Euro Crisis Effect on Indian Banking Industry

8/2/2019 Euro Crisis Effect on Indian Banking Industry

http://slidepdf.com/reader/full/euro-crisis-effect-on-indian-banking-industry 1/40

Global Financial Crisis:

Causes, Consequences andIndia’s Prospects

By

RAKESH MOHAN

Deputy Governor

Reserve Bank of IndiaAt

London Business School

April 23, 2009



p

Scheme of Presentation

wGlobal Financial Crisis

wImpact on India

wDifference between US/Europe andIndia

w

RBI’s Policy Response and ImpactwLessons from the Crisis

wMedium-term Issues and Challenges




Global Financial Crisis

wImpact on India


wRBI’s Policy Response and Impact

wLessons from the Crisis




Global Financial Crisis (1)

wProximate causesn Sub-prime lending

n Originate and distribute model

n Financial engineering, derivativesn Credit rating agencies

n Lax regulation

n Large global imbalanceswFundamental cause

n Excessively accommodative monetary policy in

the US and other advanced economies (2002-04)



Global Financial Crisis (2)



Global Financial Crisis (4)US Monetary Policy (1)

•Volatility in monetary policy in advanced economies

•Large volatility in capital flows to EMEs

•Again very loose MP in US – likely surge in capital flows to




•US Monetary policy too loose during 2002-04;aggregate demand exceeded output; large current

a/c deficit; mirrored in large surpluses in China and




w Large Fed cuts in 2007: strong boost to oil, other

commodity and asset prices



Global Financial Crisis (3)Capital Flows to Emerging Market Economies

•Very large capital flows to EMEs –– now outflows in 2009 - largevolatility - implications for monetary management and financial



Global Financial Crisis (7)Worsening Global Economic Outlook

Growth Forecast of IMF (per cent)

Region April 2008 July 2008 October 2008 April 2009

2008 2009 2008 2009 2008 2009 2008 2009

Advanced

countries 1.3 1.3 1.7 1.4 1.5 0.5 0.9 (-)3.8

EMEs 6.7 6.6 6.9 6.7 6.9 6.1 6.1 1.6World 3.7 3.8 4.1 3.9 3.9 3.0 3.2 (-)1.3

Global Trade Volume (Goods and Services)

World 3.7 3.8 4.1 3.9 3.9 3.0 3.3 -11.0





Impact on India







Impact on India (1)Trends in Capital Flows

Component Period2007-08

2008-09

Foreign Direct Investment to India April-February 27.6 31.7

FIIs (net) April-March 20.3 -15.0External Commercial Borrowings(net)

April-December 17.5 6.0

Short-term Trade Credits (net)April-December 10.7 0.5

Total capital flows (net)

April-December 82.0 15.3

Memo:

Current Account Balance

April-December -15.5 -36.5

Valuation Gains (+)/Losses (-) onForeign Exchange Reserves

April-December 9.0 -33.4

Foreign Exchange Reserves(variation)

April-December 76.1 -53.8

April-March 110.5 -57.7



Impact on India (2)Key Macro Indicators

Indicator Period 2007-08 2008-09Growth, per cent

Real GDP Growth April-December 9.0 6.9

Industrial production April-February 8.8 2.8

Services April-December 10.5 9.7

Exports April-March 28.4 6.4

Imports April-March 40.2 17.9

GFD/GDP April-March 2.7 6.0

Stock Market

(BSE Sensex)

April-March 16,569 12,366

Rs.per US$ April-March 40.24 45.92





wImpact on India

Difference between US/Europeand India






Differences Between Financial Crisis inUS/Europe and India (1)

wWhat has not happened here

n No subprime

n No toxic derivatives

n No bank losses threatening capital

n No bank credit crunch

n No mistrust between banks




wOur Problemsn Reduction in capital flows

l Pressure on BoP

l

Stock marketsl Monetary and liquidity impact

Temporary impact on MFs/NBFCs (Sept-Oct)

Reduction in flow from non-banks

Perceptions of credit crunch




wOur Problemsn Fiscal stress

l Oil, Fertiliser, Food subsidies

l

Pay Commission, Debt waiver, NREl Stimulus packages

l GFD/GDP ratio: 5.5-6.0%

Large increase in market borrowings

Rs. crore

2008-09 BE 2008-09 RE 2009-10 BE

Gross 1,76,453 3,42,769 3,98,552

Net 1,13,000 3,29,649 3,08,647




w India’s Approach to Managing FinancialStability (1)

n Current account: Full, but gradual opening up

n Capital account and financial sector: Morecalibrated approach towards opening up.

l Equity flows encouraged;

l debt flows subject to ceilings and some end-use

restrictions.

l Capital outflows: progressively liberalized.

Diff B Fi i l C i i i




w India’s Approach to Managing Financial

Stability (2)n Financial sector, especially banks, subject to

prudential regulation

l both liquidity and capital.

l prudential limits on banks’ inter-bank liabilities inrelation to their net worth;

l asset-liability management guidelines takecognizance of both on and off balance sheet items

l Basel II framework: guidelines issued.

l Dynamic provisioning

l NBFCs: regulation and supervision tightened - toreduce regulatory arbitrage.





wImpact on India


RBI’s Policy Response and Impact





Measures since Mid-September, 2008 (1)

wExpanding rupee liquidityn Reduction in CRR (400 bps) & SLR (100 bps)

n Special Repo window under LAF for banks on-lending to NBFCs, HFCs & MFS

n

Special Refinance to banks without collateraln Unwinding of MSS – buyback/desequestering

n OMOs – pre-announced calendar

wCut in repo (425 bps) and reverse repo (275 bps) rates.

wExisting instruments – enough flexibility

n MSS and CRR – good, effective buffers of liquidity – both absorption and injection




wManaging Forex liquidity

n NRE and FCNR(B) deposits: interest rate

ceilings raised

n ECB norms relaxed

n Allowing corporates to buy back FCCBs

n Rupee-dollar swap facility for banks with

overseas branches




wEncouraging Flow of credit

n Exporters:l extension of period for export credit.

l Expansion in refinance

n Dynamic provisioningl Contracyclical adjustment of prudential norms

n SIDBI and NHB: lendable resources

expandedn Loan restructuring



Measures since Mid-September, 2008 (4)Impact of Measures (1)

w Measures ensuring orderly functioning of Indian financial markets

w Cumulative potential primary liquidity impact – over Rs. 4,90,000crore (9 % of GDP)

w Comfortable liquidity position since mid-November, 2008

n LAF window in absorption mode.

n Call rate within LAF corridor since November 3, 2008 – bottomof the corridor.

n Gradual reduction in deposit and lending rates of banks .

w Government yields:

n upward pressure from large market borrowing programme

n Proactive management by RBI

l MSS unwinding

l

Enhanced and pre-announced calendar for OMOs

M i Mid S b 2008 (5)



Measures since Mid-September, 2008 (5)Impact of Measures (2)

Item March

2008

September

2008

October

2008

March

2009

Turnover (Rupees crore, average daily)

1 Call market 11,182 11,690 14,497 11,909

2 All money markets @ 63,395 42,891 40,906 81,821

Key Interest Rates (per cent)

3 Call market 7.37 10.52 9.90 4.17

4 All money markets @ 6.55 9.26 8.66 3.76

5 BSE Sensex 15946 13943 10550 8995

6 Rs. Per US $ 40.36 45.56 48.64 51.23

7 10-year G-sec yield 7.69 8.45 7.85 6.568 Certificate of Deposits 10.0 11.6 10.0 7.0

9 Commercial Paper 10.4 12.3 14.7 8.9

10 Deposit rate (1-3 yrs)# 8.25-9.25 8.75-10.25 8.75-10.25 8.00-9.25

11 BPLR# 12.25-13.50 13.75-14.75 13.75-14.75 11.50-14.00

@: Call money, CBLO and market repo; #: Data pertain to PSBs.



Measures since Mid-September, 2008 (6)Total Resource Flow from Banks and Non-banks

Rupees crore

Item 2007-08 2008-091 Non-food Bank

credit

4,44,807 4,14,902

2 Non-banks 3,35,698 2,64,1383 Total flow of

resources (1+2)

7,80,505 6,79,040

M i Mid S b 2008 (7)



Measures since Mid-September, 2008 (7)Inflation in India

(per cent)

Item March

2008

June

2008

September

2008

December

2008

March

2009

Wholesale price inflation

All commodities 7.8 12.0 12.1 5.9 0.3

Of which:

Primary articles 9.7 11.0 12.0 11.6 3.5

Fuel 6.8 16.3 16.5 -0.7 -6.1

Manufactured

products

7.3 10.9 10.5 6.2 1.4

Consumer price inflation

Agricultural

labourers

7.9 8.8 11.0 11.4 10.8 (Feb)

Rural labourers 7.6 8.7 11.0 11.4 10.8 (Feb)

Urban non-

manual

employees

6.0 7.3 9.5 9.8 9.9 (Feb)

Industrial

workers

7.9 7.7 9.8 9.7 9.6 (Feb)





wImpact on India



Lessons from the Crisis




Lessons from the Crisis

w Avoid high volatility in monetary policyw Appropriate response of monetary policy to

asset prices

w Manage capital flow volatility

w Look for signs of over leveraging

w Active dynamic financial regulation

n Capital buffers, dynamic provisioning

n Look for regulatory arbitrage incentives/

possibilities



Medium term Issues and Challenges (1)



Medium-term Issues and Challenges (1)Macroeconomic Indicators at a Glance

(Per cent)

1950-51

to1964-65

1965-66 to1980-81 1980s 1990-91

1991/92

to1996-97

1997/98

to2002/03

2003/04

To

2007/08

1 2 3 4 5 6 7 8

1. Real GDP Growth 4.1 3.2 5.6 5.3 5.7 5.2 8.7

Agriculture 2.9 2.1 4.4 4.0 3.7 0.9 4.4

Industry 6.7 4.2 6.4 5.7 7.0 4.1 8.4

Manufacturing 6.6 3.9 5.8 4.8 7.5 3.9 9.1

Services 4.9 4.2 6.3 5.9 6.4 7.8 10.3

2. Real GDCF/GDP 13.5 19.2 20.2 24.4 22.5 24.1 31.4

3. ICOR 3.3 6.0 3.6 4.6 4.0 4.6 3.6

4. Nominal GDCF/GDP 11.8 16.7 20.8 26.0 23.9 24.5 33.0

5. GDS/GDP 10.3 15.9 19.0 22.8 22.7 24.1 32.7

6. Saving-Investment Gap -1.5 -0.7 -1.8 -3.2 -1.2 -0.4 -0.3

w Continuing increase in real GDP growth - Interregnum during the 1970s

w Secular uptrend in domestic saving and investment -investment largely

financed by domestic savingsw Continuation of growth in domestic savings necessary; fiscal prudence

M di I d Ch ll (2)



Medium-term Issues and Challenges (2)Fiscal Policy (1)

wCombined fiscal deficit in Indian Even before the recent setback: very high by international standards

n contribute to the persistence of an interestrate differential with the rest of the world,

l constrains progress towards full capitalaccount convertibility.

n self imposed rule based fiscal correctionneeds to be consolidated and carriedforward.

M di I d Ch ll (3)



Medium-term Issues and Challenges (3)Fiscal Policy (2)

wSustained interest rate differential alsoconnected with the existence of a persistent inflation differential with the

rest of the world.n A key challenge is to further reduce

inflation expectations toward

international levels.

M di t I d Ch ll (4)



Medium-term Issues and Challenges (4)Monetary Policy (1)

wA continuous need to adapt monetarymanagement to the emerging needs of a fast

growing and increasingly open economy.

wFinancial deepening and increasing monetisation.n expansion of monetary aggregates departs

from their traditional relationship with real

GDP growth.

n task of monetary management: manage such

growth without endangering price or financial

stability.




Medium-term Issues and Challenges (5)Monetary Policy (2)

wFurther development of financial marketswLarge capital inflows in recent years

n Reserve Bank’s ability to manage theimpossible trinity

w Issues for monetary policy

n current account balance as a good guide toevaluation of the appropriate level of an

exchange rate?n to what extent should the capital account

influence the exchange rate?

n implications of large current account

deficits for the real economy?




Medium-term Issues and Challenges (6)External Sector (1)

wOptimal response to the large and volatile

capital flows is a combination of (CGFS, 2009)

n sound macroeconomic policies

n prudent debt management

n exchange rate flexibility

n effective management of the capital account

n accumulation of appropriate levels of reserves as

self-insurance andn development of resilient domestic financial markets

n combination is country-specific; no “one size fits

all”.




Medium-term Issues and Challenges (7)External Sector (2)

wIndian policy approach to CALn Distinction between debt and equity

flows

n Higher inflation and interest rates inIndia vis-a-vis advanced economies

n Liberalisation of debt flows can lead to

arbitrage flowsn Ceilings on debt flows appropriate

Medium-term Issues and Challenges (8)



Medium-term Issues and Challenges (8)Financial Sector

Without Stress

Scenario - increase in NPA by:

100 per cent 150 per cent

CRAR (%) CRAR (%) CRAR (%)

Mar-08 13.0 11.6 11.0

Sept 08 12.5 11.1 10.6

•Note: CRAR = credit to risk-weighted assets ratio

n Commercial banks robustl Committee on Financial Sector Assessment(CFSA)

• Stability Assessment and Stress Testing• Concerns about credit risk remain muted atpresent




Medium-term Issues and Challenges (9)Conclusion

wIndia’s fundamentals remain strongn Financial sector robust

n Monetary policy – sufficient instruments, flexible

n Corporate sector not too leveraged – second roundof restructuring going on – productivity gains

n Foreign direct investment buoyant

n

Agriculture improvingn Growth domestically financed

Indian economy should be able to recover fast

and return to 9%+ growth path



Thank You

Documents

Euro Crisis Effect on Indian Banking Industry