GLOBAL FINANCIAL CRISIS: ITS IMPACT ON INDIAN ECONOMY.

ABSTRACT:

India is South Asia’s largest economy. The global financial crisis has had a devastating
impact on the country, with stock prices plunging, net outflows of foreign capital, a
sharp decline in foreign reserves, and a sharp contraction in domestic liquidity. This
had led to a rapid depreciation of the currency exchange rate and an increase in short
term interest rates. The second-round effects emerged as domestic demand and export
growth slowed. Demand had been hit particularly hard in the housing, construction and
consumer durables sectors, as well as in the information technology (IT) sector. A
government study had estimated that 500,000 jobs were lost in the period from October
to December 2008.

The Indian economy seemed to be largely insulated from the financial crisis that began
in August 2007 with the US subprime mortgage crisis. In fact, the RBI continued to hike
interest rates up to August 2008, with the explicit aim of cooling the Indian economy
and reducing the GDP growth rate that had clearly moved above the potential output
growth rate and was adding to the inflationary pressures in the economy. In this paper,
we attempt to analyse the origins and causes of the global financial crises and the
impact of the crisis in the Indian economy. The paper further gives a brief on the
various areas of Indian economy that were affected because of the global economic
crisis. On the whole, an analysis has been made on the causes of the global economic
crisis and its relative impacts on Indian economy.

Keywords: financial crisis, GDP, Domestic liquidity, Easy money policies, Monetary and
fiscal measures, Balance of payments, Institutional investment

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 INTRODUCTION

The Indian economy seemed to be relatively unaffected by the global financial crisis
that began in August 2007 with the US subprime mortgage crisis. In fact, the RBI was
raising interest rates up to August 2008 with the aim of cooling down the economy and
reducing the GDP growth rate, which was clearly above the potential output growth
rate and was contributing to inflationary pressures within the economy. However, when
the collapse of the US financial collapse on 23 September 2008 led to a global economic
crisis, the effects on the Indian economy were almost instantaneous. External credit
flows dried up and overnight money market interest rates rose to over 20% and stayed
high for the next few months. It is reasonable to assume that the effects of the global
economic downturn are still being felt in the Indian economy. In this regard, this paper
attempts to analyse the origins and causes of the global financial crisis and how it
impacted the Indian economy.

What is the 2008-2009 Global Financial Crisis?

The 2008-2009 global financial crisis was a massive financial crisis that occurred
between 2008 and 2009. It affected people and businesses all over the world. Millions of
Americans were affected. Financial institutions began to fail, many were taken over by
larger companies, and the US government had to provide bailouts to keep them afloat.
This crisis, also known as "The Great Recession," did not happen overnight. There are
many factors that contributed to the financial crisis. Some of these factors are still
present today.

It all started with the housing bubble, which was caused by an excessive amount of
mortgage-backed securities (MBS) that bundled risky loans. The reckless lending
caused an unprecedented number of loans to default; all together, the losses caused
many financial institutions to collapse and require government bailouts. The US

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government responded to the economic crisis by passing the American Recovering and
Reinvestment Act of 2009.

THE CAUSES OF THE GLOBAL CRISIS

The global crisis can be attributed to a number of factors. However, most people agree
that the main causes of the crisis are as follows:

The United States and some European countries experienced a boom in home prices
from the early 1990s to the end of 2006. House prices became so high that people
believed they could only go up; they would never drop. This caused banks to lend a lot
of money for home purchases, usually to people who did not have a job or steady
income.

The housing bubble was the result of a massive binge in borrowing in the United States
(and some European countries), fuelled by the central banks' easy money policies and
massive capital inflows from capital surplus countries like China, Japan, Germany and
the oil exporter Saudi Arabia. These major exporting countries sold their goods to
American and European consumers, and then invested their surpluses in US and
European government bonds. The gross debt-to-GDP ratio in the United States more
than doubled from about 160 percent in 1982 to more than 340 percent in 2007, with
most of the increase in borrowing coming from households and financial firms such as
banks.

The rapid growth in borrowing was fuelled by rapid financial innovation that claimed
to reduce and transfer risk (of default) to borrowers, for example, sub-prime mortgage
borrowers. In reality, however, these financial innovations did spread the risks of weak
credits across the entire Western Financial System. This explosion of financial

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innovation fuelled runaway growth in the finance industry, and built a massive portfolio
of financial cards on a shaky foundation of credit risks. To put it another way, the share
of total US corporate profits of financial firms, such as brands, rose from less than 10
percent in 1980 to 40 percent in 2007.

One of the reasons why this massive proliferation of complex financial products – built
on a foundation of subprime housing – could continue for decades to come is the
increasing culture of lax financial regulation and markets that has characterized the US,
UK, and some other countries over the past two decades.

Last, but not least, the massive rise in reckless borrowing and over-leveraging was
fuelled by the same old greed that fuelled the massive asset price booms in housing,
equities and commodity prices.

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THE IMPACT OF GLOBAL FINANCIAL CRISIS ON INDIAN
ECONOMY

India, South Asia’s biggest economy, has been hit hard by the global financial crisis,
with stock prices plunging, a net capital outflow, a significant decrease in foreign
exchange reserves, and a sharp tightening in domestic liquidity. This led to a rapid
depreciation of the currency exchange rate and an increase in short term interest rates.

The second-round effects of the crisis came from a decrease in domestic demand and a
decrease in exports

The demand effects have been especially pronounced in the housing, construction and
consumer durables sectors, as well as in the information technology (IT) sector. This has
led to a decline in manufacturing production and a sharp drop-in activity in the
organized services sector (including housing, construction and IT). Exports declined for
the second consecutive month in both October and November in 2008. A government
study estimates that 500,000 jobs will be lost in the period from October to December
2008.

In the midst of this ongoing crisis, the government had been very active in managing the
situation. The government had implemented several monetary and fiscal policies to
stabilise the financial system, provide adequate liquidity, and boost domestic demand.
Interest rates had been kept at a low level and domestic liquidity had been made
available. The currency exchange rate had been kept stable and foreign exchange
outflows had been contained. Foreign exchange reserves had been maintained at about
$250 billion. The pressures on the financial sector had been reduced, though there had
been some evidence of a rise in bad loans. The financial sector had also become more
risk averse. The fall in global fuel prices and other commodity prices had supported the
current account and reduced inflation. This had opened the door for monetary easing
and provided more room for fiscal stimulus. It was expected that the fiscal and

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monetary stimulus package would help contain the contraction of demand in 2009 and
provide a good foundation for recovery in 2010, but the magnitude of the impact would
have varied greatly.

Information Technology:

The global financial system is in a spiral of instability, which is affecting the Indian
Software Industry. U.S banks have a lot of operational relationships with the Indian
Software Companies. According to a rough estimate, at least 30,000 jobs in India could
be directly impacted by the events in the United States financial system. About 61% of
the revenue of the IT Sector in India comes from the financial corporations of the
United States. The top 5 Indian players alone account for 46% of the revenue in the IT
industry. The revenue contribution of U.S client companies is around 58%. About 30%
of revenue in the industry comes from the financial services. Software companies may
face difficult times in the near future.

Foreign Exchange Outflow:

The exchange rate volatility in India increased in 2008-09 as compared to previous

years. Large selling by FII and conversion of rupee holdings into dollars for
repatriation led to a sharp depreciation of the rupee against the dollar. From January 1
to October 16, 2008 the RBI reference rate for the rupee decreased by almost 25 per
cent from Rs.39,20 to Rs.48,86 per dollar. While this depreciation may be beneficial for
India’s exports that are suffering from a slowdown in global markets, it is not so good
for those who have foreign exchange payment commitments.

Real estate:

One of the biggest victims of the crisis has been the real estate sector. The Indian real
estate industry would be hit hard by the global economic slowdown. The realty industry
was facing a sudden drop in demand as a result of the recession. The real estate industry
had been forced to cut down on its expansion plans. Many ongoing real estate projects

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were facing difficulties due to a lack of capital from buyers and banks. Some realtors
had even defaulted on their delivery dates and obligations. Steel: The steel industry had
decided to cut down on production as demand for the commodity had decreased.

Stock Market:

The financial turmoil had impacted the stock markets in India as well. A rapid sell-off
by financial institutions coupled with the prospect of an economic slowdown had
dragged down the stock and commodity markets. Foreign institutional investors had
pulled out almost $ 11 billion from India, dragging down the capital market as well. The
stock prices had fallen by about 60 per cent. The Sensex index in India reached a peak
of 21,000 in January 2008 and had since fallen below 10,000 in October 2008. The
Sensex movement had a positive and significant correlation with Foreign Institutional
(FII) inflows into the market, which also had an impact on the primary market. In the
2007-08 financial year, FII inflows into India stood at $20,3 billion, whereas FII pulled
out $11,1 billion in the first nine and a half months of the 2008 calendar year, with $8,3
billion coming in in the first six and a half months in the 2008-09 financial year (from
April 1 to October 16).

Exports:

The global economic slowdown had significantly reduced demand for exports, which
would have a negative effect on the country’s growth prospects. This had an effect on
both merchandise and services exports. The drop in export growth had a significant
impact on export-oriented segments in the Indian economy. The garment industry had
been hit hard by the global economic slowdown. Orders for factories that depended on
exports, especially to the United States, had fallen due to delayed buying by big apparel
brands. The rising unemployment and decreased spending by Americans had forced
some of the top brands in the United States to close their doors, which had impacted the
apparel industry here in India as well. The United States accounts for 55 percent of all
worldwide apparel imports. The global recession also had a negative impact on other
important export sectors in the Indian economy such as sea food, gems and jewelry.

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Banks:

The current crisis had a negative effect on some of the banks in India. Some of the
Indian banks had invested in derivative products that could have an impact on
investment bankers in the United States of America. In general, Indian banks did not
have much exposure to asset markets in the developed world. Indian banks had few
foreign branches. Our banks were slightly better protected from the financial crisis,
mainly due to the increased role of the state-owned banks, even today, and other
restrictions on domestic finance. The Reserve Bank of India's strict regulation and
conservative policies had kept banks in India relatively safe from the losses and write-
offs experienced by western banks and financial institutions.

GOVERNMNET POLICIES THAT HELPED INDIA DURING GLOBAL

RECESSION.

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 Conclusion

India had largely avoided global financial disruption caused by the subprime crisis for a
number of reasons. The country’s growth trajectory had been largely driven by
domestic demand, and its reliance on external savings had remained relatively low at
about 1.5% during those years. India also had a relatively comfortable level of foreign
exchange reserves.

The credit derivatives market in India was still in its early stages; the origin-to-
disposition model was not as robust as in developed markets; residents were restricted
from investing in products issued abroad, and regulatory guidelines for securitizations
did not allow for immediate recognition of profits.

Financial stability in India was achieved through sustained prudential measures that
prevented institutions from taking excessive risks, and by preventing financial markets
from becoming extremely volatile and turbulent.

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