Beginning in the United States in December 2007 (and with much greater intensity since September 2008, according to the National Bureau of Economic Research), the industrialized world has been undergoing a recession, a pronounced deceleration of economic activity. This global recession has been taking place in an economic environment characterized by various imbalances and was sparked by the outbreak of the financial crisis of 2007–2009. Although the late-2000s recession has at times been referred to as "the Great Recession," this same phrase has been used to refer to every recession of the several preceding decades. The financial crisis has been linked to reckless and unsustainable lending practices resulting from the deregulation and securitization of real estate mortgages in the United States. The US mortgage-backed securities, which had risks that were hard to assess, were marketed around the world. A more broad based credit boom fed a global speculative bubble in real estate and equities, which served to reinforce the risky lending practices. The precarious financial situation was made more difficult by a sharp increase in oil and food prices. The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans and over-inflated asset prices. With loan losses mounting and the fall of Lehman Brothers on September 15, 2008, a major panic broke out on the inter-bank loan market. As share and housing prices declined many large and well established investment and commercial banks in the United States and Europe suffered huge losses and even faced bankruptcy, resulting in massive public financial assistance. A global recession has resulted in a sharp drop in international trade, rising unemployment and slumping commodity prices. In December 2008, the National Bureau of Economic Research (NBER) declared that the United States had been in recession since December 2007. Several economists have predicted that recovery may not appear until 2011 and that the recession will be the worst since the Great Depression of the 1930s.The conditions leading up to the crisis, characterized by an exorbitant rise in asset prices and associated boom in economic demand, are considered a result of the

extended period of easily available credit, inadequate regulation and oversight, or increasing inequality. The recession has renewed interest in Keynesian economic ideas on how to combat recessionary conditions. Fiscal and monetary policies have been significantly eased to stem the recession and financial risks. Most economists believe that the stimulus should be withdrawn as soon as the economies recover enough to "chart a path to sustainable growth

Pre-recession economic imbalances The onset of the economic crisis took most people by surprise. A 2009 paper identifies twelve economists and commentators who, between 2000 and 2006, predicted a recession based on the collapse of the then booming housing market in the U.S: Dean Baker, Wynne Godley, Fred Harrison, Michael Hudson, Eric Janszen, Steve Keen, Jakob Brøchner Madsen & Jens Kjaer Sørensen, Kurt Richebächer, Nouriel Roubini, Peter Schiff and Robert Shiller. Among the various imbalances in which the US monetary policy contributed by excessive money creation, leading to negative household savings and a huge US trade deficit, dollar volatility and public deficits, a focus can be made on the following ones: Commodity boom Further information: 2000s energy crisis and 2007–2008 world food price crisis See also: 2008 Central Asia energy crisis and 2008 Bulgarian energy crisis

Brent barrel petroleum spot prices, May 1987 – March 2009. The decade of the 2000s saw a global explosion in prices, focused especially in commodities and housing, marking an end to the commodities recession of 1980–2000. In 2008, the prices of many commodities, notably oil and food, rose so high as to cause genuine economic damage, threatening stagflation and a reversal of globalization. In January 2008, oil prices surpassed $100 a barrel for the first time, the first of many price milestones to be passed in the course of the year. In July 2008, oil peaked at $147.30 a barrel and a gallon of gasoline was more than $4 across most of the U.S.A. These high prices caused a dramatic drop in demand and prices fell below $35 a barrel at the end of 2008. Some believe that this oil price spike was the product of Oil. There is concern that if the economy was to improve, oil prices might return to pre-recession levels. The food and fuel crises were both discussed at the 34th G8 summit in July 2008. Sulfuric acid (an important chemical commodity used in processes such as steel processing, copper production and bioethanol production) increased in price 3.5-fold in less than 1 year while producers of sodium hydroxide have declared force majeure due to flooding, precipitating similarly steep price increases. In the second half of 2008, the prices of most commodities fell dramatically on expectations of diminished demand in a world recession. Housing bubble

UK house prices between 1975 and 2006. Further information: Real estate bubble

speculation in commodities. monetary easing by the Fed to tame financial crisis. IMF data indicated that inflation was highest in the oilexporting countries. Australia. Russia. Reuters reported that global inflation was at historic levels. However. Causes . housing market) … it's hard not to see that there are a lot of local bubbles". Baltic. Greece. South Korea. rising cost of imports from China and rising demand of food and commodities in the fast growing emerging markets. real estate bubbles were still under way in many parts of the world. Finland. Federal Reserve Chairman Alan Greenspan said in mid-2005 that "at a minimum. Canada. Croatia. Romania. The Economist magazine. In mid-2007. Bulgaria. United Kingdom. United Arab Emirates. growth surge supported by easy monetary policy in Asia. Real estate bubbles are (by definition of the word "bubble") followed by a price decrease (also known as a housing price crash) that can result in many owners holding negative equity (a mortgage debt higher than the current value of the property). writing at the same time. saying "the worldwide rise in house prices is the biggest bubble in history".S. inflation was also growing in countries classified by the IMF as "non-oil-exporting LDCs" (Least Developed Countries) and "Developing Asia". Spain. Poland. Israel. largely due to the unsterilized growth of foreign exchange reserves. France. New Zealand. "Excess money supply around the globe. Argentina. but remained low compared to the developing world. there's a little 'froth' (in the U. Singapore. South Africa. Norway.By 2007.S. on account of the rise in oil and food prices. went further. agricultural failure. India. Inflation was also increasing in the developed countries. U. Ireland. Sweden. especially in the United States. Ukraine and China. Italy. and that domestic inflation was at 10–20 year highs for many nations. the term “unsterilized” referring to a lack of monetary policy operations that could offset such a foreign exchange intervention in order to maintain a country's monetary policy target. Inflation In February 2008." have been named as possible reasons for the inflation.

The great asset bubble: 1.9 tn. 5. 2008. Other assets – $290 tn. Shadow banking assets – $62 tn. Bail-out money (early 2009) – $1. and SEC Chairman Arthur Levitt vehemently opposed any regulation of financial instruments known as derivatives. Born. it . On October 15. M0 (paper money) – .9 tn. the authors claim that former Federal Reserve Board Chairman Alan Greenspan. Financial crisis of 2007–2009 Debate over origins The central debate about the origin has been focused on the respective parts played by the public monetary policy (in the US notably) and by private financial institutions practices. In their investigation. Ultimately. 6.$3.845 tn. 3. Central banks' gold reserves – $0. Anthony Faiola. specifically under the leadership of Brooksley E. Traditional (fractional reserve) banking assets – $39 tn. "What Went Wrong". 2. They further claim that Greenspan actively sought to undermine the office of the Commodity Futures Trading Commission. 4. Ellen Nakashima. Treasury Secretary Robert Rubin. when the Commission sought to initiate regulation of derivatives. and Jill Drew wrote a lengthy article in The Washington Post titled.

To these novel factors. Subprime lending as a cause Based on the assumption that subprime lending precipitated the crisis. the creation of complex and opaque assets. low-quality mortgages acted as an accelerant to the fire that spread through the entire financial system. The collapse of the real estate market in 2006 was the close point of origin of the crisis. that triggered the economic crisis of 2008.was the collapse of a specific kind of derivative. while others have pointed to the passage of the Gramm-Leach-Bliley Act by the 106th Congress.S. and the application of fair value accounting. The New York Times published an article that reported the Clinton . some have argued that the Clinton Administration may be partially to blame. there is also the argument that Greenspan actions in the years 2002–2004 were actually motivated by the need to take the U. Some believe the roots of the crisis can be traced directly to subprime lending by Fannie Mae and Freddie Mac. The failure rates of subprime mortgages were the first symptom of a credit boom tuned to bust and of a real estate shock. Some economists claim that the ultimate point of origin of the great financial crisis of 2007–2009 can be traced back to an extremely indebted US economy. the failure of ratings agencies to properly assess the risk of such assets. allowed huge amounts of "easy" credit-based money to be injected into the financial system and thus create an unsustainable economic boom). While Greenspan's role as Chairman of the Federal Reserve has been widely discussed (the main point of controversy remains the lowering of Federal funds rate at only 1% for more than a year which. but only postpone it. But large default rates on subprime mortgages cannot account for the severity of the crisis. according to the Austrian School of economics. economy out of the early 2000s recession caused by the bursting of the dotcom bubble — although by doing so he did not help avert the crisis. which are government sponsored entities. and over-leveraging by banks and investors eager to achieve high returns on capital. one must add the now standard failure of regulators and supervisors in spotting and correcting the emerging weaknesses. Rather. the mortgage-backed security. The latter had become fragile as a result of several factors that are unique to this crisis: the transfer of assets from the balance sheets of banks to the markets.

50 buying loans.Administration pushed for subprime lending: "Fannie Mae. by financial institutions. Congress ordered that the companies be required to keep more capital as a cushion against losses if they invested in riskier securities.) Government activities as a cause In 1992. which repealed part of the Glass-Steagall Act of 1933. In 1995. a former advisor to President Clinton and economist at the University of California. (See "The Community Reinvestment Act After Financial Modernization. the administration also tinkered with Carter's Community Reinvestment Act of 1977 by regulating and strengthening the anti-redlining procedures. Whereas banks that held $100 could spend $90 buying mortgage loans. and was only put in place nine years later. Brad DeLong. Berkeley and Tyler Cowen of . the 102nd Congress under the George H. It is felt by many that this was done to help boost a stagnated home ownership figure that had hovered around 65% for many years." Others have pointed to deregulation efforts as contributing to the collapse. into riskier loans. the 106th Congress passed the Gramm-Leach-Bliley Act.and mid-level income borrowers and neighborhoods. Bush administration weakened regulation of Fannie Mae and Freddie Mac with the goal of making available more money for the issuance of home loans. In a 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 it was shown that $467 billion of mortgage credit poured out of CRA-covered lenders into low. the nation's biggest underwriter of home mortgages. The Washington Post wrote: "Congress also wanted to free up money for Fannie Mae and Freddie Mac to buy mortgage loans and specified that the pair would be required to keep a much smaller share of their funds on hand than other financial institutions. has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people" (NYT. some economists object to singling out the repeal of GlassSteagall for criticism. The result was a push by the administration for greater investment. But the rule was never set during the Clinton administration. W. However. In 1999. Finally. 30 September 1999). Fannie Mae and Freddie Mac could spend $97. This repeal has been criticized by some for having contributed to the proliferation of the complex and opaque financial instruments which are at the heart of the crisis. which came to office that winter." April 2000.

losses have . Under this theory. These massive... while the recovery rate for mezzanine CDO's has been approximately five cents for every dollar." The average recovery rate for high quality CDOs has been approximately 32 cents on the dollar." The pricing model for CDOs clearly did not reflect the level of risk they introduced into the system. Li's Gaussian copula model function to rapidly price Collateralized debt obligations based on the price of related Credit Default Swaps. and rating agencies. Cracks started appearing early on. with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets. around $305bn of the CDOs are now in a formal state of default. it rapidly came to be used by a huge percentage of CDO and CDS investors. followed by UBS and Citi. [o]ut of that article: "Then the model fell apart.[45] According to one wired. practically unthinkable. According to an article published in Wired. The cracks became full-fledged canyons in 2008—when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril.. Over-leveraging. issuers. the risk was further systematized by the use of David X. Because it was highly tractable. It has been estimated that the "from late 2005 to the middle of 2007. banks and investors systematized the risk by taking advantage of low interest rates to borrow tremendous sums of money that they could only pay back if the housing market continued to increase in value. when financial markets began behaving in ways that users of Li's formula hadn't expected.George Mason University have both argued that the Gramm-Leach-Bliley Act softened the impact of the crisis by allowing for mergers and acquisitions of collapsing banks as the crisis unfolded in late 2008. around $450bn of CDO of ABS were issued.Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees.. credit default obligations as causes swaps and collateralized debt Another probable cause of the crisis—and a factor that unquestionably amplified its magnitude—was widespread miscalculation by banks and investors of the level of risk inherent in the unregulated Collateralized debt obligation and Credit Default Swap markets. of which about one third were created from risky mortgage-backed bonds.

This easy availability of credit inspires a bundle of malinvestments. This perspective argues that the monetary policy of central banks creates excessive quantities of cheap credit by setting interest rates below where they would be set by a free market. This happens usually some time after interest rates rise again. particularly on long term projects such as housing and capital assets. The liquidation of the malinvestments and the consequent reduction in consumption throw the economy into a recession. kept interest rates very low for a long period of time to blunt the recession of the early 2000s. whose severity mirrors the scale of the boom's excesses. led to the recession. in which credit created through the policies of central banking gives rise to an artificial boom. the Community Reinvestment Act. led by Federal Reserve Chairman Alan Greenspan. The Austrian School argues that the conditions previous to the crisis of the late 2000s correspond exactly to the scenario described above. Austrian Economists argue further that while they probably affected the nature and severity of the crisis. businesses and banks. there are physically not enough resources to finance either the malinvestments or the consumption rate indefinitely. factors such as a lack of regulation. and entities such as Fannie Mae and Freddie Mac are insufficient by themselves to explain it. The resulting malinvestment and overconsumption of investors and consumers prompted the development of a housing bubble that ultimately burst. and also spurs a consumption boom as incentives to save are diminished.dramatically impacted the balance sheets of banks across the globe. The central bank of the United States. Credit creation as a cause The Austrian School of Economics proposes that the crisis is an excellent example of the Austrian Business Cycle Theory. The bust occurs when investors collectively realize their mistake. Thus an unsustainable boom arises. But the created credit is not backed by any real savings nor is in response to any change in the real economy. which is inevitably followed by a bust. . characterized by malinvestments and overconsumption. This crisis. precipitating the financial crisis. together with sudden and necessary deleveraging and cutbacks by consumers. leaving them with very little capital to continue operations. hence.

However.” . it creates a liquidity risk if the yield curve were to become inverted and banks would have to refund themselves at expensive short term rates while losing money on longer term loans. The price of oil rose to over $140 dollars per barrel in 2008 before plunging as the financial crisis began to take hold in late 2008. the yield curve is believed to act on the real economy with a lag of 1 to 3 years.Austrian economists argue that the history of the yield curve from 2000 through 2007 illustrates the role that credit creation by the Federal Reserve may have played in the on-set of the financial crisis in 2007 and 2008. The yield curve (also known as the term structure of interest rates) is the shape formed by a graph showing US Treasury Bill or Bond interest rates on the vertical axis and time to maturity on the horizontal axis. A positively sloped yield curve allows Primary Dealers (such as large investment banks) in the Federal Reserve system to fund themselves with cheap short term money while lending out at higher long-term rates. Other observers have doubted the role that the yield curve plays in controlling the business cycle. 2006 story CNN Money reported: “…in recent comments. When short-term interest rates are lower than long-term interest rates the yield curve is said to be “positively sloped”. However. When short-term interest rates are higher than longterm interest rates the yield curve is said to be “inverted”. When long term and short term interest rates are equal the yield curve is said to be “flat”. The narrowing of the yield curve from 2004 and the inversion of the yield curve during 2007 resulted (with the expected 1 to 3 year delay) in a bursting of the housing bubble and a wild gyration of commodities prices as moneys flowed out of assets like housing or stocks and sought safe haven in commodities. Fed Chairman Ben Bernanke repeated the view expressed by his predecessor Alan Greenspan that an inverted yield curve is no longer a good indicator of a recession ahead. In a May 24. The yield curve is believed by some to be a strong predictor of recession (when inverted) and inflation (when positively sloped). This strategy is profitable so long as the yield curve remains positively sloped.

including some methods that had previously shown a decline in the relationship between oil price shocks and the overall economy. has said he was partially wrong to oppose regulation of the markets. They are critical of theories that the free market caused the crisis and instead argue that the Federal Reserve's expansionary monetary policy and the Community Reinvestment Act are the primary causes of the crisis. had there been no increase in oil prices between 2007:Q3 and 2008:Q2. showed that the decline in GDP could have been successfully predicted to almost its full extent given knowledge of the price of oil. a time-series econometric forecast based on data up to 2003. Hamilton has argued that the increase in oil prices in the period of 2007 through 2008 was a significant cause of the recession. Other claimed causes Many libertarians.Oil prices Economist James D. the US economy would not have been in a recession over the period 2007:Q4 through 2008:Q3. (2) prolonged by an inability to evaluate counter-party risk due to opaque financial statements. Schiff also made a speech in 2006 in which he predicted the failure of Fannie and Freddie . to manage risk in the markets. claim to have predicted the crisis prior to its occurrence. and (3) worsened by the unpredictable nature of government's response to the crisis. Taylor concluded that the crisis was: (1) caused by excess monetary expansion. and expressed "shocked disbelief" at the failure of self interest. Hamilton himself acknowledged that this was probably not the case but maintained that it showed that oil price increases made a significant contribution to the downturn in economic growth. Alan Greenspan. alone. An empirical study by John B. which greatly increased global industrial output at a reduced . All of these methods "support a common conclusion. former Federal Reserve chairman. however. It has also been debated that the root cause of the crisis is overproduction of goods caused by globalization (and especially vast investments in countries such as China and India by western multinational companies over the past 15–20 years. The results imply that oil prices were entirely responsible for the recession. He evaluated several different approaches to estimating the impact of oil price shocks on the economy." Hamilton's own model. including Congressman and former 2008 Presidential candidate Ron Paul and Peter Schiff in his book Crash Proof.

The Economist claimed that the financial crisis had produced a "manufacturing crisis". in decline for five straight quarters. 1. matched the 1957–58 post war record in the first quarter of 2009.25%. On the other hand. and by early 2009 was falling at an annualized pace not seen since the 1950s. Professor Herman Daly suggests that it is not actually an economic crisis. a permanent end of economic growth could be reached sometime in the first two decades of the 21st century. with the strongest declines in industrial production occurring in export-based economies. as commodity prices tumbled and the Federal Reserve was lowering its target rate to an all-time-low 0. due to gradual depletion of natural resources. This reflects a claim made in the 1972 book Limits to Growth. dropping 23. Global Effects Overview The late-2000s recession is shaping up to be the worst post-war contraction on record: • • • Real gross domestic product (GDP) began contracting in the third quarter of 2008. Trade and industrial production In middle-October 2008. The pace of collapse in residential investment picked up speed in the first quarter of 2009.2% year-on-year. In February 2009. a measure of shipping volume. . Overproduction tends to cause deflation and signs of deflation were evident in October and November 2008.6% per quarter vs. but rather a crisis of overgrowth beyond sustainable ecological limits. nearly four percentage points faster than in the previous quarter. the Baltic Dry Index. is still three months shy of the 1974–75 record. Domestic demand. which stated that without major deviation from the policies followed in the 20th century. but the pace – down 2.9% in the earlier period – is a record-breaker already. as the credit crunch made it difficult for exporters to obtain letters of credit.cost). fell by 50% in one week. which was in decline year-on-year since the final quarter of 2006. Capital investment.

S. real estate. businesses. securing supplies of oil and minerals. A broader measure of unemployment (taking into account marginally attached workers.2%. unemployment rate was 4.In March 2009. the U. the unemployment rate had risen to 10.3%. Previously emissions had been rising by around 3% per year. Spain's unemployment rate reached 18.000. from January 2008 to January 2009: Japan −31%. recorded as the lowest number of jobs since September 2008. including China.9%. Russia −16%. news reports announced that some employers who cut jobs due to the . and discouraged workers) was 16.4%. Pollution According to the International Energy Agency man-made greenhouse gas emissions will decrease by 3% in 2009. Brazil −15%. In December 2007.7% (37% for youths) in May 2009 — the highest in the eurozone. 216. The number of unemployed people worldwide could increase by more than 50 million in 2009 as the global recession intensifies. Unemployment The International Labour Organization (ILO) predicted that at least 20 million jobs will have been lost by the end of 2009 due to the crisis — mostly in "construction. Germany −12%. Sovereign funds and private buyers from the Middle East and Asia. The Chinese government has concentrated on natural-resource deals across the world. Britain's Daily Telegraph reported the following declines in industrial output. In October 2009. Due to the global recession they are available at a low price. are increasingly buying in on stakes of European and U. those employed part time for economic reasons. the ILO has forecast. The drop in emissions is only the 4th to occur in 50 years. including industrial enterprises. In July 2009.S. financial services.5% to 9. dipping the unemployment rate from 9. Korea −26%. and the auto sector" — bringing world unemployment above 200 million for the first time. Some analysts even say the world is going through a period of deglobalization and protectionism after years of increasing economic integration. mainly as a result of the financial crisis. Italy −14%. By October 2009. Even fewer jobs were lost in August.7%. fewer jobs were lost than expected. but the unemployment rate rose to 9.

stock market. allowing a unique opportunity for entrepreneurs. Recent improvements in communication and education in these countries has allowed workers in these countries to compete more closely with workers in traditionally strong economies. India." Financial markets Main article: Financial crisis of 2007–2009 For a time. with a surge in implied volatility measurements of the US-based S&P 500 index. The rise of advanced economies in Brazil. which was sometimes dubbed The Great Moderation. after they found that most of their marketing consulting clients were recession made entrepreneurs. The return of commodity. those that had been laid off due to the economic downturn and had thus decided to use their savings and unemployment benefits to start their own business. because many economic variables appeared to have achieved relative stability.recession are beginning to hire them back. and China increased the total global labor pool dramatically. major economies of the 21st century were believed to have begun a period of decreased volatility. and a sharp decrease in non-U. This huge surge in labor supply has provided downward pressure on wages and contributed to unemployment. January . The recession has allowed many Recession Entrepreneurs to completely change course in their careers and pursue their dream jobs. "The recession has also injected life into a slew of small businesses that are thriving either in spite of or because of the economic downturn. Recession Entrepreneurs The term Recession Entrepreneurs was coined by JJ Ink in 2009. More recently. economists have announced the end of the recession last month. and currency value volatility are regarded as indications that the concepts behind the Great Moderation were guided by false beliefs. giving new relevance to the old adage that one man's misfortune is another's opportunity.S. such as the United States. Recessions are historically ripe with opportunity for innovation. stock market prices on Monday. and have predicted that job losses will stop in early 2010. January 2008 was an especially volatile month in world stock markets.

Russian markets. 2008 (continuing to a lesser extent in some markets on January 22). In addition. fell over 10% in one day. the dollar value of gold) set records. Treasury yields. one in September. Europe.3 percent drop in China's growth rate. the Australian Securities Exchange (ASX) delayed opening by an hour after a decision was made by the Australian Securities and Investments Commission (ASIC) to ban all short selling on the ASX. and another in early October. The action is based on the view that short selling in a crisis market undermines confidence in financial institutions and erodes their stability. This was revised slightly a few days later. There were several large Monday declines in stock markets world wide during 2008. while other emerging markets also exhibited losses. The Dow Jones Industrial Average had fallen about 37% since January 2008. . one in August. On September 18. Investors worried about the effect of a recession in the US economy would have on the Chinese economy. Numerous indicators of risk and of investor fear (the TED spread. The simultaneous multiple crises affecting the US financial system in midSeptember 2008 caused large falls in markets both in the US and elsewhere. already falling due to declining oil prices and political tensions with the West." though the effects were quite different in different markets.21. leading to a suspension of trading. Citigroup estimates due to the number of exports from China to America a one percent drop in US economic growth would lead to a 1. UK regulators announced a temporary ban on shortselling of financial stocks.76 percent respectively. As of October 2008. On September 22. stocks in North America. the SEC made it easier for institutions to buy back shares of their institutions. Securities and Exchange Commission (SEC) followed by placing a temporary ban of shortselling stocks of 799 specific financial institutions.14 percent. On September 19 the U. Some headline writers and a general news columnist called January 21 "Black Monday" and referred to a "global shares crash. including one in January. and the Asia-Pacific region had all fallen by about 30% since the beginning of the year. most of this on financial stocks such as Ping An Insurance and China Life which lost 10 and 8.S. The effects of these events were also felt on the Shanghai Composite Index in China which lost 5.

Resorts & Spas survey. business travel has decreased in the past year as a result of the recession. but certain countries were vastly affected more than others. equity market decline. Insurance A February 2009 study on the main British insurers showed that most of them do not plan to raise their insurance premiums for the year 2009. Blackstone Group CEO Stephen Schwarzman said that up to 45% of global wealth had been destroyed in little less than a year and a half. By measuring currency devaluation. The price of gold rose by 30% from middle of 2007 to end of 2008. corroborated with the £644 million underwriting losses suffered in 2007. Hotels are responding to the downturn by dropping rates. taken together. Countries most affected The crisis affected all countries in some ways. ramping up promotions and negotiating deals for both business travelers and tourists. and the rise in sovereign bond spreads. a picture of financial devastation emerges. However. In March 2009.As is often the case in times of financial turmoil and loss of confidence. 30% of travelers surveyed stated they travel less for business today while only 21% of travelers stated that they travel more. having their capital tied up in investments yielding smaller dividends. and Ukraine – as well as Argentina and Jamaica are the countries most deeply affected by the . in spite of the prediction of a 20% raise made by The Daily Telegraph and The Daily Mirror. investors turned to assets which they perceived as tangible or sustainable. economic uncertainty and high airline prices. Since these three indicators show financial weakness. personal economics. A further shift in investors’ preference towards assets like precious metals or land is discussed in the media.S. it is expected that the capital liquidity will become an issue and determine increases. Reasons for the decline in business travel include company travel policy changes. Hotels. they capture the impact of the crisis. Travel According to Zagat's 2009 U.[108] The Carnegie Endowment for International Peace reports in its International Economics Bulletin that two eastern European countries – Hungary.

Greece experienced extensive civil unrest that continued into January and then again in late February many Greeks took part in a massive general strike because of the economic situation and shut down schools. Prompted by the financial crisis in Latvia. the rally turned into a riot. In addition to various levels of unrest in Europe. British think tank Economist Intelligence Unit published a special report titled 'Manning the barricades' in which it estimated "who's at risk as deepening economic distress foments social unrest". disrupted economies and toppled governments around the globe. Peru and Australia are "among the least affected". an Economic Intelligence Briefing was added to the daily intelligence briefings prepared for the President of the United States. In March 2009. Police and protesters also clashed in Lithuania. The Report envisioned the next two years filled with great social upheavals. The crowd moved to the building of the parliament and attempted to force their way into it. India. the government leaders of Iceland were forced to call elections two years early after the people of Iceland staged mass protests and clashed with the police due to the government's handling of the economy. airports.crisis. By contrast. Business Week in March 2009 stated that global political instability is rising fast due to the global financial crisis and is creating new challenges that need managing. This addition reflected the assessment of United States intelligence agencies that the global financial crisis presented a serious threat to international stability. The rally gathered some 10–20 thousand people. China. The Associated Press reported in March 2009 that: United States "Director of National Intelligence Dennis Blair has said the economic . 2009. Hundreds of thousands protested in France against President Sarkozy's economic policies. and many other services in Greece. Japan. In January 2009. but were repelled by the state's police. Protests have also occurred in China as demands from the West for exports were dramatically reduced and unemployment increased. In the evening. Beginning February 26. Communists and others rallied in Moscow to protest the Russian government's economic plans. the opposition and trade unions there organized a rally against the cabinet of premier Ivars Godmanis. Asian countries have also seen various degrees of protest. Political instability related to the economic crisis In December 2008.

and Greece also experienced street protests. a former intelligence officer who now leads research at the Eurasia Group. economic stimulus meant to revive economic growth became the most common policy tool. Bailouts of failing or threatened businesses were carried out or discussed in the USA. In the final quarter of 2008. .weakness could lead to political instability in many developing nations.K. the United States." "The recent wave of popular unrest was not confined to Eastern Europe. major developed and emerging countries announced plans to relieve their economies. Deeply unpopular austerity measures. In particular. Romania and Bulgaria). As the crisis developed into genuine recession in many major economies. the U. said: "Many. NPR reports that David Gordon. Ireland. France. Hungary. economic stimulus plans were announced in China." Even some developed countries are seeing political instability. but many Eastern European governments seem more vulnerable as they have limited policy options to address the crisis and little or no room for fiscal stimulus due to budgetary or financing constrains. Lithuania. the EU. and India. of the big countries out there have room to accommodate economic downturns without having large-scale political instability if we're in a recession of normal length. then all bets are off. including slashed public wages. If you're in a much longer-run downturn. After having implemented rescue plans for the banking system." Policy responses Main article: 2008-2009 Keynesian resurgence Main article: National fiscal policy response to the late 2000s recession The financial phase of the crisis led to emergency interventions in many national financial systems. tax hikes and curbs on social spending will keep fanning public discontent in the Baltic states. the financial crisis saw the G-20 group of major economies assume a new significance as a focus of economic and financial crisis management. if not most. Iceland. Dissatisfaction linked to the economic woes will be amplified in the countries where governments have been weakened by high-profile corruption and fraud scandals (Latvia. and the European Union. Hungary and Romania.

most US employer-sponsored plans sent notices to their employees informing them that the plan default investment was changing from a cash/stable option to something new. as well as action against naked short selling. when the market crash was on every news station and media outlet. similar to the Federal Deposit Insurance Corporation (FDIC) program. Treasury. as part of its reaction to the mortgage crisis. This meant that individuals who had defaulted into a cash fund with little fluctuation or growth would soon have their account balances moved to much more aggressive investments. the Treasury also announced on September 19 a new $50 billion program to insure the investments. allowing financial groups to more easily share funds within their group. Call centers for 401(k) providers experienced record call volume and wait times. unless extended by the Federal Reserve Board. Market volatility within US 401(k) and retirement plans The US Pension Protection Act of 2006 included a provision which changed the definition of Qualified Default Investments (QDI) for retirement plans from stable value investments. such as a retirement date fund which had significant market exposure. and cash investments to investments which expose an individual to appropriate levels of stock and bond risk based on the years left to retirement. The Act required that Plan Sponsors move the assets of individuals who had never actively elected their investments and had their contributions in the default investment option. money market funds. The exceptions would expire on January 30. Starting in early 2008. and reacted in a panic by liquidating . Most participants ignored these notices until September and October. 2009. and Securities and Exchange Commission took several steps on September 19 to intervene in the crisis. It was then that participants called their 401(k) and retirement plan providers and discovered losses in excess of 30% in some cases. To stop the potential run on money market mutual funds. as millions of inexperienced investors struggled to understand how their investments had been changed so fundamentally without their explicit consent. Part of the announcements included temporary exceptions to section 23A and 23B (Regulation W). The Securities and Exchange Commission announced termination of short-selling of 799 financial stocks.United States policy responses The Federal Reserve.

money market mutual funds had begun to experience significant withdrawals of funds by investors. discussion forums filled with questions about whether or not to liquidate assets and financial gurus were swamped with questions about the right steps to take to protect what remained of their retirement accounts. Due to the speculation and uncertainty in the market. and ignoring historical data illustrating that long-term balanced investing has produced positive returns in all types of markets. over $72 billion left mutual fund investments that invested in stocks or bonds and rushed into Stable Value investments in the month of October.everything with any stock or bond exposure. locking in huge losses in their accounts. 2008. During the third quarter of 2008. Against the advice of financial experts. which then provide the funds to corporations in exchange for corporate short-term securities called asset-backed . Individual investors lend money to money market funds. This created a significant risk because money market funds are integral to the ongoing financing of corporations of all types. investors with decades to retirement instead sold their holdings during one of the largest drops in stock market history. Loans to banks for asset-backed commercial paper During the week ending September 19.

the US Treasury and Federal Reserve Bank announced that banks could obtain funds via the Federal Reserve's Discount Window using ABCP as collateral.75% 2.75% 4. However.75% 3. the ability of major corporations to secure needed short-term financing through ABCP issuance would have been significantly affected. a potential bank run had begun on certain money market funds.50% 4. If this situation had worsened.25% 3.25% 2008 Mar 16.25% 2. 2008 ) Discount Discount Fed Fed funds Date Discount rate rate rate funds rate Primary Secondary new interest new interest rate new interest rate change rate rate change rate Oct 8.75% 2008 Jan 30.00% -.00% 4. -.75% 2.50% 2008* Apr 30.50% 3.25% -. To assist with liquidity throughout the system.25% 2.00% 2008 Jan 22. .50% -.00% 2008 Mar 18.25% 3.50% 1.75% 2.50% 1. -.50% 2008 – * Part of a coordinated global rate cut of 50 basis point by main central banks. -.75% -.50% 3. -.00% -.commercial paper (ABCP).50% 3.25% 2. -. Federal Reserve lowers interest rates Federal reserve rates changes ( Just data after January 1. -.

Henry Paulson and President George W. The plan included 365.4 billion dollars aid to automobile manufacturers General Motors and Chrysler.6 million jobs in two years. HR1424 was passed by the House on October 3. a revised compromise version was approved by the Senate with a 74–25 vote. with the present economic conditions differing from past recessions. that. 275 billion (through tax rebates) to be redistributed to households and firms. Bush proposed legislation for the government to purchase up to US$700 billion of "troubled mortgage-related assets" from financial firms in hopes of improving confidence in the mortgage-backed securities markets and the financial firms participating in it. Public works projects associated with the economic recovery plan outlined by the Obama Administration have been degraded by the lack of road and bridge development projects that were highly abundant in the Great Depression but are now mostly constructed and are mostly in need of maintenance.8% of GDP). The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. however. 87 billion of direct assistance to states to help them finance health expenditures of Medicaid. 94 billion to be dedicated to social assistance for the unemployed and families. In January 2009. . These plans are meant to abate further economic contraction. 2008 and signed into law. textiles. Discussion. notably those investing in renewable energy. The administration also attributed of 13. but this plan is not included in the stimulus plan. the Obama administration announced a stimulus plan to revive the economy with the intention to create or save more than 3. The cost of this initial recovery plan was estimated at 825 billion dollars (5.Legislation Main article: Emergency Economic Stabilization Act of 2008 The Secretary of the United States Treasury. On October 1. in. many tenets of the American economy such as manufacturing. and finally 13 billion spent to improve access to digital technologies. The bill.5 billion dollars to be spent on major policy and reform of the health system. and technological development have been outsourced to other countries. hearings and meetings among legislative leaders and the administration later made clear that the proposal would undergo significant change before it could be approved by Congress.

temporary swaps of treasury bills for mortgage-backed securities. disaster rebuilding.Regulations to establish market stability and confidence have been neglected in the Obama plan and have yet to be incorporated. and the bailouts of American International Group (AIG). The stimulus package will be invested in key areas such as housing. and Citigroup. above and beyond the $700 billion authorized by Congress from the federal budget. environment. Federal Reserve announced plans to double its Term Auction Facility to $300 billion. the Federal Reserve also announced it would increase its swap facilities with foreign central banks from $290 billion to $620 billion. through a refinance operation. The Reserve Bank of Australia injected nearly $1.32 billion. the Federal Reserve had used its independent authority to spend $1. credit card companies. rural infrastructure. dollars in Europe at that time. tax cuts. This includes emergency loans to banks. at which commercial banks can borrow overnight funds from the central bank.S. Indonesia reduced its overnight repo rate. Asia-Pacific policy responses On September 15. income-building. The Reserve Bank of India added almost $1. 2008. by two percentage points to 10. on September 29 the U. On November 9. the sale of Bear Stearns. health and education. A statement on the government's website said the State Council had approved a plan to invest 4 trillion yuan ($586 billion) in infrastructure and social welfare by the end of 2010. 2008 China cut its interest rate for the first time since 2002. nearly three times as much as the market's estimated requirement. transportation. and finance. its biggest in at least a month.S. Fannie Mae and Freddie Mac.2 trillion on purchasing various financial assets and making emergency loans to address the financial crisis.25 percent. Federal Reserve response In an effort to increase available funds for commercial banks and lower the fed funds rate. Because there appeared to be a shortage of U. industry. and general businesses. . 2008 the 2008 Chinese economic stimulus plan is a RMB¥ 4 trillion ($586 billion) stimulus package announced by the central government of the People's Republic of China in its biggest move to stop the global financial crisis from hitting the world's second largest economy. As of December 24.5 billion into the banking system.

Netherlands. On November 28. In Asia. Bank of Japan pumped $29. 2008.59 billion into the foreign-currency interbank market the same day. News of the announcement of the stimulus package sent markets up across the world. plans generally amounted to 1 to 3% of GDP. the measures were dedicated to households (tax rebates) reform of the taxation system to support specific sectors such as housing. Italy. The stimulus package was welcomed by world leaders and analysts as larger than expected and a sign that by boosting its own economy. the central bank on September 16. There were also stimulus plans in some Asian countries. as the financial crisis began to seriously affect the economy.China's export driven economy is starting to feel the impact of the economic slowdown in the United States and Europe. many countries announced specific measures: Germany. Spain. 2008 and the Reserve Bank of Australia added $3. United Kingdom. 2008 said it would cut its required reserve ratios for the first time in eight years. China is helping to stabilize the global economy. 2008. with the notable exception of China. which announced a plan accounting for 16% of GDP (6% of GDP per year). responses to the global crisis mainly consisted in low-rates monetary policy (Asia and the Middle East mainly) coupled with the depreciation of the currency against the dollar. At the beginning . The European Commission proposed a €200 billion stimulus plan to be implemented at the European level by the countries. However. In Taiwan. In both countries. European policy responses Until September 2008. From September.45 billion the same day. Sweden. the Ministry of Finance of the People's Republic of China and the State Administration of Taxation jointly announced a rise in export tax rebate rates on some labor-intensive goods.3 billion into the financial system on September 17. European policy measures were limited to a small number of countries (Spain and Italy). In developing and emerging economies. and the government has already cut key interest rates three times in less than two months in a bid to spur economic expansion. The central bank added $3. These additional tax rebates will take place on December 1. in the Middle East and in Argentina. Marc Faber January 16 said that China according to him was in recession.

the UK and Spain completed their initial plans. In March 2009. First. central banks throughout the world added more than $200 billion from the beginning of the week to September 17. while Germany announced a new plan. through the Bank Recapitalization Fund. On September 29. with an initial £25 billion and another £25 billion to be provided if needed. £200 billion will be made available to the banks in the Bank of England's Special Liquidity scheme. In February 2009 Sir David Walker was appointed to lead a government inquiry into the corporate governance of banks. 2008 the Belgian. The plan comprises three parts. The European Union Presidency confirms that the EU is strongly resisting the US pressure to increase European budget deficits. Global responses Responses by the UK and US in proportion to their GDPs . Third. The European Central Bank injected $99. Luxembourg and Dutch authorities partially nationalized Fortis. Altogether.8 billion in a one-day moneymarket auction. the Government will temporarily underwrite any eligible lending between British banks up to around £250 billion. The Bank of England pumped in $36 billion. In early December German Finance Minister Peer Steinbrück indicated that he does not believe in a "Great Rescue Plan" and indicated reluctance to spend more money addressing the crisis. the Government will increase the banks' market capitalization. On 8 October 2008 the British Government announced a bank rescue package of around £500 billion ($850 billion at the time). Second. The German government bailed out Hypo Real Estate.of 2009.

They also pledged to fight against all forms of protectionism and to maintain trade and foreign investments. South Korea narrowly avoided technical recession in the the first quarter of 2009. and to implement rapidly the stimulus plans. and refused any resort to protectionism. Another G-20 summit was held in London on April 2009. as of the October. Some coordination took place at the European level. the leaders decided to help emerging and developing countries. As for central bankers. It was . Countries maintaining growth or technically avoiding recession Poland is the only member of the European Union to have avoided a decline in GDP. meaning that in 2009 Poland has created the most GDP growth in the EU. Finance ministers and central banks leaders of the G-20 met in Horsham on March to prepare the summit. They also committed to maintain the supply of credit by providing more liquidity and recapitalizing the banking system. they have not entered recession. However. While China and India have experienced slowing growth. A first summit dedicated to the crisis took place. they pledged to take measures to support their economy and to coordinate them. by individual nations. The International Energy Agency stated in mid September that South Korea could be the only large OECD country to avoid recession for the whole of 2009. The G-20 countries met in a summit held on November 2008 in Washington to address the economic crisis.Most political responses to the economic and financial crisis has been taken. the Australian economy has managed to avoid recession thanks largely to a strong mining sector and major stimulus spending. They decided to coordinate their actions and to stimulate demand and employment. contracting only in the last quarter of 2008.9 per cent is expected to be upgraded. Apart from proposals on international financial regulation. but the need to cooperate at the global level has led leaders to activate the G-20 major economies entity. as seen above. As of December 2009 the Polish economy had not entered recession nor even contracted. and pledged to restore global growth as soon as possible. at the Heads of state level in November 2008 (2008 G-20 Washington summit). while its IMF 2010 GDP growth forecast of 1. through a strengthening of the IMF. they pledged to maintain low-rates policies as long as necessary. Finally.

the only developed economy to expand in the first half of 2009. Hong Kong. Of the seven largest economies in the world by GDP. with GDP returning to positive in the first quarter of 2009. France experienced a 0. Latvia. The following countries went into recession in the second quarter of 2008: Estonia. Switzerland. Turkey and Germany. Countries in economic recession or depression Many countries experienced recession in 2008. Australia has avoided a technical recession after experiencing only one quarter of negative growth in the fourth quarter of 2008. with the Reserve Bank of Australia deciding to move rates up to 3. only China and France avoided a recession in 2008. the European Union.3% contraction in Q2 and 0. Latvia. Hong Kong. South Korea "miraculously" avoided recession with GDP returning positive at a 0. Iceland fell into an economic depression in 2008 following the collapse of its banking system. This figure may more accurately be considered to . In addition. Sweden. the G7. and the OECD all experienced negative growth in the third quarter The following countries/territories went into technical recession in the fourth quarter of 2008: United States. Australia became the first G20 country to raise its main interest rate.1% expansion in the first quarter of 2009. In the year to the third quarter of 2008 China grew by 9%. Italy. On October 6th. Japan. and Taiwan. As a whole the fifteen nations in the European Union that use the euro went into recession in the third quarter. Italy. but came out again in the second quarter. Singapore. The countries/territories currently in a technical recession are Estonia. Singapore. Ireland and New Zealand.25% from 3. and the United Kingdom.1% growth in Q3 of 2008. Russia and Germany. This is interesting as China has until recently considered 8% GDP growth to be required simply to create enough jobs for rural people moving to urban centres. Denmark went into recession in the first quarter of 2008. Spain.00%. New Zealand. Ireland. The following countries/territories went into recession in the third quarter of 2008: Japan.

expecting the US output to shrink between 0. Fed Chairman Ben Bernanke said in an interview that he felt that if banks began lending more freely. On February 18. Germany. On November 3.2%. allowing the financial markets to return to normal. In that same interview.1% (growth) and −0. the US Federal Reserve cut their economic forecast of 2009.25% and −1.). the World Bank Group predicted for 2009 for the first time a global contraction of the economic power.7% for the US. U. They also predicted negative numbers for the UK (−1. The EU commission in Brussels updated their earlier predictions on January 19. Ireland. Bernanke said Green shoots of economic revival are already evident.C. 2009.S. 2009. D.. 2008. of the same number. Official forecasts in parts of the world On March 2009. on average over the developed economies (−0. in a common press conference.0%). Growth of between 5%–8% could well have the type of effect in China that a recession has elsewhere. predicted for 2009 a worldwide decrease. On April 22. −0. Spain. 2009. and deepened further in the first quarter of 2009 with a nominal annualized GDP growth of −15. for the countries of the Euro zone (France. Ukraine went into technical depression in January 2009 with a nominal annualized GDP growth of −20%. According to new forecasts by Deutsche Bank (end of November 2008). the recession could end during 2009.5% and 1. the IMF at Washington. Three days later. etc.3%.1% of the GDP. and other countries of the EU. corrected again their numbers for 2009 downwards: this time the "prognosis" for Germany was a decrease of the GDP of at least −5 % in agreement with a recent prediction of the IMF On June 11. the German ministers of finance and that of economy. according to all newspapers. Italy. expecting Germany to contract −2.5%. precisely by −3%.8% for Germany). 2009.2% (contraction). the economy of Germany will contract by more than 4% in 2009.7%. down from its forecast in October 2008 of output between +1.8% on average for the 27 EU countries. the European Commission in Brussels predicted for 2009 only an extremely low increase by 0. and −0. The recession in Japan intensified in the fourth quarter of 2008 with a nominal annualized GDP growth of − 5–7% now that the main growth in working population is receding. .

921 million net jobs lost Current unemployment rate: 10.6 million jobs lost 2009 (January 2009–present) – 2.000 jobs lost July 2009 – 276.000 jobs lost December 2008 – 632.000 jobs lost November 2008 – 333. Many jobs have been lost worldwide.000 jobs lost May 2009 – 303.000 jobs lost 2008 (September 2008 – December 2008) – 2. such as September.000 jobs lost October 2008 – 240.Job losses and unemployment rates The examples and perspective in this article deal primarily with North America and do not represent a worldwide view of the subject.000 jobs lost October 2009 – 111.000 jobs lost August 2009 – 201. 6. job loss has been going on since December 2007.11.000 jobs lost November 2009 . Due to the collapse of the American car industry at the same time as a strong . and it accelerated drastically starting in September 2008 following the bankruptcy of Lehman Brothers Net job losses by month in the United States • • • • • • • • • • • • • • • • • • September 2008 – 280.000 jobs lost January 2009 – 741.000 jobs lost September 2009 – 263.0% Since the start of 2008. Canada net job losses by month Drastic job loss in Canada started later than in the US. according to the Bureau of Labor Statistics.000 jobs lost June 2009 – 463.7 million jobs have been lost. Some months in 2008 had job growth. while others such as July had losses.000 jobs lost February 2009 – 681.000 jobs lost April 2009 – 519.000 jobs lost March 2009 – 652. In the US.

700 jobs lost April 2009 – 27.600 jobs lost December 2008 – 1.300 jobs created May 2009 – 1.800 jobs created March 2009 – 34.4% November 2009 Canadian unemployment rate: 8.000 jobs lost October 2009 – 43.500 jobs created 2009 2009 2009 Australian Australian Australian unemployment unemployment unemployment rate: rate: rate: 5.300 jobs created November 2008 – 15.8% April July August . the crossborder manufacturing industry has been disproportionately affected throughout.400 jobs lost July 2009 – 32. • • • • • • • • • • September 2008 – No net loss October 2008 – No net loss November 2008 – 70.200 jobs created August 2009 – 27.600 jobs lost December 2008 – 34.200 jobs lost (1) 37.5% 5.700 jobs lost June 2009 – 21.000 jobs lost March 2009 – 61.200 jobs created October 2008 – 34.CAD achieved parity +10% against a poorly-performing USD.6% Australia net job losses by month • • • • • • • • • • • • • • September 2008 – 2.200 jobs lost January 2009 – 1.000 jobs lost February 2009 – 83.000 jobs lost January 2009 – 129.8% 5.200 jobs created February 2009 – 1.300 jobs lost April 2009 – No net loss (1) May 2009 – 36.600 jobs created October 2009 – 24.000 jobs are gained in the self-employment category May 2009 Canadian unemployment rate: 8.100 jobs lost September 2009 – 40.

slowdown in exports. As a result of this combining with many several structural factors that have come to India’s aid. even though 24. Australian employers have elected to cut working hours rather than fire employees. India's economic slowdown unexpectedly eased in the first quarter of 2009. the moment of financial crisis hit the real economy and became a global economic crisis. slowdown in domestic demand. The paper also highlights recovery of Indian economy from crisis and in the end of paper concluding remarks are given towards. throughout the subdued economic growth caused by the recession in the rest of the world.500 jobs were created. a large reduction in foreign reserves.000 people looking for work. a net outflow of foreign capital. The government of India has been highly proactive in managing this ongoing crisis with a slew of monetary and fiscal measures to stabilize the financial sector. The present paper makes an attempt to assess the impact of global financial crisis on the Indian economy and discuss the various policy measures taken by government of India to reduce the intensity of impacts. has made the current economic and . it was rapidly transmitted to many developing countries. in recognition of the skill shortage caused by the resources boom (which was largely unaffected by the financial crisis) which will soon re-assert itself. The intensification of the global financial crisis. By virtue of globalization. fall in stock market. sudden fall in growth rate and rise in unemployment. The crisis confronted India with daunting macroeconomic challenges like a contraction in trade. following the bankruptcy of Lehman Brothers in September 2008.7% The unemployment rate for October rose slightly due to population growth and other factors leading to 35. In general. The crisis emerged in India at the time when Indian economy was already preoccupied with the adverse effects of inflationary pressures and depreciation of currency. ensure adequate liquidity and stimulate domestic demand.8% rate: 5. The effects of the global financial crisis have been more severe than initially forecast.September 2009 Australian unemployment October 2009 Australian unemployment rate: 5.

the United States' sub-prime mortgage industry collapsed to higher-thanexpected home foreclosure rates. understand the differences among countries on how they are being impacted. Liquidity crisis promoted a substantial injection of capital into the financial markets by the US Federal Reserve. The crisis’s global effects differentiate it from the earlier crisis like Asian 1997-98 crisis2. only to Russia and Brazil or from the debt crisis of the early 1980s that affected the developing world. In 2008 alone. the US government allocated over $900 billion to special loans and rescues related to the US housing bubble. the global financial system and for central banks. China and India. The immediate cause or trigger of the present crisis was the bursting of United States housing bubble3 (Also known as Subprime). It is different from the recession of 1973-75 and 1979-81 because they did not propagate as fast and hardly affected Soviet Union. with the failure and merging of many financial institutions. finally. which spread. New Century Financial plunged 84%. second. very important that we identify the causes of the current crisis accurately so that we can then find. with over half going to the quasi-government agencies of Fannie Mae. with more than 25 sub-prime lenders declaring bankruptcy. It is. a prolonged credit expansion leading to accumulation of debt. The stock of the country's largest sub-prime lender. announcing significant losses. But the crisis came to the forefront of business world and media in September 2008. In March 2007. the pre-crisis period was characterized by surging asset prices that proved unsustainable. many large investment firms have seen their stock prices plummet. As a result. first. Lending crisis). in previous times of financial turmoil. The fall out of the current global financial crisis could be an epoch changing one for central banks and financial regulatory systems. the United States when a loss of confidence by investors in the value of securitized mortgages resulted in a liquidity crisis. Freddie Mac and the Federal . and. or putting them up for sale. and the inability of regulators to keep up (ADB. the emergence of new types of financial instruments. appropriate immediate crisis resolution measures and mechanisms. The present financial crisis which has its deep roots in closing year of the 20th century became apparent in July 2007 in the citadel of global neoliberal capital. therefore. think of the longer term implications for monetary policy and financial regulatory mechanisms. which peaked in approximately 2006-074. 2008). Added to environment a very difficult time for the world economy.

decline in the consumer wealth estimated in the trillion of U. and in oil exporting countries in the Middle East and Russia. steep falls in industrial productions. over the same time period needs to be analyzed for a more balanced analysis. quickly became a global problem affecting major economies worldwide both directly and indirectly. Global imbalances have been manifested through a substantial increase in the current account deficit of the US mirrored by the substantial surplus in Asia. The sub-prime crisis in the US. with its global effects characterized by the failure of key businesses.S. it was thought that other major world economies would not be significantly affected.Housing Administration. has sent ripples through the economies of many countries. the crisis of U. which. Following the dot com bubble burst in the US around the turn of . According to Porte’s (2009). Bailout of Wall Street and the financial industry moral hazard also lay at the core of many of the causes. slowdown in foreign investments. The crisis has brought about a slump in economic growth in most countries and has been called the most serious financial crisis since the Great Depression. The global imbalances interacted with the flaws in financial markets and instruments to generate the specific features of the crisis. The role of monetary policy in the major advanced economies. in turn. however. particularly in China. Genesis of global financial crisis The proximate cause of the current financial turbulence is attributed to the sub-prime mortgage sector in the USA. Such a view. These savinginvestment imbalances and consequent huge cross-border financial flows put great stress on the financial intermediation process. But. At a fundamental level. were the outcome of long periods of excessively loose monetary policy in the major advanced economies during the early part of this decade. Initially. offers only a partial analysis of the recent global economic environment. the crisis could be ascribed to the persistence of large global imbalances. substantial financial commitments incurred by the governments and significant decline in the economic activity. These imbalances in the current account are often seen as the consequence of the relative inflexibility of the currency regimes in China and some other EMEs. rapid decrease in international trade. following the collapse of the housing sector boom. however. global macroeconomic imbalances were the major underlying cause of the crisis.S. dollars. particularly that in the United States.

Policy rates in the US reached one per cent in June 2003 and were held around these levels for an extended period (up to June 2004) (Chart 1).the decade. op. There was no greater or more persistent deviation of actual Fed policy since the turbulent days of the 1970s. especially during 2002-04. In the subsequent period. though they did not go as far down the policy rate curve as the US Fed did. the withdrawal of monetary accommodation was quite gradual. So there is clearly evidence that there were monetary excesses during the period leading up to the housing boom” (Taylor. CHART 1: .cit. monetary policy in the US and other advanced economies was eased aggressively. was substantially looser than what a simple Taylor rule would have required (Chart 2). “This was an unusually big deviation from the Taylor Rule.). An empirical assessment of the US monetary policy also indicates that the actual policy during the period 2002-06. Taylor also finds some evidence (though not conclusive) that rate decisions of the European Central Bank (ECB) were also affected by the US Fed monetary policy decisions.

aggregate demand consistently exceeded domestic output in the US and. asset prices also recorded strong gains. The large domestic demand of the US was met by the rest of the world. with such low nominal and real interest rates. Sustained current account surpluses in some of these EMEs also reflected the lessons learnt from the Asian financial crisis. Thus. which provided goods and services at relatively low costs leading to growing surpluses in these countries. Thus measured inflation in the advanced economies remained low. it was made with purposeful and careful consideration by monetary policy makers. particularly in housing and real estate. especially China and other East Asian economies.Chart 2: Excessively loose monetary policy in the post dot com period boosted consumption and investment in the US. Furthermore. . this was mirrored in large and growing current account deficits in the US over the period (Table 1). the availability of relatively cheaper goods and services from China and other EMEs also helped to maintain price stability in the US and elsewhere. As might be expected. contributing to the persistence of accommodative monetary policy. which might have not been possible otherwise. providing further impetus to consumption and investment through wealth effects. given the macroeconomic identity.

it can be observed that the Euro area as a whole did not exhibit large current account deficits throughout the current decade. Yet. rose significantly from 2004 onwards.Table:1 The emergence of dysfunctional global imbalances is essentially a post 2000 phenomenon and which got accentuated from 2004 onwards. particularly China. The surpluses of East Asian exporters. In fact. It would be interesting to explore the outcome had the exchange rate policies in China and other EMEs been more flexible. it exhibited a surplus except for a minor deficit in 2008. as did those of the oil exporters (Table 1). The sharp hike in oil and other commodity prices in early 2008 were indeed related to the very sharp policy rate cut in late 2007 after the sub-prime crisis emerged. Thus it is difficult to argue that the US large . The availability of low priced consumer goods and services from EMEs was worldwide.

current account deficit was caused by China’s exchange rate policy. The existence of excess demand for an extended period in the U.S. was more influenced by its own macroeconomic and monetary policies, and may have continued even with more flexible exchange rate policies in China. In the event of a more flexible exchange rate policy in China, the sources of imports for the US would have been some countries other than China. Thus, it is most likely that the US current account deficit would have been as large as it was – only the surplus counterpart countries might have been somewhat different. The perceived lack of exchange rate flexibility in the Asian EMEs cannot, therefore, fully explain the large and growing current account deficits in the US. The fact that many continental European countries continue to exhibit surpluses or modest deficits reinforces this point. Apart from creating large global imbalances, accommodative monetary policy and the existence of very low interest rates for an extended period encouraged the search for yield, and relaxation of lending standards. Even as financial imbalances were building up, macroeconomic stability was maintained. Relatively stable growth and low inflation have been witnessed in the major advanced economies since the early 1990s and the period has been dubbed as the Great Moderation. The stable macroeconomic environment encouraged under pricing of risks. Financial innovations, regulatory arbitrage, lending malpractices, excessive use of the originate and distribute model, securitization of sub-prime loans and their bundling into “AAA” tranches on the back of ratings, all combined to result in the observed excessive leverage of financial market entities. Components of the crisis: Most of the crises over the past few decades have had their roots in developing and emerging countries, often resulting from abrupt reversals in capital flows, and from loose domestic monetary and fiscal policies. In contrast, the current ongoing global financial crisis has had its roots in the US. The sustained rise in asset prices, particularly house prices, on the back of excessively accommodative monetary policy and lax lending standards during 2002-2006 coupled with financial innovations resulted in a large rise in mortgage credit to households, particularly low credit quality households. Most of these loans were with low margin money and with initial low teaser payments. Due to the “originate and distribute” model, most of these mortgages had been securitized. In combination with strong growth in complex credit derivatives and the use of credit ratings, the mortgages,

inherently sub-prime, were bundled into a variety of tranches, including AAA tranches, and sold to a range of financial investors. As inflation started creeping up beginning 2004, the US Federal Reserve started to withdraw monetary accommodation. With interest rates beginning to edge up, mortgage payments also started rising. Tight monetary policy contained aggregate demand and output, depressing housing prices. With low/negligible margin financing, there were greater incentives to default by the sub-prime borrowers. Defaults by such borrowers led to losses by financial institutions and investors alike. Although the loans were supposedly securitized and sold to the off balance sheet special institutional vehicles (SIVs), the losses were ultimately borne by the banks and the financial institutions wiping off a significant fraction of their capital. The theory and expectation behind the practice of securitization and use of derivatives was the associated dispersal of risk to those who can best bear them. What happened in practice was that risk was parceled out increasingly among banks and financial institutions, and got effectively even more concentrated. It is interesting to note that the various stress tests conducted by the major banks and financial institutions prior to the crisis period had revealed that banks were well-capitalized to deal with any shocks. Such stress tests, as it appears, were based on the very benign data of the period of the Great Moderation and did not properly capture and reflect the reality (Haldane, 2009). The excessive leverage on the part of banks and the financial institutions (among themselves), the opacity of these transactions, the mounting losses and the dwindling net worth of major banks and financial institutions led to a breakdown of trust among banks. Given the growing financial globalization, banks and financial institutions in other major advanced economies, especially Europe, have also been adversely affected by losses and capital write-offs. Inter-bank money markets nearly froze and this was reflected in very high spreads in money markets. There was aggressive search for safety, which has been mirrored in very low yields on Treasury bills and bonds. These developments were significantly accentuated following the failure of Lehman Brothers in September 2008 and there was a complete loss of confidence. The deep and lingering crisis in global financial markets, the extreme level of risk aversion, the mounting losses of banks and financial institutions, the elevated level of commodity prices (until the third quarter of 2008) and their

subsequent collapse, and the sharp correction in a range of asset prices, all combined, have suddenly led to a sharp slowdown in growth momentum in the major advanced economies, especially since the Lehman failure. Global growth for 2009, which was seen at a healthy 3.8 per cent in April 2008, is now projected to contract by 1.3 per cent (IMF, 2009c) (Table 2). Major advanced economies are in recession and the EMEs – which in the earlier part of 2008 were widely viewed as being decoupled from the major advanced economies – have also been engulfed by the financial crisis-led slowdown. Global trade volume (goods and services) is also expected to contract by 11 per cent during 2009 as against the robust growth of 8.2 per cent during 2006-2007. Private capital inflows (net) to the EMEs fell from the peak of US $ 617 billion in 2007 to US $ 109 billion in 2008 and are projected to record net outflows of US $ 190 billion in 2009. The sharp decline in capital flows in 2009 will be mainly on account of outflows under bank lending and portfolio flows. Thus, both the slowdown in external demand and the lack of external financing have dampened growth prospects for the EMEs much more than that was anticipated a year ago.

but also have a profound impact on the rest of the world through changes in risk premia and search for yield leading to significant .Table 2: The Impact of the crisis on the global economy has been studied here forth and the study is focused on following factors as a whole: • Volatility in capital flows • Initial impact of sub-prime crisis • Impact of Lehman failure Volatility in capital flows Implications for emerging market Economies: Monetary policy developments in the leading economies not only affect them domestically.

such flows rose manifold to an annual average of US $ 285 billion during 2003-2007 reaching a peak of US $ 617 billion in 2007 (Chart 3). Beginning 2003. as a group. but with increased volatility over time. but with large volatility (Committee on Global Financial System. As noted earlier. macroeconomic stability. The monetary policy dynamics of the advanced economies thus involve sharp adjustment for the EMEs. After remaining nearly flat in the second half of the 1980s. Overall. Thus. The major push factor is the stance of monetary policy in the advanced economies. in response to these factors. the EMEs. The pull factors that have led to higher capital flows include strong growth in the EMEs over the past decade. 2009). Periods of loose monetary policy and search for yield in the advanced economies encourages large capital inflows to the EMEs and vice versa in periods of tighter monetary policy. a period coinciding with the low interest rate regime in the US and major advanced economies and the concomitant search for yield. are now likely to witness outflows of US $ 190 billion in 2009 – the first contraction since 1988. capital flows to the EMEs since the early 1980s have grown over time. while direct investment flows have generally seen a steady increase over the period. private capital flows jumped to an annual average of US $ 124 billion during 1990-96. Large capital flows to the EMEs can be attributed to a variety of push and pull factors. reduction in inflation. on the spectrum of asset and commodity prices. Innovations in information technology have also contributed to the twoway movement in capital flows to the EMEs. the consequent volatility in capital flows impinges on exchange rate movements and more generally.switches in capital flows. Amongst the major components. While the large volatility in the monetary policy in the US. could have been dictated by internal compulsions to maintain employment and price stability. Private capital flows to EMEs have grown rapidly since the 1980s. total private capital flows fell to an annual average of US $ 86 billion during 1997-2002. portfolio flows as well as other private flows . swings in monetary policy in the advanced economies lead to cycles and volatility in capital flows to the EMEs.1 with the onset of the Asian financial crisis. especially since the beginning of this decade. opening up of capital accounts and buoyant growth prospects.

and gross capital flows are a multiple of both net capital flows and current account transactions. Also. . large private capital flows have taken place in an environment when major EMEs have been witnessing current account surpluses leading to substantial accumulation of foreign exchange reserves in many of these economies. portfolio and bank flows reflect both the push and the pull factors. It is also evident that capital account transactions have grown much faster relative to current account transactions.(bank loans etc) have exhibited substantial volatility. While direct investment flows largely reflect the pull factors.

As the monetary accommodation was withdrawn in a phased manner. can lead to high domestic credit and monetary growth. through mid 2004. net capital flows and accretion to foreign exchange reserves in excess of such requirements necessitate sterilization and more active monetary and macroeconomic management. However. However. Given such a large monetary expansion and given the past experiences. At present. Similarly. high real GDP growth needs concomitant growth in monetary aggregates. Thus. which also needs expansion of base money. Low nominal interest rates were also witnessed in other major advanced economies over the same period. if the unwinding of the current monetary expansion is not made in a timely fashion. base money growth witnessed correction beginning 2004. This brief discussion highlights the correlation between monetary policy cycles in the advanced economies on the one hand and pricing/mispricing of risk and volatility in capital flows on the other hand. To this extent. and general excess domestic demand leading to macroeconomic and financial instability. boom in stock market and other asset prices. The expected reversal of capital flows from the EMEs was somewhat delayed and finally took place in 2008. well in excess of the current financing needs.As noted earlier. Base money in the US more than doubled over a period of just six months between June and December 2008. the policy interest rates in the US reached extremely low levels during 2002 – one per cent – and remained at these levels for an extended period of time. the previous episode (1993-96) of heavy capital inflows was also preceded by a significant expansion of base money during 1990-94. In rapidly growing economies such as India. capital flows to the EMEs continued to be strong. contrary to the previous episodes. . The extremely accommodative monetary policy in the advanced economies was mirrored in the strong base money expansion during the period 2001-02 – shortly before the beginning of the current episode of strong capital flows to EMEs. the accretion of unsterilized foreign exchange reserves to the central bank’s balance sheet is helpful in expanding base money at the required rate. and sharp contraction thereafter. large inflows of capital. large capital inflows to the EMEs could resume in the foreseeable future. monetary policies across the advanced economies have again been aggressively eased and policy interest rates have reached levels even lower than those which were witnessed in 2002.

unless managed proactively. Such reversals also result in the contraction of the central bank’s balance sheet. especially the US. Despite an abundance of cross-section. While the liberalization of equity flows seems to enhance growth prospects. The global search for yield was reflected in record high volume of capital flows to the EMEs. the evidence that the liberalization of debt flows is beneficial to the EMEs is ambiguous (Henry. in principle. during the period 2002-04 boosted consumption and asset prices. the excess was . At the same time. which may be difficult to compensate with accretion of domestic assets as fast as the reserves depletion. excessively accommodative monetary policy for an extended period in the major advanced economies in the post dot com crash period sowed the seeds of the current global financial and economic crisis. the boom and bust pattern of capital inflows can. 2007. as again shown by the current financial crisis. panel. opening the financial account does appear to raise the frequency and severity of economic crises (Obstfeld. both domestically and globally. are quick. the authorities in the EMEs need to watch closely and continuously financial and economic developments in the advanced economies on the one hand and actively manage their capital account. there is strikingly little convincing documentation of direct positive impacts of financial opening on the economic welfare levels or growth rates of developing countries. Too low shortterm rates also encouraged aggressive search for yield. 2009). Too low policy interest rates.Abrupt reversals in capital flows also lead to significant difficulties in monetary and macroeconomic management. The evidence appears to favor a hierarchy of capital flows. and resulted in aggregate demand exceeding output. heavy recourse to securitization and lax regulation and supervision. large employment and output losses and huge fiscal costs. which was manifested in growing global imbalances. necessitating a painful adjustment in bank credit. this theoretical conjecture is not supported by the accumulated empirical evidence. since such flows were well in excess of their financing requirements. Thus. These developments can then lead to banking and currency crises. While. To summarize. Committee on Global Financial System (2009)). Hence. result in macroeconomic and financial instability. and collapse of stock prices. capital account liberalization is expected to benefit the host economy and raise its growth rate. encouraged by financial engineering. and event studies. Reversals of capital flows from the EMEs. There is also little systematic evidence that financial opening raises welfare indirectly by promoting collateral reforms of economic institutions or policies.

the large volatility in monetary policy in the major reserve currency countries contributed to the initial excesses and their subsequent painful correction. Monetary policy continued with pre-emptive tightening measures up to August 2008. substantial deleveraging. leading to depressed long-term interest rates. sharp increase in risk aversion. but also in emerging market economies. credit booms. The consequent tightening of monetary policy led to correction in housing prices. the aggregate demand pressures of the accommodative monetary started getting reflected initially in oil and other commodity prices and finally onto headline inflation. thus. The combined effect of these developments was excessive indebtedness of households. The larger . there was a massive jump in net capital inflows into the country. The Reserve Bank had to sterilize the liquidity impact of large foreign exchange purchases through a series of increases in the cash reserve ratio and issuances under the Market Stabilization Scheme (MSS). large losses for banks and financial institutions. encouraged defaults on sub-prime loans. In brief.recycled back to the advanced economies. asset price booms and excessive leverage in the major advanced economies. Indeed. Financial excesses of the 2002-06 were. Initial impact of the sub-prime crisis: The initial impact of the sub-prime crisis on the Indian economy was rather muted.2 with persistent inflationary pressures emanating both from strong domestic demand and elevated global commodity prices. and large capital outflows from the EMEs. following the cuts in the US Fed Funds rate in August 2007. The Great Moderation over the preceding two decades led to under-pricing of risks and the new financial and economic regime was considered as sustainable. reversed in a disruptive manner and have now led to the severest post-war recession. complete lack of confidence and trust amongst market participants. The relatively lower presence of foreign banks in the Indian banking sector also minimized the direct impact on the domestic economy (Table 3). While forces of globalization were able to keep goods and services inflation contained for some time. policy rates were also raised. The direct effect of the sub-prime crisis on Indian banks/financial sector was almost negligible because of limited exposure to complex derivatives and other prudential policies put in place by the Reserve Bank.

as happened in Eastern European and Baltic countries. for example. in response to the stock and real estate market collapse of early 1990s. domestic bank credit supply can shrink during crisis episodes.presence of foreign banks can increase the vulnerability of the domestic economy to foreign shocks. is predicted to lead to a decline of up to 3 percent in international bank lending to developing countries (World Bank. . Econometric evidence shows a statistically significant relationship between international bank lending to developing countries and changes in global liquidity conditions. it can be forced to scale down its operations in the domestic economy. For instance. even as the fundamentals of the domestic economy remain robust. Treasury bill rates. A 10 basis-point increase in the spread between the London Interbank Offered Rate (LIBOR) and the OIS sustained for a quarter. Thus. as measured by spreads of interbank interest rates over overnight index swap (OIS) rates and U. 2008). Japanese banks pulled back from foreign markets – including the United States – in order to reduce liabilities on their balance sheets and thereby meet capital adequacy ratio requirements.S. In view of significant liquidity and capital shocks to the parent foreign bank.

As in the case of other major EMEs.Table 3 Impact of Lehman failure: Balance of payments: capital outflows There was also no direct impact of the Lehman failure on the domestic financial sector in view of the limited exposure of the Indian banks. following the Lehman failure. . However. there was a selloff in domestic equity markets by portfolio investors reflecting deleveraging. there was a sudden change in the external environment.

The contraction of capital flows and the sell-off in the domestic market adversely affected both external and domestic financing for the corporate sector. a large part of the reserve loss (US $ 33 billion out of US $ 54 billion) during April-December 2008 reflected valuation losses. net capital inflows during 2008-09 were substantially lower than in 2007-08 and there was a depletion of reserves (Table 4). like most other emerging market economies. On the positive side. credit markets appear to be drying up in the developed world. I then outline our approach to the management of the exposures of the Indian financial sector entities to the collapse of major financial institutions in the US. The sharp slowdown in demand in the major advanced economies is also having an adverse impact on our exports and industrial performance. However. I will. The financial market crisis has led to the collapse of major financial institutions and is now beginning to impact the real economy in the advanced economies. briefly set out reasons for the relative resilience shown by the Indian economy to the ongoing international financial markets’ crisis. While foreign direct investment flows exhibited resilience. has so far. However. how much will these developments affect India and other Asian emerging market economies (EMEs)? India. the significant correction in international oil and other commodity prices has alleviated inflationary pressures as measured by wholesale price index.Consequently. With the substantive increase in financial globalization. On the whole. Orderly conditions have been maintained in the . not been seriously affected by the recent financial turmoil in developed economies. various measures of consumer prices remain at elevated levels on the back of continuing high inflation in food prices. In my remarks today. As this crisis is unfolding. there were large capital outflows by portfolio investors during September-October 2008. access to external commercial borrowings and trade credits was rendered somewhat difficult. with concomitant pressures in the foreign exchange market. Impact on India Economy: The turmoil in the international financial markets of advanced economies that started around mid-2007 has exacerbated substantially since August 2008. first. This will be followed by some discussion of the impact till date on the Indian economy and the likely implications in the near future.

as measured by the sum of current receipts and current payments. This approach is consistent with the weight of the available empirical evidence with regard to the benefits that may be gained from capital account liberalization for acceleration of economic growth. which is attributable to a range of instruments available with the monetary authority to manage a variety of situations. Finally. up from about 19 per cent of GDP in 1991. With this degree of openness. to the global financial market crisis. over the 1990s. particularly in emerging market economies. needs to be assessed in this context. The relatively limited impact of the ongoing turmoil in financial markets of the advanced economies in the Indian financial markets. a more calibrated approach has been followed to the opening of the capital account and to opening up of the financial sector. the sum of gross capital inflows and outflows increased from 12 per cent of GDP in 1990-91 to around 64 per cent in 2007-081. The current account. . on the capital account. The opening to foreign direct investment. despite the capital account not being fully open. The evidence suggests that the greatest gains are obtained from. and more generally the Indian economy. Similarly. amounted to about 53 per cent of GDP in 2007-08. I would briefly set out my thinking on the extent of vulnerability of the Asian economies. The impact of crisis is studies under following aspects: • Financial globalization: the Indian approach • Impact on Indian economy Financial Globalization: The Indian Approach: • The Indian economy is now a relatively open economy. though gradually. followed by portfolio equity investment until greater domes benefits emanating from external debt flows have been found to be more questionable. in general.domestic financial markets. developments in international markets are bound to affect the Indian economy and policy makers have to be vigilant in order to minimize the impact of adverse international developments on the domestic economy. Whereas the Indian current account has been opened fully.

first. Furthermore. portfolio investment in government securities and corporate bonds are also subject to macro ceilings. especially banks. Accordingly. large reliance by banks on borrowed funds can exacerbate vulnerability to external shocks. the Reserve Bank has imposed prudential limits on banks on their purchased inter-bank liabilities and these limits are linked to their net worth.Accordingly. in India. As the current global financial crisis has shown. Resident individuals are also permitted outflows subject to reasonable limits. restricting the overnight unsecured market for funds to banks and primary dealers (PD) as well as limits on the borrowing and lending operations of these entities in the overnight inter-bank call money market. liquidity risks can rise manifold during a crisis and can pose serious downside shown. which are also modulated from time to time. in order to encourage greater reliance on stable sources of funding. Second. In regard to capital outflows. • The financial sector. Similarly. liquidity risks can rise manifold during a crisis and can pose serious downside shown. Thus. Finally. both in regard to capital and liquidity (Mohan. asset liability management guidelines for dealing with overall asset-liability mismatches take into account both on and off balance sheet items. the policy framework has been progressively liberalized to enable the non-financial corporate sector to invest abroad and to acquire companies in the overseas market. prudential policies have attempted to prevent excessive recourse to foreign borrowings and dollarization of the economy. Some of the important measures by the Reserve Bank in this regard include. This has been brought out quite strikingly in the ongoing financial crisis in the global financial markets. Third. the incremental credit deposit ratio of banks is also monitored by the Reserve Bank since this ratio indicates the extent to which banks are funding credit with borrowings from wholesale markets (now known as purchased funds). especially direct investment inflows. nuanced approach has been adopted in regard to debt flows. a more cautious. is subject to prudential regulations. which are modulated from time to time taking into account evolving macroeconomic and monetary conditions. 2007b). Companies in the overseas market. liquidity risks can rise manifold during a crisis and can pose serious downside well. Debt flows in the form of external commercial borrowings are subject to ceilings and some end-use restrictions. while encouraging foreign investment flows. guidelines on securitization of standard assets have laid down .

the Reserve Bank has also successively imposed additional prudential measures in respect of exposures to particular sectors. akin to a policy of dynamic provisioning. but higher levels under Pillar II could be prescribed on the basis of risk profile and risk management systems. 2008 and all other scheduled commercial banks encouraged to migrate to Basel II in alignment with them but not later than March 31. Furthermore. risk weights and provisioning requirements for specific off-balance sheet items including derivatives have been reviewed. In order to further strengthen capital requirements. the credit conversion factors. For example. In tune with RBI’s objective to have consistency and harmony with international standards. After analyzing the global schedule for implementation. Minimum capital-to-risk-weighted asset ratio (CRAR) would be 9 per cent. banks were advised to put in place a proper risk management system to contain the risks involved. margins to be kept. in view of the accelerated exposure observed to the real estate sector.a detailed policy on provision of liquidity support to Special Purpose Vehicles (SPVs). complex structures like synthetic securitization have not been permitted so far. in India. the risk weight on banks' exposure to commercial real estate was increased from 100 per cent to 125 per cent in July 2005 and further to 150 per cent in April 2006. 2009. the Standardized Approach for credit risk and Basic Indicator Approach for operational risk have been prescribed. collaterals to be considered. Banks were advised to formulate specific policies covering exposure limits. 2008. sanctioning authority/level and sector to be financed. Introduction of such products. would be guided by the risk management capabilities of the system. 2010. • The Reserve Bank has also issued detailed guidelines on implementation of the Basel II framework covering all the three pillars with the guidelines on Pillar II being issued as recently as on March 27. In addition to the exercise of normal prudential requirements on banks. In view of the rapid increase in loans to the real estate sector raising concerns about asset quality and the potential systemic risks posed by such exposure. it was decided that all foreign banks operating in India and Indian banks having a presence outside India should migrate to Basel II by March 31. when found appropriate. The risk weight on housing loans extended by banks to individuals against mortgage of housing properties and . The banks have been asked to bring Tier I CRAR to at least 6 per cent before March 31.

2 An additional feature of recent prudential actions by the Reserve Bank relate to the tightening of regulation and supervision of Non-banking Financial Companies (NBFCs). and thus. both for product diversity and. Thus. Thus. the Reserve Bank increased the risk weight for consumer credit and capital market exposures from 100 per cent to 125 per cent. though this was later Reduced to 50 per cent for lower value loans. despite large fiscal deficits. so that regulatory arbitrage between these companies and the banking system is minimized. Derivative instruments have been introduced cautiously in a phased manner. Investment has been predominantly financed domestically in India – the current account deficit has averaged between one and two per cent of GDP since the early 1990s. excessive leverage in this sector has been in mortgage backed securities (MBS) of housing finance companies (HFCs) was increased from 50 per cent to 75 per cent in December 2004. more importantly. it was felt that the quality of lending could suffer during the phase of rapid expansion. Various segments of the domestic financial market have been developed over a period of time to facilitate efficient channeling of resources form savers to investors and enable the continuation of domestic growth momentum (Mohan. Similarly. macroeconomic and financial stability has been maintained. All these developments have facilitated the process of price discovery in various financial market segments. Hence. as a risk management tool. The regulatory interventions are graded: higher in deposit-taking NBFCs and lower in non-deposit-taking NBFCs. capital adequacy ratios and prudential limits to single/group exposures in the case of NBFCs have been progressively brought nearer to those applicable to banks. The rate of increase in foreign exchange market turnover in India between April 2004 and April 2007 was the highest amongst the 54 countries covered in the latest Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by the Bank for International Settlements . as a counter cyclical measure. The Government’s fiscal deficit has been high by international standards but is also largely internally financed through a vibrant and well developed government securities market. The overarching principle is that banks should not use an NBFC as a delivery vehicle for seeking regulatory arbitrage opportunities or to circumvent bank regulation(s) and that the activities of NBFCs do not undermine banking regulations. 2007a). in light of the strong growth of consumer credit and the volatility in the capital markets.

are supporting domestic growth. though much further development needs to be done. as large segments of economic agents in India may not have adequate resilience to withstand volatility in currency and money markets. The risks arise mainly from the potential reversal of capital flows on a sustained mediumterm basis from the projected slow down of the global economy. These characteristics of India's external and financial sector management coupled with ample forex reserves coverage and the growing underlying strength of the Indian economy reduce the susceptibility of the Indian economy to global turbulence. relatively deep and liquid markets for government securities. Financial markets are contributing to efficient channeling of domestic savings into productive uses and.(BIS). there is recognition that the country does face some downside risks from these international developments. and the concomitant effects on the domestic forex market and liquidity conditions. taking into cognizance reforms in the other sectors of the economy. In brief. the share of India in global foreign exchange market turnover trebled from 0. currency and derivatives in India. However. phased and calibrated opening of the domestic financial and external sectors. Impact of the Crisis on India: While the overall policy approach has been able to mitigate the potential impact of the turmoil on domestic financial markets and the economy. by financing the overwhelming part of domestic investment.9 per cent in April 2007.3 per cent in April 2004 to 0. the healthy balance sheets of The Indian corporate sector and the predominant . and from some elements of potential financial Contagion. There has been consistent development of wellfunctioning. particularly in advanced economies. According to the survey. with the increasing integration of the Indian economy and its financial markets with rest of the world. daily average turnover in India jumped almost 5-fold from US $ 7 billion in April 2004 to US $ 34 billion in April 2007. In India. The macro effects have so far been muted due to the overall strength of domestic demand. the adverse effects have so far been mainly in the equity markets because of reversal of portfolio equity flows. our approach has been to be increasingly vigilant and proactive to any incipient signs of volatility in financial markets. the Indian approach has focused on gradual.

the Sensex has now dropped to a level of 11.3 billion in April-June 2007 to US$13.5 (US $ 1 = Rs. 40. there has been significant pressure on the Indian exchange rate in recent months. Similarly. have some .12) in September 2006 to 115. With portfolio flows reversing in 2008. Whereas the real exchange rate appreciated from an index of 104. both debt and non-debt.74) as on October 8. The BSE Sensex (1978-79=100) increased significantly from a level of 13. 46. relative to the previous year (Table 1).6 billion in April-June 2008. their ambitious investment Plans.2 billion in April-June 2008. With the existence of a merchandise trade deficit of 7. As might be expected.0 billion in April-June 2007 to US$ 1.072 as at end-March 2007 to its peak of 20. 48. 2008 in the presence of heavy portfolio flows responding to the high growth performance of the Indian corporate sector.5 billion in the corresponding period last year. As noted earlier. Nonetheless.5 billion in the corresponding period of 2007). the impact of global financial turmoil has been felt particularly in the equity market.5 per cent.9 (base 1993-94=100) (US$1 = Rs. and change in perceptions with respect to capital flows. it has now depreciated to a level of 101. therefore. With the volatility in portfolio flows having been large during 2007 and 2008. 2008. partially in response to policy measures in the face of excess flows in 2007-08. However. in recent years.7 billion during AprilAugust 2008 as compared with US$ 8. domestic investment is largely financed by domestic savings.domestic financing of investment.4 billion in April-September 2008 as compared with a net inflow of US$ 15. 2008. external commercial borrowings of the corporate sector declined from US$ 7. Total net capital flows fell from US$17.873 on January 8.328 on October 8. mobilized significant resources from global financial markets for funding. While Foreign Direct Investment (FDI) inflows have continued to exhibit accelerated growth (US$ 16. The current risk aversion in the international financial markets to EMEs could. the corporate sector has.0 (US$ 1 = Rs.34) in September 2007. in line with similar large declines in other major stock markets. and a current account deficit of 1. partly because of the international market turmoil. portfolio investments by foreign institutional investors (FIIs) witnessed a net outflow of about US$ 6.7 per cent of GDP in 2007-08. the main impact of the global financial turmoil in India has emanated from the significant change experienced in the capital account in 2008-09 so Far. capital flows are expected to be more than sufficient to cover the current account deficit this year as well. but also due to the current turmoil in advanced economies.

Thus. On the other hand. the combined impact of the reversal of portfolio equity flows. Such corporate would. including bank credit. and the sustained high domestic savings rate. therefore. this impact can be expected to be at the margin. have to rely relatively more on domestic sources of financing. A detailed study undertaken by the RBI in September 2007 on the impact of the subprime episode on the Indian banks had revealed that none of the Indian banks or the foreign banks. with external savings utilization having been low traditionally. This could.3 per cent a year ago). on a macro basis. the continued buoyancy of foreign direct investment suggests that confidence in Indian growth prospects remains healthy. Moreover. similar to its peers in the rest of Asia. domestic primary capital market issuances have suffered in the current fiscal year so far in view of the sluggish stock market conditions. in turn. one can expect more demand for bank credit. Moreover. insurance. the reduced availability of international capital both debt and equity. 2008 as compared with 23. and the financial services sector which is now uncertain. with . Impact on the Indian Banking System: One of the key features of the current financial turmoil has been the lack of perceived contagion being felt by banking systems in EMEs. between one to two percent of GDP.The financial crisis in the advanced economies and the likely slowdown in these economies could have some impact on the IT sector. the current developments with respect to the US financial markets are very eventful. In summary. particularly in Asia. The Indian banking system also has not experienced any contagion. and pressure on the exchange rate.impact on the Indian corporate sector’s ability to raise funds from international sources and thereby impede some investment growth.2 per cent on a year-on-year basis as on September 12. and non-food credit growth has indeed accelerated in the current year (26. the perceived increase in the price of equity with lower equity valuations. About 15 per cent to 18 per cent of the business coming to Indian outsourcers includes projects from banking. put some upward pressure on domestic interest rates. and may have a direct impact on the IT industry and likely to create a downstream impact on other sectors of the US economy and worldwide markets. growth in the Indian corporate sector is likely to feel some impact of the global financial turmoil. the software trade association. According to the latest assessment by the NASSCOM.

Central banks in some cases have substantially loosened the collateral requirements to provide the necessary short-term liquidity. In contrast to the extreme volatility leading to freezing of money markets in major advanced economies. all banks were advised to report the details of their exposures to Lehman Brothers and related entities both in India and abroad. Consequent upon filling of bankruptcy under Chapter 11 by Lehman Brothers. However. no direct impact on account of direct exposure to the sub-prime market was in evidence. had any direct exposure to the subprime markets in the USA or other markets. which are not covered by the bankruptcy proceedings. which has filed for bankruptcy is not significant and banks are reported to have made adequate provisions. the Reserve Bank has announced a series of measures to facilitate orderly operation of financial markets and to ensure financial stability which predominantly includes extension of additional liquidity support to banks.whom the discussions had been held. In response to these developments. money markets in India have . reflected in large spreads over policy rates. RBI Response to the Crisis: • The financial crisis in advanced economies on the back of subprime turmoil has been accompanied by near drying up of trust amongst major financial market and sector players. Thus. central banks in major advanced economies have taken a number of coordinated steps to increase short-term liquidity. Out of 77 reporting banks. The lack of trust amongst the major players has led to near freezing of the uncollateralized inter-bank money market. even though the overnight markets remained stable. a few Indian banks had invested in the collateralized debt obligations (CDOs) / bonds which had a few underlying entities with subprime exposures. in view of mounting losses and elevated uncertainty about further possible Losses and erosion of capital. these banks’ exposure especially to Lehman Brothers Holding Inc. Overall. However. In the aftermath of the turmoil caused by bankruptcy. 14 reported exposures to Lehman Brothers and its related entities either in India or abroad. An analysis of the information reported by these banks revealed that majority of the exposures reported by the banks pertained to subsidiaries of Lehman Bros Holdings Inc. a few of these banks did suffer some losses on account of the mark-to-market losses caused by the widening of the credit spreads arising from the sub-prime episode on term liquidity in the market.

which was absorbed through sterilization operations involving LAF. in view of some reversal in capital flows. by and large. While in 2007 and the previous years. in regard to SLR. In view of the reversal of capital flows. MSS and CRR. The MSS operates symmetrically and has the flexibility to smoothen liquidity in the banking system both during episodes of capital inflows and outflows. limited by the excess SLR securities held by banks. functioning in an orderly fashion. market sale of foreign exchange by the Reserve Bank has led to withdrawal of liquidity from the banking system. provided adequate flexibility to manage the evolving situation. reflect the evolving capital flows. In view of this flexibility. fresh MSS issuances have been scaled down and there has also been some unwinding of the outstanding MSS balances. however. the Reserve Bank has been effectively able to manage domestic liquidity and monetary conditions consistent with its monetary policy stance. While LAF and MSS have been able to bear a large part of the burden. large capital flows and their absorption by the Reserve Bank led to excessive liquidity. The existing set of monetary instruments has. • For instance. in turn. thus. money market liquidity is also impacted by our operations in the foreign exchange market. Furthermore. the Reserve Bank did not have to invent new instruments or to dilute the collateral requirements to inject liquidity. unlike central banks in major advanced economies. During 2008. to meet the liquidity mismatches. 2008. This has been enabled by the appropriate use of a range of instruments available for liquidity management with the Reserve Bank such as the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)stipulations and open market operations (OMO) including the Market Stabilization Scheme (MSS)4 and the Liquidity Adjustment Facility (LAF). purely as temporary measures. albeit with some pressures. which. the Reserve Bank permitted banks to use up to an additional 1 percent of their . some modulations in CRR and SLR have also been resorted. on September 16. However.been. The daily LAF repo operations have emerged as the primary tool for meeting the liquidity gap in the market. LAF repo operations are. • Large swings in capital flows – as has been experienced between 2007-08 and 2008-09 so far – in response to the global financial market turmoil have made the conduct of monetary policy and liquidity management more complicated in the recent months.

Liquidity modulation through a flexible use of a combination of instruments has. for a temporary period. This has imparted a sense of confidence in the market in terms of availability of short-term liquidity. for drawing liquidity support under LAF from RBI. . could be considered as a vast pool of backup liquidity that is available for liquidity management as the situation may warrant for relieving market pressure at any given time. temporary changes in the prudential ratios such as CRR and SLR combined with flexible use of the MSS. The recent innovation with respect to SLR for combating temporary systemic illiquidity is particularly noteworthy. volatility in global markets and the dangers of potential spillovers to domestic equity and currency markets.on a review of the liquidity situation in the context of global and domestic developments. The CRR which had been gradually increased from 4. Active liquidity management is a key element of the current monetary policy stance. is reflective of prudent practices. as and when the situation warrants. cushioned the impact of the international financial turbulence on domestic financial markets by absorbing excessive market pressures and ensuring orderly conditions. 2008) – the first cut after a gap of over five years . as the very recent experience shows. despite extreme turmoil in the global financial markets. In view of the evolving environment of heightened uncertainty. using all the policy instruments at its disposal flexibly. liquidity management will continue to receive priority in the hierarchy of policy objectives over the period ahead. • The relative stability in domestic financial markets. to a significant extent.NDTL. Thus. The Reserve Bank will continue with its policy of active demand management of liquidity through appropriate use of the CRR stipulations and open market operations (OMO) including the MSS and the LAF.5 per cent in 2004 to 9 per cent by August 2008 was cut by 50 basis points on October 65 (to be effective October 11. strengthened reserves and the strong growth performance in recent years in an environment of flexibility in the conduct of policies.

Depreciation of Rupee and Fall of Stock Market: The most immediate effect of that crisis on India has been an outflow of foreign institutional investment from the equity market. Foreign institutional investors. slightly higher than the FDI received in 2007-08 (US$ 34.FDI investment during 2008-09 was volatile but overall remained stable. have become major sellers in Indian markets.3 billion). Depreciation of Rupee and Fall of Stock Market| • Fall in Growth Rate. Outsourcing Services and Service Sector • Other Implications Reversals of Capital Flows. Industrial Output and Rise in Inflation • Fall in Exports. Since Then the downward trend of FII has remained unabated. who need to retrench assets in order to cover losses in their home countries and are seeking havens Of safety in an uncertain environment. . he financial crisis has also created a shortage of money supply and India is also facing a credit crunch especially in terms of foreign exchange and the Indian Banking sector and forex markets are facing tight liquidity situations each passing day for the past quite some time.6 billion. Almost immediately after the crisis surfaced FII registered a steel fall between October and November 2007. Foreign investment received in 2008-09 was US$ 35. A significant difference in the total investments of 2008-09 and 2007-08 has been on due to the inflow and outflow of foreign investment observed in 2007-08 and 2008-09 respectively. from $ 5.1 billion.7 billion to minus 1.RBI studied the impact of the crisis in various other factors which affected the Indian economy as a whole: • Reversals of Capital Flows. FIIs have pulled out an estimated US$ 13 billion from Indian stock market in 2008. This liquidity crisis along with FII sell off has forced the Indian Rupee to devaluate like never before and in a span of 9 months the Indian Rupee has slipped from around Rs 40/US $ to Rs 47.

Chart:4 As is to be expected. the sharp fall in FII followed by their withdrawal contributed. Indian stock markets are never free from falling big and the market crash in 2008 was an anticipated one. but a fall of this extent was never anticipated by even the big of the bear. Given the relative thinness of the Indian share market. FII outflows might also have had a negative impact on domestic investment. to the bursting of the India’s stock market bubble (figure 4). However. albeit with some lag. .

fuelled in part by substantial FII inflows. the share market boom continued until early 2008.858 to 19. The bullish sentiments prevailed for a short while even after the downward drift in FII began in November 2007. though IIP growth had started declining since March 2007. RPL. the Bombay Stock Exchange (BSE) index.Stocks like RNRL. a fall in the rupee and poor IIP numbers led to the fall. The crisis in the global markets. I spat. between March and December 2007. Essar oil and Nagarjuna fertilizers have lost 50-70% of their value.Chart:5 Curiously enough.827. The Indian Stock Markets have crashed8 from a peak of around 21. .000 in January 2008 to close to 10000 in December 2008. went up from 12.

That was just the beginning of slowdown impact on “India’s GDP growth. the global economy experienced. Manufacturing. Data released by CSO showed that the factory output shrank by 1.Fall in Growth Rate. These measures have however have led to widening of fiscal deficits. which constitutes 80 per cent IIP (Index of Industrial Production). intermediates and consumer goods shrank compared with a year ago (Figure 6). 8% and 10. against 8.8% and 9. Industrial Output and Rise in Inflation: Second. GDP started decelerating in the first quarter of 2007-08. GDP growth for 2008-09 was estimated at 6.6%. from November 2007 . as production of basis. For a little over a year after the outbreak of financial crisis. on week global and domestic demand. forestry and fishing. the global financial crisis and credit crunch have slowed India’s economic growth.0% posted in the previous year.8 per cent in the same period a year ago.8 per cent during April-February.4 per cent in February. So far as the Indian economy is concerned since prices of practically all petroleum products are administered and trade in agricultural goods is far from free. This is against growth rate of 9. despite tax cuts and fresh spending programme announced by the government of India in December and January to boost domestic demand. India’s industrial output fell at its fastest annualized rate in 14 years. contracted by 1. it is not only manufacturing industry but also the services sector that is getting hit. Industrial output thus grew 2. Due to shrinkage in demand in the markets.6% respectively in 2008-09 against the growth of 4. The government came up with a set of stimulus measures on three occasions to aid the ailing industry compromising on the deficits. Poor agricultural growth is also attributed to low monsoon in major parts of India (Figure 5).2 per cent in February. with the growth slowdown on the one hand and rising inflation on the other hand. 3. nearly six months before the outbreak of the US financial crisis and considerably ahead of the surge of recessionary tendencies in all developed countries from August-September 2008.7% as compared to the growth of 9.5 per cent during the same month a year ago.8% respectively in 2007-08. between September 2007 and October 2008. a pronounced stagflationary phase. transmission of global inflation to domestic prices occurred with a time lag. All the three segments of the GDP namely agriculture. industry and services sector were seen to post growth of 1.9%. Further.

1%. Further. Inflation rate stood at 16. This was driven in part by a reduction in government fuel subsidies. Inflation has climbed steadily during the year.rather than September 2007. its highest rate in 13 years. There has also been a no-less alarming rise in the price of oil and gas (Table 3). according to latest Tyre Manufacturing Association of India.3 per cent during April to June 2008. which have lifted gasoline prices by an average 10% Fall in Exports. Indeed. When coupled with rises in the price of the majority of commodities.2 million tones during the current fiscal buoyed by healthy domestic demand.516 million in March 2009. the key Indian Inflation Rate. This is more than 6% higher than a year earlier and almost three times the RBI’s target of 4. worldwide slowdown in vehicles sales is likely to drag down India’s components exports between zero and 5 per cent in the current fiscal. . There was an alarming increase in June. Centre for Monitoring Indian Economy (CMIE). by July 2008. It must be noted this growth contraction has come after a robust 25%-plus average export growth since 2003. which accounts for almost 33% decline (Figure 7). Beginning of 2008 has seen a dramatic rise in the price of rice and other basic food stuffs. Exports have declined continuously since July 2008 except the month of December. The slowdown in the trade sector post April 2008 is more explicit. During the period exports registered a 22 per cent drop against that the in the same period of 2008-09). the Wholesale Price Index. when the figure jumped to 11%.095 million in July 2008 to US$ 11. has risen above 11%.75% at the end of May.India's export of steel fall by a whopping 35 per cent to 3. Outsourcing Services and Service Sector: India’s exports fell the most in at least 14 years as the worst global recession since the Great Depression slashed demand for the nation’s jewellery. reaching 8. Automotive tyre exports from India also suffered a setback in the first quarter of current financial year. A low-to-negative growth in exports may continue for sometime until consumption revives in the developed economies. clothing and other products. They declined from US$ 17. higher inflation was the only likely outcome.

the commerce ministry had set an export target of $200 billion for 2008-09. Apparel exports from India have fallen sharply by 24 percent since August 2008 due to declining sales in the US and the European Union while those from Bangladesh.6 percent to $12. But the latest numbers reveal that India has missed even the revised target.2 billion during Q4 of 2008-09 was almost in line with an average software exports of US$ 11.• The Automotive Components Manufacturing Association has warned that if the slump in auto sales continues. the ratio goes up further. Indonesia and Vietnam are on an upswing. The domestic tea industry.from about 10% of GDP in 2002-03.9 billion) recorded in the first three quarters of 2008-09.Initially. imports fell 36.5 lakh tones in 2006-07 to only 11 lakh tones in 2007-08. exports could also be negative this year.6 percent in April from a year earlier and the trade deficit narrowed to US$5 billion from US$8. The current global meltdown has hit the country’s cashew farmers.58 per cent in terms of quantity and 8. while non-oil purchases dropped 24.6 billion. However. the contribution of merchandise exports to GDP has risen steadily over the past six years.9 billion recorded in the first three quarters of 2008-09.7 billion in the same month in 2008. The trade deficit on a Bop (Balance of Payment) basis in Q4 of 2008-09 (US$ 14. has been pushed back into gloom y the ongoing financial crisis. Indian seafood export during 2007-08 has also recorded a fall of 11. The trade deficit during Q4 of 2008-09 was much lower than that of Q4 of 2007-08 (US$ 22.6 billion) was less than half of the average trade deficit (US$ 34.5 percent to US$3. The sharp decline in both exports and imports during Q4 of 2008-09 led to a Lower trade deficit (Table 4). even though our economy is far more domestically driven than those of the East Asia. which was subsequently revised downwards to US$175 billion in January this year. to nearly 17% by 200708. If one includes service exports. Software services receipts also declined by 12. Therefore.3 billion). which was showing some signs of recovery in 2008 after a long spell of recession since 1999. software exports at US$ 11.7 per cent during Q4 of 2008-09. While. A decelerating export growth has implications for India. Oil imports slid 58. when compared with the performance in the first three quarters of 2008-09. today’s report showed. any .9 per cent in terms of rupee. Official reports with the Cashew Export Promotional Council of India (CPECI) show that cashew kernel exports have dropped marginally from 11.11 billion. Still.

The outsourcing sector is heavily dependent on demand from the US and Europe. About 30% of the industry revenues are estimated to be from financial services. . Close to 50% of India’s exports-textiles. which are currently going through a deep recession. This is going to have a strong negative impact on Indian IT groups. however. In fact. garments. when between 1996 and 2002 the average growth rate in exports was less than 10%. is likely to see its growth rate halve this year as the economic turmoil intensifies.downturn in the global economy will hurt India.4 per cent CAGR in the coming five years leading to 2013. This would necessitate government intervention. lost a major client when Green Point Mortgage was shut down by parent Capital One Financial Corp. The current crisis parallels the 2001-2002 busts especially for India’s outsourcing (BPOs and KPOs) sector. both based in Bangalore. compared with 24. After exports. There also seems to be a positive correlation between growth in exports and the country’s GDP. leather and so on-originate from the labour-intensive small. The SWITCH vendor account for over half of the country’s software exports.and mediumenterprises. Australia etc. the Indian IT and BPO market is slated to see 16. the GDP growth also averaged below 6%. Infosys. This will largely on the back of slower IT consumption in some key verticals including retail and financial services. The outsourcing arm of Infosys Technologies. the rest comes from other European countries. Wipro. A silver lining here. Approximately 61% of the Indian IT sector’s revenues are from US clients and 20% from UK. For instance. the revenue contribution from US clients are approximately 58%.4 per cent being the slowest growth since 2003. The industry. which grew by 30 per cent on a compound annual basis over the past five years. thereby easing pressures on the balance of payment. A slowdown in export growth also has other implications for the economy. India’s second-biggest software maker. gems and jewellery. Large Indian firms such as TCS. Cognizant and HCL Technologies collectively referred as SWITCH vendors are now forced to reconcile to a lower growth rate as their larger banking and auto clients became victims of the financial crisis. Satyam.3 per cent growth Recorded between 2003 and 2008. is the global slowdown will also lower cost of imports significantly. A sharp fall in export growth could mean job losses in this sector. there seems to be bad news in store for the domestic IT and BPO market in 2009 which is expected to grow only 13. and GATE Global Solutions. Just take the top five India players who account for 46% of the IT industry’s revenues.

These were air passenger traffic. A recent study by Forrester reveals that 43% of Western companies are cutting back their IT spend and nearly 30 percent are scrutinizing IT projects for better returns. Wireless telephone subscribers grew 50% in April-November 2008 compared with corresponding period of the previous year. • The service sector. The credit crunch and higher interest rates have impacted these areas. information technology and InfoTech-enabled services.In addition. aviation and real estate. the growth was 58 per cent compared to the previous year. assets mobilization by mutual funds. including offshore work. which contributes over 55 per cent to India's economy. With budgets squeezed. . just over 40 percent of companies plan to increase their use of offshore vendors. but the impact of overall reduction in discretionary IT spends. cannot be denied. During April-November 2008 various services has a negative performance (Table 6). The dipping performance in the services sector comes close on the Heels of the manufacturing sector registering a negative growth and this would result in slowdown in the overall economic growth rate. credit crunch and higher interest rates during recent months.6 per cent). fixed line telephone subscribers. asset under management of mutual funds and insurance premium.S. Internet subscribers grew by 26 per cent (20 per cent). economy has seen 70 percent of firms negotiating lower rates with suppliers and nearly 60 percent are cutting back on contractors. The government has already admitted that the expected rate of economic growth could not come down to seven per cent. Some of this can lead to offshoring12. the tentacles of the financial sector business are quite well-entrenched and have significant structural impact as well. according to a survey carried out by apex business chamber FICCI.7 percent (23. Segments adversely impacted by the global crisis include financial services. from a qualitative standpoint. In Fiscal 2007-08. has started showing a marked deterioration due to the global financial crisis. and Broadband subscribers by 87. The slowing U.

The job loss in the IT and BPO sector in the country topped 10. gems and jewellery. lay off and significant upheavals in labour markets. Official sources suggest that there has been already been a sharp fall in employment in the export oriented sectors like textiles and garments. This segment was already getting affected since the start of the year on account of the global credit and subprime crisis. corporate travelers account of the majority chunk. the total job loss in India due to lower export growth was of around 1. Even as per the estimates of the Tourism Committee of The Associated Chambers of Commerce and Industry of India(ASSOCHAM) on account of the global slowdown.16 million. valued at Rs 333. The Indian tourism industry. it is more likely to suffer due to the prolonged economic crisis. with export growth of 3.Other Implications: The major social costs of a recession are those associated with the enforcement of job cuts. While employees of medium-sized companies bore the brunt of job losses in the September-December period.5 billion. The estimates show that in the year 2008-09. automobiles. on account of recent crisis. Hotels in the metros which largely . the sector may lose as much as 40% of annual revenues14.000 in the September-December 2008. over 50. With companies cutting down travel budgets. the growth in tourism sector is likely to fall by a minimum of 10% and stay at around 5% for FY09. who would increasingly face the axe in the coming six months. As per the industry. Many companies are laying off their employees or cutting salaries for a few days in month or Cutting production and not doing any further recruitment13. Of the tourist visiting India. this segment exercised caution. tyre and metal products. a forecast by a union of IT Enabled Services warned.000 IT professionals in the country may lose their jobs over the next six months as the situation in the sector is expected to worsen due to the impact of global economic meltdown on the export-driven industry. UK and European visitors. While the recent terror attacks will affect this segment on a temporary basis. earns most of its forex revenues from the US. According to a recent report. India’s travel and tourism sector has been hit by global financial crisis. it is going to be their counterparts in the big and small firms.4%.

according to the March 2009 forecast of the International Monetary Fund . This. Mumbai.5 percent. Oilseed prices have fallen by more than five Percent. Another major item of essential consumption has also increased in price.0 per cent. This obviously impacts upon the entire population. affects household budgets. Bangalore and Kolkata have been impacted. Chennai. This. on-food primary product prices have hardly changed. While the room rates have officially increased hotels are selling corporate travel packages at huge discounts to maintain occupancy levels.Cater to corporate tourists have witnessed a sharp dip in occupancy rates in the past few weeks. Last but not the least. They are also paying more for fertilizer and pesticides. almost all the top six-hotel markets-Delhi.5 and 1. jute and silk-have barely increased at all. affects all the producers of cash crops. immediately. especially among the poor for whom food still accounts for more than half of total household expenditure. the prices of food articles has increased by more than one-fifth in this one-year. obviously. but especially the bottom half of the population who may find it extremely difficult if not impossible to meet such expenditures in times of stringency. Meanwhile. The recent economic downturn has also been a cause of concern for the Indian hospitality Industry. The prices of fibres-mainly cotton. global GDP is projected to contract for the first time since the World War II. What started off as turmoil in the financial sector of the advanced economies has snowballed into the deepest and most widespread financial and economic crisis of the last 60 years? With all the advanced economies in a synchronized recession. anywhere between 0. up by 4. prices of which have increased by more Than five percent. Policy Responses from India: The global financial crisis has called into question several fundamental assumptions and beliefs governing economic resilience and financial stability. As per hotel consultants HVS International’s analysis. in some cases as much as 25% to 30%. Hyderabad.that of drugs and medicines. Taj brand of hotels reported a 73 per cent drop in its net profits at Rs 16 crore for the quarter ended June 2009 against Rs 61 crore in the pervious corresponding quarter. who will be getting the same or less for their products even as they pay significantly more for food. Tour operators believe that the real discounts and tariff cuts are as high as 30% to 50%.

The policy reverse repo rate under the LAF was reduced by 250 basis points from 6. the permanent reduction in the SLR by 1.Governments and central banks around the world have responded to the crisis through both conventional and unconventional fiscal and monetary measures.0 per cent in 2009. under a preexisting provision of the RBI Act for a maximum period of 90 days. whereas the SLR (Statutory Liquidity Ratio) was brought down by 1 per cent to 24 per cent. The CRR (Cash Reserve Ratio) was also reduced from 9 per cent to 5 per cent over the same period. Indian authorities have also responded with fiscal and monetary policy and regulatory measures. A second repo auction in the day under the Liquidity Adjustment Facility (LAF16) was also introduced in September 2008. 22. The liquidity situation has improved significantly following the measures taken by the Reserve Bank.0 per cent of NDTL (Net Demand and Time Liability) has made available liquid funds of the order of Rs. In addition. The emerging market economies are faced with decelerating growth rates. The repo rate was cut in stages from 9 percent in October 2008 to rate of 5 per cent. have softened considerably .40.793 crore). The World Trade Organization (WTO) has forecast that global trade volume will contract by 9. severe disruptions of international money Markets. The overnight money market rates. In mid September 2008. These policy measures of the RBI since mid September resulted in augmentation of liquidity of nearly US $80 billion (4. To overcome the problem of availability of collateral of government securities for availing of LAF.0 per cent to 3. the policy responses in India since September 200815 have been designed largely to mitigate the adverse impact of the global financial crisis on the Indian economy. it started addressing the liquidity pressures through a variety of measures. which generally hovered above the repo rate during September-October 2008. The RBI responded by selling dollars consistent with its policy objective of marinating conditions in the foreign exchange market. a special refinance facility was introduced in October 2008 to enable banks to get refinance from the RBI against declaration of having extended bona fide commercial loans. sharp declines in stock markets across the globe and extreme investor aversion brought pressures on the domestic money and forex markets.000 crore for the purpose of credit expansion.5 per cent. Simultaneously.(IMF). Monetary Policy Measures: On the monetary policy front.

The liquidity problem faced by mutual funds has eased considerably.S. subprime mortgage-induced financial crisis that swept through global financial markets in 2008. the biggest monthly decline on record at the time. Lehman Brothers filed for bankruptcy. Lehman's demise also made it the largest victim. The Indian financial markets continue to function in an orderly manner. investment bank at the time of its collapse. The LAF window has been in a net absorption mode since mid-November 2008. Lehman's collapse was a seminal event that greatly intensified the 2008 crisis and contributed to the erosion of close to $10 trillion in market capitalization from global equity markets in October 2008. The cumulative amount of primary liquidity potentially available to the financial system through these measures is over US$ 75 billion or 7 per cent of GDP. This sizeable easing has ensured a comfortable liquidity position starting mid-November 2008 as evidenced by a number of Indicators including the weighted-average call money rate.S. The total utilization under the recent refinance/liquidity facilities introduced by the Reserve Bank has been low. the overnight money market rate and the yield on the 10-year benchmark government security. as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. with 25. Most commercial banks have reduced their benchmark prime lending rates. tracing its roots back to a small general store that was founded by German immigrant Henry Lehman .and have generally been close to or near the lower bound of the LAF corridor since early November 2008. as the overall liquidity conditions remain comfortable. The Collapse of Lehman Brothers: On September 15. their availability has provided comfort to the banks/FIs. However. The History of Lehman Brothers: Lehman Brothers had humble origins. of the U. With $639 billion in assets and $619 billion in debt. Lehman's bankruptcy filing was the largest in history. Lehman was the fourthlargest U. CPs (Commercial Papers) and CBLOs17 (Collateralized Borrowing and Lending Obligations) softened in tandem with the overnight money market rates. 2008.Other money market rates such as discount rates of CDs (Certificates of Deposits).000 employees worldwide. which can fall back on them in case of need.

the stock reached a record $86. a capital shortage when it was spun off by American Express in 1994. two world wars. While the firm prospered over the following decades as the U.S.S. the Great Depression of the 1930s. and the Long Term Capital Management collapse and Russian debt default of 1998. record revenues from Lehman's real estate businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006. In 2007. a faster rate of growth than other businesses in investment banking or asset management. including subprime lender BNC Mortgage and Aurora Loan Montgomery. Lehman's chief financial officer (CFO) said that the risks posed by rising home delinquencies were well contained and would have little impact on the firm's earnings. the firm reported record revenues and profit for its fiscal first quarter. Lehman's acquisitions at first seemed prescient.18. with the U. Henry Lehman and his brothers. housing boom well under way. a day after the stock had its biggest one-day drop in five years on concerns that rising defaults would affect Lehman's profitability. as its headlong rush into the subprime mortgage market proved to be a disastrous step The Prime Culprit: In 2003 and 2004. housing market ultimately brought Lehman Brothers to its knees.S. On March 14.2 billion on revenue of $19. despite its ability to survive past disasters. Emanuel and Mayer. Lehman's Colossal Miscalculation: In February 2007. the collapse of the U. 2007.S. In the postearnings conference call. The firm securitized $146 billion of mortgages in 2006. giving Lehman a capitalization of close to $60 billion. He also said that he did not foresee . Lehman survived them all – the railroad bankruptcies of the 1800s. economy grew into an international powerhouse. housing market were already becoming apparent as defaults on subprime mortgages rose to a seven-year high. the firm reported net income of a record $4.3 billion. a 10% increase from 2005. Lehman had to contend with plenty of challenges over the years. In 1850. which specialized in Alt-A loans (made to borrowers without full documentation). Lehman acquired five mortgage lenders. Lehman reported record profits every year from 2005 to 2007. in 1844. However. founded Lehman Brothers. cracks in the U. Alabama. However. by the first quarter of 2007.

However.8 billion. However. 2008.the second-largest underwriter of mortgage-backed securities . the company eliminated 2. accumulating an $85-billion portfolio. In the fourth quarter of 2007. Lehman's stock fell sharply. its first loss since being spun off by American Express. the firm did not take the opportunity to trim its massive mortgage portfolio. after it raised $4 billion through an issue of preferred stock that was convertible into Lehman shares at a 32% premium to its price at the time.500 mortgage-related jobs and shut down its BNC unit. The Beginning of the End: As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds. Lehman announced a second-quarter loss of $2. In 2007. On June 9. and reported that it had raised another $6 billion from investors. housing market gained momentum. which in retrospect. Even as the correction in the U. and its huge portfolio of mortgage securities made it increasingly vulnerable to deteriorating market conditions. economy.S.Lehman shares fell as much as 48% on concern it would be the next Wall Street firm to fail. it also closed offices of Alt-A lender Aurora in three states. would turn out to be its last chance. reduced its exposure to residential and commercial mortgages by 20%. Lehman's stock rebounded. decreased gross assets by $147 billion. Lehman continued to be a major player in the mortgage market. . In addition.the ratio of total assets to shareholders equity .S. and cut down leverage from a factor of 32 to about 25. On March 17. Confidence in the company returned to some extent in April. as global equity markets reached new highs and prices for fixed-income assets staged a temporary rebound.was 31 in 2007. Lehman underwrote more mortgage-backed securities than any other firm. Hurtling Toward Failure: Lehman's high degree of leverage .problems in the subprime market spreading to the rest of the housing market or hurting the U. the stock resumed its decline as hedge fund managers began questioning the valuation of Lehman's mortgage portfolio. The firm also said that it had boosted its liquidity pool to an estimated $45 billion. During that month. following the near-collapse of Bear Stearns . or four times its shareholders' equity.

were unsuccessful. amid plummeting equity markets worldwide. leading to a 45% plunge in the stock and a 66% spike in credit-default swaps on the company's debt. as compared to its tacit support for Bear Stearns (which was acquired by JPMorgan Chase) in March 2008. and also said that Lehman would have to sell a majority stake to a strategic partner in order to avoid a rating downgrade. these measures were perceived as being too little. Many questioned the U. The company's hedge fund clients began pulling out.S. Last-ditch efforts over the weekend of September 13 between Lehman. The stock plunged 77% in the first week of September 2008. The news was a deathblow to Lehman. The firm reported a loss of $3. Over the summer. Barclays PLC and Bank of America.6 billion. Lehman's bankruptcy led to more than $46 billion of its market value being wiped out. On September 10. given the size of the company and its status as a major player in the U. Hopes that the Korea Development Bank would take a stake in Lehman were dashed on September 9.S.Too Little. The same day. With only $1 billion left in cash by the end of that week. as investors questioned CEO Richard Fuld's plan to keep the firm independent by selling part of its asset management unit and spinning off commercial real estate assets. Its collapse also . Lehman's management made unsuccessful overtures to a number of potential partners. as the state-owned South Korean bank put talks on hold. and also announced a sweeping strategic restructuring of its businesses. including a write-down of $5. too late. Moody's Investor Service announced that it was reviewing Lehman's credit ratings. and internationally.9 billion. On Monday September 15. government's decision to let Lehman fail. These developments led to a 42% plunge in the stock on September 11. Lehman declared bankruptcy. Lehman was quickly running out of time. Lehman pre-announced dismal fiscal third-quarter results that underscored the fragility of its financial position. Too Late: However. aimed at facilitating a takeover of Lehman. while its short-term creditors cut credit lines. resulting in the stock plunging 93% from its previous close on September 12 Lehman's collapse roiled global financial markets for weeks.

The crisis has affected everyone at this time of globalization. As inflation began to edge up reaching the highest levels since the 1970s. credit ratings and financial engineering. All these factors boosted asset and commodity prices. large financial institutions have collapsed or been bought out. Abundant liquidity in the advanced economies generated by the loose monetary policy found its way in the form of large capital flows to the emerging market economies. Global imbalances were a manifestation of such an accommodative monetary policy and the concomitant boost in aggregate demand in the US outstripping domestic aggregate supply in the US. including oil. there are also some basic differences. there are some similarities. excessive leverage and weaknesses of banks’ risk models/stress testing were exposed and bank losses mounted wiping off capital of major financial institutions. all nations have found themselves in the same boat. Conclusions : The ongoing global financial crisis can be largely attributed to extended periods of excessively loose monetary policy in the US over the period 2002-04. this necessitated monetary policy tightening. . and excessive leverage. Around the world stock markets have fallen. The ongoing deleveraging in the advanced economies and the plunging consumer and business confidence have led to recession in the major advanced economies and large outflows of capital from the EMEs. across the spectrum providing a boost to consumption and investment. Very low interest rates during this period encouraged an aggressive search for yield and a substantial compression of risk-premier globally. Lax lending standards. However. first time world is facing truly global economic crisis. inappropriate use of derivatives.served as the catalyst for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on September 15.The present crisis situation is often compared to the Great Depression of the late 1920s and the early 1930s. both of these channels are now slowing down growth in the EMEs. Regardless of their political or economic system. This period coincided with lax lending standards. and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. True. Thus. The housing prices started to witness some correction.

The immediate effects were plummeting stock prices. The pressure on financial market has been eased. LAF. . the government went in for large-scale liberalization of FIIs. The decline in global fuel prices and other commodity prices has helped the balance of payments and lowered the inflation level. loss of forex reserves. the financial system has been more risk averse. the reason behind the slowdown in export growth in the pre-crisis period seems to be largely policy related. in its tendency to become dominated by speculators. Through the judicious combination of all these instruments. although there is some evidence of an increase in the non performing loans. deprecation of Indian rupee. However.The cause of the problem was located in the fundamental defect of the free market system regarding its capacity to distinguish between “enterprise” and “speculation” and hence. India which was insulted from the first round of the crisis partly owing to sound macroeconomic management policies became vulnerable to the second round effects of global crisis. viz. interested not in the long-term yield assets but only in the shortterm appreciation in asset values. Later effects emerged from a slowdown in domestic demand and exports. India’s banking system has been considerably less affected by the crisis than banking system in US and Europe32. Ignoring all economic logic and international experiences. However. CRR. At the same time it was also ensured that the growth in primary liquidity was not excessive. Weak and instable financial systems in some countries increased the intensity of crisis. outflow of foreign capital and a sharp tightening of domestic liquidity.. The single most important concern that Indian government needed to be addressed in the crisis situation was the liquidity issue. Refinance and MSS.The monetary and fiscal stimulus package is expected to contain the downward slide in demand in 2009 while providing a good basis for recovery in 2010. OMO. This has created the space for monetary easing as well as providing better scope for fiscal stimuls. For example. However. the RBI was able to ensure more than adequate liquidity in the system. SLR. there are many examples of policy failures (structural and macromanagement) that contributed towards the pre-crisis slowdown and magnified the negative impact of the slowdown. The RBI had in its arsenal a variety instruments to manage liquidity.

But. . Ongoing efforts to increase effectiveness and efficiency of the banking system must continue. The Indian economy suffers from an extended period of high interest rates. macro and micro policies adopted by RBI have ensured financial stability and resilience of the banking system. a close coordination and integration between government of India. in nutshell. apart from inflating stock market bubble. Expenditure priority should be defined rationally. Last but not the least. efforts to raise domestic productivity and competitiveness in international market become critical factors for protecting export market shares. and leveraging by systematically important NBFCs have stood us in good stead. high prices consequent to supply constraints that are more domestic in origin than global and declining business confidence that was ignored by policy players fixated on inflation and blinded by GDP numbers. At organizational level. let to a significant strengthening of Indian rupee and posed a serious hurdle to the country’s export growth. at the policy front there is need to focus of creating as much additional fiscal space as possible to prop up the domestic economy while preventing macroeconomic stability. The timely prudential measures instituted during the high growth period especially in regard to securitization. Added to these. additional risk weights and provisioning for specific sectors measures to curb dependence on borrowed funds. financial institutions and organizations is needed to deal with the crisis and restore the growth momentum. Public spending that creates jobs especially for poor is essential.This.

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