Global Financial Crisis:

Causes, Consequences and

India’s Prospects
By
RAKESH MOHAN
Deputy Governor
Reserve Bank of India
At
London Business School
April 23, 2009
 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
 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
 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
Country cent
1990- 1995- 2000-to2005
GDP)2006 2007 2008
94 99 04
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 0.9 3.5 11.2 11.0 9.5 5.9 6.1
Saudi -11.7 -2.4 10.6 28.7 27.9 25.1 28.9
Arabia
United Arab 8.3 4.6 9.9 18.0 22.6 16.1 15.8
Emirates
United -1.0 -2.1 -4.5 -5.9 -6.0 -5.3 -4.7
States
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 1.3 1.3 1.7 1.4 1.5 0.5 0.9 (-)3.8

countries
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 Challenges
 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 April- December 9.0 -33.4
Foreign Exchange Reserves
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 Growth April-December 9.0 6.9
Industrial production April-February 8.8 2.8
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
 Medium-term Issues and Challenges
 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
 Pressureon 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 BE 2008-09 RE 2009-10 BE
Gross 1,76,453 3,42,769 3,98,552
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 (5)
 India’s Approach to Managing 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 buffers of
liquidity – both absorption and injection
 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:
 extensionof 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

 MSS unwinding

 Enhanced and pre-announced calendar for OMOs

 Measures since Mid-September, 2008 (5)
Impact of Measures (2)
Item March 2008 September October 2008 March 2009
2008
Turnover (Rupees crore, average daily)
1 Call market 11,182 11,690 14,497 11,909
2 All money markets @ 63,395 42,891 40,906 81,821
Key Interest Rates (per cent)
3 Call market 7.37 10.52 9.90 4.17
4 All money markets @ 6.55 9.26 8.66 3.76
5 BSE Sensex 15946 13943 10550 8995
6 Rs. Per US $ 40.36 45.56 48.64 51.23
7 10-year G-sec yield 7.69 8.45 7.85 6.56
8 Certificate of Deposits 10.0 11.6 10.0 7.0
9 Commercial Paper 10.4 12.3 14.7 8.9
10 Deposit rate (1-3 yrs)# 8.25-9.25 8.75-10.25 8.75-10.25 8.00-9.25
11 BPLR# 12.25-13.50 13.75-14.75 13.75-14.75 11.50-14.00
@: Call money, CBLO and market repo; #: Data pertain to PSBs.
 Measures since Mid-September, 2008 (6)
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)
 Measures since Mid-September, 2008 (7)
Inflation in India
(per cent)
Item March 2008 June 2008 September December March 2009
2008 2008
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 Challenges
 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 Challenges
 Medium-term Issues and Challenges (1)
Macroeconomic Indicators at a Glance (Per cent)
1950-51 1965-66 to 1980s 1990-91 1991/92 1997/98 2003/04
to 1980-81 to to To
1964-65 1996-97 2002/03 2007/08
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
 Medium-term Issues and 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 correction needs

to be consolidated and carried forward.

 Medium-term Issues and 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.
 Medium-term Issues and 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: manage such

growth without endangering price or financial

stability.
 Medium-term Issues and 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?

 implications of large current account deficits for the

real economy?
 Medium-term Issues and 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”.
 Medium-term Issues and 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
 Medium-term Issues and Challenges (8)
Financial Sector

 Commercial banks robust

Committee on Financial Sector Assessment

(CFSA)
• Stability Assessment and Stress Testing
•  ConcernsWithout
about creditScenario
risk remain muted atin
- increase present
Stress NPA by:
100 per 150 per cent
cent
  CRAR (%) CRAR (%) CRAR (%)

Mar-08 13.0 11.6 11.0

•
Note: CRAR = credit to risk-weighted assets ratio
Sept–08 12.5 11.1 10.6
 Medium-term Issues and 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 fast and return
to 9%+ growth path
Thank You