized Economy

With the increasing integration of the Indian economy and its financialmarkets with rest of the world, there is recognition that the country doesface some downside risks from these international developments. The risksarise mainly from the potential reversal of capital flows on a sustainedmedium term basis from the projected slowdown of the global economy,particularly in advanced economies, and from some elements of potentialfinancial contagion. In India, the adverse effects have so far been mainly inthe equity markets because of reversal of portfolio equity flows, and theconcomitant effects on the domestic forex market and liquidity conditions.The macro effects have so far been muted due to the overall strength ofdomestic demand, the healthy balance sheets of the Indian corporate sector,and the predominant domestic financing of investment.72It has been recognized by the Prime Minister of India that ...it is a time ofexceptional difficulty for the world economy. The financial crisis, which a yearago, seemed to be localized in one part of the financial system in the US, hasexploded into a systemic crisis, spreading through the highly interconnectedfinancial markets of industrialized countries, and has had its effects on othermarkets also. It has choked normal credit channels, triggered a worldwidecollapse in stock markets around the world. The real economy is clearlyaffected. ...Many have called it the most serious crisis since the GreatDepression.73

(ii) Aspects of Financial Turmoil in India(a) Capital Outflow -The main impact of the global financial turmoil in India has emanated fromthe significant change experienced in the capital account in 2008-09, relativeto the previous year. Total net capital flows fell from US$17.3 billion in April-June 2007 to US$13.2 billion in April-June 2008. Nonetheless, capital flowsare expected to be more than sufficient to cover the current account deficitthis year as well. While Foreign Direct Investment (FDI) inflows havecontinued to exhibit accelerated growth (US$ 16.7 billion during April-August2008 as compared with US$ 8.5 billion in the corresponding period of 2007),

portfolio investments by foreign institutional investors (FIIs) witnessed a netoutflow of about US$ 6.4 billion in April-September 2008 as compared with anet inflow of US$ 15.5 billion in the corresponding period last year. Similarly,external commercial borrowings of the corporate sector declined from US$7.0 billion in April-June 2007 to US$ 1.6 billion in April-June 2008, partially inresponse to policy measures in the face of excess flows in 2007- 08, but alsodue to the current turmoil in advanced economies.

(b) Impact on Stock and Forex Market -With the volatility in portfolio flows having been large during 2007 and 2008,

the impact of global financial turmoil has been felt particularly in the equitymarket. Indian stock prices have been severely affected by foreign


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institutional investors' (FIIs') withdrawals. FIIs had invested over Rs 10,00,000 crore between January 2006 and January 2008, driving the Sensex20,000 over the period. But from January, 2008 to January, 2009 this year,FIIs pulled out from the equity market partly as a flight to safety and partly tomeet their redemption obligations at home. These withdrawals drove the

Sensex down from over 20,000 to less than 9,000 in a year. It has seriouslycrippled the liquidity in the stock market. The stock prices have tanked tomore than 70 per cent from their peaks in January 2008 and some have evenlost to around 90 per cent of their value. This has left with no safe haven forthe investors both retail or institutional. The primary market got derailed andsecondary market is in the deep abyss.Equity values are now at very low levels and many established companiesare unable to complete their rights issues even after fixing offer prices belowrelated market quotations at the time of announcement. Subsequently,market rates went down below issue prices and shareholders are consideringpurchases from the cheaper open market or deferring fresh investments.This situation naturally has upset the plans of corporates to raise resourcesin various forms for their ambitious projects involving heavy outlays.In India, there is serious concern about the likely impact on the economy ofthe heavy foreign exchange outflows in the wake of sustained selling by FIIson the bourses and withdrawal of funds will put additional pressure on dollardemand. The availability of dollars is affected by the difficulties faced byIndian firms in raising funds abroad. This, in turn, will put pressure on thedomestic financial system for additional credit. Though the initial impact ofthe financial crisis has been limited to the stock market and the foreignexchange market, it is spreading to the rest of the financial system, and all of

these are bound to affect the real sector. Some slowdown in real growth isinevitable.

Dollar purchases by FIIs and Indian corporations, to meet their obligationsabroad, have also driven the rupee down to its lowest value in many years.Within the country also there has been a flight to safety. Investors haveshifted from stocks and mutual funds to bank deposits and from private topublic sector banks. Highly leveraged mutual funds and non-banking financecompanies (NBFCs) have been the worst affected.

(c) Impact on the Indian Banking System -One of the key features of the current financial turmoil has been the lack ofperceived contagion being felt by banking systems in emerging economies,particularly in Asia. The Indian banking system also has not experienced anycontagion, similar to its peers in the rest of Asia. The Indian banking systemis not directly exposed to the sub-prime mortgage assets. It has very limitedindirect exposure to the US mortgage market, or to the failed institutions orstressed assets. Indian banks, both in the public sector and in the privatesector, are financially sound, well capitalised and well regulated. The averagecapital to risk-weighted assets ratio (CRAR) for the Indian banking system, asat end-March 2008, was 12.6 per cent, as against the regulatory minimum ofnine per cent and the Basel norm of eight per cent.

A detailed study undertaken by the RBI in September 2007 on the impact ofthe sub-prime episode on the Indian banks had revealed that none of the


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Indian banks or the foreign banks, with whom the discussions had been held,had any direct exposure to the sub-prime markets in the USA or othermarkets. However, a few Indian banks had invested in the collateralised debtobligations (CDOs)/ bonds which had a few underlying entities with sub-primeexposures. Thus, no direct impact on account of direct exposure to the sub-

prime market was in evidence.Consequent upon filling of bankruptcy by Lehman Brothers, all banks wereadvised to report the details of their exposures to Lehman Brothers andrelated entities both in India and abroad. Out of 77 reporting banks, 14reported exposures to Lehman Brothers and its related entities either in Indiaor abroad.An analysis of the information reported by these banks revealed thatmajority of the exposures reported by the banks pertained to subsidiaries ofLehman Brothers Holdings Inc., which are not covered by the bankruptcyproceedings. Overall, these banks exposure especially to Lehman BrothersHoldings Inc. which has filed for bankruptcy is not significant and banks arereported to have made adequate provisions. In the aftermath of the turmoilcaused by bankruptcy, the Reserve Bank has announced a series ofmeasures to facilitate orderly operation of financial markets and to ensurefinancial stability which predominantly includes extension of additionalliquidity support to banks.

(d) Impact on Industrial Sector and Export Prospect -The financial crisis has clearly spilled over to the real world. It has sloweddown industrial sector, with industrial growth projected to decline from 8.1per cent from last year to 4.82 per cent this year. The service sector, which

contributes more than 50 per cent share in the GDP and is the prime growthengine, is slowing down, besides the transport, communication, trade andhotels & restaurants sub-sectors. In manufacturing sector, the growth hascome down to 4.0 per cent in April-November, 2008 as compared to 9.8 percent in the corresponding period last year. Sluggish export markets have alsovery adversely affected export-driven sectors like gems and jewellery, fabricsand leather, to name a few. For the first time in seven years, exports havedeclined in absolute terms for five months in a row during October 2008-February 2009.In a globalised economy, recession in the developed countries would

invariably impact the export sector of the emerging economies. Exportgrowth is critical to the growth of Indian economy. Export as a percentage ofGDP in India is closer to 20 per cent. Therefore, the adverse impact of theglobal crisis on our export sector should have been marginal. But, the realityis that export is being and will continue to be adversely affected by therecession in the developed world. Indian merchandise exporters are underextraordinary pressure as global demand is set to slump alarmingly. Exportgrowth has been negative in recent months and the government has scaleddown the export target for the current year to $175 billion from $200 billion.For 2009-10, the target has been set at $200 billion.

(e) Impact on Employment -


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Industry is a large employment intensive sector. Once, industrial sector isadversely affected, it has cascading effect on employment scenario. Theservices sector has been affected because hotel and tourism have significantdependency on high-value foreign tourists. Real estate, construction andtransport are also adversely affected. Apart from GDP, the bigger concern is

the employment implications. A survey conducted by the Ministry of Labourand Employment states that in the last quarter of 2008, five lakh workers lostjobs. The survey was based on a fairly large sample size across sectors suchas Textiles, Automobiles, Gems & Jewellery, Metals, Mining, Construction,Transport and BPO/ IT sectors. Employment in these sectors went down from16.2 million during September 2008 to 15.7 million during December 2008.Further, in the manual contract category of workers, the employment hasdeclined in all the sectors/ industries covered in the survey.The most prominent decrease in the manual contract category has been inthe Automobiles and Transport sectors where employment has declined by12.45 per cent and 10.18 per cent respectively. The overall decline in themanual contract category works out to be 5.83 per cent. In the directcategory of manual workers, the major employment loss, i.e., 9.97 per cent isreported in the Gems & Jewellery, followed by 1.33 per cent in Metals.Continuing job losses in exports and manufacturing, particularly theengineering sector and even the services sector are increasingly worrying.Protecting jobs and ensuring minimum addition to the employment backlogis central for social cohesiveness.

(f) Impact on poverty -The economic crisis has a significant bearing on the country's poverty

scenario. The increased job losses in the manual contract category in themanufacturing sector and continued layoffs in the export sector have forcedmany to live in penury. The World Bank has served a warning through itsreport, The Global Economic Crisis: Assessing Vulnerability with a PovertyLens, which counts India among countries that have a high exposure toincreased risk of poverty due to the global economic downturn. Combinedwith this is a humanitarian crisis of hunger. The Food and AgricultureOrganization said that the financial meltdown has contributed towards thegrowth of hunger at global level. At present, 17 per cent of the world'spopulation is going hungry. India will be hit hard because even beforemeltdown, the country had a staggering 230 million undernourished people,the highest number for any one country in the world.


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CHAPTER 4

INDIA & THE FINANCIAL CRISIS:-

Indias economy has been one of the stars of global economies in recentyears, growing 9.2% in 2007 and 9.6% in 2006 and has seen a decade of 7plus % growth. Growth had been supported by markets reforms, huge inflowsof FDI, rising foreign exchange reserves, both an IT and real estate boom,and a flourishing capital market. But, in the middle of 2008, price increasesof global commodity (Hamilton, 2008); especially those of oil, metal and foodtook a toll on India. Inflation reached at 12.91 per cent, the highest level

seen for a decade. With this growth softened, budget deficits widened andtrade balances worsened. Before the India could recover from the adverseimpact of high commodity prices, the global financial crisis has comeknocking. Initially, it was argued that India would be relatively immune to thiscrisis, because of the strong fundamentals of the economy and thesupposedly well-regulated banking system. But, a crisis of this magnitudewas bound to affect globalized economy like India and it has. Economy beganto slow down from the middle of 2007-08. After a long spell of growth, theIndian economy is experiencing a downturn. IMF has also predicted thatIndian economy cannot remain immune from global financial crisis and crisiswill hit Indias growth story. Indian government is feeling the heat of global

crisis in India.The slowdown is likely to have a large & immediate impact on employment &

poverty. Informal surveys suggest significant job losses. Job creation is likely

to remain a key concern as new entrants to the labor force relatively better

educated & with higher aspirations continue to put pressure on the job

market.

The Country has the option of turning the crisis into an opportunity. The most

binding constraints to growth & inclusion will need to be addressed:

improving infrastructure, developing the small & medium enterprises sector,

building skills, & targeting social spending at the poor. Systematic


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improvements in the design & governance of public programs are crucial to

get results from public spending. Improving the effectiveness of these

programs that account for up to 8-10% of GDP will therefore be an

important part of the challenge.

The Union Government has constituted a committee to consider issues raisedby India Inc on global financial crisis and its impact on India.The impact of the crisis on the Indian economy has been studied here forth &

the study is chiefly focused on 4 major factors which affect the Indian

economy as a whole. These are :

Availability of global liquidity*

Decreed consumer demand affecting exports*

The financial Crisis & the Indian IT industry

Fall in Growth Rate, Industrial Output and Rise in Inflation

GLOBAL LIQUIDITY CRUNCH & THE INDIAN ECONOMY : -

The Indian Banking system was gauged as being relatively immune to the

factors that lead to the turmoil in the global banking industry. The problem of

the global banks arose mainly due to the sub-prime mortgage lending &

investments in complex collateralized debt obligations (CDOs) whose valueswere sharply eroded. Indian banks had limited vulnerability on both counts.

The reasons for tight liquidity conditions in the Indian Markets during the

earlier stages of the crisis were quite different from the factors driving the

global liquidity crisis. Large selling by foreign institutional investors (FIIs) &

the subsequent interventions by the RBI in the foreign currency market,

continuing growth in advances, and earlier increases in the Cash Reserve

Ration (CRR) to contain inflation are some of the reasons that accelerated

the Indian liquidity Crunch.Cautions investors had started to diversify away from bank deposits & cash

over the past few years, and had moved to equities, mutual funds and

insurance products. The current market turmoil is driving them back to the

safety of bank-deposits, reducing the amount of capital available to other

instruments & possibly retarding the growth of the financial services

industry as a whole.

Indias Household & Corporate Savings will fuel the domestic economy at a

time when the global liquidity crunch is aggravating the economic downturnin other parts of the globe.


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Indias high savings rate has been a crucial driver of its economic boom,

providing productive capital & helping to fuel a virtuous cycle of higher

growth, higher income & higher savings. Household savings will therefore

remain crucial to sustaining a strong saving rate.

India will be relatively unaffected by the global liquidity crisis because the

large fund of Indias household savings which stood at Rs.9.85trn (US$192bn)

in 2006/07, will remain available to fuel domestic growth. As GDP rose 14.4%

at current market prices, net savings of the households grew 15.6%. The

Indian government is trying to hasten the shift of Indias physical savings,

still locked up in unproductive physical assets such as houses, durables, &

jewelry, into financial assets. The household savings can be channelized into

the countrys debt, equity & infrastructure finance markets. This would not

only deepen & stabilize the financial markets but also reduce the

governments social-security burden.

It is evident from the graph shown alongside that the ratio of gross domestic

savings to the GDP of the country has been increasing over the years. Influx

of these household savings into the countrys debt, equity, & infrastructure

finance markets will certainly help in the deepening & stabilization of

financial markets.


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Gross National Savings also include all foreign remittances into India which

add to the domestic savings. A positive trend in the ratio further strengthens

the fact that India is self-sufficient in the short term with regard to any

immediate liquidity demand.

Indias savings rate at present is higher than all other regions of the world,

except developing Asia & Middle East. The countrys investment rate showed

sharp acceleration during the period FY02-07 to surpass the average of allmajor regions of the world in FY07.

However, according to a report, factors which could weigh down the rate of

domestic savings to a moderate 33.0% & further to 32.8% during FY09 &

FY10 respectively from around 37.7% in FY08 are :

Lower corporate profitability

Significant widening of fiscal deficit

Erosion in value of financial & physical assets.

While rich country banks were piling into ever riskier assets, Asian banks

kept their holdings of such assets small. And while America & Britain were

sucking up the worlds savings, Asian governments piled up vast stocks of

foreign reserves.

The Long term trends in the savings of the country are a clear indicator of

the fact that even if Indias savings & investment rates undergo a cyclical

reduction in FY09, by next fiscal(FY10) these rates should still br around 30%,

with 6% growth in the second half of FY10.


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DECREASED CONSUMER DEMAND AFFECTING EXPORTS:-

Some of the sharpest declines in output during the global recession have

been suffered by the strongest economies of Asia. It is feared that due to

their heavy dependence on exports, some of these economies may not see

the face of recovery until demand rebounds in America & Europe.

In Oct 2008, India registered its first every year over-year decline in exports

(of 15%), following growth of 35% in the previous five months. Indian

shipments declined 33.3% in March from a year earlier, the biggest fall since

the last 14yrs. Goods exports dropped 33% from a year earlier to $11.5

billion in April2009. This was the biggest fall since April 1995. Exports slid

21.7% in February.

Indias exports, which account for 15% of the economy, grew 3.4% to $168.7

billion in the fiscal year ended March31, missing a $20 billion target set by

the government, before the collapse of the Lehman Brothers Holding Inc.

accelerated the world financial & economic slump. The government expects

exports to total to $170 billion in the year that started April1.

According to estimates from the Federation of Indian Export Organizations,

falling overseas sales may cost India about 10million jobs.

Asia is suffering from two recessions: a domestic one as well as an external

one

A high fiscal deficit & a high current account deficit are a threat to economic

stability which is the main reason why international credit rating agencies

have brought the countrys debt close to junk status.

Asias export driven economies had benefited more than any other region

from Americas consumer boom, so its manufactures were bound to be hit

hard by the sudden downward lurch.

Asia is suffering from two recessions: a domestic one as well as an external

one. Domestic demand had been expected to cushion the blow of weakerexports, but instead it was hit by two forces. First, the surge in food & energy

prices in the first half of 2008 squeezed companies profits & consumer

purchasing power. Food & energy account for a larger portion of household

budgets in Asia than in most other regions. Second, in several countries,

including China, South Korea & Taiwan, tighter monetary policy intended to

curb inflation choked domestic spending further. With hindsight, it appears

that Chinas credit restrictions to cool its property sector worked rather too

well.

12% of Indias total exports of $168.7 billion in FY2008-09 went to the US


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Shipments of Indian natural pearls, precious & semi precious stones, &

pharmaceutical products, all recorded a decline causing Indian exports to the

US to drop by 22..63% to $5.22billion in Q1 of 2009. US exports to India also

declined by 24.9% in Q1 of 2009; it amounted to $2.69 billion as compared

to $3.94 billion in Q1 of 2008.

The Indian Gems & Jewelry sector was significantly affected by the reduced

demand in the US & Europe. Overseas sales of Indias gem & jewellry items

expanded at a seven- year low rate of 1.45% & stood at $21billion in 2008-

09, as exports contracted sharply in the last six months of the year. This lead

to about 2Lakhs job losses in the sector, especially of artisans engaged in

polishing diamonds.

The fall in exports was caused by lowering of demand in overseas markets

for luxury items in the backdrop of the ongoing recession.

The drop in expansion of gems & jewellery exports in 2008-09 was cushioned

by a 23.6% growth in gold jewellery, which stood at $6.85 billion as against

$5.54 billion in the year ago period.

India & the other Asian economies will have to brace themselves up for the

sharply reduced consumption in the United states over an extended period,

following the global financial crisis, & change the export- dependent

structure of its economies, & create more regional demand to drive their

growth.

THE FINANCIAL CRISIS & THE INDIAN IT INDUSTRY:

Indias emergence as a global competitive supplier of software & services

has attracted world wide attention. The software & service sector not only

contributed significant to export earnings & GDP but also emerges as a

major sources of employment generation in the country. Besides, the

information technology (IT) sector has served as a fertile ground for the

growth of new entrepreneurial ideas with innovation corporate practices &

has been instrumental in reversing the brain drain, raising Indias brandequity & attracting foreign direct investment (FDI) leading to other

associated benefits.


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Economists have long noted that services in general are cheaper in

developing countries than in developed countries. An abundant supply of

labor the major input in the production of services in developing

countries, leading to low wages is the chief factor that accounts for the low

cost of producing services. India, with its large pool of skilled manpower, has

emerged as a major exporter of IT software & related services, such asbusiness process outsourcing (BPO). In fact, one of the notable achievements

in India during the last decade has been the emergence of an internationally

competitive IT software & service sector (see Fig. 4)


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The US financial services & insurance sector (BFSI-Banking, Financial services

& Insurance) was one of the earliest adopters of the trend of outsourcing

along with Indias biggest IT outsourcing firms. Large outsourcing chunks

were created by the US BFSI which were created by the US BFSI which

made the Indian IT players learn from their experience. Price negotiations& increased commitments on the services level raised the share of US

financial services revenue as a percentage of total revenues for the Top

3 Indian from 25% to 38% between 1999 & 2008.

Indian companies were appreciated by the US clients for their flexibility,

good quality delivery & giving a key lever in managing their selling,

general,& administrative expenses (SG & A) & time to market by freeing up

more critical IT resources. Indian players were essentially partner in taking

some of the fixed costs out of their SG & A. Because there was no partnering

of Indian firms with the financial services entities at any closer level, liketying up of their invoices with the clients business outcomes, the Indian

players were saved from a much worse impact of the crisis.

The slowing US economy has seen 70% of firms negotiating lower rates with

their suppliers & nearly 60% are cutting back on contractors. Due to a

squeezed budget, only about 40% of the companies plan to increase their

use of offshore vendors.

The US financial crisis has put the growth of the Indian IT industry in the

short- to medium-term in an uncertain position. Growth numbers of ITcompanies were revised down by 2-3% after sentiment started building up

against the US financial sector at the time of the Q1 results. A worse

downward revision is expected this quarter as well, though some larger

players like TCS, & Satyam have denied any larger impact of the crisis.

While we have looked mainly at IT, the ITES sector is joined at the hip with IT

industry, but with its own flavors. The impact in financial services operations

will be much larger, but, over the medium to long ter, there will be huge gain

for them from the increase in outsourcing & off-shoring in the financial

sector. However, short term pain alongside the US slowdown is inevitable.

FINANCIAL CRISIS & THE SATYAM SAGA:-

In the light of the debacle of the Satyam Computer services, the current

financial crisis has brought the issue of audit committee effectiveness to

the fore in India. Satyam, Indias fourth largest computer software exporter,

after years of vastly inflated profits, was shattered & exhausted when the

shocking reality of Satyams operating margin of 24% being false was

brought to the forefront its operating margins were a meager 3%.


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The financial crisis also struck the company at a time when there were

growing suspicions related to the Maytas issue. Satyam was not able to

maintain its inflated figures in the wake of the crisis & hence, its majestic

accounting fraud was brought to the forefront.

FALL IN GROWTH RATE, INDUSTRIAL OUTPUT AND RISE ININFLATION :-

Second, the global financial crisis and credit crunch have slowed Indiaseconomic growth. GDP started decelerating in the first quarter of 2007-08,nearly six months before the outbreak of the US financial crisis andconsiderably ahead of the surge of recessionary tendencies in all developedcountries from August-September 2008. That was just the beginning ofslowdown impact on Indias GDP growth. GDP growth for 2008-09 wasestimated at 6.7% as compared to the growth of 9.0% posted in the previousyear. All the three segments of the GDP namely agriculture, forestry andfishing, industry and services sector were seen to post growth of 1.6%, 3.8%and 9.6% respectively in 2008-09 against the growth of 4.9%, 8% and 10.8%respectively in 2007-08. Poor agricultural growth is also attributed to lowmonsoon in major parts of India (Figure 5).


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FIGURE (5)

Table 2 clearly shows that due to shrinkage in demand in the markets, it isnot only manufacturing industry but also the services sector that is gettinghit. The government came up with a set of stimulus measures on threeoccasions to aid the ailing industry compromising on the deficits. Thesemeasures have however have led to widening of fiscal deficits.Further, Indias industrial output fell at its fastest annualized rate in 14 years,despite tax cuts and fresh spending programme announced by thegovernment of India in December and January to boost domestic demand.

Data released by CSO showed that the factory output shrank by 1.2 per centin February, on week global and domestic demand. This is against growthrate of 9.5 per cent during the same month a year ago. Industrial output thusgrew 2.8 per cent during April-February, against 8.8 per cent in the sameperiod a year ago. Manufacturing, which constitutes 80 per cent IIP (Index ofIndustrial Production), contracted by 1.4 per cent in February, as productionof basis, intermediates and consumer goods shrank compared with a yearago (Figure 6).


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For a little over a year after the outbreak of financial crisis, the globaleconomy experienced, between September 2007 and October 2008, apronounced stagflationary phase, with the growth slowdown on the one handand rising inflation on the other hand. So far as the Indian economy isconcerned since prices of practically all petroleum products are administeredand trade in agricultural goods is far from free, transmission of globalinflation to domestic prices occurred with a time lag, from November 2007

rather than September 2007. Beginning of 2008 has seen a dramatic rise inthe price of rice and other basic food stuffs. When coupled with rises in theprice of the majority of commodities, higher inflation was the only likelyoutcome.

Indeed, by July 2008, the key Indian Inflation Rate, the Wholesale Price Index,has risen above 11%, its highest rate in 13 years. Inflation rate stood at 16.3per cent during April to June 2008. There was an alarming increase in June,when the figure jumped to 11%. This was driven in part by a reduction ingovernment fuel subsidies, which have lifted gasoline prices by an average10%.

BAIL- OUT PACKAGES AND RBI INITIATIVES:-

Financial markets in the United States & around the world are in a state of

dire emergency & they require urgent & decisive action. Some key parts

of the credit market were on the verge of a deadlock, resulting not just in

the collapse of major financial institutions but also in credit disruption that

has been severely weakening the long term prospects of non- financial

companies.

There was a need for swift action to deal with the toxic mortgage-backed securities that had been causing credit markets to seize up. The


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Federal governments effort to support the global financial system have

resulted in significant new financial commitments, with the U.S

government having pledged more than $11.6 trillion on behalf of

American tax payers over the past 20month, far in excess of the

aggregate of the several bailout packages announced or doled out in thepast.

The Government of china had also announced a financial package of

US$585 billion to pump prime the economy by making huge public

investment & by providing subsidies to protect domestic economy which

is otherwise exposed to external market & is likely to be severely affected

because of the cuts in imports by all the importing countries.

INDIAs RESPONSE TO THE CRISIS :-

As the contagion of the financial system collapse across the world spread

towards India, & into it, the government & the Reserve Bank Of India (RBI)

responded to the challenge in close coordination & consultation. The main

plank of the governments response was fiscal stimulus while the RBIs

action comprised monetary accommodation & counter cyclical regulatory

forbearance.

The RBIs policy response was to keep the domestic money & credit

markets functioning normally & see that the liquidity stress did not trigger

solvency cascades. RBIs targets can be classified into 3 prime directions:(Duvvuri Subbarao, Governor)

To maintain a comfortable rupee liquidity position

To augment foreign exchange liquidity

To maintain a policy framework that would keep credit delivery on

track so as to arrest the moderation in growth.

The previous period has forced RBI to adopt tightened monetary policies

in response to heightened inflationary pressures. However, the RBI

changed its approach to handle the current scenario & eased monetary

constraints in response to easing inflationary pressures & moderation in

growth in the current cycle.

The following were the conventional measures of the RBI :

1) Reduced the policy interest rates aggressively & rapidly

2) Reduced the quantum of bank reserves impounded by the

central bank


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3) Expanded & liberalized the refinance facilities for export credit

To manage Foreign Exchange, the RBI

i) Made an upward adjustment on interest rate ceiling on the

foreign currency deposits by non- resident Indians

ii) Substantially relaxed the external Commercial Borrowings

(ECB) regime for corporates

iii) Allowed access to foreign borrowing to non-banking financial

companies & housing finance companies.

RBI also took unconventional measures as a response to the

liquidity scenario:

i) India banks were given the rupee- dollar swap facility to givethem comfort in managing their short term funding

requirments

ii) An exclusive refinance window, as also a special purpose

vehicle, was made available for supporting non- banking

financial companies

iii) The lendable resource available to apex finance institutions

for refinancing credit extended to small industries, housing &

exports, was expanded.

The Central Governments Fiscal Responsibility & Budget

Management (FRBM) Act, enacted to bring in fiscal discipline by

imposing limits on fiscal & revenue deficit, proved to the road map

to fiscal sustainability at the time of crisis. The emergency

provisions of the FRBM Act were invokes by the central

government to seek relaxation from the fiscal targets & two fiscal

stimulus packages were launched in December 2008 & January

2009.These fiscal stimulus packages, together amounting to about 3% of

GDP, included:

Additional public spending , particularly capital expenditure,

government guaranteed funds for infrastructure spending

Cuts in indirect taxes,

Expanded guarantee cover for credit to micro & small

enterprise, and


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Additional support to exporters.

These stimulus packages came on top of an already

announced expanded safety-net for rural poor, a farm loan

waiver package & salary increases for government staff, all of

which too should stimulate demand.

POLICY RESPONSES FROM INDIA :-The global financial crisis has called into question several fundamentalassumptions and beliefs governing economic resilience and financialstability. With all the advanced economies in a synchronized recession,global GDP is projected to contract for the firsttime since the World War II,anywhere between 0.5 and 1.0 per cent, according to the March 2009

forecast of the International Monetary Fund (IMF). The emerging marketeconomies are faced with decelerating growth rates. The World TradeOrganization (WTO) has forecast that global trade volume will contract by 9.0per cent in 2009. Governments and central banks around the world haveresponded to the crisis throughboth conventional and unconventional fiscaland monetary measures. Indian authorities have also responded with fiscaland monetary policy and regulatory measures .

Monetary Policy Measures -On the monetary policy front, the policy responses in India since September2008 have been designed largely to mitigate the adverse impact of the

global financial crisis on the Indian economy. In mid-September 2008, severedisruptions of international money markets, sharp declines in stock marketsacross the globe and extreme investor aversion brought pressures on thedomestic money and forex markets. The RBI responded by selling dollarsconsistent with its policy objective of marinating conditions in the foreignexchange market. Simultaneously, it started addressing the liquiditypressures through a variety of measures. A second repo auction in the dayunder the Liquidity Adjustment Facility (LAF16) was also introduced inSeptember 2008. The repo rate was cut in stages from 9 % in October 2008to rate of 5 per cent. The policy reverse repo rate under the LAF was reducedby 250 basis points from 6.0 per cent to 3.5 per cent. The CRR (Cash ReserveRatio) was also reduced from 9 per cent to 5 per cent over the same period,whereas the SLR (Statutory Liquidity Ratio) was brought down by 1 per centto 24 per cent. To overcome the problem of availability of collateral ofgovernment securities for availing of LAF, a special refinance facility wasintroduced in October 2008 to enable banks to get refinance from the RBIagainst declaration of having extended bona fide commercial loans, under apre-existing provision of the RBI Act for a maximum period of 90 days. Thesepolicy measures of the RBI since mid-September resulted in augmentation ofliquidity of nearly US $80 billion (4,22,793 crore). In addition, the permanentreduction in the SLR by 1.0 per cent of NDTL (Net Demand and Time Liability)

has made available liquid funds of the order of Rs.40,000 cr for the purposeof credit expansion (Table 7).


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The liquidity situation has improved significantly following the measurestaken by the Reserve Bank. The overnight money market rates, whichgenerally hovered above the repo rate during September-October 2008,have softened considerably and have generally been close to or near thelower bound of the LAF corridor since early November 2008.Other money market rates such as discount rates of CDs (Certificates ofDeposits), CPs (Commercial Papers) and CBLOs (Collateralized Borrowing and

Lending Obligations) softened in tandem with the overnight money marketrates.

The LAF window has been in a net absorption mode since mid-November2008. The liquidity problem faced by mutual funds has eased considerably.Most commercial banks have reduced their benchmark prime lending rates.The total utilization under the recent refinance/liquidity facilities introducedby the Reserve Bank has been low, as the overall liquidity conditions remaincomfortable. However, their availability has provided comfort to thebanks/FIs, which can fall back on them in case of need.Taken together, the measures put in place since mid-September 2008 have

ensured that the Indian financial markets continue to function in an orderlymanner. The cumulative amount of primary liquidity potentially available tothe financial system through these measures is over US$ 75 billion or 7 percent of GDP. This sizeable easing has ensured a comfortable liquidity positionstarting mid-November 2008 as evidenced by a number of indicatorsincluding the weighted-average call money rate, the overnight moneymarket rate and the yield on the 10-year benchmark government security.

Fiscal Stimuli Packages -To contain the knock on effects of the global slowdown, the Government of

India announced three successive fiscal stimuli packages during December2008-Feburary 2009 amounting to a total of Rs. 80,100 crore (US $16.3


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billion) to the exchequer. These stimulus packages were in addition to thealready announced post budget expenditure towards the farmer loan waiverscheme, rural employment guarantee and other social security programs,enhanced pay structure arising from the 6th pay commission, etc. As aresult, net borrowing requirement for 2008-09 increased nearly 2.5 times the

original projection in 2008-09 from 2.08 per cent of GDP to 5.89 per cent ofGDPThe governments first fiscal package, announced on December 2008, a dayafter the central bank cut the Repo and Reverse Repo rates, has Rs 20,000crore as additional expenditure, an across-the-board 4% excise duty cutamounting to Rs 8,700 crore and benefits worth Rs 2,000 crore for exporters.In less than a month since the UPA Government announced its first fiscalstimulus package in December 08, the government again announced itssecond fiscal stimulus package dose which was combined with significantmonetary measures from the RBI announcing further cuts in key benchmarkinterest rates, both being aimed at kick starting investments and stimulatingdemand in the economy which has seen a significant slowdown in demandarising out of recessionary conditions in several global markets.The second stimulus package has five elements this time which include astrong focus on interest rate reduction, additional liquidity enhancement toproductive sectors, export sector being offered financial aid, a boost beinggiven to the Infrastructure Sector and finally easier access to ECBs(External Commercial Borrowings) and FIIs22. TheStimulus package announced has an additional plan expenditure of Rs.20,000 crore during current year, mainly for critical Rural, Infrastructure andSocial Security sectors, and measures to support Exports, Housing, Micro,

Small & Medium Enterprises (MSME) and Textile sectors. In this package,government has focused on the Infrastructure needs wherein the IndiaInfrastructure Finance Company Limited (IIFCL) would be raising Rs. 10,000crore to refinance infrastructure projects worth Rs 25000 crore. It has alsoenvisaged funding of additional projects worth Rs 75000 crore at competitiverates over the next 18 months. Funding for these projects to IIFCL would beenabled in tranches of additional Rs 30000 crore by way of tax-free bonds,once funds raised during current year are effectively utilized. (Estimatedbenefits to the tune of Rs 40000 crore) Barely a week after the presentationof the Interim Budget, the government came out with the third fiscal stimuluspackage in which further tax cuts costing Rs 29,100 crore or about 0.5 per

cent of GDP were announced. The service tax was cut by two points from theprevailing level of 12 per cent and excise duty was reduced by a similarmagnitude for items presently subject to 10 per cent. The indications so farseem to be that the package of policy measures is not really having theintended impact of reviving the real sector. In spite of the more than Rs.4,00,000 crore of liquidity released into the financial markets, the creditofftake has been remarkably poor.There are also questions on the appropriateness of the measure in thealready strained fiscal scenario. The effectiveness of cuts in excise duty andservice tax in providing a demand stimulus is doubtful-first, the tax cuts

should result in price cuts and then, these should translate into higherdemand in the situation of falling incomes. Furthermore, there will always be


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dissatisfaction when the tax cuts are reversed. Many, in fact, believe thatfiscal stimulus is better served by expenditure increase rather than tax cutsnot only because the impact is direct but also because it can be bettertargeted.Hopefully, the reduction in excise duty and service tax rates will facilitate the

unification of the two taxes for levying the GST (Goods and Services Tax) at areasonable rate when implemented. In any case, the entire episode ofannouncing tax cuts just after a week of presenting the Interim Budget pointsto the governments lack of clarity in combating the slowdown.

OPTIONS AHEAD/SUGGESTION :-

(i) Diversifying ExportsThere is an imperative need to boost the exports, keeping in view its growthimpulses and employment potential. Emphasis has been laid on renewing

efforts not only to improve competitiveness, but also diversify the exportbasket and destinations. We need to be cognizant of the fact that due tofinancial turmoil, the consumption pattern of the developed countries andtheir demands for goods and services have undergone a sea change and thiswill be less likely to be reversed in near future. We need to imaginativelythink where else can we sell our products and what would be the preferredconsumption patterns of these newer markets.(ii) Boosting Domestic ConsumptionIt has been suggested by many experts that unless we boost domesticconsumption, it will be difficult to compensate for the loss of externaldemand arising out of export squeeze. But, it is not that easy to replace

exports by domestic consumption. It is a common knowledge that theproducts and processes of goods and services meant for exports aresignificantly different from the one preferred by domestic consumers.Changing production systems to suit domestic demand requires in-depthanalysis and commencing new lines of production and processes.(iii) Enhancing Public SpendingIt has been argued that along with the measures to support the financialsystem, we must increase public spending. There can be no dispute with thecontention that public spending should remain at a high level in a situationlike the present one. Fiscal profligacy is not a dirty word anymore. There is a

world-wide feeling that pampering enhanced public outlays during the periodof crisis is a key policy option. It has been commonly held that public outlayson infrastructure projects need to be optimum and particularly, projectimplementation needs to be accorded top priority, keeping in view itsmultiplier effects on growth. We need to put in place a sound mechanism ofproject management which would provide for minimal regulatory hurdles andprocess delays and functional autonomy to implementing agencies so as toensure the pace and quality of public projects. Several stimulus packageshave been announced that indicate commitment to enhanced publicspending. But such a package is meaningful only if money does not remainclogged up in the system.

For infrastructure spending to spur the economy, it is critical that usualdelays and lags are avoided and the projects are enabled to take off quickly.


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And, a clear cut policy with full commitment to increase the rate ofinvestment has the potential to engender growth and revive confidence. InIndia, the Finance Minister has pointed out; there is a huge infrastructure gapwhich could be bridged by stepping up investments from the current level offive per cent of the GDP to more than nine per cent by 2014. When private

investors are reluctant, we have to depend upon public investment tostimulate investment. We have a large public sector functioning withefficiency, as has been demonstrated by a sustained increase in itsprofitability. The Government may mobilise some of our public sectorcorporations engaged in the sectors of power, transport, construction andcommunication to expand investment in our infrastructure.Besides, we needto invest significantly in the social sector in our educational and healthcareinfrastructures. Increased public spending will help address the hugedomestic demand for both urban and rural sectors for better infrastructuresand improved social services.

(iv) Generating EmploymentEmployment generation is the key to minimize the impact of the economiccrisis on the social side. The need is all the more imperative as massive jobshave been lost due to economic slowdown and export shrink. As the sectorsthat fuelled high annual economic growth brace themselves for hard times,job creation in these areas has also weakened. Specific measures to facilitateemployment are called for in segments that are badly affected by theeconomic slowdown. Critical to protecting the households will be the abilityof governments to cope with the fallout and finance programs that createjobs, ensure the delivery of core services and infrastructure, and provide

safety nets. In India, nearly 60 per cent of the people rely on agriculture andthe rural economy. It generates less than 20 per cent of the income oroutput. Greater employment opportunity for this sizeable population inproductive ways in rural areas and in the urban economy would clearly be apriority going forward. Here again the size and strength of the domesticeconomy provide advantages for investments in education and appropriateskill formation. With half the population under the age 25, there is also ahuge upside for employment.

(v) Provisioning Credit to Productive Sectors

What is needed at present is to focus on the financial system and enable it tofulfil adequately its functions in terms of the provision of credit to productivesectors. The domestic credit system must also fill the gap created by thedrying up of external sources. We ought to be thinking of a scheme toprovide additional funds for long term capital requirements, since the abilityto raise funds from the capital market is bleak. We need to pursue aconscious policy of expanding credit to the Small and Micro Enterprises(SMEs). This sector with only 10 per cent import content and with a provenability to expand production through small amount of investment can veryrapidly increase output and employment in our system. This sector has

suffered most when the banks are in no mood to support SMEs with limitedprofitability and with practically no collateral. Only a directed public policy of


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providing financial support can galvanize them. Adequacy of liquidity withthe lending agencies will not be enough.Injection of rupee by RBI into the system will not necessarily increase banklending unless borrowers have the confidence in the sustainability of oureconomy to induce them to increase their investment and the banks have

the confidence that these borrowers will be able to pay back. The mainelement that is missing in the system is enough confidence of our economicactors in our ability to get over the crisis within a short period. In its absence,there is hardly any way that either the demand for credit and finance forinvestment or the bankers willingness to meet that demand can increase.

(vi) Need for Structural ReformsAlong with monetary and fiscal policies, there is a need to bring aboutstructural reforms to sustain the growth momentum. For instance, we needto pursue agrarian reforms. Agriculture has had declining Governmentinvestment for years. Government spending in agriculture has not led tobuilding durable assets that could help agricultural production and diversifyrural employment. Similarly, we must invest in inducting environmentfriendly technology and promoting environment friendly projects forsustainable development. We also need to improve regulatory framework sothat the economy is revived to move along a high growth trajectory.

(vii) Increased purchasing power of the peopleOne of the ways to minimize the impact of the economic crisis on the people

is to enhance purchasing power among the masses. It is true that productivecapacity of the economy has been enhanced enormously, but the majority ofpeople are too poor to be able to buy. The problem, therefore, does notrelate to increasing production, but increasing the purchasing power of themasses. This assumes critical significance, especially in India, where 70 percent of the people live on incomes of Rs.20 a day. The solution to theeconomic crisis lies in raising the purchasing power of the masses. Tax cutsand price reductions can do this.

Recovery of Indian Economy :It is interesting to note that after two years of recession, almost all thecountries are raising again. Hence statements from politicians and others aswell as official data which in other times would be seen to be pessimistic orat best neutral are now viewed as something to cheer about. In May 2009the U.S. authorities allowed ten banks to return part of the money they hadreceived from the government to shore up their financial position at theheight of the crisis. Even though President Obama admitted that the crisiswas far from over, the news of banks returning the money ahead of schedulewas received positively by the markets. U.S. Treasury Secretary Timothy F.Geithner was probably alluding to the above development when he said thatthe force of the global storm is receding a bit. The role the U.S.

government was committed to play to save the banks will probably getreduced. He also identified improving signs in the U.S. economy and better


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outlook internationally. The good news was not confined to the U.S. alone.IMF24 in its recent report also mentioned that global economic recovery hasstarted. According to reports, prices in China fell less sharply in May than inApril giving rise to expectations that the US $686-billion stimulus package ofthe Chinese government was beginning to check deflationary forces.

Indian economy is also recovering slowly since the beginning of year 2009.However, the recovery rate is very slow. India's economic slowdownunexpectedly eased in the first quarter. Indias economic growth logged anotable acceleration to 6.1 per cent for the first quarter of this fiscal from 5.8per cent for the quarter before due to strong showing by various servicesindustries (Figure 8).

Figure 8: Acceleration in GDP

The growth registered by the farm sector at 2.4 per cent and manufacturingat 3.4 per cent remained below the overall expansion, showed the data onthe countrys gross domestic product released by the Central StatisticalOrganization (CSO). The best performance was from the trade, hotels,transport and communication group, as also the financialservices and real estate sectors with an 8.1 per cent expansion each, whilemining came next 7.9 per cent followed by construction with 7.1 per cent.

The industry data revealed domestic passenger car sales in July went up to1,15,067 units from 87,901 units in the same month last year. Softwareexporters paced gains after Goldman Sachs upgraded its outlook on thecountry's information technology services sector. Tata Consultancy Services,the biggest software exporter, rose 2.85 per cent after Goldman Sachs morethan doubled the stocks target price. After auto, realty was the bestperformer, rising 2.14 per cent to 3,693.02. The metal index rose by two percent at 12,305.66 as Hindalco Industries, the biggest aluminum producer,rose 3.38 per cent to Rs 105.45 after UBS raised it to "buy" from "sell".The data during the first two months of 2009-10 on six core infrastructure

industry indicated improvement in output (Figure 9). The main drivers ofgrowth seen in the six core infrastructure industry during the period were


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cement, power and coal posting growth of 11.7 % , 5.1% and 11.8%respectively in April-May 2009-10 compared to the growth of 5.4% , 1.7%and 9.5% respectively during the same period of previous fiscal. However,production of crude petroleum and petroleum refinery were badly hit.

The official data shows that the cement sector has grown 9.97 percent inDecember 2008 as compared to November and the year on year increase is11%. Steel, which declined from September onwards last year, has shown arecovery in December last and January this year. It has now touched 22.86million metric tonnes, a figure it achieved in May 2008 when the sectoralgrowth rate was 4.1%. This may not be quite impressive but the very factthat the sector is growing is a matter of some satisfaction.Car sales in August grew a robust 25.5% as companies despatched morevehicles to dealerships to boost stocks ahead of the demand spurt inforthcoming festive season. Maruti, Hyundai, Tata and Mahindra led thegrowth in car and passenger vehicle sales after a 31% growth in July. Totalauto sales were up 24% at 10 lakh units in August against 8.1 lakh units inthe same month last year, according to industry body Siam (Table 9).

Car sales in August stood at 1.2 lakh units against 96,082 units in thecorresponding month last year. Demand for new models added to the festive


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rush and kept the momentum going for car sales that witnessed the seventhstraight month of growth.Industry analysts said demand was likely to remain strong in the comingmonths, especially over low base of last year when demand was hit byeconomic slowdown and high interest rates. The two-wheeler industry also

saw a 26% growth at 6.1 lakh units against 4.8 lakh units in August last year,with Hero Honda fuelling the demand for motorcycles. On the scooter side,Honda Motorcycle and Scooter India, Hero Honda, TVS and Suzuki pushed upsales, which grew 23% at 1.1 lakh units. Sales of commercial vehicles werealso up, growing by 18% at 40,624 units against 34,289 units in August2008. Slowdown in the economy and rapid decline in global commodityprices toned down the overall inflation to below 0 levels for the first time in35 years. However, it was found that prices of some of the items of massconsumption were still rising (Rakshit, 2009).

Foreign institutional investors' (FIIs) net investment in Indian equities crossed$8 billion in calendar 2009 with foreigners buying stocks worth $274 millionon Friday. At the end of July, net inflows from FIIs stood at $7.3 billion and ittook another 20 trading sessions before net inflows crossed the US $8 billionmark, the first time in this year. Last year, hit by recession back home FIIstook out nearly $12 billion from the Indian stock markets but with sentimentimproving from March this year, foreigners have returned with netinvestment amounting to $9.3 billion, according to SEBI. The benchmarkindex Sensex has risen25 65% till 31st August 2009 (Figure 10).

Further, the Sensex of the Bombay Stock Exchange (BSE) gained 325 pointsto reach 16,014 on 7th September 2009. Markets have surged higher in thesecond half with the NSE Nifty has surging past the 4750 mark to reach a 52weeks high and the BSE Sensex has also surged past the 16000 levels(Figure 11). Following the global financial turmoil, the markets had plungedto 8,047.17 points on March 6, 2009. Investor sentiment on 7th September

got a further boost from positive trends across Asia. Besides, expectations of


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strong quarterly earnings and signs of stability in global economy bolsteredtheir confidence.

In similar fashion, the wide-based National Stock Exchange index Niftycrossed the crucial 4,800-point level to close higher by 22.35 points at4,805.25 (Figure 12). Buying was more or less confined to fundamentallystrong stocks. As many as 15 shares in the 30-BSE index closed withsignificant gains, while the other 15 closed lower. Hindalco, Sterlite were thetwo big gainers at 6.05% and 4.78% respectively. Market leader Reliancewas up by 3.73%.

Commodities outperformed in the Mid May. The CRB (Commodity ResearchBureau) Index rose sharply from 236 to 254, a rise of nearly 8% with preciousmetals, energies and base metals moving up sharply. Crude oilsperformance was the best amongst the entire complex where prices shot upby 20% on NYMEX29 (New York Mercantile Exchange) during the lastfortnight. Except aluminum, most industrial metals surged by more than10%.The rupee has been largely volatile since January 2009, trading in a widerange between 46.75 and 52.18. The last five months of 2009 have beenquite eventful for the Indian rupee, with the currency gaining steadily against

the US dollar. At a time when the Indian economy was visibly slowing down,the recent gain in the rupee has proved to be a blessing in disguise.


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Some Reasons of RecoveryThere are also several structural factors that have come to Indias aid. First,notwithstanding the severity and multiplicity of the adverse shocks, Indiasfinancial markets have shown admirable-resilience. This is in large part

because Indias banking system remains sound, healthy, well capitalized andprudently regula

my final res.global crisis

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