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 Excessively accommodative monetary policy in the US and other advanced economies (2002-04)

 Fundamental cause

8 -4.2005 2006 2007 2008 94 99 04 China 1.2 18.7 27.3 -1.9 -6. .1 -1.7 0.9 1.3 0.0 9.7 Arabia United Arab 8. April 2009.6 -2.4 0.Country Global Financial Crisis (2) Current Account Balance (per cent to GDP) 1990.5 11.0 18.9 2.3 0.9 Saudi -11.1 28. Note: (-) indicates deficit.0 -5.0 -2.4 19.1 1.0 10.5 5.2 9.1 0.0 9.3 Russia 0.9 25.0 States Memo: Euro area n.4 India -1.1995.2 -0.4 0.0 22.8 Source: World Economic Outlook Database.a.9 6.3 Emirates United -1. International Monetary Fund.6 28.7 21.9 4.5 11.6 16.7 8.0 -1. Middle East -5.2 11.3 -4.9 18.4 10.5 -1.1 15.1 -2.8 3.2000.5 -5.4 7.

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? .

aggregate demand exceeded output.Global Financial Crisis (5) US Monetary Policy (2) •US Monetary policy too loose during 2002-04. mirrored in large surpluses in China and elsewhere. . large current a/c deficit.

Global Financial Crisis (6) US Monetary Policy (3)  Large Fed cuts in 2007: strong boost to oil. other commodity and asset prices .

large volatility .implications for monetary management and financial stability .Capital Flows to Emerging Market Economies Global Financial Crisis (3) •Very large capital flows to EMEs –– now outflows in 2009 .

9 3.9 3.6 3.1 3.3 -11.3 1.8 6.0 3.9 6.4 0.1 6.6 6.5 2008 2009 2008 2009 2008 2009 Advanced countries EMEs World World 1.8 4.9 3.9 (-)3.7 6.7 3.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 1.1 3.5 0.7 1.8 4.7 3.9 6.7 6.3 1.3 Global Trade Volume (Goods and Services) 3.1 1.0 .2 (-)1.9 3.0 3.

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 .

7 82.December April-December April-March .7 External Commercial Borrowings (net) April.5 -33.December April.5 15.4 -53.7 -15.6 20.5 10.Impact on India (1) Trends in Capital Flows Component Foreign Direct Investment to India FIIs (net) Period April-February April-March April.3 -36.3 17.1 110.8 -57.December April.5 2008-09 31.0 0.December Short-term Trade Credits (net) Total capital flows (net) Memo: Current Account Balance Valuation Gains (+)/Losses (-) on Foreign Exchange Reserves Foreign Exchange Reserves (variation) April.0 -15.0 76.0 6.December 2007-08 27.5 9.

0 12.366 45.7 16.2 2.4 17.0 8.24 2008-09 Growth.5 28.8 10.4 40.569 40.Impact on India (2) Key Macro Indicators Indicator Real GDP Growth Services Exports Imports GFD/GDP Stock Market (BSE Sensex) Rs.9 6.per US$ Period April-December April-December April-March April-March April-March April-March April-March 2007-08 9.8 9.92 Industrial production April-February .7 6. per cent 6.9 2.

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  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 .

76. Debt waiver.5-6.0% Large increase in market borrowings Rs.453 1. Food subsidies  Pay Commission. Fertiliser.08.647 1.000 3.98.29.42. crore 2008-09 BE Gross Net 2008-09 RE 2009-10 BE 3. NRE  Stimulus packages  GFD/GDP ratio: 5.552 3.769 3.13.649 .Differences Between Financial Crisis in US/Europe and India (3)  Our Problems  Fiscal stress  Oil.

but gradual opening up Capital account and financial sector: More calibrated approach towards opening up.Differences Between Financial Crisis in US/Europe and India (4)  India’s Approach to Managing Financial Stability (1)   Current account: Full.  Equity flows encouraged.  debt flows subject to ceilings and some end-use restrictions. .  Capital outflows: progressively liberalized.

 Dynamic provisioning  NBFCs: regulation and supervision tightened .to reduce regulatory arbitrage. subject to prudential regulation  both liquidity and capital. especially banks.  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.Differences Between Financial Crisis in US/Europe and India (5)  India’s Approach to Managing Financial Stability (2)  Financial sector. .

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 .

2008 (1)  Expanding rupee liquidity      Reduction in CRR (400 bps) & SLR (100 bps) Special Repo window under LAF for banks on-lending to NBFCs.  Existing instruments – enough flexibility  MSS and CRR – good.Measures since Mid-September. 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. 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:  extension of period for export credit.  Expansion in refinance  Dynamic provisioning  Contracyclical adjustment of prudential norms  SIDBI and NHB: lendable resources expanded Loan restructuring  .

4. Measures ensuring orderly functioning of Indian financial markets  Cumulative potential primary liquidity impact – over Rs. 2008  LAF window in absorption mode.  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 (4) Impact of Measures (1) .  Gradual reduction in deposit and lending rates of banks . 2008 – bottom of the corridor.000 crore (9 % of GDP)  Comfortable liquidity position since mid-November.  Call rate within LAF corridor since November 3.90.

Per US $ 10-year G-sec yield Certificate of Deposits Commercial Paper 11.85 10.25-13.906 9.909 81. 2008 (5) Impact of Measures (2) Item March 2008 September 2008 11.00-9.75-10.66 10550 48.25 12.25 13.56 8.17 3. .75-10.00 Key Interest Rates (per cent) 10 Deposit rate (1-3 yrs)# 11 BPLR# @: Call money.6 12.25 11.690 42.0 10.37 6.182 63.26 13943 45.497 40.50-14.25 13.395 7.4 8.25-9.64 7.90 8.23 6.69 10.36 7.75 14. CBLO and market repo.3 8.55 15946 40. average daily) 1 2 3 4 5 6 7 8 9 Call market All money markets @ Call market All money markets @ BSE Sensex Rs.0 8.45 11.891 10.Measures since Mid-September.75-14.0 14. #: Data pertain to PSBs.56 7.821 4.52 9.75-14.9 8.50 October 2008 March 2009 Turnover (Rupees crore.7 8.75 11.76 8995 51.

138 6.64.80.79.44.807 4.35.14.505 2.698 7.Measures since Mid-September. 2008 (6) Total Resource Flow from Banks and Non-banks 1 Item Non-food Bank credit Non-banks Total flow of resources (1+2) Rupees crore 2007-08 2008-09 4.902 3.040 2 3 .

0 11.6 (Feb) Industrial workers .3 7.7 6.9 (Feb) 9.0 16.9 7.8 7.8 9.5 10.Measures since Mid-September.9 8.3 3.8 8. 2008 (7) Inflation in India Item March 2008 June 2008 September December 2008 2008 (per cent) March 2009 Wholesale price inflation All commodities Of which: Primary articles Fuel Manufactured products Agricultural labourers Rural labourers Urban non-manual employees 7.7 7.7 11.8 11.5 -6.8 (Feb) 9.0 9.0 11.4 10.5 5.9 12.6 6.3 10.0 7.8 9.7 9.8 (Feb) 11.4 10.6 -0.7 6.1 12.2 0.4 Consumer price inflation 7.0 16.1 1.3 12.5 9.9 11.

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 .

dynamic provisioning Look for regulatory arbitrage incentives/ possibilities .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.

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 .

0 32.8 24.9 6.4 3.8 5.0 5.9 22.7 5.7 4.9 24. GDS/GDP 6.4 8.3 11.1 3.2 3.4 6.7 15.4 8.6 4.2 3.4 4. Real GDCF/GDP 3.7 -0.7 6.1 2.6 26.0 7.6 24.9 4.8 19.4 9.3  Continuing increase in real GDP growth .4 5.0 23.1 -0.0 22.3 -1.3 20.2 2.0 16.3 31.8 10.2 5. Nominal GDCF/GDP 5.9 7.7 7. Real GDP Growth Agriculture Industry Manufacturing Services 2.8 5.1 4. ICOR 4.7 4.2 6.2 0.Medium-term Issues and Challenges (1) Macroeconomic Indicators at a Glance (Per cent) 1950-51 1965-66 to to 1980-81 1964-65 1 2 3 1980s 1990-91 1991/92 to 1996-97 6 1997/98 to 2002/03 7 2003/04 To 2007/08 8 4 5 1.5 4.9 -0.5 3.9 13. Saving-Investment Gap 4.Interregnum during the 1970s  Secular uptrend in domestic saving and investment -investment largely financed by domestic savings  Continuation of growth in domestic savings necessary.7 3.3 4. fiscal prudence .2 19.6 4.5 3.5 6.6 20.2 5.6 33.1 4.8 -3.8 6.5 24.0 -1.9 4.7 -1.1 10.4 22.

 self imposed rule based fiscal correction needs to be consolidated and carried forward. . constrains progress towards full capital account convertibility.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.

.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.

 Financial deepening and increasing monetisation. .  expansion of monetary aggregates departs from their traditional relationship with real GDP growth.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.  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? .

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.Medium-term Issues and Challenges (6) External Sector (1)  Optimal response to the large and volatile capital flows is a combination of (CGFS. . 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 .

0 CRAR (%) 11.Medium-term Issues and Challenges (8) Financial Sector  Commercial banks robust Committee on Financial Sector Assessment (CFSA) • Stability Assessment and Stress Testing • Concerns about credit risk remain muted atin   Without Scenario .1 .increase present Stress NPA by: 100 per cent   Mar-08 • 150 per cent CRAR (%) 11.6 Note: CRAR Sept–08= credit to risk-weighted assets ratio 12.6 CRAR (%) 13.5 11.0 10.

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 .Medium-term Issues and Challenges (9) Conclusion  India’s fundamentals remain strong       Financial sector robust Monetary policy – sufficient instruments.

Thank You .

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