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A crisis in an economy impacts other economies via three channels: Trade Channel: When an economy falls into a recession, it impacts the affected country’s trading partners too. Falling household and business demand in the slump-hit economy hits the exports/imports of its trading partners. The share of exports to EU (excluding UK) and imports from EU has fallen over the years. In 1987-88, exports to EU constituted about 18.6% of total exports. This has declined to 17.5% by 2008-09. The decline of imports is higher from 25% in 1987-88 to 12% in 2008-09. Hence, total trade between India and EMU is about 29.5% and could be impacted due to the crisis. (Source: RBI) However, trade channel can impact Indian external sector indirectly as well. When the recent crisis gripped the world 2008, most policymakers, economists and experts put forth the view that India would be only marginally affected. Two reasons were cited for th
First, India was a virtual non-entity in global trade as its share was less than 0.5%-0.7% of the total global trade volumes. Hence, it was assumed that its economy was largely insulated from the turmoil. Second, share of developed economies in trade had declined. In 1987-88 developed economies contributed 59% of exports and in 2008-09 their share has declined to 37%. The share of developing economies has increased from 14% in 1987-88 to 37% in 2008-09. In case of imports developed
transport etcSource: RBI . Hence.2 bn levels to 10.9 Apr – 11.Mar 2009 11. it was felt Indian trade will continue to grow.7 Jan . (Source: RBI) Because of this shift it was felt that impact of global crisis on Indian economy would be limited. It declines visibly in Jan-Mar 2009 quarter when the global crisis started in September 2008. What about trade in services? We do not have country-wise data of trade in services so we just analysed the broad trend.3 Jun 2008 Jul – Sep 2008 14. The above analysis looks at trade in goods.8 10.economies share has again fallen from 60% in 1987-88 to 32% in 2008-09 while developing economies has risen from17% to 32%. Software exports decline marginally from USD 11.7 April-June 9. Unlike trade in goods which declines immediately.9 10.0 10.6 2009 Jul-Sep 2009 7.4 Oct-Dec 2009 7. impact of crisis was more on goods and muted on services.2 Oct-Dec 2008 13. (in USD India Services Software Billion) trade Receipts Jan – Mar 2008 10.6 11.4 levels which is great given the global nature of the crisis.7 Software exports are more than services trade as we import more in case of other services like travel. Indian trade sector declined sharply and growth was negative for 13 straight months from Oct-08 to Oct-09.2 10. However once the crisis struck in September 2008. we see a decline in services trade with a lag.7 12.4 11.7 10. As crisis originated in US and developed economies with developing economies still growing.
Financial Channel: The current crisis has shown the power offinance channel (though trade channel was also very strong as above analysis points). rise in corporate bond spreads and depreciation in currency). Trade volumes declined as world economy is far more integrated than we assume it to be. So. So. So much so. If you plot the BSE Sensex with other advanced economy stock indices. Besides. The Indian government had to intervene and provide stimulus to exporters. the correlation between assets too has been rising across the world. IMF says the decline in world trade in 2009 was around 12.3%. you more or less see the same trend. Demand in developing economies also declined leading to overall slump in world trade. there could be a possibility of slowdown in FDI in India.8% of total FDI since . the quantum and direction of the movement is also more or less similar (decline in equity markets. Apart from movement in financial markets. three kinds of financial flows could impact Indian financial markets: Foreign Direct Investment: There are many European companies which have investments in India. The impact of turmoil in one economy’s financial markets is not merely transmitted to other markets. the overall impact of European crisis on Indian trade could be much more than direct linkage indicates. World Trade volumes declined for the first time in 60 years.Moreover. EU economies have contributed about 12. This is because cross border financial linkages have increased substantially over the years. We looked at top 15 FDI investors in India which constitute about 92% of total FDI (Source: DIPP). one can determine the trend in the Indian equity market by just looking at movements in other global indices.
7 -4. Given the severity of the crisis it was felt there will be little FDI investment.3 -5.April 2000.2 6. However.9 Source: RBI Foreign Institutional Investment: Unlike FDI.0 -4.2 April-June 2009 8.7 8. With a turmoil in global financial markets.4 Jan .2 3. The FDI inflows actually helped keep maintain capital account when all other categories showed sharp decline.4 6. the linkage here is pretty direct.Mar 2009 8. FII inflows will decline.9 4.9 0.8 3.6 6. (in USD billion) Jan – Mar 2008 Apr – Jun 2008 Jul – Sep 2008 Oct-Dec 2008 Jan . However. (in USD billion) Gross FDI Gross FDI Net FDI inflows Outflows (Inflows minus Outlflows) Jan – Mar 2008 13.4 Apr – Jun 2008 11. there is a pull out from other markets as well.8 -3.7 -2. FDI inflows remained positive throughout the crisis.3 -5.9 -2.9 Oct-Dec 2008 6.1 -3.7 5. But again FDI remained robust throughout this crisis.7 -4.9 9.7 -7.2 -1.1 Jul-Sep 2009 10.0 Jul – Sep 2008 8.3 9. in case of India.Mar 2009 April-June 2009 Jul-Sep 2009 Oct-Dec 2009 FII -3. it is difficult to pinpoint the origin of FII investment.7 . We have a large number of global financial firms which operate across the world and in case of a decline in one major market.5 Oct-Dec 2009 7.8 -2.
The deposits increase in the crisis periods Oct-Dec 2008 and Jan.8 1. (see thisstudy on remittances) Remittances 13.6 (in USD billion) Jan – Mar 2008 Apr – Jun 2008 NRI Deposits 1.Mar 2009 and decline thereafter.8 .5 Remittances and NRI deposits: Another important flow is NRI deposits and Remittances.Mar 2009 April-June 2009 Jul-Sep 2009 Oct-Dec 2009 ECB 4.5 1.5 1.2 1. We see an interesting trend in the case of NRI deposits.4 11.1 0.1 -0.8 1. It could be that NRI preferred to invest higher proceeds in India seeing crisis in their own economies!In case of remittances. External Commercial Borrowings: External commercial borrowings could also decline if the European crisis spreads to other economies. In some countries they did collapse worsening poverty status. There were huge concerns of remittances collapsing because of the crisis. Former shows whether NRI depositors withdrew funds in wake of crisis and latter shows whether Indians living abroad stopped sending funds to their homes again because of the crisis. (in USD billion) Jan – Mar 2008 Apr – Jun 2008 Jul – Sep 2008 Oct-Dec 2008 Jan .7 3. we see a decline in crisis period Oct 08 – Mar 09 but see improvements as crisis eases. despite the decline it manages to remain in positive. In India. ECB’s declined in the first stage of the crisis as well.
Bank of Japan Governor Masaaki Shirakawa in a recent speech said confidence cycle plays a crucial role in all crises: . Credit growth also declined because of decline in business investments. Even both trade and finance are interlinked. Confidence channel This channel shows confidence declines in business and households seeing the global uncertainty.2 1. Role of confidence channel in crisis has grown overtime. First. So even if an economy’s macroeconomic conditions and outlook look favorable.0 9. A problem in latter could lead to worsening of the conditions of domestic banks/financial firms as well (this was seen in the case of Swedish banks).0 0.5 12.0 10.8 Again like in the trade channel.Jul – Sep 2008 Oct-Dec 2008 Jan . Decline in confidence is also one of the reasons for decline in business investments which led to decline in overall Indian GDP growth. Financial markets are far more integrated than the trade channel. Second. domestic banks can lend to companies in other economies as well.9 13. In the initial phase of post September 2008 crisis.Mar 2009 April-June 2009 Jul-Sep 2009 Oct-Dec 2009 0.6 13.8 1.8 12. WTO and World Bank chiefs raised concerns over trade finance in numerous forums.0 2. RBI Governor Mr Subbarao has stressed on this channel on numerous occasions (see this speech in 2009). Banks are at the center of the international trade as they provide trade finance and other financing facilities that facilitate trade.3 1. A problem in financial markets will disrupt the international trade as well. the decline in confidence can disrupt the economic conditions. the impact of financial markets could be more via the indirect linkage.
The cyclical movement in India’s exports and world imports during the earlier period 197091 was not significantly synchronised with a relatively low correlation of 0. Then the cycle begins once again. RBI Executive Director Deepak Mohanty in his speech explained the increasing correlation: With increased global integration.20 in during the period 1971-1990 The traditional conduit of transmission of global shocks is through trade cycles. and for that matter bubbles which precede them. but we also need a holistic perspective which cannot be captured just by focusing on individual causes.Why do financial crises. Indian economy has become more global over the years.50 during the period 1991-2009 from 0. excessive leverage. Success breeds confidence which unfortunately turns into over-confidence or even arrogance. However. failure of supervision. The business and trade cycle of India has started to follow the cycles of advanced economies.38. The correlation between the cyclical component of the index of industrial production (IIP) of the advanced economies and India has risen to 0. existence of financial institutions which are perceived to be too-big-tofail. occur repeatedly? Many reasons are given — lax risk management. which is followed by rebuilding efforts. The collapse of the bubble based upon this over-confidence leads now to under-confidence. From this perspective. I would like to emphasize that. with rising exports alongwith a transition from primary article exports to manufacturing . what one could term as a “cycle of confidence” which evolves over a very long time horizon. Complacency also sets in. Increasing integration of India with global economy Apart from these three channels. plays a decisive role. the Indian economy now is subject to greater influence of global business cycles. excessively accommodative monetary policy and the list goes on. I generally agree with such assessments.
IIP is increasing in double digits. sentiment has already reversed in some cases: The investments might not increase seeing the global uncertainty. As this crisis has shown that world economy is far more global with many complex interlinkages. Hence. Investment was a key driver in Indian 9% growth period (2003-08). export markets are picking up and capital inflows have been robust. it could impact Indian economy via other indirect linkages as well. if the European crisis continues to spread. credit growth has increased to 17%. Concluding thoughts and possible scenarios The above analysis looks at some preliminary evidence of the linkages of Indian economy with European economies. because of the global uncertainty all these calculations can easily go wrong. Given this global uncertainty.exports.80 during the recent period 1992-200. We have seen business confidence evaporating in thin air quick time IIP could again decline as September 2008 crisis it did post Credit growth could decline both because of banks becoming uncertain and business not demanding credit . Again it is expected to play the key. If we look at Indian economy alone fundamentals look quite strong. However. the correlation between India’s exports and world imports has increased significantly to 0. GDP growth is expected to be around 8. Again. I must emphasize that we need to look beyond the direct impact of European economy on India. Infact.5% in 2010-11. it puts Indian policymakers in a peculiar situation.
Indian government might again have to intervene to ease the crisis situation. It had increased from 20 level in Jan 2008 to 85 levels in Nov-08. This is quite a turnaround as most market participants expected yields to touch 8-8. Export markets could also reasons explained above. It has again started increasing to touch 34 levels now. Though the probability is remote. The market participants were also expecting RBI to increase interest rates even before its monetary policy in July 2010. This crisis has reversed the sentiment and most now expect RBI to keep interest rates unchanged in July policy. The decline in inflows along with global uncertainty has led to decline in equity markets. Foreign capital inflows could reverse to an outflow position. Infact this has already started to happen with FII showing outflows worth USD 1.000 levels are being revised downwards.65 billion in May (from May 1 2010 to May 24 2010) from equity markets.35% levels looking at the global crisis. There are expectations that fiscal deficit and government borrowing program could be . The volatility is again increasing. It then declines to go back to pre-crisis level of 17-18. The expectations of BSE Sensex reaching soon to 21. we had nearly USD 6. but it is till there.65 billion of capital inflows.25% levels after April Monetary Policy. Yields in bond markets have eased considerably to 7. If we see the NSE VIX index. decline for If the crisis situation worsens. Till April 2010.
The recent events show the situation is quite severe. This was especially the case for financial market players. I mean it is just amazing. European policymakers have again showed resolve to fight this crisis. In US you have one government and here you have 16 governments who are trying to resolve the issue. the government borrowing and fiscal deficit could get worse. And just after saying this. . Finally a reminder for all those who forget/prefer to forget economic history so quickly. Oil and commodity prices have declined as well. This is because of the higher than expected proceeds from 3-G auctions. And then the crisis hit and hit them hard with equity markets declining from 21000 levels to 8000 levels. There is little coordination between European policymakers as daily edition ofeurointelligence shows. So. Comparisons have been made on how the crisis is similar to earlier US crisis but we have a far more complex problem here. This could be a positive factor as inflation might just become lower. Germany was seen as the economy which could support falling Eurozone but its government has been severely criticised for its dilly-dally approach. This angered other European governments who said why Germany should make standalone policies when we are all fighting this crisis together. The above is a worse-case scenario and all will depend on the nature of European crisis. overall it is all very chaotic and complex at the moment.lower than budgeted amount. If crisis worsens. Before the crisis in Sep-08 we kept saying we will not be impacted because of the global crisis for all kinds of reasons. We still do not know where the crisis is headed. Germany recently imposed ban on naked short selling without taking other European governments in confidence.
We may not be impacted by the European crisis as much as previous crisis. And now we are seeing some strains on equity markets. As Europe started to decline.And again. we again laughed off when asked whether we could be impacted. Infact much of the gains in Indian economy did not come from some economy wonders but government wonders. we preferred to call it a one time event etc. It drives you nuts really . but forgetting history so quickly is a crime. it rose not because of some Indian economy wonders but because global financial markets started picking up (or stopped declining). And as global crisis eased. capital inflows etc. And again it is the same set of people expressing confidence over Indian economy etc.