Global Financial Crisis:

Causes, Consequences and

India’s Prospects
 Scheme of
Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe
and India
RBI’s Policy Response and
Impact
Lessons from the Crisis
Medium-term Issues and
 Scheme of
Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe
and India
RBI’s Policy Response and
Impact
Lessons from the Crisis
Medium-term Issues and
Global Financial Crisis (1)
Proximate causes
Sub-prime lending
Originate and distribute model
Financial engineering, derivatives
Credit rating agencies
Lax regulation
Large global imbalances
Fundamental cause
Excessively accommodative monetary policy in
the US and other advanced economies (2002-
04)
 Global Financial Crisis (2)
Current Account Balance (per cent to
GDP)
1990- 1995- 2000-
Country 94 99 04 2005 2006 2007 2008
China 1.4 1.9 2.4 7.2 9.5 11.0 10.0
India -1.3 -1.3 0.5 -1.3 -1.1 -1.0 -2.8
Russia
Saudi 0.9 3.5 11.2 11.0 9.5 5.9 6.1
Arabia -11.7 -2.4 10.6 28.7 27.9 25.1 28.9
United Arab
Emirates
United 8.3 4.6 9.9 18.0 22.6 16.1 15.8
States -1.0 -2.1 -4.5 -5.9 -6.0 -5.3 -4.7
Memo:
Euro area n.a. 0.9 0.4 0.4 0.3 0.2 -0.7
Middle East -5.1 1.0 8.4 19.7 21.0 18.2 18.8
Source: World Economic Outlook Database, April 2009, International Monetary Fund.

Note: (-) indicates deficit.

 Global Financial Crisis (4)
US Monetary Policy (1)

•Volatility in monetary policy in advanced economies

•Large volatility in capital flows to EMEs
•Again very loose MP in US – likely surge in capital flows to EMEs?
 Global Financial Crisis (5)
US Monetary Policy (2)

•US Monetary policy too loose during 2002-04; aggregate

demand exceeded output; large current a/c deficit;
mirrored in large surpluses in China and elsewhere.
 Global Financial Crisis (6)
US Monetary Policy (3)

Large Fed cuts in 2007: strong boost to oil,

other commodity and asset prices
 Global Financial Crisis (3)
Capital Flows to Emerging Market Economies

•Very large capital flows to EMEs –– now outflows in 2009 - large

volatility - implications for monetary management and financial stability
 Global Financial Crisis (7)
Worsening Global Economic Outlook

Growth Forecast of IMF (per cent)

Region April 2008 July 2008 October 2008 April 2009

2008 2009 2008 2009 2008 2009 2008 2009

Advanced
countries 1.3 1.3 1.7 1.4 1.5 0.5 0.9 (-)3.8
EMEs 6.7 6.6 6.9 6.7 6.9 6.1 6.1 1.6
World 3.7 3.8 4.1 3.9 3.9 3.0 3.2 (-)1.3
Global Trade Volume (Goods and Services)
World 3.7 3.8 4.1 3.9 3.9 3.0 3.3 -11.0
 Scheme of
Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe
and India
RBI’s Policy Response and
Impact
Lessons from the Crisis
Medium-term Issues and
 Impact on India (1)
Trends in Capital Flows
Component Period 2007-08 2008-09
Foreign Direct Investment to India April-February 27.6 31.7
FIIs (net) April-March 20.3 -15.0
External Commercial Borrowings (net) April- December 17.5 6.0
Short-term Trade Credits (net) April- December 10.7 0.5
Total capital flows (net) April- December 82.0 15.3
Memo:
Current Account Balance April- December -15.5 -36.5
Valuation Gains (+)/Losses (-) on
Foreign Exchange Reserves April- December 9.0 -33.4
Foreign Exchange Reserves April-December 76.1 -53.8
(variation)
April-March 110.5 -57.7
 Impact on India (2)
Key Macro Indicators
Indicator Period 2007-08 2008-09
Growth, per cent
Real GDP April-December 9.0 6.9
Growth
Industrial April-February 8.8 2.8
production
Services April-December 10.5 9.7
Exports April-March 28.4 6.4
Imports April-March 40.2 17.9
GFD/GDP April-March 2.7 6.0
Stock Market April-March 16,569 12,366
(BSE Sensex)
Rs.per US$ April-March 40.24 45.92
 Scheme of
Presentation
Global Financial Crisis
Impact on India
Difference between
US/Europe
and India
RBI’s Policy Response and
Impact
Lessons from the Crisis
Differences Between Financial
Crisis in US/Europe and India (1)
What has not happened here
No subprime
No toxic derivatives
No bank losses threatening
capital
No bank credit crunch
No mistrust between banks
Differences Between Financial
Crisis in US/Europe and India
(2)
Our Problems
Reduction in capital flows
 Pressure on BoP
 Stock markets

 Monetary and liquidity impact

Temporary impact on MFs/NBFCs

(Sept-Oct)
Reduction in flow from non-banks
Perceptions of credit crunch
Differences Between Financial
Crisis in US/Europe and India
(3)
Our Problems
Fiscal stress
 Oil, Fertiliser, Food subsidies
 Pay Commission, Debt waiver, NRE

 Stimulus packages

 GFD/GDP ratio: 5.5-6.0%

Large increase in market borrowings

Rs. crore
2008-09 2008-09 2009-10
Gross BE1,76,453 RE3,42,769 BE3,98,552

Net 1,13,000 3,29,649 3,08,647

 Differences Between Financial Crisis
in US/Europe and India (4)

India’s Approach to Managing Financial

Stability (1)
Current account: Full, but gradual opening up
Capital account and financial sector: More
calibrated approach towards opening up.
 Equity flows encouraged;
 debt flows subject to ceilings and some end-use
restrictions.
 Capital outflows: progressively liberalized.
Differences Between Financial
Crisis in US/Europe and
India’s Approach to Managing India
(5) Financial Stability (2)
Financial sector, especially banks, subject
to prudential regulation
 both liquidity and capital.
 prudential limits on banks’ inter-bank
liabilities in relation to their net worth;
 asset-liability management guidelines
take cognizance of both on and off
balance sheet items
 Basel II framework: guidelines issued.
 Dynamic provisioning
 NBFCs: regulation and supervision
tightened - to reduce regulatory
arbitrage.
 Scheme of
Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe
and India
RBI’s Policy Response and Impact
Lessons from the Crisis
Medium-term Issues and
Challenges
 Measures since Mid-September,
2008 (1)
Expanding rupee liquidity
Reduction in CRR (400 bps) & SLR (100 bps)
Special Repo window under LAF for banks on-
lending to NBFCs, HFCs & MFS
Special Refinance to banks without collateral
Unwinding of MSS – buyback/desequestering
OMOs – pre-announced calendar

Cut in repo (425 bps) and reverse

repo (275 bps) rates.
Existing instruments – enough
flexibility
MSS and CRR – good, effective
 Measures since Mid-September,
2008 (2)
Managing Forex liquidity
NRE and FCNR(B) deposits: interest
rate ceilings raised
ECB norms relaxed
Allowing corporates to buy back
FCCBs
Rupee-dollar swap facility for banks
with overseas branches
 Measures since Mid-September,
2008 (3)
Encouraging Flow of credit
Exporters:
 extension of period for export credit.
 Expansion in refinance

Dynamic provisioning
 Contracyclical adjustment of prudential norms
SIDBI and NHB: lendable resources
expanded
Loan restructuring
 Measures since Mid-September,
2008 (4)
Impact of Measures (1)
Measures ensuring orderly functioning of Indian
financial markets
Cumulative potential primary liquidity impact – over
Rs. 4,90,000 crore (9 % of GDP)
Comfortable liquidity position since mid-November,
2008
LAF window in absorption mode.
Call rate within LAF corridor since November 3,
2008 – bottom of the corridor.
Gradual reduction in deposit and lending rates of
banks .
Government yields:
upward pressure from large market borrowing
programme
Proactive management by RBI

Measures since Mid-September,
Item 2008 (5)
March Septemb October March
2008 er 2008 2008 2009
Impact of Measures (2)
Turnover (Rupees crore, average daily)
1 Call market 11,182 11,690 14,497 11,909
2 All money 63,395 42,891 40,906 81,821
markets @ Key Interest Rates (per cent)
3 Call market 7.37 10.52 9.90 4.17
4 All money 6.55 9.26 8.66 3.76
5 markets @
BSE Sensex 15946 13943 10550 8995
6 Rs. Per US $ 40.36 45.56 48.64 51.23
7 10-year G-sec 7.69 8.45 7.85 6.56
8 yield
Certificate of 10.0 11.6 10.0 7.0
Deposits
9 Commercial Paper 10.4 12.3 14.7 8.9
1 Deposit rate (1-3 8.25-9.25 8.75- 8.75- 8.00-9.25
0 yrs)# 10.25 10.25
 Total Resource Flow from Banks and Non-
banks

Rupees crore
Item 2007-08 2008-09
1
Non-food Bank 4,44,807 4,14,902
credit
2
Non-banks 3,35,698 2,64,138
3
Total flow of 7,80,505 6,79,040
resources (1+2)
 2008 (7)
Inflation in India
(per cent)
Item March June 2008 September December March
2008 2008 2008 2009
Wholesale price inflation
All commodities 7.8 12.0 12.1 5.9 0.3
Of which:
Primary articles 9.7 11.0 12.0 11.6 3.5
Fuel 6.8 16.3 16.5 -0.7 -6.1
Manufactured 7.3 10.9 10.5 6.2 1.4
products
Consumer price inflation
Agricultural 7.9 8.8 11.0 11.4 10.8 (Feb)
labourers
Rural labourers 7.6 8.7 11.0 11.4 10.8 (Feb)
Urban non-manual 6.0 7.3 9.5 9.8 9.9 (Feb)
employees
Industrial workers 7.9 7.7 9.8 9.7 9.6 (Feb)
 Scheme of
Presentation
Global Financial Crisis
Impact on India
Difference between
US/Europe and India
RBI’s Policy Response and
Impact
Lessons from the Crisis
Medium-term Issues and
 Lessons from the
Crisis
 Avoid high volatility in monetary policy
 Appropriate response of monetary policy to
asset prices
 Manage capital flow volatility
 Look for signs of over leveraging
 Active dynamic financial regulation
 Capital buffers, dynamic provisioning
 Look for regulatory arbitrage incentives/
possibilities
 Scheme of
Presentation
Global Financial Crisis
Impact on India
Difference between
US/Europe and India
RBI’s Policy Response and
Impact
Lessons from the Crisis
Medium-term Issues and
 Glance
(Per cent)

2003/04
1950-51 1965-66 1991/92 1997/98
To
to to to to
2007/08
1964-65 1980-81 1980s 1990-91 1996-97 2002/03
1 2 3 4 5 6 7 8

1. Real GDP Growth 4.1 3.2 5.6 5.3 5.7 5.2 8.7
Agriculture 2.9 2.1 4.4 4.0 3.7 0.9 4.4
Industry 6.7 4.2 6.4 5.7 7.0 4.1 8.4
Manufacturing 6.6 3.9 5.8 4.8 7.5 3.9 9.1
Services 4.9 4.2 6.3 5.9 6.4 7.8 10.3
2. Real GDCF/GDP 13.5 19.2 20.2 24.4 22.5 24.1 31.4
3. ICOR 3.3 6.0 3.6 4.6 4.0 4.6 3.6
4. Nominal
GDCF/GDP 11.8 16.7 20.8 26.0 23.9 24.5 33.0
5. GDS/GDP 10.3 15.9 19.0 22.8 22.7 24.1 32.7
6. Saving-
Investment Gap -1.5 -0.7 -1.8 -3.2 -1.2 -0.4 -0.3
 Continuing increase in real GDP growth - Interregnum during the 1970s
 Secular uptrend in domestic saving and investment -investment largely financed
by domestic savings
 Continuation of growth in domestic savings necessary; fiscal prudence
 Challenges (2)
Fiscal Policy (1)

Combined fiscal deficit in India

Even before the recent setback:
very high by international
standards
contribute to the persistence of an
interest rate differential with the
rest of the world,
constrains progress towards full
capital account convertibility.
self imposed rule based fiscal
 Challenges (3)
Fiscal Policy (2)

Sustained interest rate

differential also connected with
the existence of a persistent
inflation differential with the rest
of the world.
A key challenge is to further
reduce inflation expectations
toward international levels.
 Challenges (4)
Monetary Policy (1)

A continuous need to adapt monetary

management to the emerging needs of
a fast growing and increasingly open
economy.
Financial deepening and increasing
monetisation.
expansion of monetary aggregates
departs from their traditional
relationship with real GDP growth.
task of monetary management:
 Challenges (5)
Monetary Policy (2)

Further development of financial markets

Large capital inflows in recent years
Reserve Bank’s ability to manage
the impossible trinity
Issues for monetary policy
current account balance as a good
guide to evaluation of the
appropriate level of an exchange
rate?
to what extent should the capital
account influence the exchange
rate?
 Challenges (6)
External Sector (1)
Optimal response to the large and volatile
capital flows is a combination of (CGFS, 2009)
sound macroeconomic policies
prudent debt management
exchange rate flexibility
effective management of the capital account
accumulation of appropriate levels of reserves as
self-insurance and
development of resilient domestic financial
markets
combination is country-specific; no “one size fits
all”.
 Challenges (7)
External Sector (2)
Indian policy approach to CAL
Distinction between debt and
equity flows
Higher inflation and interest
rates in India vis-a-vis
advanced economies
Liberalisation of debt flows can
lead to arbitrage flows
Ceilings on debt flows
appropriate
 Challenges (8)
Financial Sector

 Commercial banks robust

Committee on Financial Sector Assessment

(CFSA)
• Stability Assessment and Stress Testing
Scenario - increase in
• Concerns about credit risk remain
NPA muted at present
by:
Without 100 per 150 per
  Stress cent cent
  CRAR (%) CRAR (%) CRAR (%)

Mar-08 13.0 11.6 11.0

Sept– 12.5 11.1 10.6
08
•Note: CRAR = credit to risk-weighted assets
 Challenges (9)
Conclusion

India’s fundamentals remain

strong
Financial sector robust
Monetary policy – sufficient instruments,
flexible
Corporate sector not too leveraged – second
round of restructuring going on – productivity
gains
Foreign direct investment buoyant
Agriculture improving
Growth domestically financed
Indian economy should be able to recover
Thank You