1

Global Financial Crisis: Impact on India

Mathew JosephPankaj Vashisht

ICRIER-INVENT Workshop

Current Developments in Indian Financial System

New Delhi

20 March 2009

2

Roots of Global Crisis• Global macroeconomic imbalances

– Results in huge cross-border capital flows from surplus to deficit countries

– International financial system failed to intermediate these flows properly

• Lending to sub-prime borrowers/ imprudent credit expansion• Lack of effective supervision and regulation

– Debt crisis of 1980s, East Asian crisis of late 1990s and the present global crisis

– Current one the severest and the impact so enormous and widespread

3

-1.425.15.915.44.87.611.3-10.1-3.8-5.3-6.22007

-1.127.99.517.33.96.19.4-8.9-3.4-6.0-5.32006

-1.328.71116.33.65.27.2-7.4-2.6-5.9-5.82005

0.120.810.112.73.74.73.6-5.3-2.1-5.3-6.12004

1.513.18.212.33.22.02.8-3.5-1.6-4.8-5.32003

1.46.38.412.62.92.02.4-3.3-1.7-4.4-3.72002

0.35.111.116.12.101.3-3.9-2.1-3.8-2.02001

-1.07.618152.6-1.71.7-4.0-2.6-4.3-3.82000

-1.6-3.72.23.62.1-1.20.2-0.3-1.2-1.5-5.21995

IndiaSaudi ArabiaRussiaNorwayJapanGermanyChinaSpainUKUSAustralia

Table 1: Current Account Balance as % of GDP, 1995-2007

•Persistent deficits and surpluses among nations

•India not part of global imbalances

Global Macroeconomic Imbalances

Source: IMF.

4

Capital Inflows into India India's Current and Capital Account Balances

as % of GDP

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

% o

f GD

P

Current account Capital account

Far exceeding the current account deficits!

5

India’s Reserve Build-upInd ia 's Fore ign Ex cha nge Re se rve s (US $ Bill ion )

38.0 42.354.1

76.1

113.0

141.5 151.6

199.2

309.7

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Turned out to be building up a war chest!

6

Huge Stock Market Rally

Stock index rising from an average 5500 during 2004 to over 20,000 in January 2008

B SE Se n s e x (1 9 7 8 -7 9 =1 0 0 )

0

5 0 0 0

1 0 0 0 0

1 5 0 0 0

2 0 0 0 0

2 5 0 0 0Ja

n,02

May

Sep

Jan,

03

May

Sep

Jan,

04

May

Sep

Jan,

05

May

Sep

Jan,

06

May

Sep

Jan,

07

May

Sep

Jan,

08

7

Remarkable Growth PerformanceGDP Growth Rates, 1997-98 to 2007-08 (Per cent)

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

•Lifted to a new high growth trajectory

•Cheap and plentiful supply foreign capital partly behind high growth

8

Overheating of Indian Economy

Note: HP filter technique as proposed by Hodrick and Prescott (1997)

•GDP growth above potential rate in recent years

•Inflation above 5 per cent from 2003-04

9

Monetary Tightening from 2004

Major Policy Rates

3

4

5

67

8

9

10

11

Mar

31,

04

Oct

2,0

4

Apr 2

9,05

Jan

24,0

6

Jul 2

5,06

Dec

23,

06

Jan

31,0

7

Mar

3,0

7

Apr 1

4,07

Aug

4,07

Apr 2

6,08

May

24,

08

Jun

25,0

8

Jul 1

9,08

Aug

30,0

8

3

4

5

67

8

9

10

11

Reverse repo rate Repo rate Cash Reserve Ratio

•Tightening from Sep 2004 became harder from 2006-07

10

Soft-landing of Indian EconomyCyclical Slowdown of GDP Growth from Q3 2007-08

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Slowdown of Q3 2007-08 to Q2 2008-09, RBI effect

11

Global Crisis

12

Reversal of Capital Flows from India

•Huge FII outflows from India since December 2007 due to US financial meltdown (Massive de-leveraging of US banks)

•FII equity outflows over US$ 15.4 bn from Jan 08

Net FII Inflows into India (US$ Million)

-6000

-4000

-2000

0

2000

4000

6000

8000

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep-

06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-

07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

09 (u

p to

13)

13

Stock Market Crash

Sensex and Dow Jones, 2003-09

0

5000

10000

15000

20000

25000

Jan,

03

May

Sep

Jan,

04

May

Sep

Jan,

05

May

Sep

Jan,

06

May

Sep

Jan,

07

May

Sep

Jan,

08

May

Sep

Jan,

09

Sensex

Dow Jones

•Plummeting from 20,873 on 8 Jan 08 to 9093 on 28 Nov, 56% fall

•NYSE stock price fall started earlier (November 07) but much less steeper than BSE

14

Foreign Reserves & Exchange Rate

•Stock of Reserves falling from $315 bn in May 08 to $246 bn in Nov 08

•Rupee tumbling by 20% from end-Mar 08 to end-Nov 08

34

36

38

40

42

44

46

48

50

52

W1

Jan

08

W4

Jan

08

W3

Feb

08

W2

Mar

08

W1

Apr

08

W4

Apr

08

W3

May

08

W2

Jun

08

W1

Jul 0

8

W4

Jul 0

8

W3

Aug

08

W2

Sep

08

W1O

ct 0

9

W4

Oct

08

W2

Nov

08

W1

Dec

08

W4

Dec

08

W3

Jan

09

W2

Feb

09

W1M

ar 0

9

200

225

250

275

300

325

FER (US$ bn) Exchange Rate (Rs/$US)

15

Liquidity Crisis

•Inter-bank call money rate spiking to 20% in October 08

•Drying up funds from domestic and foreign capital markets leading to pressure on bank financing

•Outflow through banking channels

16

Credit Crunch to Low Credit Demand

•In September and October 08, bank finance (loans & investments) rose to compensate for drying up funds from domestic and foreign capital markets

•In November 08 onwards, bank finance expansion sharply lower as demand has fallen/ bank averse to lending; and bank finance turned negative in Jan 09 and remained lower than last year level in February 09

Expansion of Bank Finance to Commercial Sector (Rs crore)

-60000-40000-20000

020000400006000080000

100000

Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb

2007-08 2008-09

17

Aggressive Policy Response

• RBI loosening cost and availability of liquidity in a series of steps from mid-September 08– Initial reluctance due to high inflation and

aggressive response from mid-October 08

18

RBI Policy Rate Changes

•Cash reserve ratio (CRR) brought down from 9% to 5%•Statutory liquidity ratio (SLR) from 25% to 24%•Repo rate reduced from 9% to 5% & reverse repo rate from 6% to 3.5%•Special window for banks in their lending to mutual funds, NBFCs and housing finance companies•Refinance facility for banks from the central bank & dollar swap arrangements, etc.

M ajo r P o licy Rate s

3456789

1011

Apr

14,

07

Aug

4,0

7

Apr

26,

08

May

24,

08

Jun

25,0

8

Jul 1

9,08

Aug

30,

08

Oct

20,

08

Nov

3,0

8

Dec

8,0

8

Jan

17,0

9

34567891011

Re v e rs e re p o ra te Re p o ra te Ca s h Re s e rv e Ra t io

19

RBI Liquidity Injection

40,000Memo: Statutory Liquidity Ratio (SLR) Reduction

3,88,045Total (1 to 7)

25,000Liquidity Facility for NBFCs through SPV7

16,000Refinance Facility for SIDBI/NHB/EXIM Bank6

38,500Special Refinance Facility for SCBs (Non-RRB)5

25,500Increase in Export Credit Refinance4

60,000Term Repo Facility3

63,045MSS Unwinding2

1,60,000Cash Reserve Ratio (CRR) Reduction1

Actual/Potential Release of Primary Liquidity since Mid-September 2008 (Rs crore)

Nearly Rs. 4000 bn ($80 bn), over 7% of GDP of liquidity release

20

Fiscal Stimulus• Deterioration of the economy leading to Central

government’s three packages of fiscal stimulus in early Dec 08, early Jan 09, early Mar 09– Direct fiscal burden of stimulus just 1.8% of GDP

• Across-the-board excise duty reduction by 4 %age points• Additional plan spending of Rs. 200 billion• State governments allowed additional market borrowing of Rs 300

billion for plan expenditure• Assistance to export industries• 2 percentage point reduction in central excise and service tax

– Non-fiscal measures in package (ECB and FII debt inflow relaxations, IIFL tax-free bonds, etc.)

– Fiscal deficit (Central and States combined) rising sharply to 11% of GDP in 2008-09 (5.4% in 2007-08) and likely to be over 10% in 2009-10

• Loose fiscal policy due to domestic compulsions

21

Sharp Real Sector deterioration from September 2008

Source: CSO, Ministry of Commerce, CMIE and Economic Times.

(2520 companies)

-25.6-25.44.77.121.2Corporate profit

13.334.631.424.018.5Corporate sales

5.37.67.98.88.8Real GDP

Q3 08-09Q2 08-09Q1 08-09Q4 07-08Q3 07-08

-18.6-3.5-4.626.025.0Central government tax revenue

-12.6-13.6-7.7-14.0-0.8Airport passenger traffic

-31.7-52.3-58.2-48.0-34.9-0.63.9Commercial vehicle sales

-0.40.0-4.6-5.71.18.7Major ports traffic

2.93.01.3-0.18.28.6Railway freight traffic

-18.2-18.28.86.110.643.337.7Imports

-13.7-15.9-1.1-9.9-12.110.435.1Exports

-0.5-0.61.70.16.04.8Industry

Feb-09Jan-09Dec-08Nov-08Oct-08Sep-08Apr-Aug 08

Growth in Selected Economic Indicators (% Change, Y-O-Y)

Global crisis impact on India’s real economy from September 08

22

Growth Prospects: 2008-09 and 2009-10

23

GDP Forecasts

• Methodology:– Use of an index of leading economic

indicators (LEI)– Also a external shock in the form of a dummy

variable

24

GDP Forecasts…• LEI Consists of:

– (i) production of machinery and equipment– (ii) non-food credit– (iii) railway freight traffic– (iv) cement sales – (v) net sales of the corporate sector – (vi) fuel and metal prices – (vii) real rate of interest – (viii) BSE sensex and – (ix) exports

25

Index of Leading Economic Indicators (LEI)….

• Composite index constructed for 1997-08 with quarterly growth series

• Principal component index (PCI) method– Weights assigned through iteration process based on the

contribution to total variation in the composite index• LEI predicts future growth based on the past, 5-quarter

in advance• Cannot capture the effects of sudden external shocks

having immediate impact on growth– East Asia crisis, 1997-98– Dotcom bust and September 11 incident in 2000-01 and 2001-02– Crop failure in 2002-03 – Current shock of US financial crisis in 2008-09 and 2009-10

26

External Shocks & India’s GDP Growth

GDP Growth Rates, 1992-93 to 2007-08 (Per cent)

0.0

2.0

4.0

6.0

8.0

10.0

12.0

GDP 5.4 5.7 6.4 7.3 8.0 4.3 6.7 6.4 4.4 5.8 3.8 8.5 7.5 9.5 9.7 9.0

1992-93

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

East Asia crisis

Dotcom bust & Sep 11 Crop

failure

External shocks bring down India’s growth sharply

27

Projection of Growth Rate through Index of Leading Indicators & a Shock Variable

The estimated equation for GDP growth forecast, given below, is satisfactory with adjusted R-square value of 0.65 and all the co-efficients significant at 99% level.

GrGDPt = 7.98 + 1.34 LEI (t-5) - 3.70 Dummy(4.70) (-7.56)

Dotcom bust & Sep 11 Crop failure

28

Growth Prospects of India

GDP Growth Forecast for 2008-09 and 2009-10

•Based on leading Indicators and a shock variable to incorporate the global crisis, the growth rates for 2008-09 and 2009-10 are projected as:

6.35.5

6.34.8

7.98.4

2008-092009-10

Shock Moderated by Policy Response

With ShockNo Shock

Three scenarios of growth and third one assumes the impact of policy stimulus

29

Concluding Remarks• India is seriously affected by the global crisis

• Growth to come down sharply but not below zero

• Soundness of banking, cautious capital account opening, and highreserve level have saved the country

• Recovery possible in late 2009-10 or early 2010-11 provided the government is able to push through massive investment in social and physical infrastructure through public-private participation

• Structural and procedural reforms imperatives for restoring confidence and to raise the potential growth rate

• Huge fiscal deficits and record debt levels will damage recoveryprospects

30

Thank You.

31

Deepening Global Integration(Current Account & Capital Account as % GDP)

•Current account transactions rising from less than 20% of GDP to 50% •Both current and capital account transactions from less than a third of GDP to over 115%