The on-going global financial crisis (GFC) has cast a shadow over the global economy with

world output and trade forecasted (by the IMF) to shrink in 2009.
In the Australia South Asia Research Centre Working Paper, ‘The Global Financial Crisis and
Short run Prospects for India’, [pdf] I outline the major contours of the GFC, its evolution since
the subprime mortgage crisis in 2007, its implications for India and India’s response to the crisis.

Exhibiting a strong dynamism, economic growth in India in 2007–08 was a high 9 per cent
despite the fact that the sub-prime crisis had already started to impact the US and other major
economies. However, growth rates dropped steadily during the first three quarters of 2008–09.
Government forecasts economic growth to be 7.1 per cent during 2008–09 but the fourth quarter
growth figures may be overestimates so that growth in 2008–09 may be lower.
Several other indicators, e.g. industrial production and trade, have also pointed toward a
slowdown in the economy. Traditional wisdom has it that the GFC should have had minimal
impact on India because i) Indian banking had no direct exposure to the sub-prime mortgage
crisis, and ii) India’s growth is largely based on domestic consumption and domestic investment.
External demand as measured by merchandise exports account for less than 15 per cent of
India’s GDP.
However, the Indian economy has globalized rapidly during the past few years. The ratio of
exports plus imports to GDP increased by more than 50 per cent between 1997–98 and 2007–08
(from 21.2 per cent to 34.7). The growth of financial integration has been even more rapid.
During the same 10 year period the ratio of total external transactions more than doubled from
46.8 percent to 117.4 percent. Corporate borrowing from external sources has also increased
significantly. In 2007–08 India received capital inflows to the extent of 9 per cent of GDP as
against a current account deficit of 1.5 per cent of GDP.
Three different channels of the GFC’s impact on India can be identified: i) The financial channel,
i.e., the growing integration of India’s financial markets with global financial markets; ii) The
growing trade links between India and the rest of the world indicate that exports would decline
quite sharply, and; iii) A final avenue is the confidence channel. The tightened global liquidity
situation following from the failure of Lehman brothers in September 2008 increased the risk-
aversion of several banks and other lending institutions.
There is a slowdown in India’s growth performance — but not a collapse. India instituted three
stimulus packages (amounting to a liquidity injection of about 7 per cent of GDP) in response to
the slowdown in demand:
The short-run outlook for the Indian economy is unclear. Real GDP growth and major sectors
have shown strong signs of slipping. But, the stimulus packages announced by the government
and the RBI have had their desired effect. Thus, the Indian auto industry, which was heading
towards decline recorded positive growth of 0.71 per cent in total vehicle sales in fiscal 2008–09,
services and manufacturing sectors are expected to record reasonable growth and investment
rates are still high. The sharp fall in inflation has provided room for more aggressive interest rate
cuts by the RBI, although the burden of servicing the larger debt because of the stimulus
packages will not be insignificant. Although equity markets have registered steep declines the
wealth impact on domestic residents is limited since only a small number of Indians participate
in equity markets.
Assuming that the global economy starts picking up in 2009–10, of which there are some signs,
and provided developed countries do not resort to widespread protectionism, an assumption that
may be proved wrong, the Indian economy should be in a good position to register a strong
comeback. However, since the stimulus packages have already imposed a significant fiscal
burden, the new central government would need to eschew undue populism, failing which high
fiscal deficits could again restrict India’s growth between potential as was the case in the mid to
late 1990s. The chances of this happening are lower now. The Indian economy has certainly
grown in terms of sophistication and depth since the 1990s. On balance, there is reason to be
guardedly optimistic about the Indian economy in the short run.