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1. INTRODUCTION
5. CONCLUSION
6. REFERENCES
1. INTRODUCTION:
THE CAUSES OF GLOBAL ECNOMIC CRISIS THAT EMERGED IN UNITED
STATES OF AMERICA DURING EARLY 2008.
There are several underlying causes of the current global economic crisis. Firstly the
United States and some other European countries enjoyed a prolonged boom in the
property prices since the early 1990’s right up to the end of 2006. People began to
believe that real estate prices can only go up north bound and not otherwise. This led to
the massive amounts of lending by banks for home purchases, often to borrowers who
did not have jobs or steady incomes. Many of the borrowers were subprime or more
simply not credit worthy.
This housing bubble was a part of the massive borrowing in US and other European
countries by households and financial institutions that was fuelled by the “easy money”
policies of their central banks and huge inflow of funds from capital surplus such as
China, Japan, Germany and oil exporters. These big oil exporting nations sold their
products to American and European consumers and then parked their surpluses in
American and European government securities. As an indication of huge borrowing, the
ratio of gross debt to GDP of US households, businesses and government more than
doubled from about 160% in 1982 to 340% in 2007.Most of the massive increase in
borrowing was accounted by households and financial firms.
An important reason why this massive expansion of complex financial products built on a
foundation of very shaky housing loans could go on for many years is because of a
growing culture of weak regulation of financial institutions and markets that prevailed in
the western countries for the past two decades.
This huge increase in unregulated borrowing and excessive lending further increased
the asset price bubbles in housing, stock markets and commodity prices.
In spite of the government declaring trillions of dollars of bail outs and fiscal stimulus,
bank credit continued to remain frozen. This led to the steep falls in production,
consumer spending, investment and foreign trade.
The sharp slowdown in economic activity in US and Europe quickly spread across the
globe through the channels of a global credit squeeze and a massive drop in demand for
goods and services from exporting nations like China, Japan, Germany and several
other Asian countries including India.
In this way the financial crisis not only damaged production and inhibited growth in these
countries but led to sharp drops in exports and production throughout all these countries.
By the beginning of 2009, it became quite clear that the current global recession is the
worst since the great depression of 1929-1932.
Here is the illustration of the formation of the real estate housing bubble and the domino
effect as the housing prices declined.(The housing bubble bursted in the early 2008).
Coutesy: Wikipedia
Although the global financial crisis gained force in the western counries, In India it was
not felt to that extent in the first seven months uptil august 2008. The main concern
during the first 7-8 months was the sharp increase in inflation because of the commodity
price shock that had hit India from early 2008. The rate of Inflation had jumped from 5%
in February 2008 to over 10% in April 2008.This happened inspite of government
keeping the prices of food grains, fertilizers unchanged during that period.
Many economists perceived that this sharp increase in global commodity prices from the
late 2007 was because of the global economic boom during 2002-2007 than because of
recession in the western countries which began in the spring 2008.
Many economists view that the economic growth of Asian developing countries like
China and India was decoupled from the slowdown in the advanced countries in the
west. This view was gaining support from the fact that the rate of India’s economic
growth in the first half of 2008-2009 was still close to 8%.
This sense of thought and the view of decoupling from the global slowdown was
shattered by the events of September 2008 with the collapse of the huge Wall Street
banks. The resulting freeze of bank credit flows in the west created a worldwide liquidity
crunch and a massive amplification of recessionary forces in US, Europe and
Japan.This liquidity shock was immediately felt in India also with foreign institutional
investors withdrawing their money , credit for foreign trade vanishing and loans from
foreign banks drying up. Even before the end of 2008, export and industrial output had
begun to decline and overall economic growth slowed down to 5.3% in the final quarter
of October- December 2008.
But even though the effect of economic crisis was felt in India the threat was not as bad
as it was for the western countries. India was easily able to recover from the effect of the
crisis. This is evident from the fact that the growth in Jan- Mar 2009 was much better in
India implying a quick full year growth of 6.5% in 2009.
The governor general of Reserve Bank of India Mr. T. SubbaRao has answered some of
the questions in his speech regarding how India was hit by the recession and how the
government and the RBI in coordination had swiftly faced the challenge by implementing
several monetary and Fiscal measures.
Let us look at answers which T Subbarao had given for these questions
• Why India was hit by the crisis?
The governor had expressed his dismay that India has also been hit by the effect of the
global economic Crisis. This dismay had come from two arguments.
1. Indian banking system had no direct exposure to the subprime mortgage assets
or to the failed institutions. It has a very limited off balance sheet activities or
securitized assets .Indian Banks continue to remain safe and healthy. Now the
question is how India can be caught up in a crisis when it has nothing to do with
any of the issues that are at the core of the crisis.
2. The second argument was that India’s recent growth has been predominantly by
domestic consumption and domestic investment. External demand as measured
by merchandize exports accounts for less than 15% of the GDP. The question is
even if there is a global downturn why should India be affected when its
dependence on external demand is so limited.
The answer to both the questions is nothing but globalization. There is rapid integration
of the Indian Economy into the world economy in the last one decade. As a proportion of
GDP, India’s two way trade(Merchandise exports and imports) grew from 21.2% in
1997-1998 to 34.7% in 2007-2008. The ratio of the total transactions (gross current
account flows plus the gross capital flows to GDP) has more than doubled from 46.8% in
1997-1998 to 117.4% in 2007-2008. In the five year period of 2003-2008, the share of
investments in India’s GDP rose by 11% points.
The effect of the crisis had spread to India through three channels.
1. Financial Channel
1. Real Channel:
1. Confidence Channel:
Beyond the financial and the real channels, the crisis also spread through the
confidence channel. The tightened global liquidity situation in the period following the
Lehman Brother’s failure increased the risk aversion of the financial system and made
banks cautious about lending.
Reserve Bank of India took immediate action to face the challenge by implementing the
monetary accommodation and cyclical regulatory forebearance.
This part is quite interesting to know how India could easily recover from the effect of the
crisis. Let us look at the monetary policies taken by RBI and the government’s fiscal
stimulus which were immediately put into action. Both the government and the RBI
responded to the challenge in close coordination and consultation.
1. MONETARY AND FISCAL POLICIES IMPLEMENTED DURING
THE RECESSION PERIOD.
The policy responses in India since September 2008 have been designed largely to
mitigate the adverse impact of the global financial crisis on the Indian economy.
The Reserve Bank has multiple instruments at its command such as repo and
reverse repo rates; cash reserve ratio (CRR), statutory liquidity ratio (SLR), open market
operations, including the market stabilisation scheme (MSS) and the LAF(Liquidity
adjustment facility), special market operations, and sector specific liquidity facilities. In
addition, the Reserve Bank also uses prudential tools to modulate flow of credit to
certain sectors consistent with financial stability. The availability of multiple instruments
and flexible use of these instruments in the implementation of monetary policy has
enabled the Reserve Bank to modulate the liquidity and interest rate conditions amidst
uncertain global macroeconomic conditions.
The thrust of the various policy initiatives by the Reserve Bank has been on providing
ample rupee liquidity, ensuring comfortable dollar liquidity and maintaining a market
environment conducive for the continued flow of credit to productive sectors.
There are, however, some key differences between the actions taken by the Reserve
Bank of India and the central banks in many advanced countries:
➢ First, in the process of liquidity injection the counter-parties involved were banks;
even liquidity measures for mutual funds, NBFCs and housing finance
companies were largely channelled through the banks.
➢ Third, despite large liquidity injection, the Reserve Bank’s balance sheet did not
show unusual increase, unlike global trend, because of release of earlier
sterilised liquidity.
The thrust of the various policy initiatives by the Reserve Bank has been on
providing ample rupee liquidity, ensuring comfortable dollar liquidity and
maintaining a market environment conducive for the continued flow of credit to
productive sectors. The key policy initiatives taken by the Reserve Bank since
September 2008 are set out below:
Policy Rates
• The policy repo rate under the liquidity adjustment facility (LAF) was reduced by
400 basis points from 9.0 per cent to 4.75 per cent.
• The policy reverse repo rate under the LAF was reduced by 250 basis points
from 6.0 per cent to 3.25 per cent.
Rupee Liquidity
• The cash reserve ratio (CRR) was reduced by 400 basis points from 9.0 per
cent of net demand and time liabilities (NDTL) of banks to 5.0 per cent.
• The statutory liquidity ratio (SLR) was reduced from 25.0 per cent of NDTL to
24.0 per cent.
• The export credit refinance limit for commercial banks was enhanced to 50.0
per cent from 15.0 per cent of outstanding export credit.
• A special 14-day term repo facility was instituted for commercial banks up to 1.5
per cent of NDTL.
• A special refinance facility was instituted for scheduled commercial banks
(excluding RRBs) up to 1.0 per cent of each bank’s NDTL as on October 24,
2008.
• Special refinance facilities were instituted for financial institutions (SIDBI, NHB
and Exim Bank).
Forex Liquidity
• The Reserve Bank sold foreign exchange (US dollars) and made available a
forex swap facility to banks.
• The interest rate ceilings on non resident Indian (NRI) deposits were raised.
• The all-in-cost ceiling for the external commercial borrowings (ECBs) was
raised. The all-in-cost ceiling for ECBs through the approval route has been
dispensed with up to June 30, 2009.
• The systemically important non-deposit taking non-banking financial companies
(NBFCs-ND-SI) were permitted to raise short-term foreign currency borrowings.
Regulatory Forbearance
The actions of the Reserve Bank since mid-September 2008 have resulted in
augmentation of actual/potential liquidity of over Rs.4,22,000 crore. In addition, the
permanent reduction inthe SLR by 1.0 per cent of NDTL has made available liquid funds
of the order of Rs.40,000 crore for the purpose of credit expansion.
Taken together, the measures put in place since mid-September 2008 have
ensured that the Indian financial markets continue to function in an orderly
manner. The cumulative amount of primary liquidity potentially available to the
financial system through these measures is over US$ 75 bln or 7 per cent of
GDP. This sizeable easing has ensured a comfortable liquidity position starting
mid-November 2008 as evidenced by a number of indicators including the
weighted-average call money rate, the overnight money market rate and the yield
on the 10-year benchmark government security.
The reduction of fiscal deficit from 5.91 percent of GDP in 2002-03 to 2.69 percent in
2007-08 on basis of FRBM guidelines proved vital during the crisis. It generated the
space for expansionary fiscal stance to boost aggregate demand to counter the crisis.
(In percent)
1. CONCLUSION
Even though the impact of recession was felt in India the threat was not so bad as in
developed countries. Though the growth declined from 9% to 6.7% during the
recessionary period, India’s performance was remarkable given the global economic
back drop. The primary reason behind such strong growth rate was that India is a
domestic demand driven economy. The rural consumer and the middle class consumer
are willing to spend because of which domestic demand has got triggered. The
government stimulus further increased the domestic demand. Farm loan waiver,
expansion of National Rural employment Guarantee Act (NREGA) and hike in public
sector salaries had a huge role in increasing domestic demand. The government reacted
very quickly to the financial crisis in October 2008 and RBI stepped in to ease the
monetary conditions.
Another reason for the economy to show robust performance is the demographics. India
is much younger nation to its western counterparts. Moreover, savings rate in India is
far higher compared to international standards and has a very young population
and people are saving a lot. India’ savings rate has moved up from 24% to 36% in
the span of 5-6 years. So most of the investments are funded through domestic
sources. India’s investments stand at nearly 38% GDP, which is in turn driving our
growth.
Unlike US, which funds its growth from borrowings, India’s growth is a result of savings
led investments. Around 45% of India’s income is generated in agriculture sector. It
makes rural consumer very important. Over last ten years, marketers have adopted
various strategies to tap the rural consumer.
In nutshell, India has an advantage in the form of young population, which is
going to play a critical role in years going to come. The government has shown
that it has the ability to act quickly in order to meet challenges. Few reforms on
the policy front can help strengthening the economy even more.
REFERENCES
1. http://www.corecentre.co.in/Database/Docs/DocFiles/crisis_agriculture.pdf
Global Crisis, India and Agriculture
2. www.unescap.org
United Nations Economic and Social Commission for Asia and the Pacific
3. http://www.rbi.org.in/SCRIPTs/BS_SpeechesView.aspx?Id=410
Impact of the Global Financial Crisis on India Collateral Damage and Response
(Speech delivered at the Symposium on "The Global Economic Crisis and
Challenges for the Asian Economy in a Changing World" organized by the
Institute for International Monetary Affairs, Tokyo on February 18, 2009 By
Duvvuri Subbarao, Governor)
4. http://knowledge.nrega.net/311/2/Indian_economy_thwart_the_turbulence_of_glo
bal_recession.pdf
Indian economy thwart the turbulence of global recession
11 Feb 2010, ET Bureau