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2.THE SUBPRIME CRISIS..........................................................................................................................6
A) DEFINITIONS................................................................................................................................................6
B) U.S SUBPRIME CRISIS :..............................................................................................................................10
D) ECONOMIC CONTEXT...................................................................................................................................14
E) CREDIT DEFAULT SWAPS ............................................................................................................................16
F) FIXED INCOME TOOLBOX..............................................................................................................................16

3. IMPACTS ON U.S....................................................................................................................................18
A) FINANCIAL MARKET IMPACTS, 2007: ............................................................................................................23
B) FINANCIAL MARKET IMPACTS, 2008:.............................................................................................................24
4. IMPACTS ON INDIA..............................................................................................................................25
C) ON REAL-ESTATES............................................................................................................................27
5. MEASURES TAKEN BY INDIAN GOVERNMENT ........................................................................28
B)FISCAL AND MONETARY POLICY PACKAGES:...........................................................................29
i) Stimulus Package I............................................................................................................................29
ii) Stimulus Package II..........................................................................................................................30
iii) Stimulus Package III.......................................................................................................................33
C) RBI MEASURES .......................................................................................................................................35
D) REACTIONS : MIXED REACTIONS FROM THE INDUSTRY..............................................................................36
E) MEASURES PROTECTING THE POOR AND THE VULNERABLE:.............................................37
F) MEASURES SAFEGUARDING WORKER’S RIGHTS....................................................................37
G) SOCIAL DIALOGUE..........................................................................................................................39
H) CONCLUDING REMARKS................................................................................................................39

6. ACTIONS TAKEN BY U.S. GOVERNMENT......................................................................................40

A) FEDERAL RESERVE RESPONSES TO THE SUBPRIME CRISIS:.................................................................................40
B) REGULATORY RESPONSES TO THE SUBPRIME CRISIS:.........................................................................................41
C) ECONOMIC STIMULUS ACT OF 2008:............................................................................................................42
D) HOUSING AND ECONOMIC RECOVERY ACT OF 2008.......................................................................................42
E) FAILURES AND GOVERNMENT BAILOUTS OF FINANCIAL FIRMS:............................................................................43

7. CONCLUSION.........................................................................................................................................44
This paper was submitted as a final year project, BBA department, ravenshaw university
March 2009. Its goal is to give a profound insight to the subprime crisis from a fixed
income perspective. Following essential definitions and economic context setting, a deep
look into the roots of the subprime crisis will be taken, with the U.S. as a reference. Then,
the yield curve is analyzed as a prediction tool for past crisis, the current one, and future
ones. It is concluded that the crisis could have been foreseen, eventually dampened, but
not avoided. This is due to the complexity of the financial system. The TED spread will
also be analyzed in the same way and gives an insight to the severity of the crisis –
probably the largest one since the great depression! Finally, an insight to what has been
happening and what it is like to work for such a hard-hit bank during times of crisis will
be given. The goal is to provide other Master students with a deeper understanding of the
subprime crisis, of fixed income tools and of an internship at an investment bank in such

“Information’s pretty thin stuff unless mixed with experience”
– Clarence Day, The Crow’s Nest

The above quotation reflects the reason behind our choice to undertake a practical thesis.
However, given our lack of experience, this task proved to be more difficult than We
thought. In consequence, the goal of this thesis is to transform our knowledge into
something that a person, typically another student, can learn from. The following pages
are an attempt to make a profound review of the subprime crisis and its effects from a
fixed income perspective.

There are no proofs or theorems but some interesting results. It is merely the
effects that we observed as an intern within the department of Fixed Income at UBS
Investment bank, Geneva. This is a summary of most of what we’ve done and seen, with
some suggestions of what I would do if I had more time.

In this context, we would like to express our deep-felt gratitude to our advisor, Mr..
, of the Ravenshaw University, BBA Department, for his advice, encouragement,
enduring patience and constant support. Additionally, I want to express my warmest
thanks to those who encouraged me during the perepartion of this project report which is
actually way above our capabilities.

The main objectives of doing this project on global financial crisis during this time of
economic slowdown are as follows:
• To study about sub-prime crisis.
• To study the main reasons of this crisis.
• To study why did it turn into global economic crisis.
• To study the impacts of crisis on U.S. economy.
• To study the impacts of crisis on Indian markets.
• To study the measures taken by U.S government as well as Indian Government.
• To study the reactions of various sectors against the measures taken by the

The goal of this thesis is to provide a better understanding of the subprime crisis. This
will be achieved from a fixed income point of view, as this is the department from which
the crisis originates. There are no particularly revolutionary findings within the following
lines, but there is a true explanation and linkage making between the various factors,
causes and consequences.

In this chapter, the economic context in which this thesis is written will be described.
This is an important aspect in order to understand the rest. Then the fixed income
department will be described, as well as its tools. This may also inspire other students to
join such a team, or perhaps it will have the complete adverse effect!

In chapter 2, a deep economic and financial explanation of the subprime crisis will be
provided. First, the necessary definitions will be provided in order to ensure a smooth
reading. Second, the true explanation will unravel, as long as the key players in this
crisis. Third will come its consequences and then finally we shall suggest some
solutions/improvement/steps in order for this not to happen again (the true question being
whether it can it ever be prevented!)

The third chapter will be dedicated to the yield curve and its applications. Definitions,
examples, theory and history will be provided before moving on to its predicting power.
This chapter is closely linked to the next one, where the same steps will be taken
regarding what is called the TED-spread, which can be viewed as a measure of the
amplitude of a crisis. These two chapters together constitute the bulk of this thesis, and
will allow us to realize the depth and importance of this crisis, and that it may have been

The conclusion will summarize the various aspects developed in this thesis, but more
importantly it shall suggest future work that could be done which could lead to very
interesting results that would not only be applicable to this crisis, but to the coming one

2.The subprime crisis

a) Definitions

The term “subprime” refers to mortgagees who are unable to qualify for prime mortgage
rates. Reasons for this include poor credit rating, which includes payment delinquencies,
charge offs, bankruptcies, low credit scores, large exiting liabilities and high loan value
ratios. In other words, subprime mortgages simply mean lending to house borrowers with
weak credit. Lenders did so by providing teasers like minimal or zero down payment, and
low introductory adjustable rate mortgages, as well as lax documentation and credit
checks. Total subprime loans form 25% of the housing mortgage market. These subprime
loans were fine as long as the housing market continued to boom and interest rates did
not rise. When these conditions disappeared, the first to default were subprime borrowers.
These defaults caused an implosion of the mortgage-backed securities (MBS) and the
collateralized debt obligations (CDOs) industry. The blow out surfaced in June 2007 with
the collapse of two subprime mortgage hedge funds managed by Bear Stearns, quickly
followed by the suspension of three other funds managed by BNP Paribas. Interestingly,
there were some forerunners to this spectacular blow out, and these could be observed
already as of march 2007. However, as in any given environment of economic growth
and prosperity, these were ignored.

Mortgage-Backed Securities (MBS) are the securitization of housing mortgages. They

have enabled banks and mortgage companies to increase the velocity and turnover of
loans as banks and mortgage companies securitized and sold off these loans. This is
known as the “origination-distribution” model. The volume of MBS originated and traded
reached $3 trillion in 2005 in a U.S. housing mortgage industry of $10 trillion.
Securitization enabled banks and mortgage companies, the originators of these loans, to
take on more loans as they moved the securitized loans off their books.

In the early nineties, financial innovation took these MBS to a higher level in terms of
complication and leverage with the introduction of collateralized debt obligations
(CDOs). CDOs are simply the bundling of a class of asset-backed securities into a special
purpose vehicle and then rearranging these assets into different tranches with different
credit ratings, interest rate payments, and priority of repayment. For example, a CDO
could consist of 100 subprime MBS. Using historical rates of default and recovery, it can
be assumed that in an extreme case of default, the loss ratio is no more than 10% . These
subprime MBS are then divided into AAA tranche (70%), mezzanine tranche (20%), and
subordinated tranche (10%). An investor, depending on risk propensity, can choose
which tranche to invest in. The AAA tranche pays lowest interest rate, but provides
highest priority in terms of debt repayment. To further complicate matters, these CDOs
were used as underlying assets and repackaged to the next level of CDOs. This is referred
to as CDO squared and after another round, it becomes CDO cubed. Layered on top of
these are CDOs of credit default swaps (CDS) that multiplied the risks further. However,
these were marketed as spreading the risks! They were seen as a revolutionary tool to
combine all different asset classes covering a wide range of investment possibilities into
one product, thus theoretically spreading the risks as much as possible. This was ignoring
the underlying assumptions. The defaults are confined not only to the underlying
securities, but also the contracts written (CDS) on the traded securities. The higher the
level of CDO, the more removed it is from the actual underlying security, complicating
the pricing of these CDOs. The volume of CDOs issued tripled between 2004 and 2006
from $125 billion to $350 billion per year (Bloomberg). These CDOs were distributed far
and wide. It was not only banks throughout the world that bought these CDOs, but also
establishments such as town councils in far flung places like Australia that were chasing
for higher yields. Bank of China alone is exposed to $9 billion of ubprime CDOs. In this
day, it is considered trivial that the CDOs were a complete disaster, but it should be
pointed out that not more than a year ago, this was totally ignored .

Fig01: Graph of houses purchased with prime and sub-prime mortgages

A special, or structured, investment vehicle (SIV) is a limited purpose, bankrupt remote,

company that purchases mainly highly rated medium and long term assets. The SIV funds
these purchases with short-term asset backed commercial paper (ABCP), and medium
term notes (MTNs) and capital. Capital is usually in the form of subordinated debt,
sometimes tranched and often rated. Some SIVs are sponsored by financial institutions
that have an incentive to create off balance sheet structures that facilitate the transfer of
assets off their balance sheet and generate products that can be sold to investors. The aim
is to generate a 9 spread between the yield on the asset portfolio and the cost of funding
by managing the credit, market and liquidity risks. General descriptions of the
methodologies employed for SIVs by the agencies are publicly available on their web
sites. The basic approach is to determine whether the senior debt of the vehicle will retain
the highest level of credit worthiness, (for example, AAA/A- rating) until the vehicle is
wind-down for any reason. The level of capital is set to achieve this AAA type of rating,

with capital being used to make up possible short falls. The vehicle is designed with the
intent to repay senior liabilities, or at least with an AAA level of certainty, before the
vehicle ceases to exist. If a trigger event occurs and the SIV is wind-down by its manger
(defeasance) or the trustee (enforcement), the portfolio is gradually liquidated. Wind-
down occurs if the resources are becoming insufficient to repay senior debt. No debt will
be further rolled over or issued and the cash generated by the sale of assets is used to
payoff senior liabilities.
Monoline insurers provide insurance to investors that they will receive payment when
investing in different types of assets. Given the low risk of the bonds and the perceived
low risk of the structured transactions insured by monolines, they have a very high
leverage, with outstanding guarantees amounting to close to 150 times capital. Monolines
carry enough capital to earn a triple-A rating and this prevents them from posting
collateral. The two largest monolines, MBIA and AMBAC, both started out in the 1970s
as insurers of municipal bonds and debt issued by hospitals and nonprofits groups. The
size of the market is approximately US$2.6 trillion, with more than half of municipal
bonds being insured by monolines (Bloomberg). This insurance wrap guarantees a
triple-A rating to the bonds issued by U.S. municipalities. In recent years, much of their
growth has come in structured products such as asset backed bonds and CDOs. The total
outstanding amount of bonds and structured financing insured by monolines is around
US$2.5 trillion (Bloomberg). According to S&P, monolines insured US$127 billion of
CDOs that relied, at least partly, on repayments on subprime home loans and face
potential losses of US$19 billion .

Since the end of 2007 monolines have been struggling to keep their triple-A rating. Only
the two major ones, MBIA and AMBAC, and a few others less exposed to subprime
mortgages such as Financial Security Assurance (FSA) and Assured Guaranty, have been
able to inject enough new capital to keep their sterling credit rating.

b) U.S Subprime Crisis :

What is a sub-prime loan?

In the US, borrowers are rated either as 'prime' - indicating that they have a good credit
rating based on their track record - or as 'sub-prime', meaning their track record in
repaying loans has been below par. Loans given to sub-prime borrowers, something
banks would normally be reluctant to do, are categorised as sub-prime loans. Typically, it
is the poor and the young who form the bulk of sub-prime borrowers.

1. Concept :-

The prime guidelines of US regulation to give a simple loan with rules of minimum,
interest rate charged by US central bank with a mortgage of security. And the loan given
by violation of these prime guidelines is known as sub prime loans.

1993, The era when US economy is going with a very good time,development rate was
very high, interest rates are going down,no inflation,huge liquidity in stock markets.

And in this era, with a objective of giving a house to every poor and young people at
US..The US Clinton govt. eased these prime guidelines by giving loan on very small or
even on no security and the interest rates made higher by 2% for these loans, because of
increased risk.

The banks started granting these loans. till now everything is going in a simple way but
Freddie Mac and Fannie Mae the 2 govt subsidary companies made whole situation
complicated, who functions as an intermediary in the U.S by purchasing and securitizing
mortgages, Fannie Mae facilitates liquidity in the primary mortgage market by ensuring
that funds are consistently available to the institutions that do lend money to home

Now the intial topic CDS (credit debt secutirties )comes into picture.what is credit
default swaps?

CDS is essentially a form of insurance in which the buyer of the swap makes a series of
payments to seller of the swap and in return has the right to payoff if the financial
security he has invested in defaults.usually not all default occur at one time but this time
it does happened,let us see how ?

Fannie Mae buys loans from mortgage originators, repackages the loans as mortgage-
backed securities and this mortgage backed securities (MBS) is a type CDS.

Fannie mae sells these MBS to investors in the secondary mortgage market in whole
global market with a guarantee that principal and interest payments will be passed

through to the investor in a timely manner. Also, Fannie Mae may hold the purchased
mortgages for its own portfolio.By purchasing the mortgages, Fannie Mae and Freddie
Mac provide banks and other financial institutions with fresh money to make new loans.

This all started a race between banks to make subprime loans and generting more
revenues and become market leader and the greedy loan agent helped out them too.

There was huge increase in subprime loans and The overall U.S. home ownership rate
increased from 64% in 1994 (about where it was since 1980) to a peak in 2004 with an
all-time high of 69.2%.Subprime borrowing was a major contributor to an increase in
home ownership rates and the demand for housing. This demand helped fuel housing
price increases and consumer spending.

American home prices increased by 124%.

Many financial institutions borrowed enormous sums of money during 2004–2007 and
made investments in mortgage-backed securities. The top five US investment banks each
significantly increased their financial leverage during the 2004–2007 time period, which
increased their vulnerability to the MBS losses.

Immediate impacts

1. Jan 2007, inflationary pressure started coming on america's economy, govt. started
increasing lending rates and there is too much supply of homes upto that time.

Sub prime Credit holder started doing defaults and at time came when huge subprime
credit holder made default at a time and that was a real mess up situation for us economy.

All the MBS or CDS are become worthless because the people whose loans are made as
gurantee for them are no more.

Almost all the public companies have MBS and CDS are in their portfolio in huge
amount. The financial sector began to feel the consequences of this crisis, in February
2007 with the $10.5 billion writedown of HSBC which was the first major CDO or MBO
related loss to be reported

2. August 15, 2007, Biggest result of these crises came when the Dow dropped below
13,000.FII become impatient and started putting out their money from all over the world
stock market.and all stock market gone down.

3. Sept 2007, The biggest 5 investment banks reported over $4.1 trillion in debt for fiscal
year 2007, a figure roughly 30% the size of the U.S. economy. Three of the five either
went bankrupt like Lehman Brothers or were sold at fire-sale prices to other banks like
Bear Stearns and Merrill Lynch during September 2008, creating instability in the global
financial system. The remaining two converted to commercial bank models, subjecting
themselves to much tighter regulation like J.P.Morgan.

Main culprit :-At the end of day I hope u all people are supposing CDS as the main
culprit to make a big messing US subprime financial crises but the story was not like that.

That was not CDS instrument that made all went wrong, but the wrong implementation of
the security instrument,the preception of equating the sphosticated compliacted CDS with
the simple life insurance of many finance company like AIG, Fannie Mae and Freddie
Mac which resulted all of them into big bail out packages and US govt. subsidisation
themselves and fall of whole world economy.

Impact on world:-

1. Apart from the fact that banks based in other parts of the world also suffered losses
from the subprime market, there are two major ways in which the effect is felt across the

• First, the US is the biggest borrower in the world since most countries hold their
foreign exchange reserves in dollars and invest them in US securities. Thus, any
crisis in the US has a direct bearing on other countries, particularly those with
large reserves like Japan, China and to a lesser extent India.
• Also, since global equity markets are closely interlinked through institutional
investors, any crisis affecting these investors sees a contagion effect through the

Some of the instances which shows world is affected by subprime crises:-

• The oil prices which were gone upto 150 US$ per barrel is now came to less than
60 US $.
• Northern Rock, which was an eminent mortgage lender took refuge in the Bank of
England for purposes of emergency financing in the month of September, 2007.
Prospective purchasers for the mortgage lender are still being looked for.
• Another instance in Germany, which implies the impact of US subprime crisis on
Europe is when Germany 's IKB Deutsche Industrial bank accepted USD$11.1
billion from the Government as a bailout pertaining to its various United States
mortgage investments.
• BNP Paribas, the French Bank was compelled to take some drastic steps. It
stopped all withdrawals from a fund of USD$2.2 billion pertaining to investment
funds as the true value of the investment portfolios could not be ascertained.

c) IMF (International monetary Fund)

The International monetary Fund works as :-

I. Increasing international monetary cooperation.

II. Promoting the growth of trade.
III. Promoting exchange rate stability.

IV. Establishing a system of multilateral payments, eliminating exchange restrictions
which hamper the growth of world trade, and encouraging progress towards convertibility
of member currencies.
V.Building a reserve base.

In the current prices, IMF has issued bail out packages of many countries slashing
economy like Iceland US$ 6 billion, Pakistan 9.6 billion.

The Job Scenario :-

1. The job scenario changed drastically in last one year and all because of above financial
muddle. Banking sector already gone with this mess, because the crisis starts only
because,with,from the banks,all the big banks of world are facing problem.

2. All the export oriented industries jewellery,textile,handicrafts and many more,all

suffering from liquidity crunch around the world.Low demand, low sales, low revenue,
low profits simply means to stand by in present scenario cost cutting is only way and this
cost cutting converts into no new recruitment at all,even in some sectors out way to the
non performer employees.

India : The liquidity crunch :-

1 . Increase in banking rates :- To control the inflation RBI made a cut in all its key
lending and policy rates like CRR,SLR,Repo,Reverse Repo etc. which strengthen the
liquidity crunch.

2. FII money pull out :-As I already explained how FII pulled out their money from
India and other part of world stock market.But in this money pulling the real looser is not
the FII but the small investor because FII pulled out their huge money in bull rally,and
leave the small investor in the bear market with huge stock market fall.

3. Backing of FDI :- USA has 17.08% share in FDI inflows to India, The US investor
community was sharing confidence in the future of the Indian economy. Several areas
like infrastructure, IT, Telecom sector, energy and other knowledge industries such as
pharmaceuticals and biotechnology, possess immense potential for progressing economic
cooperation between India and the US.

On investment front, USA covers almost every sector in India, which is open for private
participants. Both government-to-government level and business-to-business level
conduct regular interactions with each other to promote and strengthen the trade and
economic interactions between the two countries.

FDI in banking is permitted up to 49%. US Success stories in this sector include Citicorp,
GE Capital, and American Express. The insurance sector in India is opened up for up to
26% FDI. However, there are proposals to hike this limit to 49%. US companies that
have successfully entered this field in India include New York Life, AIG etc.

A very important aspect of US India economic relations comes with the emergence of
Business Process Outsourcing, where in many US companies are reaping the advantages
offered by India's IT sector. India offers a large pool of trained, English speaking
personnel, which offers huge cost benefits to the US MNCs.

4. Export decrease :- India's sizable population and growing middle and higher income
class makes India a potentially large market for U.S. goods and services. According to
the figure from government sources, U.S. exports to and imports from India in 2003,
totalled US $5.0 billion and US $13.1 billion, respectively.

India's main exports to US are precious stones, metals (worked diamonds & gold
jewellery), Woven apparel, Knit apparel, miscellaneous textile article, Fish and seafood
(frozen shrimp), Textile floor coverings, Iron/steel products, Organic chemicals and
Machinery (taps, valves, transmission shafts, gears, pistons, etc).

Among the major multi national corporations of USA that are doing a profitable business
in India are- General Electric, Whirlpool Ford (India), 3M, Tecumseh Products (India)
Limited, Pepsi, Proctor and Gamble (India), Microsoft, Intel, IBM Corporation, EDS,
Sun Microsystems, Adobe Systems Inc, Agilent Technologies Inc, Oracle Corporation,
Texas Instruments.

5. Panicing environment :-

This is not that much fundamentals of liquidity crunch effect the market but the
influencing panic environment all over the country. The investor don't want to invest his
money into any asset class because he don't perceive his money safe in any asset class by
investing it to any asset class rather he belives best to keep his money safe in his bank

d) Economic context

The credit crisis of 2007 started in the subprime mortgage market in the U.S. It has
affected investors in North America, Europe, Australia and Asia and it is feared that
write-offs of losses on securities linked to U.S. subprime mortgages and, by contagion,
other segments of the credit markets, could reach a trillion US dollars [23]. It has brought
the asset backed commercial paper market to a halt, hedge funds have halted
redemptions, or have failed, and special investment vehicles have been wound-down.
Banks have suffered liquidity problems, with losses since the start of 2007 at leading
banks and brokerage houses topping US$250 billion, as of April 2008 (Bloomberg).
Financial institutions are expected to write off an additional US$80 billion in the first
quarter of 2008 . Credit related problems have forced some banks in Germany to fail or to
be taken over and Britain had its first bank run in 140 years, resulting in the nationalizing
of the troubled mortgage lender. The U.S. Treasury and Federal Reserve helped to broker

the rescue of Bear Stearns, the fifth Wall Street investment bank, by JP Morgan Chase
during the week-end of March 17, 2008. Banks, concerned about
the magnitude of future write downs and counterparty risk, have been trying to keep as
much cash as possible as a cushion against potential losses. They have been wary of
lending to one another and consequently, have been charging each other much higher
interest rates than normal in the inter bank loan markets.

The severity of the crisis on bank capital has been such that U.S. banks have had to cut
dividends and call global investors, such as sovereign funds, for capital infusions of more
than US$230 billion, as of May 2008, based on data compiled by Bloomberg. The credit
crisis has caused the risk premium for some financial institutions to increase eightfold
since last summer and is higher than the cost of raising cash for non-financial firms with
the same credit rating. The effects of the crisis have affected the general economy. For
example, credit conditions have tightened for all types of loans since the subprime crisis
started nearly a year ago.

The biggest danger to the economy is that, to preserve their regulatory capital ratios,
banks will cut off the flow of credit, causing a decline in lending to companies and
consumers. According to some economists, tighter credit conditions could directly
subtract 1.25 percentage point from first quarter growth in the U.S. and 2.5 points from
the secondquarter growth [4]. The Fed lowered its benchmark interest rate 3.25
percentage points to 2 4 percent between August 2007 and June 2008 in order to address
the risk of a deep recession (Bloomberg). This alone represents one of the largest cuts in
interest rates in U.S. history. The Fed has also been offering ready sources of liquidity for
financial institutions, including investment banks and primary dealers, that are finding it
progressively harder to obtain funding, and has taken on mortgage debt as collateral for
cash loans.
The deepening crisis in the subprime mortgage market has affected investor confidence in
multiple segments of the credit market, with problems for commercial mortgages
unrelated to subprime, corporate credit markets, leverage buy-out loans (LBOs), auction-
rate securities, and parts of consumer credit, such as credit cards and car loans. In January
2008, the cost of insuring against default by European speculative bonds had risen by
almost one-and-a-half percentage point over the previous month, from 340 basis points
(bps; 100bps = 1%) to 490 bps, while the U.S. high-yield bond spread has reached 700
bps over Treasuries, from 600 bps at the start of the year.

e) Credit Default Swaps

The monster that ate US economy.

1994, Somewhere in Florida -The sea beach with sexy gals, lavishing food, hard core
drinks and music, the bankers of J.P. Morgan met for an offsite weekend.

The guys were there to have a brain storming session about the money which US
regulation make them to keep aside in case of their investment get bust. This money
hardly earned any return. This brainstorming on ways to obviate the risk of default in
financial securities and free up the reserve money for investment. All that brain storming
led to the birth of a new concept-CDS. (Credit Default Swaps).

The modern financial system rests on 3 pillars:

1. Capital
2. Liquidity
3. Confidence

Currently, All of them under attack.

Capital :- Unprecedented losses have depleted financial institution's capital faster than
their ability to raise new capital.

Liquidity:-Illiquid capital markets have made it hard for them to finanace their own debt.

Confidence :-Falling confidence has damaged inter-bank lending and made depositors

The total estimated fianacial damage till now is 1.5 trillion US $.

f) Fixed income toolbox

Fixed income refers to any type of investment that yields a regular return. The most basic
tool in fixed income is the bond, or corporate bank debt. At UBS Investment bank,
preferred stock is also considered to be fixed income. Such securities can be contrasted
with variable return securities, such as stocks. People who invest in fixed income
securities are typically looking for constant and secure return on their investment.

Interest rates change over time, base on a variety of factors, particularly the rates set by
the Federal Reserve (regarding U.S. bonds). When a company is issuing a bond, it will
have to pay the investor a premium in order for them to buy their bonds in order to attract
them to their security. Otherwise investors would buy government bonds which are
considered to be 100% secure. To complicate matters a bit, fixed income securities are
traded on the open market, just like stocks.

Based on the above, it is obvious the most important aspects within fixed income are the
interest rates. The interest rate will directly affect the yield of a bond. The term yield
refers to the percentage that measures the cash returns to the owners of a security. The
yield of a bond is inversely related to its price today: if the price of a bond falls, its yield
goes up, and viceversa.

From this, we derive the yield curve, which is the relation between the interest rate and
the time to maturity of the debt for a given borrower in a given currency. This tool will be
one of the foci of this thesis, along with the TED-spread. The TED-spread is also a fixed
income tool that is directly linked to interest rates on bonds. It is the difference between
the yield of interbank loans (rates at which the banks loan to each other) and government
loans (which are directly derived from the rates set by the Fed).


The chain reaction from the described problem can be summarized as in the figure below:

At the end of spring 2007, Ben Bernanke, Chairman of the Federal Reserve, stated, “We
do not expect significant spillovers from the subprime market to the rest of the economy
or the financial system”. At the start of August, the European Central Bank injected 95
billion euros (US$131 billion) and informed banks that they could borrow as much
money as they wanted at the bank’s current 4% base rate without limit. The Bank of
Canada issued a statement that it pledges to “provide liquidity to support the Canadian
financial system and the continued functioning of financial markets” .

In the second week of August, the Fed reported that the total commercial paper (CP)
outstanding fell more than US$90 billion to US$2.13 trillion over the last week.
Traditionally, 18 prime corporate names used the CP market to finance short term cash
needs. However, the low levels of interest rates during the past few years has meant that
many of these issuers moved away from the CP market and issued low cost debt with
maturities ranging from 5 to 10 years. The current lack of demand for CP made it very
difficult for borrowers to rollover debt. William Poole, President of the St. Louis Federal
Reserve publicly argued against a rate cut (August 16). The Fed took the unusual step of
issuing a public statement that Mr. Poole’s comments did not reflect Fed policy.

During the same week, a flight to quality occurred, with investors buying Treasuries. The
yield on the three month T-bill fell from approximately 4% to as low as 3.4%. The FTSE
100 index declined by 4.1%, with financial companies being the hardest hit. Man Group
fell 8.3% and Standard Chartered fell 7.6%. The Unwinding of carry trades caused a
sudden 2% increase in the yen/dollar exchange rate. Further unwinding occurred two
days later, with hedge funds and institutional investors unwinding carry trades, causing
the yen to increase 4% against the dollar, 5.3% against the Euro, 5.8% against the pound,
10.3% against the New Zealand dollar and 11.5% against the Australian dollar.

Also during this period, the Fed injected US$5 billion into the money market through 14
day repurchase agreements and another US$12 billion through one day repurchase
agreements. The Russian Central Bank injected Rbs 43.1 billion (US$1.7 billion) into the
banking system. Foreign investors had started to flee the ruble debt market, causing a
liquidity squeeze. The European Central Bank has pumped money into Europe’s
overnight money markets. Fed has done similar in the US.

Four banks, Citigroup, JP Morgan, Bank of America and Wachovia, each borrowed
US$500 million from the Fed [4]. In a statement, JP Morgan, Bank of America and
Wachovia, stated that they have substantial liquidity and have the capacity to borrow

money elsewhere on more favourable terms. They were trying to encourage other banks
to take advantage of the lower discount rate at the Fed window.

During the third week of August, the flight to quality continued. At the start of trading in
New York, the yield on the 3 month T-bill was 3.90%, during the day, it fell to 2.51%,
and by the end of day, it closed at 3.04%. However, other parts of fixed incomes markets
continued to function, with investment grade companies issuing debt: Comcast Corp sold
US$3 billion 19 in notes; Bank of America sold US$1.5 billion in notes and Citigroup
US$1 billion in notes. There was a rare high yield issuing by SABIC Innovative Plastics.
It sold US$1.5 billion in senior unsecured notes.
The volatility in the foreign exchange market caused some hedge funds to close their yen
carry trade positions. Between August 16th and 22nd, investors poured US$42 billion
into money market funds. Institutional investors switch from commercial paper to

More recently, in April 2008, the Fed took the unprecedented measure of introducing a
new lending facility, called the Primary Dealer Credit Facility (PDCF), for investment
banks and securities dealers that give them the possibility to borrow against a wide range
of securities as collateral for cash loans. Among other things the securities pledged by
dealers must have market prices and “investment grade” credit ratings .

Today, the losses incurred by this crisis are enormous. The table below summarizes the
top 15 announced losses per bank, as of July 2008, the key word being announced.
Indeed, the more worrying aspect, are the reports that state that today’s announced losses
may represent only one third of the actually losses that have been or will be incurred by
this crisis [8]. The consequences have not fully revealed themselves, yet, and inflation as
well as economic downturn in the industrial sector are only starting to point their noses .

Since the beginning of this year, economists and government officials have had great
concerns over a recession taking place in the U.S. Although not official yet, it is
becoming increasingly obvious that the American economy has slipped into recession.
The labour market figures point to a shrinking economy: As of June 2008, there has been
a jump in the unemployment rate to 5.5% from 4.6% a year earlier and non-farm payrolls
have declined 6 months in a row, losing 438’000 jobs since January 2008. Ben Bernanke,
chairman of the Federal Reserve, On April 2nd told a congressional committee that
output was unlikely to “grow much, if at all, over the first half of 2008 and could even
contract slightly”.

The hangover's duration will depend on many things, from the strength of foreign
economies to the degree to which American firms cut jobs and investment. But top of the
list, given the recession's origins in the property bust and the credit crunch, are the fate of

the housing market and the resilience of consumer spending. On both counts, the odds are
against catastrophe but on a lasting headache.

No one knows by how much, or for how long, America's economy will be weighed
down. The IMF's gloom is based in part on its reading of history . An analysis by the
fund of post-war housing busts in rich countries, written in 2003, suggests that crashes
typically last about four years and are often accompanied by banking crises. Economies
end up 8% smaller on average than they would have been had they carried on growing at
pre-crunch rates . Perhaps this time will be different, and the hangover will soon be gone.
But given the scale of America's housing binge and of the financial crisis the bust has
spawned, it seems unlikely.

Between June 2007 and November 2008, Americans lost more than a quarter of their net
worth. By early November 2008, a broad U.S. stock index, the S&P 500, was down 45
percent from its 2007 high. Housing prices had dropped 20% from their 2006 peak, with
futures markets signaling a 30-35% potential drop. Total home equity in the United
States, which was valued at $13 trillion at its peak in 2006, had dropped to $8.8 trillion
by mid-2008 and was still falling in late 2008. Total retirement assets, Americans'
second-largest household asset, dropped by 22 percent, from $10.3 trillion in 2006 to $8
trillion in mid-2008. During the same period, savings and investment assets (apart from
retirement savings) lost $1.2 trillion and pension assets lost $1.3 trillion. Taken together,
these losses total a staggering $8.3 trillion.

a) Financial market impacts, 2007:

FDIC Graph - U.S. Bank & Thrift Profitability By Quarter

The crisis began to affect the financial sector in February 2007, when HSBC, the world's
largest (2008) bank, wrote down its holdings of subprime-related MBS by $10.5 billion,
the first major subprime related loss to be reported. During 2007, at least
100 mortgage companies either shut down, suspended operations or were sold. Top
management has not escaped unscathed, as the CEOs of Merrill
Lynchand Citigroup resigned within a week of each other in late 2007. As the crisis
deepened, more and more financial firms either merged, or announced that they were
negotiating seeking merger partners.

During 2007, the crisis caused panic in financial markets and encouraged investors to
take their money out of risky mortgage bonds and shaky equities and put it
into commodities as "stores of value". Financial speculation in commodity futures
following the collapse of the financial derivatives markets has contributed to the world
food price crisis and oil price increases due to a "commodities super-cycle." Financial
speculators seeking quick returns have removed trillions of dollars from equities and
mortgage bonds, some of which has been invested into food and raw materials.

Mortgage defaults and provisions for future defaults caused profits at the 8533
USA depository institutions insured by the FDIC to decline from $35.2 billion in 2006
Q4 billion to $646 million in the same quarter a year later, a decline of 98%. 2007 Q4
saw the worst bank and thrift quarterly performance since 1990. In all of 2007, insured
depository institutions earned approximately $100 billion, down 31% from a record profit
of $145 billion in 2006. Profits declined from $35.6 billion in 2007 Q1 to $19.3 billion in
2008 Q1, a decline of 46% .

b) Financial market impacts, 2008:

As of August 2008, financial firms around the globe have written down their holdings of
subprime related securities by US$501 billion. The IMF estimates that financial
institutions around the globe will eventually have to write off $1.5 trillion of their
holdings of subprime MBSs. About $750 billion in such losses had been recognized as of
November 2008. These losses have wiped out much of the capital of the world banking
system. Banks headquartered in nations that have signed the Basel Accords must have so
many cents of capital for every dollar of credit extended to consumers and businesses.
Thus the massive reduction in bank capital just described has reduced the credit available
to businesses and households .

When Lehman Brothers and other important financial institutions failed in September
2008, the crisis hit a key point. During a two day period in September 2008, $150 billion
were withdrawn from USA money market funds. The average two day outflow had been
$5 billion. In effect, the money market was subject to a bank run. The money market had
been a key source of credit for banks (CDs) and nonfinancial firms (commercial paper).
The TED spread(see graph above), a measure of the risk of interbank lending, quadrupled
shortly after the Lehman failure. This credit freeze brought the global financial system to
the brink of collapse. The response of the USA Federal Reserve, the European Central
Bank, and other central banks was immediate and dramatic. During the last quarter of
2008, these central banks purchased US$2.5 trillion of government debt and troubled
private assets from banks. This was the largest liquidity injection into the credit market,
and the largest monetary policy action, in world history. The governments of European
nations and the USA also raised the capital of their national banking systems by $1.5
trillion, by purchasing newly issued preferred stock in their major banks.

Globalisation has ensured that the Indian economy and financial markets cannot stay
insulated from the present financial crisis in the developed economies.

The debate, therefore, can only be on the extent of impact and how resilient India is to
withstand the storm with minimal damage! In the light of the fact that the Indian
economy is linked to global markets through a full float in current account (trade and
services) and partial float in capital account (debt and equity), we need to analyse the
impact based on three critical factors: Availability of global liquidity; demand for India
investment and cost thereof and decreased consumer demand affecting Indian exports.

The concerted intervention by central banks of developed countries in injecting liquidity

is expected to reduce the unwinding of India investments held by foreign entities, but
fresh investment flows into India are in doubt.

The impact of this will be three-fold: The element of GDP growth driven by off-shore
flows (along with skills and technology) will be diluted; correction in the asset prices
which were hitherto pushed by foreign investors and demand for domestic liquidity
putting pressure on interest rates.

While the global financial system takes time to “nurse its wounds” leading to low
demand for investments in emerging markets, the impact will be on the cost and related
risk premium. The impact will be felt both in the trade and capital account.

Indian companies which had access to cheap foreign currency funds for financing their
import and export will be the worst hit. Also, foreign funds (through debt and equity) will
be available at huge premium and would be limited to blue-chip companies.

The impact of which, again, will be three-fold: Reduced capacity expansion leading to

supply side pressure; increased interest expenses to affect corporate profitability and
increased demand for domestic liquidity putting pressure on the interest rates.

Consumer demand in developed economies is certain to be hurt by the present crisis,

leading to lower demand for Indian goods and services, thus affecting the Indian exports.

The impact of which, once again, will be three-fold: Export-oriented units will be the
worst hit impacting employment; reduced exports will further widen the trade gap to put
pressure on rupee exchange rate and intervention leading to sucking out liquidity and
pressure on interest rates.

The impact on the financial markets will be the following: Equity market will continue to
remain in bearish mood with reduced off-shore flows, limited domestic appetite due to
liquidity pressure and pressure on corporate earnings; while the inflation would stay
under control, increased demand for domestic liquidity will push interest rates higher and
we are likely to witness gradual rupee depreciation and depleted currency reserves.
Overall, while RBI would inject liquidity through CRR/SLR cuts, maintaining growth
beyond 7% will be a struggle.

The banking sector will have the least impact as high interest rates, increased demand for
rupee loans and reduced statutory reserves will lead to improved NIM while, on the other
hand, other income from cross-border business flows and distribution of investment
products will take a hit.

Banks with capabilities to generate low cost CASA and zero cost float funds will gain the
most as revenues from financial intermediation will drive the banks’ profitability.

Given the dependence on foreign funds and off-shore consumer demand for the India
growth story, India cannot wish away from the negative impact of the present global

financial crisis but should quickly focus on alternative remedial measures to limit damage
and look in-wards to sustain growth!


The crisis in the US financial market will hit the Indian real estate sector hard. The sector
was already reeling under tremendous pressure as RBI increased the interest rates to
contain inflation, besides restricting the fund flow in it. Consultants said that in the
present circumstances the real estate prices will go for a sharp correction in the short to
medium term.

The financial crisis in the global market will affect the availability of fund for the
domestic realty sector. As RBI has already put restriction on Indian banks to finance real
estate companies in the country, they are depended on foreign funds through FDI route
for their fund requirements. But, a senior consultant said following the development in
US, many of the private equity funds are returning back to their mother countries.

The source said that many of these private equity funds were launched by investment
banks. But, now as the fate of these investment banks is uncertain, their capability to raise
funds in their country is doubtful. This will put severe constraint on availability of funds
in India.

A large player in the sector said that as the availability of funds from banking sector is
restricted for the realty sector, they are forced to borrow from the high net worth
individuals at high interest rates at around 20%.



The Indian economy, which was widely believed to be less integrated with the global
economy, felt the aftermath of the financial crisis emanating from the US rather quickly.
First the crisis appeared as a crash in the stock market following the steady withdrawal of
funds by the Foreign Institutional Investors. This in turn led to a credit crunch giving rise
to soaring interest rates especially in the money market. As External Commercial
Borrowings (ECBs) got dried up, many Indian corporate firms turned to the domestic
market for their credit needs thus compounding the problem. Sectors which were exposed
to the global market to a high degree such as civil aviation, textiles, leather, gems and
jewellery and so on were suddenly faced with a decline in demand that led to job loss
and/or adjustments in wages and salaries. Suddenly it was realized that the economy was
not going to realize its expected growth rate of 9 percent. Official circles talked about a 7
percent growth rate while independent estimates came out with predictions that were less
than this rate. It is in this background that the Government of India came out with two
stimulus packages.

These stimulus packages were intended to rebuild confidence in the economy

basically to
a)support most affected sectors,
b) improve access to credit and liquidity for enterprises and
c) to boost local demand for selected goods and services.

A Stimulus Package for US $ 4 billion was announced on 6 December 2008 and was
followed later by a second package on 2 January to prevent a further slow down of the
economy. The overall stimulus package adds up to around US$8 billion that is less than
one percent of the GDP. There is some concern that these measures would lead to an
increase in the fiscal deficit significantly (approx. 3-5%) which is a concern to many
stakeholders, given the already growing fiscal deficit of India. Even though measures like
further tax cuts is unlikely to be announced, Goernment is aware that announced
measures (providing an economic stimulus to economy) need to be extended beyond the
current financial year. Hence, Government is finalising Plan and Non-plan expenditure
that will be required for the next financial year to maintain the same momentum.
Amongst other proposals, the plan will include recapitalisation of public sector banks
with an app. amount of another 20’000 Crore for the next 2 years. This should keep the
potential for liquidity constraints in banks minimal.

The Prime Minister of India had a review meeting with captains of Industry on the
impact of the ongoing global financial crisis and constituted an apex group under his

chairmanship to monitor and coordinate the government’s response to the crisis. The
other embers of this high powered committee are the Ministers of Commerce and
Industry, Finance, Deputy Chairman, Planning Commission and the Governor of the
Reserve Bank of India, India’s central bank (The Hindu, 5 November 2008). The Prime
Minister also approved a Committee of Officers under the chairmanship of the Finance
Secretary to consider the issues raised by the Industry on daily basis.


i) Stimulus Package I

Amount : First Package US 4. billion (Rs. 20,000 crore) (the Indian News: 7 December

The first fiscal package, a modest one, was intended to keep the domestic demand high as
well as to provide incentives to some selected export sectors. This included enhanced
credit for exports, cut in excise duties, relief to the dooming housing sector and SMEs.
According to the Deputy Chairman of the Planning Commission Mr. Montek Singh
Ahluwalia, the package will, “minimize the impact of weak global economy on the
Indian economy” and help achieve a 7% growth rate.

Monetary /Fiscal

A cut in interest rates by India’s central bank: The Reserve Bank of India reduced its
repo rate, the rate at which it lends to commercial banks -to 6.5 percent, and its reverse
repo rate , the rate at which it borrows overnight to 5.0 percent. (Flash Comment, Danske
Bank: 8 December 2008) .

- Interest subvention of two percent on export credit for labour intensive sectors
- Additional allocations for export incentive schemes
- Full refund of service tax paid by exporters to foreign agents
- Incentives for loans on housing for up to Rs.500,000, and up to Rs.2 million
- Limits under the credit guarantee scheme for small enterprises doubled
- Lock-in period for loans to small firms under credit guarantee scheme reduced
- India Infrastructure Finance Co allowed to raise Rs.100 billion through tax-free bonds
- Norms for government departments to replace vehicles relaxed
- Import duty on naphtha for use by the power sector is being reduced to zero
- Export duty on iron ore fines eliminated
- Export duty on lumps for steel industry reduced to five percent

The RBI also announced that it will extend a line of credit to small scale industries and
housing finance banks:

The government announced a cut in Centrally-imposed Value Added Tax by 4% to
increase spending across-the-board .In addition:

 To boost exports, govt. announced extra allocation of 70 million dollars.

 To boost infrastructure spending, the government authorized a recently created India
Infrastructure Finance Co. Ltd to raise Rs. 10,000 crores through tax free bonds.

 The government also announced that initiatives are being taken to support Public
Private Partnership programme of Rs. 100,000 core to the highway sector.

 To boost housing sector, public sector banks were urged to announce attractive home
loan packages.

 The government decided to seek authorization for additional plan expenditure of upto
Rs. 20,000 crore in the current year mainly for critical rural infrastructure and social
security schemes such as Pradhan Mantri Gram Sadak Yojana, Jawaharlal Nehru
National Urban Renewal Mission, National Rural Employment Guarantee Scheme, India
Awas Yojana, Accelerated Irrigation Benefit Programme and National Social Assistance

In the light of the decline in exports by 12%, the government has decided to subsidize
this sector with an interest subvention of 2% upto March 2009 to pre and post shipment
export credit for labour intensive exports like textile, leather, marine products and SME
sector. Concession is subject to a minimum rate of interest.

ii) Stimulus Package II

Amount: US $ 4.1 billion

The second stimulus package liberalized overseas borrowing norms, restored benefits to
exporters, set up an alternative channel of finance for non-banking finance companies
and allowed state-run India Infrastructure Finance Company Ltd (IIFCL) to issue
additional taxfree bonds. The fiscal incentives announced so far will continue till a new
government gets the opportunity to present a full budget after General Elections during
mid 2009 (The Financial Express dt. 5 Jan 2009) .


1. Ease Access to Overseas Loans and investments

- Additional steps are being taken on the monetary, credit and fiscal front to further
strengthen the contra-cyclical stance of policy. The RBI has on 2.1.09 announced a set of
measures, as second fiscal stimulus package. In addition, with view to further liberalizing
the policy on External Commercial Borrowing (ECB) the Government and the RBI have

(a) The “all-in-cost” ceilings on such borrowing would be removed, under the
approval route of RBI: for particular industries;

(b) To facilitate access to funds for the housing sector, the ‘development of integrated
townships’ would be permitted as an eligible end-use of the ECB, under the approval
route of RBI; and

c) Non-Banking Finance Companies (NBFCs), dealing exclusively with infrastructure

financing, would be permitted to access ECB from multilateral or bilateral financial
institutions, under the approval route of RBI: (, 5 January

2. To Enhance Credit Flows

- In order to give a boost to the corporate bond market Foreign Institutional

Investments (FII) limit in rupee denominated corporate bonds in India would
be increased from US $ 6 billion to US $ 15 billion.

- A Special Process Vehicle(SPV) will be designated shortly to provide liquidity

support against investment grade paper to Non-Banking Finance Companies
(NBFCs) fulfilling certain conditions. Details will be announced separately.
The scale of liquidity potentially available through this window is Rs. 25,000
crores (6 billion USD)

- An arrangement will be worked out with leading Public Sector Banks to

provide line of credit to NBFCs specifically for purchase of commercial

- Recently, the guarantee cover under Credit Guarantee Scheme for MSME on
loans was extended from Rs. 50 lakhs to Rs. 1 with a guarantee cover of 50%.
In order to enhance flow of credit to micro enterprises, it has been decided to
increase the guarantee cover extended by Credit Guarantee Fund Trust to 85%
for credit facility up to Rs. 5 lakh.

3. For Infrastructure Capex

o States will be allowed to raise in the current financial year add. Market
borrowings of .5% of Gross State Domestic Product) amounting to about
30,000 Crore for capital expenditure.

o Authorizing India Infrastructure Finance Company Limited (IIFCL) being

enabled to access additional in trenches an additional Rs 30 000 Crore through
tax-free bonds to fund additional projects of about Rs. 75000 Crore at
competitive rates over the next 18 months.

4. For Exports

Exporters are especially hit by the recessionary conditions globally. To support exports, a
number of steps have been taken:

- Taking into account the fact that the rupee has appreciated nearly 4%
against the dollar since November 2008, it has been decided to restore
DEPB rates to those prevailing prior to November 2008. In order to
provide predictability and stability of regime in the short term for future
contracts, the DEFB scheme would be extended till 31.12.09.

- Duty drawback benefits on certain items including knitted fabrics, bicycles,

agricultural hand tools and specified categories of yarn are being enhanced
with retrospective effect from September 1 2008.

- EXIM Bank has obtained from RBI a line of credit of Rs. 5000 crore and
will provide pre-shipment and post-shipment credit in rupees of dollars to
Indian exports at competitive rates.

5. For Commercial Vehicles

States, as a one time measure up to June 30 2009, will be provided

assistance under the JNNURM to buy buses for their urban transport

Accelerated depreciation of 50% to be provided for commercial vehicles to

be bought on or after January 1 2009 and up to March 31 2009.
Arrangement to be worked out with leading government-owned banks to
provide credit to NBFCs specifically to buy commercial vehicles.

6. Other Measures

Exemption from Counter veiling duties (CVD) on particular construction

materials/cement which were given to contain inflation is being withdrawn.

Full exemption from basic customs duty for zinc and ferroalloys, which was also
provided to contain inflation, is being withdrawn.

iii) Stimulus Package III

• The employment oriented Gems and Jewellery sector in India has got a fresh
boost with the series of measures announced by Kamal Nath, Minister of
Commerce and Industry on Thursday.

The Export Promotion Council for Gems and Jewellery and Star Trading Houses
(in the Gems and Jewellery sector), besides Diamond India Limited, MSTC
Limited and STCL Limited have now been added under the list of nominated
agencies notified under para 4 A.4 of foreign trade policy for the purpose of
import of precious metals.

Surat in Gujarat, which is home to thousands of diamond units with lakhs of

diamond workers has been recognized as “Town of Export Excellence”.

The export facilitation measures as announced today also state that authorized
persons of Gems and Jewellery units in Export Oriented Units shall be allowed
personal carriage of gold in primary form up to 10 kg. in a financial year subject
to RBI and customs guidelines.

While a full year policy for 2009-10 will be unveiled in due course by the next
Government, the following measures were announced by the Government to
further simplify procedures and make life of our exporters a bit more easy:-

• Duty credit scrips under Chapter 3 and under DEPB scheme shall now be issued
without waiting for realization of export proceeds.
• Export incentives have been provided for certain items like Technical textiles,
Stapling machine, Handmade carpets and Dried vegetables. In addition, incentives
of Rs. 325 crores would be provided for leather, textiles, etc for exports w.e.f.
• STCL Limited, Diamond India Limited, MSTC Limited, Gem & Jewellery Export
Promotion Council and Star Trading Houses (only for gem and jewellery sector)
have been added under the list of nominated agencies notified under Para 4A.4 of
Foreign Trade Policy for the purpose of import of precious metals.

• Import restrictions on worked corals have been removed to address the grievance
of gem and jewellery exporters.
• Bhilwara in Rajasthan and Surat in Gujarat have been recognized as Towns of
Export Excellence, for textiles and diamonds respectively.
• At present, Govt. recognizes Premier Trading Houses based on an export turnover
of Rs.10,000 crores in the previous three years and the current year taken
together. In view of the prevailing global slowdown, the threshold limit for
recognition as Premier Trading Houses is now been reduced to Rs.7500 crores.
• Under EPCG scheme, in case of decline in exports of a product(s) by more than
5%, the export obligation for all exporters of that product(s) is to be reduced
proportionately. This provision has been extended for the year 2009-10, for
exports during 2008-09.
• At present, DEPB/Duty Credit Scrip can be used for payment of duty only on
items which are under free category. The utilization is now extended for payment
of duty for import of restricted items also.
• The procedural formalities for claiming duty drawback refund and for getting
refund of Terminal Excise Duty for deemed exports is further simplified.
• Export of blood samples is now permitted without license after obtaining ‘no
objection certificate’ from Director General of Health Services (DGHS).
• Supply of an Intermediate product by the domestic supplier directly from their
factory to the Port against Advance Intermediate Authorisation, for export by
ultimate exporter, has been allowed.
• Re-credit of 4% SAD, in case of payment of duty by incentive scheme scrips such
as VKGUY, FPS and FMS, has now been allowed.
• An independent office of DGFT at Srinagar.
• In case of Advance Authorisation for Annual Requirement where Standard Input-
Output Norms are not fixed, the provisions in Foreign Trade Policy have been
aligned with the relevant Custom Notifications.
• Value cap applicable under DEPB have been revised for two products.
• Export through Krishnapatnam seaport has been included for the purpose of
Export Promotion Scheme.
• Electronic Message Transfer facility for Advance Authorisation and EPCG
Scheme established for shipments from EDI ports w.e.f. 1.4.2009. Requirement of
hard copy of Shipping Bills dispensed with thereafter for Export Obligation
• Authorised person of Gem & Jewellery units in EOU shall be allowed personal
carriage of gold in primary form up to 10 kgs in a financial year subject to RBI
and customs guidelines.
• For Advance Licenses issued prior to 1.4.2002, the requirement of
MODVAT/CENVAT certificate dispensed with in case the Customs Notification
itself prescribed for payment of CVD. This will help in closure of a number of
pending advance licences.
• Export obligation period against advance authorizations extended up to 36 months
in view of the present global economic slowdown.

• Re-imbursement of additional duty of excise levied on fuel would also be
admissible for EOUs.

c) RBI Measures

• To improve liquidity and check depreciation of rupee, finance ministry relaxed

norms to allow companies in the mining, exploration and refineries sectors to
bring in up to $500 million in external commercial borrowing (ECB) to the
country for rupee expenditure. The earlier limit was $50 million.
• 20 Oct 2008 (RBI) slashed its key lending rate by 100 basis points to 7.5 percent.
• 1Nov, 2008, CRR cut by 350 basis points to 5.5 per cent,. This measure will
release additional liquidity into the system of the order of Rs 48,000 crore.
• Nov. 1, 2008, To reduce the repo rate or its main short-term lending rate by 50
basis points to 7.5 percent. Again both repo cut made a liquidity of 40000crore
Rs. into system.
• Increased interest rates on Non-Resident deposit schemes by 50 basis points, or
0.5 per cent
• As a temporary measure, banks permitted to avail of additional liquidity support
under the LAF to the extent of up to 1 per cent of their NDTL.
• The mechanism of Special Market Operations (SMO) for public sector oil
marketing companies instituted in June-July 2008 taking into account the
extraordinary situation then prevailing in the money and forex markets will be
instituted when oil bonds become available.
• Under the Agricultural Debt Waiver and Debt Relief Scheme Government had
agreed to provide to commercial banks, RRBs and co-operative credit institutions
a sum of Rs.25,000 crore as the first instalment. At the request of the
Government, RBI agreed to provide the sum to the lending institutions
• Interest rates on FCNR (B) Deposits and NRE(R)A deposits were increased by
100 basis points each to Libor/Euribor/Swap rates plus 25 basis points and to
Libor/Euribor/Swap rates plus 100 basis points, respectively.
• Banks allowed to borrow funds from their overseas branches and correspondent
banks up to a limit of 50 per cent of their unimpaired Tier I capital as at the close
of the previous quarter or USD 10 million, whichever is higher, as against the
existing limit of 25 per cent.
• Special 14 days repo to be conducted every day upto a cumulative amount of
Rs.20,000 crore with a view to enabling banks to meet the liquidity requirements
of Mutual Funds.
• Purely as a temporary measure, banks allowed to avail of additional liquidity
support exclusively for the purpose of meeting the liquidity requirements of
mutual funds to the extent of up to 0.5 per cent of their NDTL.
• Under the existing guidelines, banks and FIs are not permitted to grant loans
against certificates of deposits (CDs). Furthermore, they are also not permitted to
buy-back their own CDs before maturity. It was decided to relax these restrictions
for a period of 15 days effective October 14, 2008, only in respect of the CDs held
by mutual funds.

These above are some measures which RBI has taken to face the world crises on India
with a special effect of liquidity crunch and inflation at a time.

d) REACTIONS : Mixed reactions from the Industry.

A leading industry lobby said, “The second stimulus package unveiled Friday is in the
right direction but falls short of expectation that it would be around Rs. 1 trillion (US$20
bn), as against the Rs. 200 billion (US$4 billion). This would amount to app. 2
percentage as a proportion to the GDP, which is required to be a real booster.

Further, there are concerns that stimulus packages are not sufficient to boost economic
growth, as fiscal incentives and monetary policies delay the process and further, nor do
they ensure outreach within a given time due to a slow and weak delivery system or a
change in confidence in the market hence increased demand..

The urban development ministry has asked for additional changes at the last minute to the
second stimulus package to make the package beneficial for the end-user. The ministry
has demanded specific sops, like interest rates for home loans upto Rs. 5 lakh be reduced
to 6.5%, while loans between Rs. 5 lakhs (Rs. 3 million) be 7.5 percent annually – a
senior official’s quote.

Particularly representatives of Industries and Exporters and SMEs stated that both the
stimulus packages announced by the Central Government are inadequate and negligible
for the Indian Industry when compared to the relief packages offered to the textile
Manufacturers in the competing countries like China and Pakistan to manage the global

The second stimulus package evoked disappointment in the textile sector as it doesn’t
contain anything to stimulate the slugging exports in the sector. Major textile trade bodies
6 (Texprcil, CMAI, SIMA and TEA) have requested the government to have a re-look at
the various proposals they made for relief and potential bailout.

Overall: The fiscal package in India does not have an explicit employment target; it
primarily focuses on measures to augment liquidity in the system in addition to providing
some fiscal incentives especially to the export oriented sectors.


An important agenda for providing a measure of social security to the informal workers
in the Indian economy has been pending with the government for quite sometime. This
has now been set in motion, albeit in a limited form, by way of legislation. The
Unorganized Workers Social Security Bill, earlier passed by the Rajya Sabha (Upper
House) was subsequently passed by the Lok Sabha (Lower House) in December 2008
through which a statutory body will be established under the chairmanship of Ministry of
Labour and employment which will formulate welfare schemes through a consultative
process with the state governments.

Government intensified efforts for accelerated delivery and more efficient

implementation of existing schemes and programmes (housing, NREGS, RURAL
INFRASTRUCTURE, Rashtriya Swasth Bhima Yogana for BPL families. About 14
states have initiated implementation of this scheme.).

There are discussions to intensify and put into practice the existing social security
schemes (eg Rajeev Gandhi Shramik Kalyan Yojna which has been put in practice in
2007 and provides 6-months unemployment benefits and ESI for retrenched workers).


Government is strong against lay offs and job cuts of the private sector. This has very
strongly emerged by the words of the PM and the Finance Minister in two occasions (RIT
News and Asia Pulse Date Source via COMTEX)

With the exception of the PM’s announcement (3 Nov) where he urges corporates and
Industries to refrain from “knee jerk reactions” such as large-scale layoffs and
emphasized the societal obligation the corporate offices have and the potential that large
lay-offs might lead to a negative downward spiral. (Rediff News, 3rd Nov, 2008, RIT
News), and few selective incidences where the Government had to interfere (eg. Case of
Airlines in November 2008), most of the employment adjustments have been at the
enterprise level. No particular measures have been taken to safeguard worker’s rights.

Working groups have been established in Employers’ associations to seek alternatives to

layoffs by taking rational decision and by cutting prices, while dubbing the decision of
some companies to shut down their plants for a few days to combat the economic crisis as
“short-sighted.”(Asia Pulse Date Source via COMTEX).

However, there is a clear tendency in all the industries towards rationalization of

employment and stop of further expansion of employment (no new hiring).

One incidence has been particularly delicate which is mentioned below:


End of December, Ministry of Labour and Employment has constituted Industrial

Tripartite Committees (ITCs), one each for Cotton Textiles, Jute, Road transport,
Electricity Generation and Distribution, Engineering, Sugar and Plantation industry.
These are non-statutory Standing Committees constituted with the objective of providing
a forum whereby the social partners through dialogue can appreciate the problems of
industries and workers affected by economic reforms.

There have been incidences of adjustments at enterprise/industry levels, which were

based on social dialogue but no particular incidences to solve employment
retrenchment at a tripartite level till date.


Contrary to expectations, the Indian economy felt the shocks of the financial and
economic crisis in the developed countries rather quickly. This has resulted in lowering
the expectations for growth during the current financial year ending 31 March 2009 as
well as in the next year. Not surprisingly, export oriented industries and services felt the
shock suddenly and in significant measure. The government has responded with two
stimulus packages that are largely in conformity with its policies of economic reforms
and reliance on the market mechanism. Although no direct measures have been taken to
create additional domestic demand, the expectation is that employment will be protected
to some extent by these stimulus packages. Given the overwhelming presence of the
informal sector in the Indian economy, special measures are called for to protect the
informal workers.


Various actions have been taken since the crisis became apparent in August 2007. In
September 2008, major instability in world financial markets increased awareness and
attention to the crisis. Various agencies and regulators, as well as political officials, began
to take additional, more comprehensive steps to handle the crisis. To date, various
government agencies have committed or spent trillions of dollars in loans, asset
purchases, guarentees, and direct spending .

a) Federal Reserve responses to the subprime crisis:

The central bank of the USA, the Federal Reserve, in partnership with central
banks around the world, has taken several steps to address the crisis. Federal Reserve
Chairman Ben Bernanke stated in early 2008: "Broadly, the Federal Reserve's response
has followed two tracks: efforts to support market liquidity and functioning and the
pursuit of our macroeconomic objectives through monetary policy.

• Lowered the target for the Federal funds rate from 5.25% to 2%, and the discount
rate from 5.75% to 2.25%. This took place in six steps occurring between 18
September 2007 and 30 April 2008.
• Undertaken, along with other central banks, open market operations to ensure
member banks remain liquid. These are effectively short-term loans to member
banks collateralized by government securities. Central banks have also lowered
the interest rates (called thediscount rate in the USA) they charge member banks
for short-term loans .
• Used the Term Auction Facility (TAF) to provide short-term loans (liquidity) to
banks. The Fed increased the monthly amount of these auctions throughout the
crisis, raising it to $300 billion by November 2008, up from $20 billion at
inception. A total of $1.6 trillion in loans to banks were made for various types of
collateral by November 2008 .
• Finalized, in July 2008, new rules for mortgage lenders .
• In October 2008, the Fed expanded the collateral it will lend against to
include commercial paper, to help address continued liquidity concerns. By
November 2008, the Fed had purchased $271 billion of such paper, out of a
program limit of $1.4 trillion .
• In November 2008, the Fed announced the $200 billion Term Asset-Backed
Securities Loan Facility (TALF). This program supported the issuance of asset-
backed securities (ABS) collateralized by loans related to autos, credit cards,
education, and small businesses. This step was taken to offset liquidity concerns .
• In November 2008, the Fed announced a $600 billion program to purchase the
MBS of the GSE, to help lower mortgage rates .

b) Regulatory responses to the subprime crisis:
Regulators and legislators have contemplated taking action with respect to lending
practices, bankruptcy protection, tax policies, affordable housing, credit counseling,
education, and the licensing and qualifications of lenders. Regulations or guidelines can
influence the transparency and reporting required of lenders and the types of loans they
choose to issue. Congressional committees are also conducting hearings to help identify
solutions and apply pressure to the various parties involved .

• On 31 March 2008, a sweeping expansion of the Fed's regulatory powers was

proposed, that would expand its jurisdiction over nonblank financial institutions,
and its authority to intervene in market crises .
• Responding to concerns that lending was not properly regulated, the House and
Senate are both considering bills to further regulate lending practices .
• Countrywide's VIP program has led ethics experts and key senators to recommend
that members of Congress be required to disclose information about the
mortgages they take out .
• Nondepository banks (e.g., investment banks and mortgage companies) are not
subject to the same capital requirements as depository banks. Many investment
banks had limited capital to offset declines in their holdings of MBSs, or to
support their side of credit default insurance contracts .
• Nobel prize winner Joseph Stiglitz has recommended that the USA adopt
regulations restricting leverage, and preventing companies from becoming "too
big to fail.
• British Prime Minister Gordon Brown and Nobel laureate A. Michael
Spence have argued for an "early warning system" to help detect a confluence of
events leading to systemic risk. Dr. Ram Charan has also argued for risk
management early warning systems at the corporate board level .
• On 18 September 2008, UK regulators announced a temporary ban on short-
selling the stock of financial firms .
• The Australian government will invest AU$4 billion in mortgage backed
securities issued by nonbank lenders, in an attempt to maintain competition in the
mortgage market. However this is considered a drop in the ocean in regards to
total lending .
• Fed Chairman Ben Bernanke stated there is a need for "well-defined procedures
and authorities for dealing with the potential failure of a systemically important
non-bank financial institution .
• Alan Greenspan has called for banks to have a 14% capital ratio, rather than the
historical 8-10%. Major U.S. banks had capital ratios of around 12% in December
2008 after the initial round of bailout funds. The minimum capital ratio is
regulated .
• Economists Nouriel Roubini and Lasse Pederson recommended in January 2009
that capital requirements for financial institutions be proportional to the systemic
risk they pose, based on an assessment by regulators. Further, each financial
institution would pay an insurance premium to the government based on its
systemic risk

c) Economic Stimulus Act of 2008:

On 13 February 2008, President Bush signed into law an economic stimulus package
costing $168 billion, mainly taking the form of income tax rebate checks mailed directly
to taxpayers. Checks were mailed starting the week of 28 April 2008. However, this
rebate coincided with an unexpected jump in gasoline and food prices. This coincidence
led some to wonder whether the stimulus package would have the intended effect, or
whether consumers would simply spend their rebates to cover higher food and fuel prices.
Some Congressmen even contemplated a second round of tax rebates to ensure that the
American economy would indeed be stimulated. Secretary of the TreasuryHenry
Paulson strongly opposed such initiative .

d) Housing and Economic Recovery Act of 2008

The Housing and Economic Recovery Act of 2008 included six separate major acts
intended to restore confidence in the American mortgage industry . The Act:

Insures $300 billion in mortgages, that will assist an estimated 400,000 borrowers.
• Creates a new Federal regulator to ensure the safe and sound operation of the
GSEs (Fannie Mae and Freddie Mac) and Federal Home Loan Banks;
• Raises the ceiling on the dollar value of the mortgages the government sponsored
enterprises (GSEs) may purchase;
• Lends money to mortgage bankers to help them refinance the mortgages of
owner-occupants at risk of foreclosure. The lender reduces the amount of the
mortgage (typically taking a significant loss), in exchange for sharing in any
future appreciation in the selling price of the house via the Federal Housing
Administration. The refinancing must have fixed payments for a term of 30 years;
Requires that lenders disclose more information about the products they offer and the
deals they close.
• Helps local governments buy and renovate foreclosed properties.

e) Failures and government bailouts of financial firms:

Northern Rock, encountering difficulty obtaining the credit it required to remain in

business, was nationalized on 17 February 2008. As of 8 October 8 2008, United
Kingdom taxpayer liability arising from this takeover had risen to £87 billion
($150 billion).
Bear Stearns was acquired by J.P. Morgan Chase in March 2008 for $1.2 billion. The sale
was conditional on the Fed's lending Bear Sterns US$29 billion on
a nonrecourse basis .
IndyMac Bank, America's leading Alt-A originator in 2006 with approximately $32
billion in deposits was placed into conservatorship by the FDIC on July 11,
2008, citing liquidity concerns. A bridge bank, IndyMac Federal Bank, FSB,
was established under the control of the FDIC .
The GSEs Fannie Mae and Freddie Mac were both placed in conservatorship in
September 2008. The two GSE's guarantee or hold mortgage backed
securities(MBS), mortgages and other debt with a Notional value of more than
$5 trillion .
Merrill Lynch was acquired by Bank of America in September 2008 for $50 billion.
Scottish banking group HBOS agreed on 17 September 2008 to an emergency acquisition
by its UK rival Lloyds TSB, after a major decline in HBOS's share price
stemming from growing fears about its exposure to British and American MBSs.
The UK government made this takeover possible by agreeing to waive its
competition rules.
Lehman Brothers declared bankruptcy on 15 September 2008, after the Secretary of the
Treasury Henry Paulson, citing moral hazard, refused to bail it out .
AIG received an $85 billion emergency loan in September 2008 from the Federal
Reserve. which AIG is expected to repay by gradually selling off its assets. In
exchange, the Federal government acquired a 79.9% equity stake in AIG .
Washington Mutual (WaMu) was seized in September 2008 by the USA Office of Thrift
Supervision (OTS). Most of WaMu's untroubled assets were to be sold to J.P.
Morgan Chase .
British bank Bradford & Bingley was nationalised on 29 September 2008 by the UK
government. The government assumed control of the bank's £50 billion
mortgage and loan portfolio, while its deposit and branch network are to be sold
to Spain's Grupo Santander .
In October 2008, the Australian government announced that it would make AU$4 billion
available to nonbank lenders unable to issue new loans. After discussion with
the industry, this amount was increased to AU$8 billion .
In November 2008, the U.S. government announced it was purchasing $27 billion of
preferred stock in Citigroup, a USA bank with over $2 trillion in assets,
and warrants on 4.5% of its common stock. The preferred stock carries an 8%

dividend. This purchase follows an earlier purchase of $25 billion of the same
preferred stock using TARP funds .

After completing this project on how sub-prime mortgage crisis turned into global
economic crisis which caused a slowdown in business and cost cutting in all segments of
global market, we came to the conclusions that:

• The current financial crisis was caused both by "dishonesty on the part of
financial institutions, and incompetence on the part of policymakers". So yes, it
was a serious mistake to lend money to people who could not afford it, but why
did these people abruptly become unable to pay? The reason is most important
and commentators of the crisis systematically fail to discuss and analyze it.
• The current events that nobody saw coming, were already announced in as early
as 2006 by Dr. Colin Campbell, a geologist, former Vice-President of Fina Oil
Company and founder of the nowadays respected ASPO (Association for the
Study of Peak Oil) .
"Expansion becomes impossible without abundant cheap energy. So I think that
the debt of the world is going bad. That speaks of a financial crisis, unseen,
probably equaling the Great Depression of 1930; it's probable we face the Second
Great Depression. It would be a chain reaction, one bank would fail, and another
one would fail, industries will close…” .
The same was warned by few financial researches made by some institutions. The
government and few financial institutions like Lehman Brothers never took it
seriously, so according to us the government should have taken this thing
seriously at that time and should have taken some serious measures. Due to the
lack of this all these kind of trouble got bigger.