Current Financial Crisis in India

Abstract:- This paper points out to the current financial crisis that is taking place in India and

the severe impacts that is making our economy lethargic which is one of the fastest growing

economies of the world. Our economy is the 10th largest economy in the world with $1.824

trillion GDP worth and third largest as per the purchasing power parity with $4.684 trillion GDP

worth. As per the Moody’s Group, the growth of the Indian Economy has been estimated to be

5.5%. In the end, the paper attempts to reveals the steps to revive the economy.

Financial Crisis refers to a condition in which some of the financial assets suddenly drop their

nominal value. Some of the examples of the financial crisis are the stock market crash, bursting

of the financial bubbles, currency crisis, etc. Financial Crisis leads to the reduction in the paper

wealth rather than the alterations in the real economy. Economic crisis are increasing day-by-day

due to the increasing globalisation.

It was observed that the forecaster of the economy all around the world are completely

influenced by the fact that the world is now directed for another financial crisis and a likely

downturn, exactly six years after the one the financial crisis that took place in 2008.

The paper draws the attention towards the following financial crisis:-

• Sub-prime crisis and its impact on India;

• Eurozone crisis and its impact on India;

• Current Financial crisis in India;

• Global crisis and its impact on India.

Firstly, we will talk about the Sub-Prime crisis and its impacts on the Indian economy. Under the

Sub-Prime crisis, the main country that was being affected was the United States. It was the

colossal subprime crisis that took place in United States that sparked the last recession and

swallowed up the whole world. This crisis was also known as the mortgage crisis, Sub-Prime

meaning, subordinate to the primary one, was the effect of giving huge loans to the borrowers

who were not having the good creditworthiness in the market at an interest rates higher than the

prime lending rates. In order to develop the market additionally, the loan assortment were sold

again to the further investors like Private Equity funds, Hedge funds and NBFC’s (Non-Banking

Finance Companies) through the securitisation. This scenario created the artificial boom in the

market and as a result the time came when the borrowers who were unable to pay the money

started defaulting on the loans taken by them and so the prices of the property on the other hand

started collapsing due to the further evasion and breaking down of the prices.

Sub-Prime Crisis went through the four main stages.:-

• Firstly, during the year 2007,100 of the loan sanctioning companies broke out as the

securities that were being backed was not saleable and so they could not acquire the funds.

• The second stage, started in the quarter 4 (Q4) of 2007, and they observed that in each

quarters, the financial institutions were facing severe losses as they were adjusting the value

of their backed securities to the fraction of their purchased prices. The losses continued to

worsen as the banks had the weaker capital base from which they were lending.

• The third stage started during the first quarter of the year 2008, when the investment bank

Bear Stearns joined hands with JP Morgan with $30 billion as guarantee to the government

after which it was not possible for them to continue lending the money to carry out its

operations.

• The fourth stage took place in September,2008 when Fannie Mae and Freddie Mac,

signifying $5 trillion in the obligations of mortgage were publicly owned by the United

States government as the losses were increasing.

Now as the crisis ate up the entire financial system in the United States and the parts of Europe,

large financial entities, that is, those entities that deal with the financial transactions, like

Lehmann Brothers and many other banks like American Express, Citi Bank, Morgan Stanley,

etc. went out of order as they had to put off all the large loans and wanted government’s

assistance to last longer.

Impact on the Indian Economy:-

• Stock Market Crash

The effect of the United States financial crisis has been experienced when the stock market

of India started dropping. The Sensex on 27th July, 2007 started plummeting as the Foreign

Institutional Investors (FII’s) exited the Indian market which had a heavy impact on the

Sensex.

• Smash of India’s Foreign Exchange Reserve (FOREX)

The proportion of trade deficit of India is giving a distressing signal. It is because of the

payments made to the workers, the deposit of NRI’s , FII investment and so it was noticed

that the (CAD) Current Account Deficit is at around $10 billion. So, if the payments dry up

and FII’s takes a new height, then a day is not far when we will head for another 1991 crisis.

To bring into account, the foreign exchange reserves of the country has deteriorated by

around $57 billion to $253 billion for the week ended October 31, 2008.

• Impact on India’s export

The Indian economy had to face tough times when the United States and other European

countries were slipping into the recession. Manufacturing industries such as textiles, leather,

gems and jewellery were highly affected. The exports in India fell down by 9.9 percent in

November,2008.

• Impact on India’s handloom sector, jewellery export and tourism

It was observed that when there is fall in the need of the OECD countries(Organisation for

Economic Co-operation and Development), the demand of the handloom sector,jewellery

industry, handloom and tourism sectors fell down. Approximately, 50,000 artisans employed

in jewellery became unemployed due to the economic meltdown. To add beyond, the

handloom industries production fell down badly by 4.6% in 2007-08 which is a 3000cr.

industry today.

• Depreciation of the Exchange Rate

As the FII’s exited the Indian market, the Indian rupee depreciated by approximately 20%

against the US dollar which created a panic situation among all the exporters.

• IT-BPO sector

It was noticed that the IT sector obtains 75% of its revenue from the IT-ITES (Information

Technology Enabled Services) which ultimately directs to 5.5% towards the Indian exports.

So, the crisis in US will definitely impact the IT sector as if the IT companies in Fortune 500

cut down their budget, then the Indian firms would be badly affected.

• Foreign Institutional Investor and Foreign Direct Investment

Due to the sub-prime crisis, FII’s exited the market by making a withdrawal of $5.5 billion,

whereas the FDI investment during that period doubled from $7.5 billion in 2007-08 to 419.3

billion in 2008.

• Banking Industry

It was estimated that global banks such as Merrill Lynch, CitiBank and Deutsche Bank have

lost $180 billion due to the sub-prime crisis. Also, ICICI bank lost approximately Rs10.56

billion till January,2008.

So, this ends up with the impact of sub-prime crisis on the Indian Economy. Hardly had the

world countries economic conditions have improved, by that time, another crisis popped in. This

crisis was known as Eurozone Crisis that originated in Europe and also extended to some of the

parts of the United States.

Eurozone, is an assembly of 17 European countries who have adopted Euro as their common

currency. The crisis emerged due to the problem created by some of the member countries such

as Greece, Spain, Italy, etc who were are unable to pay the huge debts borrowed from the

government for the reason that they were unable to handle their financial situation well. Also,

their borrowing and expenditures increased significantly.

On the other hand, the lenders start demanding higher rates of interest, generally four times

higher than the nominal rate of interest due to which the economy will be swallowed up. There

were other countries too like Portugal, Cyprus and Ireland which were already in trouble that

time. The troubled countries saw the relegation of their credit ratings, while the other countries

were imposed to threats.

According to Peter Praet, member of the executive Board, European Central Bank, there are

other causes of the crisis which were as follows:-

• The “US mortgage crisis is only the tip of the iceberg”.

• Collapse of Lehman brothers in the year 2008, caused a transitory freeze in trade financing

and also affected the global trade as the demand and supply of the global economy went

down.

• Countries that had the weak currencies they were benefitted by the favourable credit terms

offered to them.

• Violation To European Union Rules When the European Union was formed, countries like Greece and Cyprus did not presented

the real financial and economic condition of their country. This fact was being ignored by

EU. EU accepted the countries with the high budget deficit and the debt levels by many

countries during the crisis.

• Problem of Banking SectorThe banking sector in Europe is much more susceptible and has shown a spectacular fall

down since it got trapped in the global financial chain in the year 2007 financial crisis. The

banks were in a bad state as they were using their money to finance the government deficits

and were unable to provide the loans and advances to the general public and the businesses.

• Rating Agencies Rating agencies have played an important role in paving the way for crisis causing the rise in

the yields of the bonds and tensions in bond market as well as finding difficulty in raising

money by governments due to the low trust of the creditors as they were unable to pay the

money.

• Political Conflict

It is well known that politics and economics are the two sides of the same coin.Politics play a

very important role as different parties play different roles and have their different

viewpoints. Germany sticked to its austerity-led strategy to deal with crisis.

It was said by Robert Zoellick, President of World Bank, that things have so much worsened up

that we need to seek the help of China to pay off the sovereign funds.

Impact on the Indian Economy:-

• Firstly, Eurozone crisis was affecting India through the monetary route as the euro was losing

value, the dollar strengthened more, implying the Indian currency was losing value against

the dollar.

• The trade deficit of India was worsening as we needed to buy more dollars for the trade

purpose.

• The interest rates were rising due to inflation as a result of which there was a decline in the

credit taken by the banks.

• There was a rise in the unemployment level of the economy.

Steps India should take:-

• Reduce the Current Account Deficit;

• Reduce the imports of Oil and Gold

• Globalisation of finance;

• Credit conditions should be made string-less during the 2002–2008 period;

• Imbalancing of the trade internationally;

• Real estate bubbles that have bursted;

• Economic growth has slowed down since 2008;

• Fiscal policy choices related to government revenues and expenses;

Current Financial Crisis India is Facing

The most important financial crisis that India is facing right now from past 6-8 months is the

Currency Depreciation. It has been seen that India is unable to be a star performer compared to

the rest of the markets that are emerging. This is because of the currency depreciation. From

August 2013, the Indian rupee has improved only 10% of its value against the dollar. It is being

depicted in the following graph below.

If we compare India with China in terms of growth India still lacks behind though the wages in China are

very low, that is to imply the cost of labour in manufacturing and the production sectors. As per the

World Bank’s Ease of Doing Business Index, India is 38 countries below China as there are

number of negative factors that have taken into consideration such as:-Corruption, Bureaucracy,

Weak Infrastructure, etc. Those nations which were exporting the raw materials to China grew

and their currencies strengthened. It is depicted in the graph below.

In the West, there was weaker growth as India’s 5% of the exports are being consumed by the

China on yearly basis and so Indian economy suffered a lot and was being hampered by it. Five

years down the line from the financial crisis, the rupee is fully trading at 57% lower against the

greenback. But it will become more relevant when the debt markets will become tight in the year

2014.

There are number of factors that had led to the rupee depreciation. These factors can be both

external and internal factors. It has been seen that the rupee in the last few months has been

trading at 10% higher against the greenback. The internal factor that has an effect on the rupee

depreciation is the huge amount of trade deficit and the declining FDI (Foreign Direct

Investment). India is being continuously importing oil and gold which forms a major component

of its imports. It has been seen that India has a huge consumption of gold, and so the increased

value of the gold in the past five years have increased the value of India’s imports in value terms.

Gold has been seen a commodity which can be stored and then can be sold when the rates are

higher. And so, the impending signals to the government caused it to take the steps to curb the

increasing exports in 2013 which saw a huge change in May. The figure below shows India’s

balance of payments and the imports of crude products as well the Gold which it is making.

If we observe closely United States is the largest contributor to India’s exports if expressed in

trade value terms. Considering the data from April, 2012 to September, 2013, United States

contribution to India’s exports is around 14%. So, under the financial crisis, the GDP was able to

move forward just because of the expansion of the credit granted to them or the export market.

Now, if we consider the zero-sum game, a healthy yield to growth and investment made will

have a huge impact on India’s export market.

To take into consideration the inflation level, it was perceived that holding the currency for long

will reap us profit. The current interest rates were out of the RBI who had set the rates below the

inflation levels implying there is already a risk in the economy. And until the spread narrows

down, there is likely to be a pressure on the rupee. If there is an increase in exports on one side

and growth in United States on the other side, it would give the freedom to the RBI to hike the

rates at a faster pace.

Global Crisis and its impact on IndiaIt has been observed that the Indian Economy has done a good job in the last two decades, which

led to the high growth rate and Gross Domestic Product (GDP) inspite of rise in the savings of

the domestic people and the investment and increase in productivity levels. Though the major

crisis that took place was the Sub-Prime Crisis but its impact was seen all over the world as it

affected many of the developing nations. Earlier the Indian officials denied the fact that the

economic crisis will have an impact, but, later on, the government felt that the economic crisis

was affecting the Indian economy.

The US meltdown swallowed the world , considering a small impact on India, because India has

a strong fundamental, the banking system is well regulated and there is less disclosure of

financial sector with the global financial market. Unlike US, where the private ownership exists,

India is controlled by the government which makes it.

The US meltdown has not created any credit crunch in the Indian economy, but has surely led to

the panic in Indi. Indian economy faced a serious downturn where the industrial growth

weakened, the inflation went in double-digit and the Current Account Deficit widened to a great

extent. This global crisis has affected the health of many countries through the pathway of trade

flows; import and export; exchange rates,etc.

To study the impact of global crisis on the Indian economy, an analysis is being done between

the growth rates of sectoral GDP pre-meltdown and the meltdown years.

The above table shows that among all the different sectors of the Indian economy, mining and

manufacturing and to some part trade was high;ly influence dby the global meltdown in 2007-08.

The main reason was there was a fall in the demand for the iron ore and the fall in the garment

exports. It was a remarkable point that at time India had a growth rate of 9.2% in the year 2007-

08. It was the second highest growth rate after China across the world.

In the year 2008-09, the growth rates fell drastically for almost all the sectors except fro the

community, personal and social services.So, the GDP of India in the year 2008-09 wa sjust 6.7%,

but the Indian economy started reviving in the year 2009-10. Agriculture was the area where

India suffered a negative growth of 0.2%, whereas all the other sectors such as transport, real

estate, finance and community they have shown the recovery.

At this point of time, the biggest concern was the employment opportunity. The Ministry of

Labour and Employment carried out a survey on a large sample that included the textiles

industry, automobile industry, gems and jewellery, etc. and during that time five lakh workers

lost their jobs at the end of the year 2008. The employment in these sectors went down from 16.2

million during September 2008 to 15.7 million during December 2008. The automobile sector

and the transport sector saw the decline in employment by 12.45 per cent and 10.18 per cent

respectively. There was an overall impact on the employment rate The overall decline in

employment was calculated to be 5.83 per cent.

In case of gems & jewelleries, the employment rate reached to around 9.97 per cent, also 1.33

percent in case of metals. So, the constant losses in the job in the engineering and service sector

were a tough test for the government. The trade in the international market turned down because

of the economice and financial crisis. Taking into consideration the time span of july,2008 and

May, 2009 the value of the world trade in terms of rupees declined by almost 37% out of which

16% was due to the falling prices.

Though India was as much affected as the other countries, but a tremendous decline was seen in

the rate of Indian exports and imports in the second and third quarter of the year 2008 and 2009

respectively. WTO and IMF both said that the trade would decline by 9% and 11% respectively.

The quarterly growth rate of Exports & Imports in India are depicted in the figure below:-

It was observed that the growth rate of exports and imports in the year 2008-09 declined and

even went negative in the year 2009-10. As the country took several steps to by undertaking

specific export measures, so the exports and imports then turned positive in the third quarter of

the year 2008-09 and 2009-10.

I have also tried to study the overall impact of the global crisis on the external sector of the

country through the BOP (Balance of Payment) position. Balance of Payment is defined as the

methodical record of all the economic transactions that takes place between the residents of the

foreign countries. It consists of Current Account, Capital Account, errors and omissions and the

changes in the FOREX. Current account, signifies the net amount the country will earn if it is

surplus and pay if it is deficit. It takes into account the exports and imports of goods and

services. Capital account, signifies the net alteration in ownership of the foreign assets. Here the

capital inflows are classified on the basis of the instruments or the maturity. Capital account

takes into consideration Foreign Investment, the amount of loans. The figure depicted below

shows the BOP position of the Indian economy during the year 2005.

It was inferred that the BOP position has been improving since the year 2005, but from

the year 2008-09, the BOP turned negative, that is, US$ 20080 determining that the

financial crisis has severely hit the capital inflow into the country. However, the recovery

of the economy was seen just after this year, that is, the year 2009.

Today if we see India, it has become one of the most fast growing economy in the world

and has opened the ways for Foreign Direct Investment in the areas as telecom,

construction, power, etc. investors are interested in putting the money in the economy

which is growing at a faster pace rather than becoming sluggish. The moment they see

the economy is not doing well, Foreign Institutional Investors will exit the market by

withdrawing their money. The table mentioned below shows the foreign investment and

flow of income in India.

The following points were drawn out:-

• FDI has been growing at a quicker pace since 2003.

• In the year when the crisis took place, the figures went negative showing a growth rate of

31.82%.

• The same pattern was seen in case of capital flows to India too.

It was observed that as the markets collapsed due to the global financial crisis, the huge impact

was seen on the stock markets too. FII’s they started withdrawing their money from the Bombay

Stock Exchange. This plunged the BSE Sensex. The value of SENSEX went down from 17578

to 16371 as on March 28, 2008. This decline was not only seen in India but also the other Asian

countries. This can be depicted in the form of the table:-

The table below shows the variation in the equity index value of share indices of major Asian

economies in major Asian Stock Markets at the time when the financial crisis took place. There

was huge pressure on the downward values. But the share values started recovering their values

in the year 2009 and 2010 because of the measures taken by the government. Lastly to sum up

with, the economic crisis really affected the poor people in India. There were loss of jobs in the

area of manufacturing sector.

Conclusion:- Crisis is such a phenomenon which will swallow all the countries. In context to

India, following points were drawn out.

• The fiscal and monetary policies need to be modified.

• There is greater need of transparency when the bank rate, repo rate, reverse repo rate, cash

reserve ratio and statutory liquidity ratio is decided.

• In order to boost up the investments, RBI needs to lower down the rates, as if rates are

lowered down, big firms will then raise the loans, carry out their production well. If the

production is carried on well, it will provide the employment opportunities to the public.

• There has to be a coordination between the monetary and the fiscal policy so as to ensure the

overall performance of the economy.

• It is advised that the corruption in the country should be controlled. Moral and ethical

standards should be followed by the company.

• In order to ensure the economic development of the country, India needs to keep in mind

that it has to attract the FDI by ensuring the interest of the investors and maintaining the law

and order.

• It is also important to protect the rural economy so that the purchasing power of the people

could be increased.

• The development of entrepreneurship in both the rural and urban areas should be emphasised.

• The allocation of funds to the developing sectors of the economy becomes the major part.

Thus, no country can escape from it but yes steps can be taken to decrease the impact of financial

or global crisis on India.

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