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The Global Crisis and Its Impact on India

The Global Crisis and Its Impact on India

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Published by: nirav_champ on Nov 22, 2009
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September 21, 2008
Globalisation has ensured that the Indian economy and financial markets cannot stayinsulated from the present financial crisis in the developed economies.The debate, therefore, can only be on the extent of impact and how resilient India is towithstand the storm with minimal damage! In the light of the fact that the Indianeconomy is linked to global markets through a full float in current account (trade andservices) and partial float in capital account (debt and equity), we need to analyse theimpact based on three critical factors: Availability of global liquidity; demand for Indiainvestment and cost thereof and decreased consumer demand affecting Indian exports.The concerted intervention by central banks of developed countries in injecting liquidityis expected to reduce the unwinding of India investments held by foreign entities, butfresh investment flows into India are in doubt.The impact of this will be three-fold: The element of GDP growth driven by off-shoreflows (along with skills and technology) will be diluted; correction in the asset priceswhich were hitherto pushed by foreign investors and demand for domestic liquidity putting pressure on interest rates.While the global financial system takes time to “nurse its wounds” leading to lowdemand for investments in emerging markets, the impact will be on the cost and relatedrisk premium. The impact will be felt both in the trade and capital account.Indian companies which had access to cheap foreign currency funds for financing their import and export will be the worst hit. Also, foreign funds (through debt and equity) will be available at huge premium and would be limited to blue-chip companies.The impact of which, again, will be three-fold: Reduced capacity expansion leading tosupply side pressure; increased interest expenses to affect corporate profitability andincreased demand for domestic liquidity putting pressure on the interest rates.Consumer demand in developed economies is certain to be hurt by the present crisis,leading to lower demand for Indian goods and services, thus affecting the Indian exports.The impact of which, once again, will be three-fold: Export-oriented units will be theworst hit impacting employment; reduced exports will further widen the trade gap to put pressure on rupee exchange rate and intervention leading to sucking out liquidity and pressure on interest rates.The impact on the financial markets will be the following: Equity market will continue toremain in bearish mood with reduced off-shore flows, limited domestic appetite due toliquidity pressure and pressure on corporate earnings; while the inflation would stay
under control, increased demand for domestic liquidity will push interest rates higher andwe are likely to witness gradual rupee depreciation and depleted currency reserves.Overall, while RBI would inject liquidity through CRR/SLR cuts, maintaining growth beyond 7% will be a struggle.The banking sector will have the least impact as high interest rates, increased demand for rupee loans and reduced statutory reserves will lead to improved NIM while, on the other hand, other income from cross-border business flows and distribution of investment products will take a hit.Banks with capabilities to generate low cost CASA and zero cost float funds will gain themost as revenues from financial intermediation will drive the banks’ profitability.Given the dependence on foreign funds and off-shore consumer demand for the Indiagrowth story, India cannot wish away from the negative impact of the present globalfinancial crisis but should quickly focus on alternative remedial measures to limit damageand look in-wards to sustain growth!
India and the global financial crisis
C. P. Chandrasekhar Jayati Ghosh
While India is not likely to face a financial meltdown of the kind that was nearly experienced in the US, theglobal financial crisis will certainly have an impact. In this edition of Macroscan, C. P. Chandrasekhar and Jayati Ghosh consider the possible negative effects of the crisis on India and whether the Government’sresponse so far has been appropriate.
When the financial crisis erupted in a comprehensive manner on Wall Street, there was some prematuretriumphalism among Indian policymakers and media persons. It was argued that India would be relativelyimmune to this crisis, because of the “strong fundamentals” of the economy and the supposedly well-regulated banking system.This argument was emphasised by the Finance Minister and others even when other developing countries inAsia clearly experienced significant negative impact, through transmission of stock market turbulence anddomestic credit stringency.These effects have been most marked among those developing countries where the foreign ownership of banks is already well advanced, and when US-style financial sectors with the merging of banking andinvestment functions have been created.If India is not in the same position, it is not to the credit of our policymakers, who had in fact wanted to goalong the same route. Indeed, for some time now there have been complaints that these “necessary”reforms which would “modernise” the financial sector have been held up because of opposition from the Leftparties.But even though we are slightly better protected from financial meltdown, largely because of the still largerole of the nationalised banks and other controls on domestic finance, there is certainly little room for complacency.
The recent crash in the Sensex is not simply an indicator of the impact of international contagion. Therehave been warning signals and signs of fragility in Indian finance for some time now, and these are likely tobe compounded by trends in the real economy.Economic downturnAfter a long spell of growth, the Indian economy is experiencing a downturn. Industrial growth is faltering,inflation remains at double-digit levels, the current account deficit is widening, foreign exchange reserves aredepleting and the rupee is depreciating.The last two features can also be directly related to the current international crisis. The most immediateeffect of that crisis on India has been an outflow of foreign institutional investment from the equity market.Foreign institutional investors, who need to retrench assets in order to cover losses in their home countriesand are seeking havens of safety in an uncertain environment, have become major sellers in Indian markets.In 2007-08, net FII inflows into India amounted to $20.3 billion. As compared with this, they pulled out $11.1billion during the first nine-and-a-half months of calendar year 2008, of which $8.3 billion occurred over thefirst six-and-a-half months of financial year 2008-09 (April 1 to October 16). This has had two effects: in thestock market and in the currency market.Given the importance of FII investment in driving Indian stock markets and the fact that cumulativeinvestments by FIIs stood at $66.5 billion at the beginning of this calendar year, the pullout triggered acollapse in stock prices. As a result, the Sensex fell from its closing peak of 20,873 on January 8, 2008, toless than 10,000 by October 17, 2008 (Chart 1).Falling rupee

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