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A PROJECT REPORT ON

BY DIANA HARRIS In partial fulfillment of M.A in ECONOMICS.

NOWROSJEE WADIA COLLEGE ROLL NO. 316 2011- 12

CERTIFICATE

This is to certify that Miss DIANA HARRIS of M.A ECONOMICS has Successfully completed her project entitled on a Research on GLOBAL FINANCIAL CRISIS & ITS IMPACT ON INDIA Under the Guidance of Dr.MANJUSHA MUSMADE

DR.MANJUSHA MUSMADE RESEARCH GUIDE HEAD OF ECONOMIC DEPARTMENT NOWROSJEE WADIA COLLEGE PUNE- 411001

DR.B.B THANKUR PRINCIPAL

ACKNOWLEGEMENT

A project is Golden opportunity for learning & self-development. I consider myself very lucky & honored to have wonderful people lead me through in completion of this project. My Grateful thanks to my HOD (Dr.Mrs.M.Musmade) who in spite of being extraordinarily busy with her duties took time to hear, guide & keep me on correct path. I dont know where I would have been without her. A humble Thank You madam. Dr.Mrs.M.Musmade monitored my progress and without her encouragement I would have not been able to complete this project. I choose this moment to acknowledge her contribution gratefully. Last but not the least there were so many who shared valuable information that helped in the successful completion of this project.

DIANA HARRIS

OBJECTIVE: TO study the role of cause of Recession TO study the impact of Recession on India for the period 2007-10

To analyze the opportunity created by recession before India Policy responses of the Government to tackle the Crisis Main aim of study is to find relevant answers to questions like why & how India has been hit by the Crisis & how the Indian economy & the RBI have responded to Crisis

HYPOTHESIS:
Global financial Crisis affects credit financial market & confidence of the banking &

The capital market Capital has become more expensive as banks are lending to each other at higher rates The stock market- fall in value of stocks& real estate as a result of credit, assets & investment bubbles Service sector, particularly the IT sector. Companies in the IT & financial sectors continue to downsize & cut costs & will not likely hire more people Impact on employment & poverty

METHODOLOGY:For the requirement of this research & for the collection of material, Secondary data has been used, E-books, websites & E-newspaper, reports, periodicals, journals. LIMITATIONS: Due to time constraints more issues have not been detailed The accuracy & reliability of the data collected data across different sources may vary slightly The measurability of the crisis across a global scale may not be through- considering all the factors would not be a feasible option Option biasness may also exit. Apart From internal factors that have affected Global economies, there are critical external factors & trade behavior that dicate the nations across the globe to resort to measures to help themselves. The

discussion of such issues in detail hasnt been made a part of report at hand, though a significant amount of information has been analyzed & studied for the same. The Study of Global Financial Crisis is inexhaustible, & it will continue as long as the world economy doesnt become self-sustainable again.

INDEX:I. CHAPTER 1 II. Introduction of Global Economic crisis Understanding Business Cycle

CHAPTER 2

Background of crisis Causes of Crisis GENESIS & DEVELOPMENT OF CRISIS :-

Subprime Mortgage Securitization & Repackaging of loans Mismatch between financial innovation & regulation Complex interplay of multi-factors
III.

CHAPTER-3IMPACT OF GLOBAL CRISIS Impact on India i) ii) Off Shoot of Globalized economy Aspects of financial turmoil in India Capital outflow Impact on stock forex market Impact on Indian Banking system Impact on Indian Sector & export prospect Impact on employment Impact on poverty

IV.

CHAPTER -4 INDIA & THE FINANCIAL CRISIS Global liquidity crunch & Indian economy Decreased consumer demand affecting exports Financial crisis & Indian IT industry Indian financial Markets BAILOUT PACKAGES & RBI INITIATIVES Indias response to crisis Policy response i) fiscal stimuli ; ii) monetary policy response Option Ahead RECOVERY: Recovery of Indian economy Some reasons of recovery

V.

CHAPTER-5 Outlook for Indian economy

VI.

CHAPTER-6 Summary Conclusions Bibliography

CHAPTER 1
INTRODUCTION OF GLOBAL ECONOMIC CRISIS:-

The Indian economy is experiencing a downturn after a long spell of growth. Industrial growth is faltering, the current account deficit is widening, foreign exchange reserves are depleting, & the rupee is depreciating. The crisis originated in US but Indian government had reasons to worry because there was potential adverse impact of the crisis on the Indian Banks. Lehman Brothers & Merril Lynch had invested a substantial amount in the Indian banks. Who in turn had invested the money in derivatives, leading to exposure of even the derivatives market to this investment bankers. 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, the United States, when a loss of confidence by investors in the value of securitized mortgages resulted in a liquidity crisis. But the crisis came to the forefront of business world and media in September 2008, with the failure and merging of many financial institutions. Added to this, in previous times of financial turmoil, the pre-crisis period was characterized by surging asset prices that proved unsustainable; a prolonged credit expansion leading to accumulation of debt; the emergence of new types of financial instruments; and the inability of regulators to keep up (ADB, 2008) The immediate cause or trigger of the present crisis was the bursting of United States housing bubble3 (Also known as Subprime lending crisis), which peaked in approximately 2006-074. In March 2007, the United States' sub-prime mortgage industry collapsed to higher-than-expected home foreclosure rates, with more than 25 sub-prime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale. As a result, many large investment firms have seen their stock prices plummet. The stock of the country's largest sub-prime lender, New Century Financial plunged 84%. Liquidity crisis promoted a substantial injection of capital into the financial markets by the US Federal Reserve.

Public sector Unit (PSU) banks of India like Bank of Baroda had significant exposure towards derivatives. ICICI faced the worst hit. With Lehman Brothers having filed for bankruptcy in the US, ICICI (Indias largest private bank), survived a rumor during the crisis which argued that the giant bank was slated to lose $80million (Rs.375crs) invested in Lehmans bonds through the banks UK subsidiary. UNDERSTANDING BUSINESS CYCLES:Business Cycle or Economic Cycle refers to economy wide fluctuations in production or economic activity over several months or years. These cycles are characteristic features of market oriented economies whether in the form of the altering expansions & contractions which characterize a classic business cycle, or the altering speedups & slowdowns that mark cycles in growth. A recession occurs when a decline- however initiated or instigated occurs in some measure of aggregate economic activity & causes cascading decline in the other key measures of activity. Thus, when a dip in sales causes a drop in production, triggering declines in employment & income, which in turn feeds back into a further fall in sales, a vicious cycle results & a recession ensues. This domino effect of the transmission of the economic weakness, from sales to output to employment to income, feeding back into further weakness in all of these measures in turn, is what characterizes a recessionary downturn. The phases of the business cycle are characterized by changing employment, industrial productivity & interest rates. In the Keynesian view, business cycles reflect the possibilities that the economy may reach short run equilibrium at levels below or above full employment. If the economy is operating with less than full employment, i.e., with high unemployment , then in theory monetary policy & fiscal policy can have a positive role to play rather than simply causing inflation or diverting funds to inefficient uses.

CHAPTER 2 BACKGROUND OF CRISIS:A disorderly contraction in wealth & money supply in the market is the basic cause of a financial crisis, also known as a credit crunch. The participants in an economy lose confidence in having loans repaid by debtors, leading them to limit further loans as well as recall existing loans. Credit creation is the lifeblood of the financial/banking system. Credit is created when debtors spend the money & which in turn is banked & loan to other debtors. Due to this, a small contraction in lending can lead to a dramatic contraction in more supply. The present global meltdown is a culmination of several factors, the most important being irrational & unsustainable consumption in the West particularly in United States disproportionate to its income by consistent borrowings fueled by savings & surplus of the East particularly China & Japan. The Second important factor is the greed of the investment bankers who induced housing loans by uncontrolled leveraging in an optical illusion of increasing prices in the housing sector. The third important factor is the failure of the regulating agencies who ignored the warning signals arising out of the ballooning debts, derivatives & financial innovation on the assumption that the Collateral Debt Obligation (CDO), the credit Default Swapping (CDS) & Mortgaged Backed Securities (MBS) would continue to remain safe with the mortgage guarantees provided

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by Government Sponsored Enterprises (GSEs) namely Fannie Mae & Freddie Mac which had enjoyed the political patronage since inception. There are other several factors including shadow banking system, financial leveraging by the investment bankers & lack of adequate disclosures in the financial statements leading to fallacious ratings by the rating agencies. The global financial crisis is the unwinding of the debt bubbles between 2007 &2009. On Dec1, 2008 the National Bureau of Economic Research (NBER) officially declared that the U.S economy had entered recession in Dec, 2007. The financial crisis has moved into an Industrial crisis now as countries after countries are sharing negative results in their manufacturing & service sectors.

CAUSE OF THE CRISIS: The Financial Crisis: How it happened

The current crisis has been linked to the sub-prime mortgage business, in which US banks give high risk loans to people with poor credit histories. These & other loans, bonds or assets are bundles into portfolios or collateralized Debt Obligations (CDOs) & sold to investors across the globe.

Falling housing prices & rising interest rates led to high numbers of people who could not repay their mortgages. Investors suffered losses & hence became reluctant to take on more CDOs. Credit markets froze & banks

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became reluctant to each other, not knowing how many bad loans & nonperforming assets could be on their rivals books.

The crisis began with the bursting of the United States housing bubble & high default rates on subprime mortgages & adjustable rate mortgages (ARM). The foreclosures exceeded 1.3 million during 2007 up 79% for 2006 which increased to2.3million in 2008, an 81% increase over 2007. Financial product called mortgaged backed securities (MBS) which in turn derive their value from the mortgage installment payments & housing prices had enabled financial institutions & investors around the world to invest in U.S housing markets. Major banks & financial institutions which had invested in such MBS incurred losses of approx.The value of all outstanding residential mortgage owned by US households was US$10.6 trillion as of Mid-2008 of which $6.6 trillion were held by mortgaged pools Consisting of Collectivized debt obligation(CDO) already mortgage backed securities (MBS)(CDO & MBS) and the remaining US$3.4 trillion by traditional depository institutions. The owners of Stock In US Corporation alone have suffered loss of about US$8trillion between 1Jan & 11Oct 2008 as the value of their holding decline from US$20 trillion to US$12trillion. The first catastrophe took place when Bear Stearns was sold to JP Morgan at a throw away price in April 2008. The biggest adverse impact was on Freddie Mac (the Federal home loan Mortgage Corporation) the two Governments sponsored Enterprises (GSEs) were granted a very quick bailout package by the US Treasury. A record breaking level of mortgage foreclosures took place for the subprime mortgages. Most of the investment bankers including Fannie Mac & Freddie Mac reached to the brink of bankruptcy.

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When homeowners default, the payments received by MBS & CDO investors decline & the perceived credit risk rises. This has had a significant adverse effect on investors & the entire mortgage industry. The effect is magnified by the high debt levels (financial leverage) households & business have incurred in recent years. Finally, the risks associated with American mortgage lending have global impacts, because a major consequence of MBS & CDOs is a closer integration of the USA housing & mortgage markets with global financial markets.

GENESIS & DEVELOPMENT OF CRISIS:(i) Sub-prime mortgage: The current global economic crisis has originated in the sub-prime mortgage crisis in USA in 2007. With easy availability of credit at low interest rates, real estate prices in US had been rising rapidly since the late 1990s and investment in housing had assured financial return. US home-ownership rates rose over the period 1997-2005 for all regions, all age groups, all racial groups, and all income groups. The boom in housing sector made both banks and home buyers believe that the price of a real estate would keep going up. Housing finance seemed a very safe bet. Banks went out of their way to lend to sub-prime borrowers who had no collateral assets. Low income individuals who took out risky sub-prime mortgages were often unaware of the known risks inherent in such mortgages. While on the one hand, they were ever keen to become house-owners, on the other, they were offered easy loans without having any regard to the fact that they were not in a position to refinance their mortgages in the event of the crisis. All this was fine as long as housing prices were rising. But the housing bubble burst in 2007. Home prices fell between 20 per cent and 35 per cent from their peak and in some areas more than 40 per cent; mortgage rates also rose. Sub-prime borrowers started defaulting in large numbers. The banks had to report huge losses. (ii) Securitization and Repackaging of Loans: The mortgage market crisis that originated in the US was a complex matter involving a whole range of instruments of the financial market that transcended the boundaries of sub-prime mortgage. An interesting aspect of the crisis emanated from the fact that the banks/ lenders or the mortgage originators that sold sub-prime housing loans did not hold onto them. They sold them to other banks and investors through a process called securitization. Securitization, as a financial process, has gained wide currency in the US in the last couple of decades.

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In the context of the boom in the housing sector, the lenders enticed the naive, with poor credit histories, to borrow in the swelling sub-prime mortgage market. They originated and sold poorly underwritten loans without demanding appropriate documentation or performing adequate due diligence and passed the risks along to investors and securitizers without accepting responsibility for subsequent defaults. These sub-prime mortgages were securitized and re-packaged, sold and resold to investors around the world, as products that were rated as profitable investments. They had a strong incentive to lend to risky borrowers as investors, seeking high returns and were eager to purchase securities backed by subprime mortgages. This kind of dangerous risk-shifting took place at every stage of the financial engineering process. The booming housing sector brought to the fore a system of repackaging of loans. It thrived on the back of flourishing mortgage credit market. The system was such that big investment banks such as Merrill Lynch, Morgan Stanley, Goldman Sachs, Lehman Brothers or Bears Stearns would encourage the mortgage banks countrywide to make home loans, often providing the capital and then the Huge Investment Banks (HIBs) would purchase these loans and package them into large securities called the Residential Mortgage Backed Securities (RMBS). They would package loans from different mortgage banks from different regions. Typically, an RMBS would be sliced into different pieces called tranches. As it was hard to sell some of lower levels of these securities, the HIBs would take a lot of the lower level tranches and put them into another security called a collateralized debt obligation (CDO). They sliced them up into tranches and went to the rating agencies and got them rated. The highest tranche was typically rated again AAA. The finance investment banks took sub-prime mortgages and turned nearly 96 per cent of them into AAA bonds. The outstanding CDOs are estimated at $ 3.9 trillion against the estimated size risk of the sub-prime market of $1 to $ 1.3 trillion. This is a revealing index of the multiplier effect of securitization structures and CDOs. (iii) Mismatch between Financial Innovation and Regulation: It is not surprising that governments everywhere seek to regulate financial institutions to avoid crisis and to make sure a countrys financial system efficiently promotes economic growth and opportunity. Striking a balance between freedom and restraint is imperative. Financial innovation inevitably exacerbates risks, while a tightly regulated financial system hampers growth. When regulation is either too aggressive or too lax, it damages the very institutions it is meant to protect. In the context of this crisis, it would be pertinent to know that in US, the financial institutions, during the past forty years, focused considerable energy on creating instruments and structures to exploit loopholes in the regulation and supervision of financial institutions. Financial globalization assisted in this process by enabling corporations and financial institutions to escape burdensome regulations in their home countries by strategically booking their business offshore. Regulatory authorities proved ineffective in acknowledging that large and complex financial institutions were using securitization to escape restrictions on their ability to expand leveraged risk-

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taking. Central Banks in US and Europe kept credit flowing to devious institutions that as originators of risky loans or as sponsors of securitization conduits had sold investors structured securitization whose highest quality tranches were so lightly subordinated that insiders had to know that the instruments they had designed were significantly over-rated. It is important to understand that the goal of financial regulation and supervision is not to reduce risk-taking of the financial institutions, but to manage the safety net. This goal implied that supervisors have a duty to see that risks can be fully understood and fairly priced by investors. The loopholes in supervision clearly sowed the seeds of the current crisis. In tolerating an on-going decline in transparency, supervisors encouraged the very mis-calculation of risk whose long-overdue correction triggered the crisis. Financial markets did well through capital market liberalization. Enabling America to sell its risky financial products and engage in speculation all over the world may have served its firms well, even if they imposed large costs on others. Today, the risk is that the new Keynesian doctrines will be used and abused to serve some of the same interests. The crisis has taken by surprise everyone, including the regulators. The regulators failed to see the impact of the derivative products which clouded the weaknesses of the underlying transactions. The financial innovation two words that should, from now on, strike fear into investors hearts... to be fair, some kinds of financial innovation are good. ... but the innovations of recent years were sold on false pretences. They were promoted as ways to spread risk. Quite clearly, there was a mismatch between financial innovation and the ability of the regulators to monitor. Regulatory failure comes out glaringly. (vi) Complex Interplay of multiple factors: It may be said with a measure of certainty that the global economic crisis is not alone due to sub-prime mortgage. There are a host of factors that led to a crisis of such an enormous magnitude. The declaration made by the G-20 member states at a special summit on the global financial crisis held on 15th November 2008 in Washington, D.C. identified the root causes of the current crisis and put these in a perspective. During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions. Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.

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CHAPTER 3
IMPACT OF THE CRISIS:-

The global financial crisis is already causing a considerable slowdown in most developed countries. Governments around the world are trying to contain the crisis, but many suggest the worst is not yet over. The continuous development of the crisis had promoted fears of a global economic collapse. Quoting US Economist Paul Krugman, as noted in New York Times column, Rate of unemployment hikes to 8.9% in the US: 539,000 jobs lost US GDP shrinks by 8.1% in the first Quarter US foreclosures spike 32% in April, 2009 US Home Prices fall 14% in first quarter

These financial losses have left many financial institutions with too little capital too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years. Financial institutions have been trying to pay down their debt by selling their assets, including those mortgage backed securities, but this drives asset prices down & makes their financial condition even worse. This vicious cycle is what some call the paradox of deleveraging.

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IMPACT OF ECONOMIC CRISIS ON INDIA (i) Offshoot of Globalized Economy With the increasing integration of the Indian economy and its financial markets with rest of the world, there is recognition that the country does face some downside risks from these international developments. The risks arise mainly from the potential reversal of capital flows on a sustained medium term basis from the projected slowdown of the global economy, particularly in advanced economies, and from some elements of potential financial contagion. In India, the adverse effects have so far been mainly in the equity markets because of reversal of portfolio equity flows, and the concomitant effects on the domestic forex market and liquidity conditions. The macro effects have so far been muted due to the overall strength of domestic demand, the healthy balance sheets of the Indian corporate sector, and the predominant domestic financing of investment.72 It has been recognized by the Prime Minister of India that ...it is a time of exceptional difficulty for the world economy. The financial crisis, which a year ago, seemed to be localized in one part of the financial system in the US, has exploded into a systemic crisis, spreading through the highly interconnected financial markets of industrialized countries, and has had its effects on other markets also. It has choked normal credit channels, triggered a worldwide collapse in stock markets around the world. The real economy is clearly affected. ...Many have called it the most serious crisis since the Great Depression.73 (ii) Aspects of Financial Turmoil in India (a) Capital Outflow The main impact of the global financial turmoil in India has emanated from the significant change experienced in the capital account in 2008-09, relative to the previous year. Total net capital flows fell from US$17.3 billion in AprilJune 2007 to US$13.2 billion in April-June 2008. Nonetheless, capital flows are expected to be more than sufficient to cover the current account deficit this year as well. While Foreign Direct Investment (FDI) inflows have continued to exhibit accelerated growth (US$ 16.7 billion during April-August 2008 as compared with US$ 8.5 billion in the corresponding period of 2007), portfolio investments by foreign institutional investors (FIIs) witnessed a net outflow of about US$ 6.4 billion in April-September 2008 as compared with a net inflow of US$ 15.5 billion in the corresponding period last year. Similarly, external commercial borrowings of the corporate sector declined from US$ 7.0 billion in April-June 2007 to US$ 1.6 billion in April-June 2008, partially in response to policy measures in the face of excess flows in 2007- 08, but also due to the current turmoil in advanced economies. (b) Impact on Stock and Forex Market With the volatility in portfolio flows having been large during 2007 and 2008, the impact of global financial turmoil has been felt particularly in the equity market. Indian stock prices have been severely affected by foreign

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institutional investors' (FIIs') withdrawals. FIIs had invested over Rs 10, 00,000 crore between January 2006 and January 2008, driving the Sensex 20,000 over the period. But from January, 2008 to January, 2009 this year, FIIs pulled out from the equity market partly as a flight to safety and partly to meet their redemption obligations at home. These withdrawals drove the Sensex down from over 20,000 to less than 9,000 in a year. It has seriously crippled the liquidity in the stock market. The stock prices have tanked to more than 70 per cent from their peaks in January 2008 and some have even lost to around 90 per cent of their value. This has left with no safe haven for the investors both retail or institutional. The primary market got derailed and secondary market is in the deep abyss. Equity values are now at very low levels and many established companies are unable to complete their rights issues even after fixing offer prices below related market quotations at the time of announcement. Subsequently, market rates went down below issue prices and shareholders are considering purchases from the cheaper open market or deferring fresh investments. This situation naturally has upset the plans of corporates to raise resources in various forms for their ambitious projects involving heavy outlays. In India, there is serious concern about the likely impact on the economy of the heavy foreign exchange outflows in the wake of sustained selling by FIIs on the bourses and withdrawal of funds will put additional pressure on dollar demand. The availability of dollars is affected by the difficulties faced by Indian firms in raising funds abroad. This, in turn, will put pressure on the domestic financial system for additional credit. Though the initial impact of the financial crisis has been limited to the stock market and the foreign exchange market, it is spreading to the rest of the financial system, and all of these are bound to affect the real sector. Some slowdown in real growth is inevitable. Dollar purchases by FIIs and Indian corporations, to meet their obligations abroad, have also driven the rupee down to its lowest value in many years. Within the country also there has been a flight to safety. Investors have shifted from stocks and mutual funds to bank deposits and from private to public sector banks. Highly leveraged mutual funds and non-banking finance companies (NBFCs) have been the worst affected.

(c) 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 emerging economies, particularly in Asia. The Indian banking system also has not experienced any contagion, similar to its peers in the rest of Asia. The Indian banking system is not directly exposed to the sub-prime mortgage assets. It has very limited indirect exposure to the US mortgage market, or to the failed institutions or stressed assets. Indian banks, both in the public sector and in the private sector, are financially sound, well capitalised and well regulated. The average capital to risk-weighted assets ratio (CRAR) for the Indian banking system, as at end-March 2008, was 12.6 per cent, as against the regulatory minimum of nine per cent and the Basel norm of eight per cent. A detailed study undertaken by the RBI in September 2007 on the impact of the sub-prime episode on the Indian banks had revealed that none of the

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Indian banks or the foreign banks, with whom the discussions had been held, had any direct exposure to the sub-prime markets in the USA or other markets. However, a few Indian banks had invested in the collateralised debt obligations (CDOs)/ bonds which had a few underlying entities with sub-prime exposures. Thus, no direct impact on account of direct exposure to the subprime market was in evidence. Consequent upon filling of bankruptcy by Lehman Brothers, all banks were advised to report the details of their exposures to Lehman Brothers and related entities both in India and abroad. Out of 77 reporting banks, 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 Brothers Holdings Inc., which are not covered by the bankruptcy proceedings. Overall, these banks exposure especially to Lehman Brothers Holdings Inc. which has filed for bankruptcy is not significant and banks are reported to have made adequate provisions. In the aftermath of the turmoil caused by bankruptcy, 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.

(d) Impact on Industrial Sector and Export Prospect The financial crisis has clearly spilled over to the real world. It has slowed down industrial sector, with industrial growth projected to decline from 8.1 per cent from last year to 4.82 per cent this year. The service sector, which contributes more than 50 per cent share in the GDP and is the prime growth engine, is slowing down, besides the transport, communication, trade and hotels & restaurants sub-sectors. In manufacturing sector, the growth has come down to 4.0 per cent in April-November, 2008 as compared to 9.8 per cent in the corresponding period last year. Sluggish export markets have also very adversely affected export-driven sectors like gems and jewellery, fabrics and leather, to name a few. For the first time in seven years, exports have declined in absolute terms for five months in a row during October 2008February 2009. In a globalised economy, recession in the developed countries would invariably impact the export sector of the emerging economies. Export growth is critical to the growth of Indian economy. Export as a percentage of GDP in India is closer to 20 per cent. Therefore, the adverse impact of the global crisis on our export sector should have been marginal. But, the reality is that export is being and will continue to be adversely affected by the recession in the developed world. Indian merchandise exporters are under extraordinary pressure as global demand is set to slump alarmingly. Export growth has been negative in recent months and the government has scaled down the export target for the current year to $175 billion from $200 billion. For 2009-10, the target has been set at $200 billion.

(e) Impact on Employment -

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Industry is a large employment intensive sector. Once, industrial sector is adversely affected, it has cascading effect on employment scenario. The services sector has been affected because hotel and tourism have significant dependency on high-value foreign tourists. Real estate, construction and transport are also adversely affected. Apart from GDP, the bigger concern is the employment implications. A survey conducted by the Ministry of Labour and Employment states that in the last quarter of 2008, five lakh workers lost jobs. The survey was based on a fairly large sample size across sectors such as Textiles, Automobiles, Gems & Jewellery, Metals, Mining, Construction, Transport and BPO/ IT sectors. Employment in these sectors went down from 16.2 million during September 2008 to 15.7 million during December 2008. Further, in the manual contract category of workers, the employment has declined in all the sectors/ industries covered in the survey. The most prominent decrease in the manual contract category has been in the Automobiles and Transport sectors where employment has declined by 12.45 per cent and 10.18 per cent respectively. The overall decline in the manual contract category works out to be 5.83 per cent. In the direct category of manual workers, the major employment loss, i.e., 9.97 per cent is reported in the Gems & Jewellery, followed by 1.33 per cent in Metals. Continuing job losses in exports and manufacturing, particularly the engineering sector and even the services sector are increasingly worrying. Protecting jobs and ensuring minimum addition to the employment backlog is central for social cohesiveness.

(f) Impact on poverty The economic crisis has a significant bearing on the country's poverty scenario. The increased job losses in the manual contract category in the manufacturing sector and continued layoffs in the export sector have forced many to live in penury. The World Bank has served a warning through its report, The Global Economic Crisis: Assessing Vulnerability with a Poverty Lens, which counts India among countries that have a high exposure to increased risk of poverty due to the global economic downturn. Combined with this is a humanitarian crisis of hunger. The Food and Agriculture Organization said that the financial meltdown has contributed towards the growth of hunger at global level. At present, 17 per cent of the world's population is going hungry. India will be hit hard because even before meltdown, the country had a staggering 230 million undernourished people, the highest number for any one country in the world.

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CHAPTER 4
INDIA & THE FINANCIAL CRISIS:Indias economy has been one of the stars of global economies in recent years, growing 9.2% in 2007 and 9.6% in 2006 and has seen a decade of 7 plus % growth. Growth had been supported by markets reforms, huge inflows of FDI, rising foreign exchange reserves, both an IT and real estate boom, and a flourishing capital market. But, in the middle of 2008, price increases of global commodity (Hamilton, 2008); especially those of oil, metal and food took a toll on India. Inflation reached at 12.91 per cent, the highest level seen for a decade. With this growth softened, budget deficits widened and trade balances worsened. Before the India could recover from the adverse impact of high commodity prices, the global financial crisis has come knocking. Initially, it was argued that India would be relatively immune to this crisis, because of the strong fundamentals of the economy and the supposedly well-regulated banking system. But, a crisis of this magnitude was bound to affect globalized economy like India and it has. Economy began to slow down from the middle of 2007-08. After a long spell of growth, the Indian economy is experiencing a downturn. IMF has also predicted that Indian economy cannot remain immune from global financial crisis and crisis will hit Indias growth story. Indian government is feeling the heat of global crisis in India. The slowdown is likely to have a large & immediate impact on employment & poverty. Informal surveys suggest significant job losses. Job creation is likely to remain a key concern as new entrants to the labor force relatively better educated & with higher aspirations continue to put pressure on the job market. The Country has the option of turning the crisis into an opportunity. The most binding constraints to growth & inclusion will need to be addressed: improving infrastructure, developing the small & medium enterprises sector, building skills, & targeting social spending at the poor. Systematic

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improvements in the design & governance of public programs are crucial to get results from public spending. Improving the effectiveness of these programs that account for up to 8-10% of GDP will therefore be an important part of the challenge. The Union Government has constituted a committee to consider issues raised by India Inc on global financial crisis and its impact on India. The impact of the crisis on the Indian economy has been studied here forth & the study is chiefly focused on 4 major factors which affect the Indian economy as a whole. These are :
Availability of global liquidity* Decreed consumer demand affecting exports*

The financial Crisis & the Indian IT industry Fall in Growth Rate, Industrial Output and Rise in Inflation

GLOBAL LIQUIDITY CRUNCH & THE INDIAN ECONOMY : The Indian Banking system was gauged as being relatively immune to the factors that lead to the turmoil in the global banking industry. The problem of the global banks arose mainly due to the sub-prime mortgage lending & investments in complex collateralized debt obligations (CDOs) whose values were sharply eroded. Indian banks had limited vulnerability on both counts. The reasons for tight liquidity conditions in the Indian Markets during the earlier stages of the crisis were quite different from the factors driving the global liquidity crisis. Large selling by foreign institutional investors (FIIs) & the subsequent interventions by the RBI in the foreign currency market, continuing growth in advances, and earlier increases in the Cash Reserve Ration (CRR) to contain inflation are some of the reasons that accelerated the Indian liquidity Crunch. Cautions investors had started to diversify away from bank deposits & cash over the past few years, and had moved to equities, mutual funds and insurance products. The current market turmoil is driving them back to the safety of bank-deposits, reducing the amount of capital available to other instruments & possibly retarding the growth of the financial services industry as a whole. Indias Household & Corporate Savings will fuel the domestic economy at a time when the global liquidity crunch is aggravating the economic downturn in other parts of the globe.

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Indias high savings rate has been a crucial driver of its economic boom, providing productive capital & helping to fuel a virtuous cycle of higher growth, higher income & higher savings. Household savings will therefore remain crucial to sustaining a strong saving rate. India will be relatively unaffected by the global liquidity crisis because the large fund of Indias household savings which stood at Rs.9.85trn (US$192bn) in 2006/07, will remain available to fuel domestic growth. As GDP rose 14.4% at current market prices, net savings of the households grew 15.6%. The Indian government is trying to hasten the shift of Indias physical savings, still locked up in unproductive physical assets such as houses, durables, & jewelry, into financial assets. The household savings can be channelized into the countrys debt, equity & infrastructure finance markets. This would not only deepen & stabilize the financial markets but also reduce the governments social-security burden.

It is evident from the graph shown alongside that the ratio of gross domestic savings to the GDP of the country has been increasing over the years. Influx of these household savings into the countrys debt, equity, & infrastructure finance markets will certainly help in the deepening & stabilization of financial markets.

23

Gross National Savings also include all foreign remittances into India which add to the domestic savings. A positive trend in the ratio further strengthens the fact that India is self-sufficient in the short term with regard to any immediate liquidity demand. Indias savings rate at present is higher than all other regions of the world, except developing Asia & Middle East. The countrys investment rate showed sharp acceleration during the period FY02-07 to surpass the average of all major regions of the world in FY07. However, according to a report, factors which could weigh down the rate of domestic savings to a moderate 33.0% & further to 32.8% during FY09 & FY10 respectively from around 37.7% in FY08 are :

Lower corporate profitability Significant widening of fiscal deficit Erosion in value of financial & physical assets.

While rich country banks were piling into ever riskier assets, Asian banks kept their holdings of such assets small. And while America & Britain were sucking up the worlds savings, Asian governments piled up vast stocks of foreign reserves. The Long term trends in the savings of the country are a clear indicator of the fact that even if Indias savings & investment rates undergo a cyclical reduction in FY09, by next fiscal(FY10) these rates should still br around 30%, with 6% growth in the second half of FY10.

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DECREASED CONSUMER DEMAND AFFECTING EXPORTS:Some of the sharpest declines in output during the global recession have been suffered by the strongest economies of Asia. It is feared that due to their heavy dependence on exports, some of these economies may not see the face of recovery until demand rebounds in America & Europe. In Oct 2008, India registered its first every year over-year decline in exports (of 15%), following growth of 35% in the previous five months. Indian shipments declined 33.3% in March from a year earlier, the biggest fall since the last 14yrs. Goods exports dropped 33% from a year earlier to $11.5 billion in April2009. This was the biggest fall since April 1995. Exports slid 21.7% in February. Indias exports, which account for 15% of the economy, grew 3.4% to $168.7 billion in the fiscal year ended March31, missing a $20 billion target set by the government, before the collapse of the Lehman Brothers Holding Inc. accelerated the world financial & economic slump. The government expects exports to total to $170 billion in the year that started April1. According to estimates from the Federation of Indian Export Organizations, falling overseas sales may cost India about 10million jobs. Asia is suffering from two recessions: a domestic one as well as an external one A high fiscal deficit & a high current account deficit are a threat to economic stability which is the main reason why international credit rating agencies have brought the countrys debt close to junk status. Asias export driven economies had benefited more than any other region from Americas consumer boom, so its manufactures were bound to be hit hard by the sudden downward lurch. Asia is suffering from two recessions: a domestic one as well as an external one. Domestic demand had been expected to cushion the blow of weaker exports, but instead it was hit by two forces. First, the surge in food & energy prices in the first half of 2008 squeezed companies profits & consumer purchasing power. Food & energy account for a larger portion of household budgets in Asia than in most other regions. Second, in several countries, including China, South Korea & Taiwan, tighter monetary policy intended to curb inflation choked domestic spending further. With hindsight, it appears that Chinas credit restrictions to cool its property sector worked rather too well. 12% of Indias total exports of $168.7 billion in FY2008-09 went to the US

25

Shipments of Indian natural pearls, precious & semi precious stones, & pharmaceutical products, all recorded a decline causing Indian exports to the US to drop by 22..63% to $5.22billion in Q1 of 2009. US exports to India also declined by 24.9% in Q1 of 2009; it amounted to $2.69 billion as compared to $3.94 billion in Q1 of 2008. The Indian Gems & Jewelry sector was significantly affected by the reduced demand in the US & Europe. Overseas sales of Indias gem & jewellry items expanded at a seven- year low rate of 1.45% & stood at $21billion in 200809, as exports contracted sharply in the last six months of the year. This lead to about 2Lakhs job losses in the sector, especially of artisans engaged in polishing diamonds. The fall in exports was caused by lowering of demand in overseas markets for luxury items in the backdrop of the ongoing recession. The drop in expansion of gems & jewellery exports in 2008-09 was cushioned by a 23.6% growth in gold jewellery, which stood at $6.85 billion as against $5.54 billion in the year ago period. India & the other Asian economies will have to brace themselves up for the sharply reduced consumption in the United states over an extended period, following the global financial crisis, & change the export- dependent structure of its economies, & create more regional demand to drive their growth. THE FINANCIAL CRISIS & THE INDIAN IT INDUSTRY: Indias emergence as a global competitive supplier of software & services has attracted world wide attention. The software & service sector not only contributed significant to export earnings & GDP but also emerges as a major sources of employment generation in the country. Besides, the information technology (IT) sector has served as a fertile ground for the growth of new entrepreneurial ideas with innovation corporate practices & has been instrumental in reversing the brain drain, raising Indias brand equity & attracting foreign direct investment (FDI) leading to other associated benefits.

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Economists have long noted that services in general are cheaper in developing countries than in developed countries. An abundant supply of labor the major input in the production of services in developing countries, leading to low wages is the chief factor that accounts for the low cost of producing services. India, with its large pool of skilled manpower, has emerged as a major exporter of IT software & related services, such as business process outsourcing (BPO). In fact, one of the notable achievements in India during the last decade has been the emergence of an internationally competitive IT software & service sector (see Fig. 4)

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The US financial services & insurance sector (BFSI-Banking, Financial services & Insurance) was one of the earliest adopters of the trend of outsourcing along with Indias biggest IT outsourcing firms. Large outsourcing chunks were created by the US BFSI which were created by the US BFSI which made the Indian IT players learn from their experience. Price negotiations & increased commitments on the services level raised the share of US financial services revenue as a percentage of total revenues for the Top 3 Indian from 25% to 38% between 1999 & 2008. Indian companies were appreciated by the US clients for their flexibility, good quality delivery & giving a key lever in managing their selling, general,& administrative expenses (SG & A) & time to market by freeing up more critical IT resources. Indian players were essentially partner in taking some of the fixed costs out of their SG & A. Because there was no partnering of Indian firms with the financial services entities at any closer level, like tying up of their invoices with the clients business outcomes, the Indian players were saved from a much worse impact of the crisis. The slowing US economy has seen 70% of firms negotiating lower rates with their suppliers & nearly 60% are cutting back on contractors. Due to a squeezed budget, only about 40% of the companies plan to increase their use of offshore vendors. The US financial crisis has put the growth of the Indian IT industry in the short- to medium-term in an uncertain position. Growth numbers of IT companies were revised down by 2-3% after sentiment started building up against the US financial sector at the time of the Q1 results. A worse downward revision is expected this quarter as well, though some larger players like TCS, & Satyam have denied any larger impact of the crisis. While we have looked mainly at IT, the ITES sector is joined at the hip with IT industry, but with its own flavors. The impact in financial services operations will be much larger, but, over the medium to long ter, there will be huge gain for them from the increase in outsourcing & off-shoring in the financial sector. However, short term pain alongside the US slowdown is inevitable. FINANCIAL CRISIS & THE SATYAM SAGA:In the light of the debacle of the Satyam Computer services, the current financial crisis has brought the issue of audit committee effectiveness to the fore in India. Satyam, Indias fourth largest computer software exporter, after years of vastly inflated profits, was shattered & exhausted when the shocking reality of Satyams operating margin of 24% being false was brought to the forefront its operating margins were a meager 3%.

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The financial crisis also struck the company at a time when there were growing suspicions related to the Maytas issue. Satyam was not able to maintain its inflated figures in the wake of the crisis & hence, its majestic accounting fraud was brought to the forefront. FALL IN GROWTH RATE, INDUSTRIAL OUTPUT AND RISE IN INFLATION :Second, the global financial crisis and credit crunch have slowed Indias economic growth. GDP started decelerating in the first quarter of 2007-08, 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. That was just the beginning of slowdown impact on Indias GDP growth. GDP growth for 2008-09 was estimated at 6.7% as compared to the growth of 9.0% posted in the previous year. All the three segments of the GDP namely agriculture, forestry and fishing, industry and services sector were seen to post growth of 1.6%, 3.8% and 9.6% respectively in 2008-09 against the growth of 4.9%, 8% and 10.8% respectively in 2007-08. Poor agricultural growth is also attributed to low monsoon in major parts of India (Figure 5).

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FIGURE (5) Table 2 clearly shows that due to shrinkage in demand in the markets, it is not only manufacturing industry but also the services sector that is getting hit. The government came up with a set of stimulus measures on three occasions to aid the ailing industry compromising on the deficits. These measures have however have led to widening of fiscal deficits. Further, Indias industrial output fell at its fastest annualized rate in 14 years, despite tax cuts and fresh spending programme announced by the government of India in December and January to boost domestic demand. Data released by CSO showed that the factory output shrank by 1.2 per cent in February, on week global and domestic demand. This is against growth rate of 9.5 per cent during the same month a year ago. Industrial output thus grew 2.8 per cent during April-February, against 8.8 per cent in the same period a year ago. Manufacturing, which constitutes 80 per cent IIP (Index of Industrial Production), contracted by 1.4 per cent in February, as production of basis, intermediates and consumer goods shrank compared with a year ago (Figure 6).

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For a little over a year after the outbreak of financial crisis, the global economy experienced, between September 2007 and October 2008, a pronounced stagflationary phase, with the growth slowdown on the one hand and rising inflation on the other hand. 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, transmission of global inflation to domestic prices occurred with a time lag, from November 2007 rather than September 2007. Beginning of 2008 has seen a dramatic rise in the price of rice and other basic food stuffs. When coupled with rises in the price of the majority of commodities, higher inflation was the only likely outcome. Indeed, by July 2008, the key Indian Inflation Rate, the Wholesale Price Index, has risen above 11%, its highest rate in 13 years. Inflation rate stood at 16.3 per cent during April to June 2008. There was an alarming increase in June, when the figure jumped to 11%. This was driven in part by a reduction in government fuel subsidies, which have lifted gasoline prices by an average 10%.
BAIL- OUT PACKAGES AND RBI INITIATIVES:-

Financial markets in the United States & around the world are in a state of dire emergency & they require urgent & decisive action. Some key parts of the credit market were on the verge of a deadlock, resulting not just in the collapse of major financial institutions but also in credit disruption that has been severely weakening the long term prospects of non- financial companies. There was a need for swift action to deal with the toxic mortgagebacked securities that had been causing credit markets to seize up. The

31

Federal governments effort to support the global financial system have resulted in significant new financial commitments, with the U.S government having pledged more than $11.6 trillion on behalf of American tax payers over the past 20month, far in excess of the aggregate of the several bailout packages announced or doled out in the past. The Government of china had also announced a financial package of US$585 billion to pump prime the economy by making huge public investment & by providing subsidies to protect domestic economy which is otherwise exposed to external market & is likely to be severely affected because of the cuts in imports by all the importing countries. INDIAs RESPONSE TO THE CRISIS :As the contagion of the financial system collapse across the world spread towards India, & into it, the government & the Reserve Bank Of India (RBI) responded to the challenge in close coordination & consultation. The main plank of the governments response was fiscal stimulus while the RBIs action comprised monetary accommodation & counter cyclical regulatory forbearance. The RBIs policy response was to keep the domestic money & credit markets functioning normally & see that the liquidity stress did not trigger solvency cascades. RBIs targets can be classified into 3 prime directions: (Duvvuri Subbarao, Governor) To maintain a comfortable rupee liquidity position To augment foreign exchange liquidity
To maintain a policy framework that would keep credit delivery on

track so as to arrest the

moderation in growth.

The previous period has forced RBI to adopt tightened monetary policies in response to heightened inflationary pressures. However, the RBI changed its approach to handle the current scenario & eased monetary constraints in response to easing inflationary pressures & moderation in growth in the current cycle. The following were the conventional measures of the RBI : 1) Reduced the policy interest rates aggressively & rapidly 2) Reduced the quantum of bank reserves impounded by the central bank

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3) Expanded & liberalized the refinance facilities for export credit To manage Foreign Exchange, the RBI i) ii) iii) Made an upward adjustment on interest rate ceiling on the foreign currency deposits by non- resident Indians Substantially relaxed the external Commercial Borrowings (ECB) regime for corporates Allowed access to foreign borrowing to non-banking financial companies & housing finance companies.

RBI also took unconventional measures as a response to the liquidity scenario: i) India banks were given the rupee- dollar swap facility to give them comfort in managing their short term funding requirments An exclusive refinance window, as also a special purpose vehicle, was made available for supporting non- banking financial companies The lendable resource available to apex finance institutions for refinancing credit extended to small industries, housing & exports, was expanded.

ii)

iii)

The Central Governments Fiscal Responsibility & Budget Management (FRBM) Act, enacted to bring in fiscal discipline by imposing limits on fiscal & revenue deficit, proved to the road map to fiscal sustainability at the time of crisis. The emergency provisions of the FRBM Act were invokes by the central government to seek relaxation from the fiscal targets & two fiscal stimulus packages were launched in December 2008 & January 2009. These fiscal stimulus packages, together amounting to about 3% of GDP, included: Additional public spending , particularly capital expenditure, government guaranteed funds for infrastructure spending Cuts in indirect taxes, Expanded guarantee cover for credit enterprise, and to micro & small

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Additional support to exporters. These stimulus packages came on top of an already announced expanded safety-net for rural poor, a farm loan waiver package & salary increases for government staff, all of which too should stimulate demand.

The global financial crisis has called into question several fundamental assumptions and beliefs governing economic resilience and financial stability. With all the advanced economies in a synchronized recession, global GDP is projected to contract for the first time since the World War II, anywhere between 0.5 and 1.0 per cent, according to the March 2009 forecast of the International Monetary Fund (IMF). The emerging market economies are faced with decelerating growth rates. The World Trade Organization (WTO) has forecast that global trade volume will contract by 9.0 per cent in 2009. Governments and central banks around the world have responded to the crisis through both conventional and unconventional fiscal and monetary measures. Indian authorities have also responded with fiscal and monetary policy and regulatory measures .

POLICY RESPONSES FROM INDIA :-

On the monetary policy front, the policy responses in India since September 2008 have been designed largely to mitigate the adverse impact of the global financial crisis on the Indian economy. In mid-September 2008, severe disruptions of international money markets, sharp declines in stock markets across the globe and extreme investor aversion brought pressures on the domestic money and forex markets. The RBI responded by selling dollars consistent with its policy objective of marinating conditions in the foreign exchange market. Simultaneously, it started addressing the liquidity pressures through a variety of measures. A second repo auction in the day under the Liquidity Adjustment Facility (LAF16) was also introduced in September 2008. The repo rate was cut in stages from 9 % in October 2008 to rate of 5 per cent. The policy reverse repo rate under the LAF was reduced by 250 basis points from 6.0 per cent to 3.5 per cent. The CRR (Cash Reserve Ratio) was also reduced from 9 per cent to 5 per cent over the same period, whereas the SLR (Statutory Liquidity Ratio) was brought down by 1 per cent to 24 per cent. To overcome the problem of availability of collateral of government securities for availing of LAF, 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, under a pre-existing provision of the RBI Act for a maximum period of 90 days. These policy measures of the RBI since mid-September resulted in augmentation of liquidity of nearly US $80 billion (4,22,793 crore). In addition, the permanent reduction in the SLR by 1.0 per cent of NDTL (Net Demand and Time Liability) has made available liquid funds of the order of Rs.40,000 cr for the purpose of credit expansion (Table 7).

Monetary Policy Measures -

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The liquidity situation has improved significantly following the measures taken by the Reserve Bank. The overnight money market rates, which generally hovered above the repo rate during September-October 2008, have softened considerably and have generally been close to or near the lower bound of the LAF corridor since early November 2008. Other money market rates such as discount rates of CDs (Certificates of Deposits), CPs (Commercial Papers) and CBLOs (Collateralized Borrowing and Lending Obligations) softened in tandem with the overnight money market rates. The LAF window has been in a net absorption mode since mid-November 2008. The liquidity problem faced by mutual funds has eased considerably. Most commercial banks have reduced their benchmark prime lending rates. The total utilization under the recent refinance/liquidity facilities introduced by the Reserve Bank has been low, as the overall liquidity conditions remain comfortable. However, their availability has provided comfort to the banks/FIs, which can fall back on them in case of need. Taken together, the measures put in place since mid-September 2008 have ensured that the Indian financial markets continue to function in an orderly manner. 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, the overnight money market rate and the yield on the 10-year benchmark government security.

Fiscal Stimuli Packages -

To contain the knock on effects of the global slowdown, the Government of India announced three successive fiscal stimuli packages during December 2008-Feburary 2009 amounting to a total of Rs. 80,100 crore (US $16.3

35

billion) to the exchequer. These stimulus packages were in addition to the already announced post budget expenditure towards the farmer loan waiver scheme, rural employment guarantee and other social security programs, enhanced pay structure arising from the 6th pay commission, etc. As a result, net borrowing requirement for 2008-09 increased nearly 2.5 times the original projection in 2008-09 from 2.08 per cent of GDP to 5.89 per cent of GDP The governments first fiscal package, announced on December 2008, a day after the central bank cut the Repo and Reverse Repo rates, has Rs 20,000 crore as additional expenditure, an across-the-board 4% excise duty cut amounting to Rs 8,700 crore and benefits worth Rs 2,000 crore for exporters. In less than a month since the UPA Government announced its first fiscal stimulus package in December 08, the government again announced its second fiscal stimulus package dose which was combined with significant monetary measures from the RBI announcing further cuts in key benchmark interest rates, both being aimed at kick starting investments and stimulating demand in the economy which has seen a significant slowdown in demand arising out of recessionary conditions in several global markets. The second stimulus package has five elements this time which include a strong focus on interest rate reduction, additional liquidity enhancement to productive sectors, export sector being offered financial aid, a boost being given to the Infrastructure Sector and finally easier access to ECBs (External Commercial Borrowings) and FIIs22. The Stimulus package announced has an additional plan expenditure of Rs. 20,000 crore during current year, mainly for critical Rural, Infrastructure and Social Security sectors, and measures to support Exports, Housing, Micro, Small & Medium Enterprises (MSME) and Textile sectors. In this package, government has focused on the Infrastructure needs wherein the India Infrastructure Finance Company Limited (IIFCL) would be raising Rs. 10,000 crore to refinance infrastructure projects worth Rs 25000 crore. It has also envisaged funding of additional projects worth Rs 75000 crore at competitive rates over the next 18 months. Funding for these projects to IIFCL would be enabled in tranches of additional Rs 30000 crore by way of tax-free bonds, once funds raised during current year are effectively utilized. (Estimated benefits to the tune of Rs 40000 crore) Barely a week after the presentation of the Interim Budget, the government came out with the third fiscal stimulus package in which further tax cuts costing Rs 29,100 crore or about 0.5 per cent of GDP were announced. The service tax was cut by two points from the prevailing level of 12 per cent and excise duty was reduced by a similar magnitude for items presently subject to 10 per cent. The indications so far seem to be that the package of policy measures is not really having the intended impact of reviving the real sector. In spite of the more than Rs. 4,00,000 crore of liquidity released into the financial markets, the credit offtake has been remarkably poor. There are also questions on the appropriateness of the measure in the already strained fiscal scenario. The effectiveness of cuts in excise duty and service tax in providing a demand stimulus is doubtful-first, the tax cuts should result in price cuts and then, these should translate into higher demand in the situation of falling incomes. Furthermore, there will always be

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dissatisfaction when the tax cuts are reversed. Many, in fact, believe that fiscal stimulus is better served by expenditure increase rather than tax cuts not only because the impact is direct but also because it can be better targeted. Hopefully, the reduction in excise duty and service tax rates will facilitate the unification of the two taxes for levying the GST (Goods and Services Tax) at a reasonable rate when implemented. In any case, the entire episode of announcing tax cuts just after a week of presenting the Interim Budget points to the governments lack of clarity in combating the slowdown. OPTIONS AHEAD/SUGGESTION :(i) Diversifying Exports There is an imperative need to boost the exports, keeping in view its growth impulses and employment potential. Emphasis has been laid on renewing efforts not only to improve competitiveness, but also diversify the export basket and destinations. We need to be cognizant of the fact that due to financial turmoil, the consumption pattern of the developed countries and their demands for goods and services have undergone a sea change and this will be less likely to be reversed in near future. We need to imaginatively think where else can we sell our products and what would be the preferred consumption patterns of these newer markets. (ii) Boosting Domestic Consumption It has been suggested by many experts that unless we boost domestic consumption, it will be difficult to compensate for the loss of external demand arising out of export squeeze. But, it is not that easy to replace exports by domestic consumption. It is a common knowledge that the products and processes of goods and services meant for exports are significantly different from the one preferred by domestic consumers. Changing production systems to suit domestic demand requires in-depth analysis and commencing new lines of production and processes. (iii) Enhancing Public Spending It has been argued that along with the measures to support the financial system, we must increase public spending. There can be no dispute with the contention that public spending should remain at a high level in a situation like the present one. Fiscal profligacy is not a dirty word anymore. There is a world-wide feeling that pampering enhanced public outlays during the period of crisis is a key policy option. It has been commonly held that public outlays on infrastructure projects need to be optimum and particularly, project implementation needs to be accorded top priority, keeping in view its multiplier effects on growth. We need to put in place a sound mechanism of project management which would provide for minimal regulatory hurdles and process delays and functional autonomy to implementing agencies so as to ensure the pace and quality of public projects. Several stimulus packages have been announced that indicate commitment to enhanced public spending. But such a package is meaningful only if money does not remain clogged up in the system. For infrastructure spending to spur the economy, it is critical that usual delays and lags are avoided and the projects are enabled to take off quickly.

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And, a clear cut policy with full commitment to increase the rate of investment has the potential to engender growth and revive confidence. In India, the Finance Minister has pointed out; there is a huge infrastructure gap which could be bridged by stepping up investments from the current level of five per cent of the GDP to more than nine per cent by 2014. When private investors are reluctant, we have to depend upon public investment to stimulate investment. We have a large public sector functioning with efficiency, as has been demonstrated by a sustained increase in its profitability. The Government may mobilise some of our public sector corporations engaged in the sectors of power, transport, construction and communication to expand investment in our infrastructure.Besides, we need to invest significantly in the social sector in our educational and healthcare infrastructures. Increased public spending will help address the huge domestic demand for both urban and rural sectors for better infrastructures and improved social services. (iv) Generating Employment Employment generation is the key to minimize the impact of the economic crisis on the social side. The need is all the more imperative as massive jobs have been lost due to economic slowdown and export shrink. As the sectors that fuelled high annual economic growth brace themselves for hard times, job creation in these areas has also weakened. Specific measures to facilitate employment are called for in segments that are badly affected by the economic slowdown. Critical to protecting the households will be the ability of governments to cope with the fallout and finance programs that create jobs, ensure the delivery of core services and infrastructure, and provide safety nets. In India, nearly 60 per cent of the people rely on agriculture and the rural economy. It generates less than 20 per cent of the income or output. Greater employment opportunity for this sizeable population in productive ways in rural areas and in the urban economy would clearly be a priority going forward. Here again the size and strength of the domestic economy provide advantages for investments in education and appropriate skill formation. With half the population under the age 25, there is also a huge upside for employment. (v) Provisioning Credit to Productive Sectors What is needed at present is to focus on the financial system and enable it to fulfil adequately its functions in terms of the provision of credit to productive sectors. The domestic credit system must also fill the gap created by the drying up of external sources. We ought to be thinking of a scheme to provide additional funds for long term capital requirements, since the ability to raise funds from the capital market is bleak. We need to pursue a conscious policy of expanding credit to the Small and Micro Enterprises (SMEs). This sector with only 10 per cent import content and with a proven ability to expand production through small amount of investment can very rapidly increase output and employment in our system. This sector has suffered most when the banks are in no mood to support SMEs with limited profitability and with practically no collateral. Only a directed public policy of

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providing financial support can galvanize them. Adequacy of liquidity with the lending agencies will not be enough. Injection of rupee by RBI into the system will not necessarily increase bank lending unless borrowers have the confidence in the sustainability of our economy to induce them to increase their investment and the banks have the confidence that these borrowers will be able to pay back. The main element that is missing in the system is enough confidence of our economic actors in our ability to get over the crisis within a short period. In its absence, there is hardly any way that either the demand for credit and finance for investment or the bankers willingness to meet that demand can increase. (vi) Need for Structural Reforms Along with monetary and fiscal policies, there is a need to bring about structural reforms to sustain the growth momentum. For instance, we need to pursue agrarian reforms. Agriculture has had declining Government investment for years. Government spending in agriculture has not led to building durable assets that could help agricultural production and diversify rural employment. Similarly, we must invest in inducting environment friendly technology and promoting environment friendly projects for sustainable development. We also need to improve regulatory framework so that the economy is revived to move along a high growth trajectory. (vii) Increased purchasing power of the people One of the ways to minimize the impact of the economic crisis on the people is to enhance purchasing power among the masses. It is true that productive capacity of the economy has been enhanced enormously, but the majority of people are too poor to be able to buy. The problem, therefore, does not relate to increasing production, but increasing the purchasing power of the masses. This assumes critical significance, especially in India, where 70 per cent of the people live on incomes of Rs.20 a day. The solution to the economic crisis lies in raising the purchasing power of the masses. Tax cuts and price reductions can do this.

Recovery of Indian Economy :

It is interesting to note that after two years of recession, almost all the countries are raising again. Hence statements from politicians and others as well as official data which in other times would be seen to be pessimistic or at best neutral are now viewed as something to cheer about. In May 2009 the U.S. authorities allowed ten banks to return part of the money they had received from the government to shore up their financial position at the height of the crisis. Even though President Obama admitted that the crisis was far from over, the news of banks returning the money ahead of schedule was received positively by the markets. U.S. Treasury Secretary Timothy F. Geithner was probably alluding to the above development when he said that the force of the global storm is receding a bit. The role the U.S. government was committed to play to save the banks will probably get reduced. He also identified improving signs in the U.S. economy and better

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outlook internationally. The good news was not confined to the U.S. alone. IMF24 in its recent report also mentioned that global economic recovery has started. According to reports, prices in China fell less sharply in May than in April giving rise to expectations that the US $686-billion stimulus package of the Chinese government was beginning to check deflationary forces. Indian economy is also recovering slowly since the beginning of year 2009. However, the recovery rate is very slow. India's economic slowdown unexpectedly eased in the first quarter. Indias economic growth logged a notable acceleration to 6.1 per cent for the first quarter of this fiscal from 5.8 per cent for the quarter before due to strong showing by various services industries (Figure 8). Figure 8: Acceleration in GDP

The growth registered by the farm sector at 2.4 per cent and manufacturing at 3.4 per cent remained below the overall expansion, showed the data on the countrys gross domestic product released by the Central Statistical Organization (CSO). The best performance was from the trade, hotels, transport and communication group, as also the financial services and real estate sectors with an 8.1 per cent expansion each, while mining came next 7.9 per cent followed by construction with 7.1 per cent. The industry data revealed domestic passenger car sales in July went up to 1,15,067 units from 87,901 units in the same month last year. Software exporters paced gains after Goldman Sachs upgraded its outlook on the country's information technology services sector. Tata Consultancy Services, the biggest software exporter, rose 2.85 per cent after Goldman Sachs more than doubled the stocks target price. After auto, realty was the best performer, rising 2.14 per cent to 3,693.02. The metal index rose by two per cent at 12,305.66 as Hindalco Industries, the biggest aluminum producer, rose 3.38 per cent to Rs 105.45 after UBS raised it to "buy" from "sell". The data during the first two months of 2009-10 on six core infrastructure industry indicated improvement in output (Figure 9). The main drivers of growth seen in the six core infrastructure industry during the period were

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cement, power and coal posting growth of 11.7 % , 5.1% and 11.8% respectively in April-May 2009-10 compared to the growth of 5.4% , 1.7% and 9.5% respectively during the same period of previous fiscal. However, production of crude petroleum and petroleum refinery were badly hit.

The official data shows that the cement sector has grown 9.97 percent in December 2008 as compared to November and the year on year increase is 11%. Steel, which declined from September onwards last year, has shown a recovery in December last and January this year. It has now touched 22.86 million metric tonnes, a figure it achieved in May 2008 when the sectoral growth rate was 4.1%. This may not be quite impressive but the very fact that the sector is growing is a matter of some satisfaction. Car sales in August grew a robust 25.5% as companies despatched more vehicles to dealerships to boost stocks ahead of the demand spurt in forthcoming festive season. Maruti, Hyundai, Tata and Mahindra led the growth in car and passenger vehicle sales after a 31% growth in July. Total auto sales were up 24% at 10 lakh units in August against 8.1 lakh units in the same month last year, according to industry body Siam (Table 9).

Car sales in August stood at 1.2 lakh units against 96,082 units in the corresponding month last year. Demand for new models added to the festive

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rush and kept the momentum going for car sales that witnessed the seventh straight month of growth. Industry analysts said demand was likely to remain strong in the coming months, especially over low base of last year when demand was hit by economic slowdown and high interest rates. The two-wheeler industry also saw a 26% growth at 6.1 lakh units against 4.8 lakh units in August last year, with Hero Honda fuelling the demand for motorcycles. On the scooter side, Honda Motorcycle and Scooter India, Hero Honda, TVS and Suzuki pushed up sales, which grew 23% at 1.1 lakh units. Sales of commercial vehicles were also up, growing by 18% at 40,624 units against 34,289 units in August 2008. Slowdown in the economy and rapid decline in global commodity prices toned down the overall inflation to below 0 levels for the first time in 35 years. However, it was found that prices of some of the items of mass consumption were still rising (Rakshit, 2009). Foreign institutional investors' (FIIs) net investment in Indian equities crossed $8 billion in calendar 2009 with foreigners buying stocks worth $274 million on Friday. At the end of July, net inflows from FIIs stood at $7.3 billion and it took another 20 trading sessions before net inflows crossed the US $8 billion mark, the first time in this year. Last year, hit by recession back home FIIs took out nearly $12 billion from the Indian stock markets but with sentiment improving from March this year, foreigners have returned with net investment amounting to $9.3 billion, according to SEBI. The benchmark index Sensex has risen25 65% till 31st August 2009 (Figure 10).

Further, the Sensex of the Bombay Stock Exchange (BSE) gained 325 points to reach 16,014 on 7th September 2009. Markets have surged higher in the second half with the NSE Nifty has surging past the 4750 mark to reach a 52 weeks high and the BSE Sensex has also surged past the 16000 levels (Figure 11). Following the global financial turmoil, the markets had plunged to 8,047.17 points on March 6, 2009. Investor sentiment on 7th September got a further boost from positive trends across Asia. Besides, expectations of

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strong quarterly earnings and signs of stability in global economy bolstered their confidence.

In similar fashion, the wide-based National Stock Exchange index Nifty crossed the crucial 4,800-point level to close higher by 22.35 points at 4,805.25 (Figure 12). Buying was more or less confined to fundamentally strong stocks. As many as 15 shares in the 30-BSE index closed with significant gains, while the other 15 closed lower. Hindalco, Sterlite were the two big gainers at 6.05% and 4.78% respectively. Market leader Reliance was up by 3.73%.

Commodities outperformed in the Mid May. The CRB (Commodity Research Bureau) Index rose sharply from 236 to 254, a rise of nearly 8% with precious metals, energies and base metals moving up sharply. Crude oils performance was the best amongst the entire complex where prices shot up by 20% on NYMEX29 (New York Mercantile Exchange) during the last fortnight. Except aluminum, most industrial metals surged by more than 10%. The rupee has been largely volatile since January 2009, trading in a wide range between 46.75 and 52.18. The last five months of 2009 have been quite eventful for the Indian rupee, with the currency gaining steadily against the US dollar. At a time when the Indian economy was visibly slowing down, the recent gain in the rupee has proved to be a blessing in disguise.

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Some Reasons of Recovery There are also several structural factors that have come to Indias aid. First, notwithstanding the severity and multiplicity of the adverse shocks, Indias financial markets have shown admirable-resilience. This is in large part because Indias banking system remains sound, healthy, well capitalized and prudently regulated. Second, Indias comfortable reserve position provides confidence to overseas investors. Third, since a large majority of Indians do not participate in equity and asset markets, the negative impact of the wealth loss effect that is plaguing the advanced economies should be quite muted. Consequently, consumption demand should hold up well. Fourth, because of Indias mandated priority sector lending, institutional credit for agriculture will be unaffected by the credit squeeze. The farm loan waiver package implemented by the Government further insulated the agriculture sector from the crisis. Fifth, over the years, India has built an extensive network of social safety-net programmes, including the flagship rural employment guarantee programme, which is protecting the poor and the returning migrant workers from the extreme impact of the global crisis. Sixth, throughout the crisis, the RBI has also been very proactive in providing liquidity to the system, releasing about Rs 2.5lakh crore in the form of CRR cuts and MSS redemptions and also cutting the Repo and Reverse Repo rates rapidly to 4.75% and 3.25% from peaks of 9% and 6% respectively. As a result, broader lending and deposit rates have also gradually come down by 200-300bp on an average. Last but not the least, the recent victory of the Congress party in the Indian general elections is a positive signal for international business and diplomacy. During the last five years India has moved forward in opening its economy, but the last governments speed and the level of engagement was restricted due to threats by powerful left-wing allies of necessity. It is ironic that in the middle of an international financial crisis that has seriously dented the reputation of capitalism the Indian communists have suffered their worst electoral defeat in decades.

CHAPTER -5
OUTLOOK FOR THE INDIAN ECONOMY:India is witnessing a mixed result with respect to its growth prospects in the wake of the global economic downturn. Real GDP growth has moderate to 6.6% and is projected to grow at the same rate in 2009-10 The Service sector too, which accounts for 57% of Indias GDP, & has been the countrys prime growth engine for the last five years, is slowing mainly in construction, transport & communication, trade, hotels & restaurants subsectors. According to recent data, demand for bank credit has been slackening despite sufficient liquidity in the system.

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Indias export, which account for 15% of the economy, grew 3.4% to $168.7 billion in the fiscal year ended March 31, missing a $200 billion target set by the government. Corporate margins have been dented due to higher input costs & dampened demand; business confidence has been affected by the uncertainty around the economic condition. The Index of Industrial production has been showing a negative growth & the demand for investment is decelerating. India, though, certainly has some advantages in addressing the fallout of the crisis:
I)

Headline inflation, as measured by the wholesale price index, has fallen sharply; inflation has decline faster than expected. Key factors behind the disinflations have been commodity prices & a part of it is contributed by slowing domestic demand. Decline in inflation should prove to be positive for reviving consumer demand and reducing input costs for corporates Fiscal space will open up for infrastructure spending as the decline in global crude prices & naphtha prices will reduce the amount of subsidy given to the oil & fertilizer companies. Imports are expected to shrink more than exports; this will keep the current account deficit at modest levels Indias sound banking system has helped to sustain the financial market stability to a large extent- well capitalized & prudently regulated Overseas investors are confident about the India economy due to comfortable levels of foreign reserves. The negative impact of the wealth loss effect in the capital markets that have plagued the advanced countries will not affect India because majority of Indians stay away for asset & equity markets. Institutional credit for agriculture will also remain unaffected because of Indias mandated priority sector lending Agriculture sector of India will be further insulated from the crisis due to the governments farm waiver package Indias development of social safety programs over the years (e.g the rural employment guarantee program), will protect

II) III)

IV) V)

VI)

VII)

VIII) IX)
X)

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the poor & migrant classes from the ill effects of the global crisis. Therefore, once the global economy begins to recover, Indias turn around will be sharper & swifter, backed by its strong financial system & regulatory norms. Overall, the Indian economic outlook is mixed. There is evidence of economic activity slowing down. Real GDP growth has moderated in the first half of 2008/09. Industrial activity, particularly in the manufacturing and infrastructure sectors, is decelerating. The services sector too, which has been our prime growth engine for the last five years, is slowing, mainly in construction, transport & communication, trade and hotels & restaurants subsectors. For the first time in seven years, exports had declined in absolute terms in October. Data indicate that the demand for bank credit is slackening despite comfortable liquidity. Higher input costs and dampened demand have dented corporate margins while the uncertainty surrounding the crisis has affected business confidence. On the positive side, on a macro basis, with external savings utilisation having been low traditionally, between one to two per cent of GDP, and the sustained high domestic savings rate, this impact can be expected to be at the margin. Moreover, the continued buoyancy of foreign direct investment suggests that confidence in Indian growth prospects remains healthy. India is experiencing the knock-on effects of the global crisis, through the monetary, financial and real channels all of which are coming on top of the already expected cyclical moderation in growth. Our financial markets equity market, money market, forex market and credit market have all come under pressure mainly because of what we have begun to call 'the substitution effect' of : (i) drying up of overseas financing for Indian banks and Indian corporates; (ii) constraints in raising funds in a bearish domestic capital market; and (iii) decline in the internal accruals of the corporates. All these factors added to the pressure on the domestic credit market. Simultaneously, the reversal of capital flows, caused by the global deleveraging process, has put pressure on our forex market. The sharp fluctuation in the overnight money market rates in October 2008 and the depreciation of the rupee reflected the combined impact of the global credit crunch and the de-leveraging process underway. In brief, the impact of the crisis has been deeper than anticipated earlier although less severe than in other emerging market economies. The extent of impact on India should have been far less keeping in view the fact that our financial sector has had no direct exposure to toxic assets outside and its off balance sheet activities have been limited. Besides, Indias merchandise exports, at less than 15 per cent of GDP, are relatively modest. Despite these positive factors, the crisis hit India has underscored the rising trade in goods and services and financial integration with the rest of the world.

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CHAPTER -6
EXECUTIC SUMMARY The world economy is engaged in a spiraled mortgage crisis, starting in US, which is carving the route to the largest financial shock since the Great Depression. A loss of confidence by investors in the value of securitized mortgages in US was the beginning of Financial Crisis that swept the Global economy off its feet. The Major financial crisis of 21st Century involves esoteric instruments, unaware regulators & nervous investors. Starting from the summer of 2007, the US experienced a startling contraction in wealth, triggered by the subprime crisis, thereby leading to increase in spreads, & decrease in credit market functioning. During boom years, mortgage brokers, enticed by the lure of big commissions, talked buyers with poor credit into accepting housing mortgages with little or no down payment & without credit checks. Higher default levels, particularly among less credit worthy borrowers, magnified the impact of crisis in the financial sector. The ability to raise cash, i.e liquidity is an essential component for the markets & for the economy as whole. The freezing liquidity has closed shops

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of large no. of markets. Interest rates have been rising across the world, even rates at which bank lend to each other. The freezing up of the financial markets eventually lead to a severe reduction in the rate of lending, followed by slow & drastically reduced business investments, paving the way for nasty recession in the overall economic state of globe. The impact of crisis is more vividly observable in the emerging markets which are suffering from one of their biggest selloffs. Economies with disproportionate offshore borrowings (like that of Australia) are adversely affected by the financial crunch. Globalization has ensured that none of the economies of the world stay insulated from the financial crisis in the developed economies. Contrary to the decoupling theory, emerging economies too have been hit by the crisis. According to the decoupling theory, even if advanced economies went into a downturn, emerging economies would remain unscathed because of the substantial foreign exchange reserves, improved policy framework robust corporate balance sheets, & a relatively health banking sector. In a rapid globalizing world, the decoupling theory was never totally persuasive. The decoupling theory stands totally invalidated today in the face of capital flow reversals, sharp widening of spreads on sovereign & corporate debt & abrupt currency depreciations. CONCLUDING OBSERVATION India has by-and-large been spared of global financial contagion due to the subprime turmoil for a variety of reasons. Indias growth process has been largely domestic demand driven and its reliance on foreign savings has remained around 1.5 per cent in recent period. It also has a very comfortable level of forex reserves. The credit derivatives market is in an embryonic stage; the originate-to-distribute model in India is not comparable to the ones prevailing in advanced markets; there are restrictions on investments by residents in such products issued abroad; and regulatory guidelines on securitisation do not permit immediate profit recognition. Financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent. BIBLOGRAPHY
Newsletters, reports, periodicals, journals of : -

The International Monetary Fund Asian Development Bank

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Global Meltdown :Road Ahead, Dr D.R Agarawal Economist.com

The RBI Press Release, Special Reports Jha, Raghbendra (2009) The Global Financial Crisis and Short Run

Prospects for India. www.timesof india.com Google.com Wikipedia.org www.Businessweek.com Manorama Year Book

Chindambaram 2008- Spill over effects of Global Crisis will be tackledTHE HINDU DALY