Global Financial Crisis: A Perspective from India

In the last two years we’ve heard a lot about the global financial crisis. Two years hence we now need to ask how the global financial crisis effected India and why?

The global financial crisis effected India in one way and in a another way it did not. We begin with the adverse affects. Exports, investment and capital flows took a direct hit in the country. Due to a marked decrease in global demands for goods and services, for the first time in 7 years, exports in India fell 12.1% year-on year for the second quarter in 2008. The textile industry which accounts for 17% of India’s exports also showed considerable strain resulting in retrenchment of workforce. A marked drop in the foreign institutional investment by $12 billion from the stock market directly hit the Indian stock exchange. The sudden vanishing of financial credit mostly affected the small and medium enterprise sectors, infrastructural development projects and real estate. The IT sector was also badly affected as IT sector’s revenue depends heavily on banking and financial institutions.

Even though India was adversely impacted by the financial crisis, it still faired much better in comparison to most countries around the world. As opposed to the 9% growth rate in 2007-08, India managed a growth rate of close to 6% in the last three financial quarters. Even though this is a significant drop, it has far exceeded the World Bank’s forecast of 4% growth for 2009. Even those corporates in India which had over-borrowed have mostly survived the crisis without the need for government bail-out.  India’s resilience in the face of the crisis led to foreign investors returning to the Indian markets at the rate of close to $1 billion in May 2009. India’s stock market recovered in the last six months from the level of 8,160 on March 9, 2009 to 17,223 on October 20, 2009. This recovery definitely indicates a climate of growing confidence in the Indian markets even though some people suggest that the surge is on account of a speculative rush rather than a boom in Indian Industry.

How is it that India was able to successfully tackle the crisis? India’s resilience in the face of the financial crisis can be attributed to a number of reasons of which only some can be put on account of the fiscal and monetary measures taken by the government in response to the crisis.

The primary reason for the limited impact of the financial crisis was that banks and financial institutions in India did not invest in mortgage-backed securities and credit default swaps that turned toxic when the housing bubble in the US collapsed. When the crisis hit the Indian economy, our high foreign exchange reserve helped avoid panic when foreign investors left the country. Most companies were well-capitalized and had not over-borrowed and therefore were able to weather the crisis. Both public and private banks remain mostly unaffected and so there was no threat to the basic payment system of India requiring massive rescue missions common in US and other countries. Remittances from abroad continued as before and the long term foreign direct investment further helped stabilize the economy.

The government in response to the crisis also took some steps that undoubtedly blunted the affects of the crisis. The government made the monetary policies more accommodating with the Reserve Bank of India slashing main policy rates so that banks don’t suffer from capital adequacy constraints and are able to expand credit availability and increase liquidity. With a decrease in interest rates the value of the rupee was allowed to fall from Rs. 40 to Rs 52 to the dollar. The foreign borrowing rules for firms in infrastructure and real estate sectors were also eased and a 4% cut was made in excise duty.

To kick start the economy India has also announced three stimulus packages since December 2008. As suggested by the current Union Finance Minister, Pranab Mukharjee, these packages will be continued till global recovery. The packages guarantee funding to revive the sectors of power, housing, export, automobiles, textiles and small and medium enterprise sectors and infrastructure sectors. The major proportion of this stimulus package along with funds allocated towards public expenditure in the $204 billion national budget presented in July 2009 was allocated to critical rural, infrastructure and social security schemes such as the National Rural Employment Guarantee Scheme (NREGS), Pradhan Mantri Gram Sadak Yojana (PMGSY) and the Jawaharlal Nehru National Urban Renewal Mission (JNNURM).

This fiscal stimulus which led to the expansion of the fiscal deficit beyond the originally targeted levels has been widely accepted as a solution to the financial crisis. However, the extent of the contribution of the fiscal stimulus in tackling the crisis remains suspect. The fiscal stimulus packages as suggested above have mainly been allocated in rural, infrastructure and social security schemes, that is, in those sectors which were not really badly hit by the crisis. Even though there are a number of forward and backward linkages between these sectors and those sectors actually affected by the crisis—IT, call centres and BPOs and exports—the economic recovery in these areas can hardly be attributed to the stimulus packages.

Even though India was able to successfully tackle the crisis this does not mean that we will necessarily be able to do so in the future unless we ask ourselves broader questions on why the crisis happened in the first place and what we can do to safeguard against it.