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B Y

T . T . R A M M O H A N

P U B L I S H E D I N E C O N O M I C A N D P O L I T I C A L

W E E K L Y

The Impact of the Crisis on theIndian Economy

Presented by:Cicy Ambooken


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Severity of the Crisis

y Financial crises are considered to be cripiling inimpact

y The worst being the Great Depression, that followed

the stock market crash in 1929y Financial crisis cover a whole range of events,

including crashes in the housing market, stockmarket, foreign exchange market, current account of

nations and problems in the banking sectory The banking crisis in the US was only estimated to be

moderate


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y When compared with past episodes of crises thecurrent imbalances seemed smaller, except in thereal estate sector and the current account

y

The IMF did not believe that the financial crisis wasof the same severity as some of the bigger crises ofthe past

y Until the fall of Lehman Brothers there was a sensethat the financial crisis was coming under control

y The impact of the crisis on the world economy wasconsidered to be modest but the Lehman collapsechanged the situation dramatically


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Implications of the Lehman fall

y The bankruptcy had implications for the market in 3ways:

Impact on credit default swaps ( CDS)

Liquidation of money market funds due to lossesConsequences of the prime brokerage client


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Impact on CDS

y Lehman was a counterparty to many CDS and wasreferenced to others

y The net settlement was estimated around $6 billion

and payments of $ 5.2 billion were madey News of bankruptcy made the market volatile and it

raised the possibility of failure of AIG


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Fallout in the Money Markets

y Principle source of funding was Commercial Paperand Short-term Debts

y Reserve Primary fell below $1 and had to be

liquidatedy Led to redemptions in other market funds

y US treasury introduced a temporary insuranceprogramme for investors


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Prime Brokerage

y Lehman provided hedge funds against assets postedby them as collateral

y These asset were used by them for meeting its

obligations through re-hypothecationy Clients lost access to their collateral until the

bankruptcy process was completed

y They were locked in positions of changing value and

hedge funds had to resort to sale of assets to meetfunding


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Impact on Emerging Economies

y In the initial stages there was a high degree ofoptimism that emerging markets like China andIndia

y Reasons for decoupling were: Slowdown was limited to factors specific to the US economy

Trade linkages of the emerging economies with the US haddiminished and trade between emerging economies werebecoming more important

Growth in these economies were driven by domestic demand

Emerging markets were net savers in the world economy

Several reforms which made emerging markets more stable


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y The IMF distinguished between the effects of amoderate slowdown and a sharp recession

y In a modest recession emerging markets are affected

through trade channelsy When there is a sharp recession the financial flows to

emerging markets are severely affected and equityprices tend to become correlated with the US market

y Emerging markets particularly India and Chinaremained decoupled from the US in 2008


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Impact on the Indian Economy

y Impact on India was more than initially supposed

y It affected the economy in 3 ways: Reducing Indian companies access to overseas economy

Lowering domestic liquidity Fall in stock prices

y Job losses accentuate the impact on consumerspending

y Banks are averse to lending capital and hoardscapital or lends only at a steep price


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Limited access to global finance

y Fresh international borrowings became difficult

y Long term finance for international acquisition madethrough bridge finance was not available

y

Buyers credit became scarce for internationaltransactions

y Indian banks overseas branches and subsidiarieswere unable to access funds in the wholesale marketand had to be provided with dollar funds by theirparents from out of India

y The BOP swung from an increase in reserves from $40.4 billion in 2008 to $ 2.5 billion in 2009


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Fall in Stock Prices

y Low share prices so firms were reluctant to tap thecapital market

y Investors cut back on spending due to low

confidence


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Policy Response

y India has made changes to both fiscal and monetarypolicies

y Focus of fiscal policies from fiscal stabilisation to

providing growth stimulusy The stimulus has come through 2 supplementary

grants

y Its major revision were pay and pension revision, oil

and fertilizer subsidies, additional allocations forNRGA and farmers debt relief


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Monetary Policy Response

y Monetary response activated in Sept., 2008 after theLehman Collapse

y Duel to flight of capital from India and drying up ofsources abroad both rupee and dollar was squeezed

y Rupee depreciated with the dollar

y Monetary responses include: Reduction in repo rate from 9% to 5.5% and reverse repo rate from

6% to 4%

Reduction in cash reserve ratio

Reduction in statutory liquidity ratio

y This was further supplemented by various measures tosupport liquidity


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Impact on the Banking System

y Less affected in comparison to US and Europe

y In advanced countries banks suffered huge losseswhich led to a collapse in the flow of credit and in

confidence and dragged down the real economyy In India the real economy has been affected through

various channels

y Key issues with respect the banking system are: Volume of credit

Price of credit

Performance of the banking system


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Conclusion

y India has integrated itself with the rest of the worldand has not escaped unscathed

y Overseas finance has become important for

corporates and drying up of such funds affects theirfortunes

y By making policy changes India has responded to theslowdown

y The banking sector is well placed


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Thank You

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