F Inancial Crises And Its Impact On Indian Economy

FINANCIAL CRISIS
& ITS IMPACT ON
INDIAN ECONOMY

 Monetary Policy in the US and other Western
Countries were eased aggressively after dot com
bubble.
 Policy rates in the US reached 1% in June 2003.
The monetary excess during 2002-06 leading to
Housing Boom.
 Assets prices recorded strong gains. Demand
constantly exceeded domestic output.
 This mirrored in large growing Current Account
deficit over the period.

 China/East Asian Countries exporting to USA at low cost leading to
growing surplus.
 Creations of huge Forex Reserves at EMEs.
 The Forex Reserves deployed back in US Treasuries.
 This flood of dollar resulted in sharp rise in US spending.
 Large Global imbalance due to very low interest rate and
accommodative monetary policy.
 Projected global growth in April 2008 at 3.8% down to contract by
1.3%.
 Major advance economies are in recession.
 Global trade volume to contract by 11%

Table 2: Global Economic Outlook for 2009 (per cent)
Month of Forecast
Indicator Apr-08 Jul-08 Oct-08 Nov-08 Jan-09 Apr-0
2008 2009 2008 2009 2008 2009 2008 2009 2008 2009 2008 200
1. Global
Growth 3.7 3.8 4.1 3.9 3.9 3 3.4 0.5 3.4 0.5 3.2 -1.
(a)
Advanced
Economie
s 1.3 1.3 1.7 1.4 1.5 0.5 1 -2 1 -2 0.9 -3.
(b) EMEs 6.7 6.6 6.9 6.7 6.9 6.1 6.3 3.3 6.3 3.3 6.1 1.
2. World
Trade
Volume 3.7 3.8 4.1 3.9 3.9 3 4.1 -2.8 4.1 -2.8 3.3 -1

COMPONENT OF CRISIS
 Crisis roots in USA.
 Sustain rise in Asset prices, lax lending standards in 2002-06.
 Low credit quality.
 Originate Distribute model. Strong growth in complex credit
derivatives.
 Predominately Sub-Prime mortgages sold to financial investors.
 Inflation in USA started to rise in 2004 – so rise in interest rate.
 Housing prices depressed. With low/negligible margin; prime-
borrower encouraged to default.

 US regulatory failure, multiplicity of regulators, well over 100
at the federal and state level.
Role of rating agencies.
Default by such borrowing led to losses by financial
institution.
Wiping of significant portion of capital of Banks.
Mounted losses and dwindling net worth led to breakdown of
trust among banks.
Inter-bank money market nearly frozen.
Failure of Lehman Brothers in September 2008.
Complete loss of confidence.
Deep and lingering crisis in global financial market.

Implications for Emerging
Market Economy
 Beginning 2003 low interest regime in USA, flight of
capital to EMEs.
 Average flow of USD 285 Billion during 2003-2007.
 Peak of USD 617 Billing in 2007.
 Estimated outflow of USD 190 billion in 2008-09.
 Portfolio and private flows were volatile.
 Substantial accumulation of large forex reserves with
EMEs.
 Constant volatility in capital flows impinges on Exchange

Excess Foreign Exchange reserves necessitates sterilisation
and more active monetary policy.
Excess capital flows results boom in Capital Market and
high domestic credit and other assets prices.
Abrupt reversal in capital flows leads to significant
difficulties in economy.
In current financial crisis reversal of capital flow are quick,
leading to contraction of Bank Credit and collapsed stock
prices.
This further leads to banking and currency crisis,
employment and output losses.

IMPACT ON INDIA
A . Impact of sub-prime crisis.

 As initial impact of sub – prime crisis, followed by cuts
in US fed fund rates, resulted in massive jump in net
capital in flow.
 RBI sterlize liquidity by increase in cash reserve rates
and through market Stablisation scheme (MSS)
 Policy rates were also raised
 India has limited exposure on complex derivations.
 Lower presence of foreign banks also minimised direct
impact.

B. Fiscal Impact
 Govt. did higher expenditure on account of higher crude
price, subsidies, debt waiver scheme in 2008-09.
 Fiscal deficit doubled from 2.7% of GDP in 2007-08 to 6%
in 2008-09.
 Net Market borrowing trebled from Rs. 130 billion to Rs.
329.65 billion.
 Standard is Poor downgraded its outlook on long term
sovereign rating from stable to negative

C. Impact on Real Economy
 Slowdown in external demand, reversal of capital
flow, growth in Industrial production decelerated to 2.8% in
2008-09 from 8% previous year.
 Service sector remained largely in effected with growth of
9.7% in 2008-09 as against 10.5% in previous year.
 Real GDP growth slowed down to 6.7% in 2008-09 as
against 9%.
 Rupee dollar rate under pressure. Rupee depreciated.
 Slowdown in Exports.
 Reduced credit take off.

Impact on Capital Market

Index Movement in last one year

Impact on yield on 10 years Government Bond

ACTION BY CENTRAL BANK
 Cash Reserve Ratio brought down to 5% in January 2009
from 9% (September 2008) injecting Rs. 1600 billion is
primary liquidity.
 Statutory liquidity ratios brought down, opening of
refinance windows, refines to SIDBI and EXIM banks
 Repo and Reverse Repo rates are cut down from 9% to
4.75% and 6% to 3.25% respectively.
 MSS operations were reversed Balance Rs. 860 billion end
March 2009 against Rs. 1754 billion at May 2007.

 Various monitory and liquid measures released liquidity
of Rs. 4900 Billion since mid September 2008 (about 9%
GDP)
 Banks were advised to step up lending to core sectors.
 Banks were advised to bring down BPLR.
 Restriction on interest rate to bulk deposits.
 Restrictions loosened on External commercial borrowing
by corporates.

STRENGTH OF INDIAN
FINANCIAL SECTOR
Full but gradual opening of current account.
Foreign investment flows are encouraged.
External commercial borrowing is subject to ceiling and end
– use restrictions.
Macro ceiling stipulated on portfolio investment in Govt.
Securities and Corporate Bonds by FIIs.
Imposition of prudential limits on Banks, such as inter-bank
liabilities, borrowing and lending, money market, assets -
liability Management for both on and off balance sheet terms.

 Implementation of Based II ……. Minimum 9% CRAR.
 CRAR of all scheduled commercial banks at 13% at end
March 2008.
 Single factor stress tests reveal that Banks can
withstand shocks on account of change in credit
quality, interest rates and liquidity conditions.
 Strict prudential norms towards income
recognition, Asset classifications and provisions by the
Banks.

WHY THE INDIAN FINANCIAL
SECTOR WEATHERED THE STORM

 Negligible direct exposure to toxic assets which
contaminated Western Banking System.

 Banks credit quality remained high.

 Credit Growth apx. 30% during 2004-07.

 RBI tightened prudential norms CRR at 13% at March
2008 end against regulatory requirement of 9%.

 Net NPA at 1% of net advance and 0.6% of assets.

LESSONS

 Central Bank should adopt a broader macro-prudential
views of asset price movements, credit boom and the build
up of systematic risk.
 Asset price bubble leads to strong credit growth such as
real estate and stock market.
 Only substantial hike in policy rates can pick the bubble.
 Pre-emptive action like hike in risk weights and provision
norms for Banks.

 Sharper focus on liquidity risk management, risk
transmission.
 Global imbalances are to be reduced to a manageable
proportion.
 US needs to save more & export more.
 Asian Countries have to consume more, export less.

STABILITY BEYOND EXPECTATIONS.

INDIA GENERAL ELECTION
MAY 2009.

PRE-POLL CRITICAL ISSUES

 Global Financial crisis.
 Rajor-thin majority Government.
 Melt down in Capital Market. Sensex touching a low
of 8160 in April 2009, down from a peak of 20728, a
fall of 61%.
Weakening economy. Rising job losses in export
sector.
 General Election in May 2009. Political Uncertainty
 Formation of 4 front – UPA led by Congress, NDA
led by BJP, Third Front – led by Left Parties.
 No coalition likely to get majority

INDIAN ELECTIONS 2009

 India, world’s 7th largest Country. Area 3.2 million sq.km.
 Population more than 10.1 billion.
 Religion – Hindu – 80.5%, Muslim – 13.4% (3rd largest)
 Estimated voters 714 million.
 Election duration – 1 months in 5 phases – 16 April to 13th May
2009.
 Number of polling stations 687402
 Number of Seats – 543
 National parties 9
 Regional parties 24

PRE – POLL MARKET SENTIMENTS
 Either UPA or NDA form the Government. Both are
seen market friendly.
 Market on upward swings since chances of Left
Parties (3rd Front) were remote.
 Market may show higher volatility if there is a
fractured verdict.
 Sensex rises 300 points on the eve of election.

POST – POLL MARKET
SENTIMENTS
 Major News Paper Headlines / Views
 Finally a free hand
 Decisive vote for growth.
 The Indian economy is set to maintain its growth.
 Stable Government to put the confidence laid to all time
high.
 A strong Government, influence of the Left Parties
disappeared.
 With clear mandate there is a certainty in terms of
policies.

 The Congress will have the last word in issues of
Government .
 Smooth transition of Government.
 Economy will be the main priority of the Government.
 Congress is a pre reform party.
 The Congress will unlock long awaited reforms.

STABILITY - KEY AGENTS

 Strong United Progressive Alliance (UPA) led government
allows continuity in policies.
 Smooth transition – this is more like an extension of UPA’s
term. IN the event of any other party / alliance coming to
power, it would have taken some time for the new
government to formulate its policies.
 UPA to continue with its policies with more power in hand
now, no fear of strange coalitions or drag of the communist
parties anymore.
 Economic reforms may speed up. FDI inflows into the country
over the next 6-12 months can improve as India gets to play a
larger role in G20.

 Government is likely to continue to boost credit to support
growth.
 Rural focus and reforms to speed up.
 Disinvestments – Pressure on fiscal position will push the
government for disinvestments, though moves are unlikely
to be very aggressive.
 Infrastructure – Focus on low-cost housing and power
generation.
 Focus on rural populace: Improve access to rural credit at
lower interest rates;
 Subsidise food for poor; implementation of NREGA;
develop rural infrastructure.
 Marching of reforms in financial sector in particular
banking and insurance.

ACTION AT DALAL STREET

 May 15, 2009 - Previous Day Sensex at 12173.
 May 18, 2009 -Market opened at 9.55 A.M. at 15% high
 Circuit Breaker applied. Trading halted to 1 hour.
 Market re-opened at 11.55 A.M. at 20% high.
 Circuit Breaker applied. Market Closed for the day.
 Sensex closed at 14284.

Sensex For The Month May 2009

16000.00 18/05/09
(14296)
14000.00

15/05/09
12000.00
(12173)

10000.00
Sensex

8000.00

6000.00

4000.00

2000.00

0.00

Market Wide circuit Breaker in the
Indian Stock Market

 There Were five days in which Circuit breaker had been
applied by the exchanges in the history.

 The upper circuit filter was placed only once i.e on 18th
may 2009.

Table V – Incidence of Market Wide Circuit Breaker In Indian Stock Market

Previous Points
Trade Date Opening High Low Close Close (Increase % Change
17-May-04 5020.89 5020.89 4227.5 4505.16 5069.87 -842.37 -16.62
22-May-06 11071.63 11142.9 9826.91 10481.77 10938.61 -1111.7 -10.16
17-Oct-07 18037.9 18841.29 17307.9 18715.82 19051.86 -1743.96 -9.15
22-Jan-08 16884.09 17068.57 15332.42 16729.94 17605.35 -2272.93 -12.91
18-May-09 13479.39 14284.21 13479.39 14284.21 12173.42 2110.79 17.34

F Inancial Crises And Its Impact On Indian Economy

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