Global Financial Crisis

2009

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 Sub Prime Housing Loan Bubble
 Crisis happened in US in second half of 2007 with the burst of the
housing bubble.
 IT bubble burst in 2001had already led to recession in the US
 To get the economy out of recession, US Federal Reserve cut
interest rates to increase the liquidity or money supply in the
economy thereby encouraging consumers to borrow.
 Crisis happened due to sub prime housing loans given on a large
scale by American banks and widespread mortgage defaults.
 Banks that held the sub prime mortgage loans sold them to other
banks and investors through a financial innovation called CDO
(collateralized debt obligations) securities which were backed by a
host of mortgage assets.
 To make them safe for investment and increase their marketability,
the CDOs were given high ratings by credit agencies.
 American and European intermediaries such as banks, pension
funds, mutual funds invested heavily in these complex securities
(CDO) unaware of the risks involved.
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 Sub Prime Housing Loan Bubble
 Those who bought these securities had in turn borrowed heavily
from banks and financial institutions to make investment in them.
 Fall of housing prices in 2007 led to defaults in payment schedules
by borrowers, as a result of which value of sub prime housing
securities and CDO’s declined.
 Banks and investment funds which had invested millions in these
securities suffered heavy losses leading to liquidity crunch.
 As a result of huge losses investment institutions like Lehman
Brothers became bankrupt.
 September 2008 saw the “Top 5” of Wall Street succumbing to sub
prime losses, Lehman Bros filed for bankruptcy, Merill Lynch was
merged with Bank of America, Goldman Sachs and Morgan Stanley
converted into commercial banks and Bear Stearns was acquired by
JP Morgan Chase.
 Lack of proper regulation of financial institutions, banks and stock
markets in a free market system led to the creation of complex and
non transparent securities (CDO). Problem of liquidity and credit
crunch led to the stock market crash in US and Europe. Share
prices and capital value of many companies tumbled. 3
Sub Prime Housing Loan Bubble
 Investor confidence shrunk and credit markets around the world
gradually dried up.
 Erosion of capital base of banks and FIs, led to adversely affecting
liquidity and flow of credit to companies and end consumers. Lines
of credit to corporates dried up even for working capital
requirements thereby affecting employees and suppliers and stalling
of ongoing investment projects.
 Banks stopped giving credit to consumers and corporates,
negatively impacting consumption demand and investment leading
to a slowdown in economic growth in US and countries around the
world.
 Subsequently, Federal Reserve and other banks injected substantial
liquidity in the markets by means of lowering interest rates or bailing
out financial institutions.
 Due to globalisation with its free flow of capital and goods between
US and other countries, countries closely integrated with the US
heavily suffered.
 Exports of European and Asian countries to US were affected
leading to decline in output of export goods and subsequent job
losses in these countries too.
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Impact of Global Financial Crisis on
India

 Stock market crash

 Depreciation of Indian Rupee
 Liquidity crunch in the Banking sector
 Impact on Indian Economic Growth
 Slowdown in the Manufacturing Sector
 Balance of Payments

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Impact of Global Financial Crisis on
India: Stock Market Crash
 Following eruption of financial crisis, stock markets of US and other
European countries crashed and it’s effect spilled over to India and the
Indian stock market was also badly hit.
 To meet liquidity requirement of parent companies, Investors (FIIs)
started selling shares of Indian companies held by them.
 In the last few years, FIIs had invested massively in the equity shares
of Indian companies ranging from consumer goods to infrastructure
industries.
 As a result of the buying spree by FIIs, share prices rose, with the
Sensex reaching the peak of around 21,000 in Jan 2008.
 Around this time (Jan 2008), share prices in US and European markets
started falling sharply and the problem of liquidity and credit crunch
assumed grave proportions which led to FIIs selling shares held by
them in the Indian stock market.
 The Sensex started tumbling and fell to the 9000 mark in Nov 2008 ie
60% fall since Jan 2008. This caused huge losses to Indian companies
and investors.
 FIIs sold more than $13 billion worth of shares of Indian companies in
2008 and repatriated them to their home countries. This also led to a
decline in foreign exchange reserves held by RBI.
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Impact of Global Financial Crisis on
India: Depreciation of Indian Rupee
 Revenue got by sale of shares by FIIs was converted to dollars
in order to facilitate the repatriation of the money to the home
country. This led to an increase in the demand for dollars.
 Rupee-dollar exchange rate being determined by demand for
and supply of currencies, the increase in demand for dollars
caused an appreciation of US dollar in rupee terms, ie rupee
depreciated against US dollar.
 Indian importers also demanded dollars to pay for the import of
goods.
 Indian banks doing foreign operations also bought US dollars in
India to keep their foreign exchange operations afloat as due to
the credit crunch their was hardly any lending happening in
foreign countries.
 This further raised the demand for dollars causing fast
depreciation of the rupee in Sept – Nov 2008. The value of
Indian rupee depreciated from Rs. 39.4 for a dollar in 2007 to
Rs. 50.6 in Nov 2008. This depreciation did make our exports
cheaper and imports more expensive.
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Impact of Global Financial Crisis on India:
Liquidity crunch in the Banking Sector
 Large outflow of dollars led to depreciation of rupee,
to prevent depreciation of rupee and maintain
exchange rate stability, Reserve Bank of India
intervened and supplied dollars from its foreign
exchange reserves and got rupees in return.
 With this too much depreciation of the rupee was
prevented but in the process quantity of rupees with
the banking system declined in turn causing liquidity
problem in the Indian banking system and affecting
the credit flow to the industry.
 Affected credit flow impacted the credit availability for
working capital and fixed investment requirements
by the industry.
 Risk aversion by Banks in India also restricted credit
flow to consumers for buying cars, houses etc.
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Impact of Global Financial Crisis on
India: Economic Growth in India
 With the US economy witnessing a slowdown in economic
growth, its effect spilled over to Europe, Japan and other
Asian countries, Britain, Germany, Italy…….
 IMF’s assessment was that the growth rate of the global
economy was expected to hit 3% in 2008 and near zero in
2009.
 In Sept 2008, IMF also predicted lower growth of 7% for India
as against over 9% growth in the previous years.
 Even though India’s economic growth depends more on
domestic demand and is driven largely by domestic savings
and investment, after 18 years of globalisation, our exports
constitute 17% and imports 20% of GDP.
 There has been a fall in output of automobile, shipping and
aviation industries, also export oriented units of textiles,
leather, gems and jewellery have been hit by the global
meltdown. 9
Impact of Global Financial Crisis on India:
Slowdown in the Manufacturing Sector
 As per FICCI’s survey, the manufacturing
sector comprising industries like textiles,
metals and metal products, leather and
leather products, jewellery and automobiles
has seen a steep decline in production.
 Both domestic demand and declining export
orders have been the cause of the slowdown.
 Other important cause was that banks were
not willing to give credit and high input costs.
 Various industries were planning to downsize
employment
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Impact of Global Financial Crisis on India:
Balance of Payments
 Globalization and adoption of export oriented
strategy of growth has increased the
dependence of the Indian economy in the
external market.
 In 1990-91, exports were to the tune of 5.8%
of GDP while in 2006-07 exports were
approx. 14% of GDP.
 India’s foreign trade balance worsened in
2008-09 and registered a deficit of $60 billion
in first half of 2008-09. Decline of exports was
one of the main reasons. Also, depreciation
of the rupee made our imports costlier 11
Indian Response to Financial Crisis –
Monetary Policy Measures
 RBI for several months before the financial crisis had been
increasing the cash reserve ratio and interest rates to curb
the upward trend of inflation. However, it reversed its track
from Oct 2008.
 To curb the depreciation of the Indian rupee the RBI sold
billions of dollars in the foreign exchange market from its
reserves.
 Due to the global financial crisis there was liquidity crunch
in the money market which adversely affected the flow of
credit to industries. In order to increase the liquidity, RBI
cut the cash reserve ratio three times in Oct – Nov from
9% to 5.5%. With this approx Rs. 1,40,000 crores was
infused in the banking system. Currently, the CRR is 5%.
 RBI also cut the statutory liquidity ratio from 25% to 24%
which enabled banks to get Rs. 20,000 crores from RBI 12
against Govt securities for lending to mutual funds.
Indian Response to Financial Crisis –
Monetary Policy Measures
 Also, RBI released Rs. 25,000 crores to banks in
connection with the farm loan waiver scheme. In this way
about Rs. 2,00,000 crores has been infused to alleviate
the pressures brought on by deterioration in global
business environment.
 RBI also further sought to lower lending rates of banks in
order to decrease the cost of borrowing. Repo rate was
decreased from 9% to 4.75%.
 Lowering of repo rates was to ensure that banks lower
their lending rates so that cost of borrowing from banks fall
and more credit is created for investment by the
companies and there is higher demand for durable
consumer goods such as houses, cars etc.
 In today’s date, banks have surplus cash with them.

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Indian Response to Financial Crisis –
Fiscal Stimulus
 In Dec 2008, GOI announced a fiscal stimulus package of
over Rs. 30,000 crores and is aiming towards increase of
Government expenditure and cut of Central Excise Duty.
 The fiscal package is expected to help the growth of
infrastructure projects, housing, textiles, automobiles etc.
 Expenditure on development of infrastructure plays an
important role in boosting economic growth. The
government hopes to implement infrastructure projects
under public private partnership schemes. Infrastructure
projects would in turn boost demand for steel, cement and
other items.
 The government has reduced the Central Excise Duty by
4% on all commodities on which excise duty is levied. This
would boost demand for cars, consumer durables,
washing machines etc. provided manufacturers pass on 14
the benefit to consumers.
Indian Response to Financial Crisis –
Fiscal Stimulus
 Government has allocated an additional Rs. 1400
crore to the textile industry for technology
upgradation which in turn would make the Indian
textile industry more competitive in the international
market by lowering cost.
 Public sector banks announced a package for
borrowers of home loans and reduced the home loan
interest rates in order to boost demand for housing
which would further have a multiplier effect on other
industries like cement, steel, transport and also
generation of employment.
 The fiscal stimulus also provides for subsidizing of
interest costs of exporters. The Govt. would bear 2%
of interest on loans taken by exporters subject to a
minimum rate of 7%.This would help sectors such as
handloom, textiles, leather, gems and jewellery. 15