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Global Financial Crisis:
Causes, Consequences andIndia’s Prospects
By
RAKESH MOHAN
Deputy Governor
Reserve Bank of IndiaAt
London Business School
April 23, 2009
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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
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Scheme of Presentation
Global Financial Crisis
wImpact on India
wDifference between US/Europe andIndia
wRBI’s Policy Response and Impact
wLessons from the Crisis
wMedium-term Issues and Challenges
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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)
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Global Financial Crisis (2)
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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
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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
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Global Financial Crisis (6)US Monetary Policy (3)
w Large Fed cuts in 2007: strong boost to oil, other
commodity and asset prices
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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
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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
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Scheme of Presentation
wGlobal Financial Crisis
Impact on India
wDifference between US/Europe andIndia
wRBI’s Policy Response and Impact
wLessons from the Crisis
wMedium-term Issues and Challenges
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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
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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
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Scheme of Presentation
wGlobal Financial Crisis
wImpact on India
Difference between US/Europeand India
wRBI’s Policy Response and Impact
wLessons from the Crisis
wMedium-term Issues and Challenges
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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
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Differences Between Financial Crisis inUS/Europe and India (2)
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
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Differences Between Financial Crisis inUS/Europe and India (3)
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
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Differences Between Financial Crisis inUS/Europe and India (4)
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
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Differences Between Financial Crisis inUS/Europe and India (5)
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.
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Scheme of Presentation
wGlobal Financial Crisis
wImpact on India
wDifference between US/Europe andIndia
RBI’s Policy Response and Impact
wLessons from the Crisis
wMedium-term Issues and Challenges
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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
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Measures since Mid-September, 2008 (2)
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
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Measures since Mid-September, 2008 (3)
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
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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)
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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)
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.
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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)
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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)
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Scheme of Presentation
wGlobal Financial Crisis
wImpact on India
wDifference between US/Europe andIndia
wRBI’s Policy Response and Impact
Lessons from the Crisis
wMedium-term Issues and Challenges
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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
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Medium term Issues and Challenges (1)
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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)
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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)
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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)
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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.
M di t I d Ch ll (5)
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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?
M di t I d Ch ll (6)
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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”.
M di t I d Ch ll (7)
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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)
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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
M di t I d Ch ll (9)
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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
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Thank You