Global Financial Crisis:

1
Global Financial Crisis Causes, Consequences
and Indias Prospects By RAKESH MOHAN Deputy
Governor Reserve Bank of India
2
Scheme of Presentation

• Global Financial Crisis
• Impact on India
• Difference between US/Europe and India
• RBIs Policy Response and Impact
• Lessons from the Crisis
• Medium-term Issues and Challenges

3
Scheme of Presentation

• Global Financial Crisis
• Impact on India
• Difference between US/Europe and India
• RBIs Policy Response and Impact
• Lessons from the Crisis
• Medium-term Issues and Challenges

4
Global Financial Crisis (1)

• Proximate causes
• Sub-prime lending
• Originate and distribute model
• Financial engineering, derivatives
• Credit rating agencies
• Lax regulation
• Large global imbalances
• Fundamental cause
• Excessively accommodative monetary policy in the
  US and other advanced economies (2002-04)

5
Global Financial Crisis (2)Current Account
Balance (per cent to GDP)

Country 1990-94 1995-99 2000-04 2005 2006 2007 2008
China 1.4 1.9 2.4 7.2 9.5 11.0 10.0
India -1.3 -1.3 0.5 -1.3 -1.1 -1.0 -2.8
Russia 0.9 3.5 11.2 11.0 9.5 5.9 6.1
Saudi Arabia -11.7 -2.4 10.6 28.7 27.9 25.1 28.9
United Arab Emirates 8.3 4.6 9.9 18.0 22.6 16.1 15.8
United States -1.0 -2.1 -4.5 -5.9 -6.0 -5.3 -4.7
Memo
Euro area n.a. 0.9 0.4 0.4 0.3 0.2 -0.7
Middle East -5.1 1.0 8.4 19.7 21.0 18.2 18.8
Source World Economic Outlook Database, April 2009, International Monetary Fund. Source World Economic Outlook Database, April 2009, International Monetary Fund. Source World Economic Outlook Database, April 2009, International Monetary Fund. Source World Economic Outlook Database, April 2009, International Monetary Fund. Source World Economic Outlook Database, April 2009, International Monetary Fund. Source World Economic Outlook Database, April 2009, International Monetary Fund. Source World Economic Outlook Database, April 2009, International Monetary Fund.
Note (-) indicates deficit. Note (-) indicates deficit.
6
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 EMEs?

7
Global Financial Crisis (5)US Monetary Policy (2)

• US Monetary policy too loose during 2002-04
  aggregate demand exceeded output large current
  a/c deficit mirrored in large surpluses in China
  and elsewhere.

8
Global Financial Crisis (6)US Monetary Policy (3)

• Large Fed cuts in 2007 strong boost to oil,
  other commodity and asset prices

9
Global Financial Crisis (3)Capital Flows to
Emerging Market Economies

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

10
Global Financial Crisis (7) Worsening Global
Economic Outlook
Growth Forecast of IMF (per cent) Growth Forecast of IMF (per cent) Growth Forecast of IMF (per cent) Growth Forecast of IMF (per cent) Growth Forecast of IMF (per cent) Growth Forecast of IMF (per cent) Growth Forecast of IMF (per cent) Growth Forecast of IMF (per cent) Growth Forecast of IMF (per cent)
Region April 2008 April 2008 July 2008 July 2008 October 2008 October 2008 April 2009 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 1.6
World 3.7 3.8 4.1 3.9 3.9 3.0 3.2 (-)1.3
Global Trade Volume (Goods and Services) Global Trade Volume (Goods and Services) Global Trade Volume (Goods and Services) Global Trade Volume (Goods and Services) Global Trade Volume (Goods and Services) Global Trade Volume (Goods and Services) Global Trade Volume (Goods and Services) Global Trade Volume (Goods and Services) Global Trade Volume (Goods and Services)
World 3.7 3.8 4.1 3.9 3.9 3.0 3.3 -11.0
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Scheme of Presentation

• Global Financial Crisis
• Impact on India
• Difference between US/Europe and India
• RBIs Policy Response and Impact
• Lessons from the Crisis
• Medium-term Issues and Challenges

12
Impact on India (1)Trends in Capital Flows
Component Period 2007-08   2008-09
Foreign Direct Investment to India April-February 27.6 31.7
FIIs (net) April-March 20.3 -15.0
External 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 (-) on Foreign Exchange Reserves April- December 9.0 -33.4
Foreign Exchange Reserves (variation) April-December 76.1 -53.8
Foreign Exchange Reserves (variation) April-March 110.5   -57.7
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Impact on India (2)Key Macro Indicators
Indicator Period 2007-08 2008-09
Growth, per cent Growth, per cent Growth, per cent Growth, 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
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Scheme of Presentation

• Global Financial Crisis
• Impact on India
• Difference between US/Europe
• and India
• RBIs Policy Response and Impact
• Lessons from the Crisis
• Medium-term Issues and Challenges

15
Differences Between Financial Crisis in US/Europe
and India (1)

• What has not happened here
• No subprime
• No toxic derivatives
• No bank losses threatening capital
• No bank credit crunch
• No mistrust between banks

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Differences Between Financial Crisis in US/Europe
and India (2)

• Our Problems
• Reduction in capital flows
• Pressure on BoP
• Stock markets
• Monetary and liquidity impact
• Temporary impact on MFs/NBFCs (Sept-Oct)
• Reduction in flow from non-banks
• Perceptions of credit crunch

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Differences Between Financial Crisis in US/Europe
and India (3)

• Our Problems
• Fiscal stress
• Oil, Fertiliser, Food subsidies
• Pay Commission, Debt waiver, NRE
• Stimulus packages
• GFD/GDP ratio 5.5-6.0
• Large increase in market borrowings

Rs. crore Rs. crore Rs. crore 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
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Differences Between Financial Crisis in US/Europe
and India (4)

• Indias Approach to Managing Financial Stability
  (1)
• Current account Full, but gradual opening up
• Capital account and financial sector More
  calibrated approach towards opening up.
• Equity flows encouraged
• debt flows subject to ceilings and some end-use
  restrictions.
• Capital outflows progressively liberalized.

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Differences Between Financial Crisis in US/Europe
and India (5)

• Indias Approach to Managing Financial Stability
  (2)
• Financial sector, especially banks, subject to
  prudential regulation
• both liquidity and capital.
• prudential limits on banks inter-bank
  liabilities in relation to their net worth
• asset-liability management guidelines take
  cognizance of both on and off balance sheet items
• Basel II framework guidelines issued.
• Dynamic provisioning
• NBFCs regulation and supervision tightened - to
  reduce regulatory arbitrage.

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Scheme of Presentation

• Global Financial Crisis
• Impact on India
• Difference between US/Europe and India
• RBIs Policy Response and Impact
• Lessons from the Crisis
• Medium-term Issues and Challenges

21
Measures since Mid-September, 2008 (1)

• Expanding rupee liquidity
• Reduction in CRR (400 bps) SLR (100 bps)
• Special Repo window under LAF for banks
  on-lending to NBFCs, HFCs MFS
• Special Refinance to banks without collateral
• Unwinding of MSS buyback/desequestering
• OMOs pre-announced calendar
• Cut in repo (425 bps) and reverse repo (275 bps)
  rates.
• Existing instruments enough flexibility
• MSS and CRR good, effective buffers of
  liquidity both absorption and injection

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Measures since Mid-September, 2008 (2)

• Managing Forex liquidity
• NRE and FCNR(B) deposits interest rate ceilings
  raised
• ECB norms relaxed
• Allowing corporates to buy back FCCBs
• Rupee-dollar swap facility for banks with
  overseas branches

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Measures since Mid-September, 2008 (3)

• Encouraging Flow of credit
• Exporters
• extension of period for export credit.
• Expansion in refinance
• Dynamic provisioning
• Contracyclical adjustment of prudential norms
• SIDBI and NHB lendable resources expanded
• Loan restructuring

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

• Measures ensuring orderly functioning of Indian
  financial markets
• Cumulative potential primary liquidity impact
  over Rs. 4,90,000 crore (9 of GDP)
• Comfortable liquidity position since
  mid-November, 2008
• LAF window in absorption mode.
• Call rate within LAF corridor since November 3,
  2008 bottom of the corridor.
• Gradual reduction in deposit and lending rates of
  banks .
• Government yields
• upward pressure from large market borrowing
  programme
• Proactive management by RBI
• MSS unwinding
• Enhanced and pre-announced calendar for OMOs

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Measures since Mid-September, 2008 (5)Impact of
Measures (2)
Item March 2008 September 2008 October 2008 March 2009
Turnover (Rupees crore, average daily) Turnover (Rupees crore, average daily) Turnover (Rupees crore, average daily) Turnover (Rupees crore, average daily) Turnover (Rupees crore, average daily) Turnover (Rupees crore, average daily) Turnover (Rupees crore, average daily)
1 Call market Call market 11,182 11,690 14,497 11,909
2 All money markets _at_ All money markets _at_ 63,395 42,891 40,906 81,821
Key Interest Rates (per cent) Key Interest Rates (per cent) Key Interest Rates (per cent) Key Interest Rates (per cent) Key Interest Rates (per cent) Key Interest Rates (per cent) Key Interest Rates (per cent)
3 Call market Call market 7.37 10.52 9.90 4.17
4 All money markets _at_ All money markets _at_ 6.55 9.26 8.66 3.76
5 BSE Sensex BSE Sensex 15946 13943 10550 8995
6 Rs. Per US Rs. Per US 40.36 45.56 48.64 51.23
7 10-year G-sec yield 10-year G-sec yield 7.69 8.45 7.85 6.56
8 Certificate of Deposits Certificate of Deposits 10.0 11.6 10.0 7.0
9 Commercial Paper Commercial Paper 10.4 12.3 14.7 8.9
10 Deposit rate (1-3 yrs) Deposit rate (1-3 yrs) 8.25-9.25 8.75-10.25 8.75-10.25 8.00-9.25
11 BPLR BPLR 12.25-13.50 13.75-14.75 13.75-14.75 11.50-14.00
_at_ Call money, CBLO and market repo Data pertain to PSBs. _at_ Call money, CBLO and market repo Data pertain to PSBs. _at_ Call money, CBLO and market repo Data pertain to PSBs. _at_ Call money, CBLO and market repo Data pertain to PSBs. _at_ Call money, CBLO and market repo Data pertain to PSBs. _at_ Call money, CBLO and market repo Data pertain to PSBs. _at_ Call money, CBLO and market repo Data pertain to PSBs.
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Measures since Mid-September, 2008 (6)Total
Resource Flow from Banks and Non-banks
Rupees crore Rupees crore Rupees crore Rupees crore
Item 2007-08 2008-09
1 Non-food Bank credit 4,44,807 4,14,902
2 Non-banks 3,35,698 2,64,138
3 Total flow of resources (12) 7,80,505 6,79,040

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Measures since Mid-September, 2008 (7)Inflation
in India
(per cent) (per cent) (per cent) (per cent) (per cent) (per cent)
Item March 2008 June 2008 September 2008 December 2008 March 2009
Wholesale price inflation Wholesale price inflation Wholesale price inflation Wholesale price inflation Wholesale price inflation 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 Consumer price inflation Consumer price inflation Consumer price inflation Consumer price inflation 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)
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Scheme of Presentation

• Global Financial Crisis
• Impact on India
• Difference between US/Europe and India
• RBIs Policy Response and Impact
• Lessons from the Crisis
• Medium-term Issues and Challenges

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Lessons from the Crisis

• Avoid high volatility in monetary policy
• Appropriate response of monetary policy to asset
  prices
• Manage capital flow volatility
• Look for signs of over leveraging
• Active dynamic financial regulation
• Capital buffers, dynamic provisioning
• Look for regulatory arbitrage incentives/
  possibilities

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Scheme of Presentation

• Global Financial Crisis
• Impact on India
• Difference between US/Europe and India
• RBIs Policy Response and Impact
• Lessons from the Crisis
• Medium-term Issues and Challenges

31
Medium-term Issues and Challenges
(1)Macroeconomic Indicators at a Glance
(Per cent) (Per cent) (Per cent) (Per cent) (Per cent) (Per cent) (Per cent) (Per cent)
1950-51 to 1964-65 1965-66 to 1980-81 1980s 1990-91 1991/92 to 1996-97 1997/98 to 2002/03 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

• Continuing increase in real GDP growth -
  Interregnum during the 1970s
• Secular uptrend in domestic saving and investment
  -investment largely financed by domestic savings
• Continuation of growth in domestic savings
  necessary fiscal prudence

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

• Combined fiscal deficit in India
• Even before the recent setback very high by
  international standards
• contribute to the persistence of an interest rate
  differential with the rest of the world,
• constrains progress towards full capital account
  convertibility.
• self imposed rule based fiscal correction needs
  to be consolidated and carried forward.

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

• Sustained interest rate differential also
  connected with the existence of a persistent
  inflation differential with the rest of the
  world.
• A key challenge is to further reduce inflation
  expectations toward international levels.

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

• A continuous need to adapt monetary management to
  the emerging needs of a fast growing and
  increasingly open economy.
• Financial deepening and increasing monetisation.
• expansion of monetary aggregates departs from
  their traditional relationship with real GDP
  growth.
• task of monetary management manage such growth
  without endangering price or financial stability.

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

• Further development of financial markets
• Large capital inflows in recent years
• Reserve Banks ability to manage the impossible
  trinity
• Issues for monetary policy
• current account balance as a good guide to
  evaluation of the appropriate level of an
  exchange rate?
• to what extent should the capital account
  influence the exchange rate?
• implications of large current account deficits
  for the real economy?

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

• Optimal response to the large and volatile
  capital flows is a combination of (CGFS, 2009)
• sound macroeconomic policies
• prudent debt management
• exchange rate flexibility
• effective management of the capital account
• accumulation of appropriate levels of reserves as
  self-insurance and
• development of resilient domestic financial
  markets
• combination is country-specific no one size
  fits all.

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

• Indian policy approach to CAL
• Distinction between debt and equity flows
• Higher inflation and interest rates in India
  vis-a-vis advanced economies
• Liberalisation of debt flows can lead to
  arbitrage flows
• Ceilings on debt flows appropriate

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Medium-term Issues and Challenges (8)Financial
Sector

• Commercial banks robust
• Committee on Financial Sector Assessment (CFSA)
• Stability Assessment and Stress Testing
• Concerns about credit risk remain muted at
  present

  Without Stress Scenario - increase in NPA by Scenario - increase in NPA by
  Without Stress 100 per cent 150 per cent
  CRAR () CRAR () CRAR ()
Mar-08 13.0 11.6 11.0
Sept08 12.5 11.1 10.6

• Note CRAR credit to risk-weighted assets ratio

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Medium-term Issues and Challenges (9)Conclusion

• Indias fundamentals remain strong
• Financial sector robust
• Monetary policy sufficient instruments,
  flexible
• Corporate sector not too leveraged second round
  of restructuring going on productivity gains
• Foreign direct investment buoyant
• Agriculture improving
• Growth domestically financed
• Indian economy should be able to recover fast
  and return to 9 growth path

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• Thank You