Final - - Macro Economics Project

8/14/2019 Final - - Macro Economics Project.

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Lessons from

Economic/Financial Crisesin recent times

(SE Asian/ Subprime)

9/1/2009

IBS

SUBMITTED BY-

(GROUP-IX)

SONU GUPTA (08BS0003326)

SONU KUMAR SHAH (08BS0003327)

SHINJINI SHEKHAR (08BS0003133)

SOUMYA RANJAN DASH (08BS0003333)

SOVANLAL BISWAS (08BS0003344)

ACKNOWLEDGEMENT


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Working on this project would not have been possible if our respected teacherMrs. Paromita

Mukherjee would not have helped us. Though the topic given to us was not that tough but she

taught us the right way to do it. She was always there and willing to help us whenever we needed

her help. The class notes and lecture were of immense help. Thus, we take this opportunity tothank her for her support and guidance.


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Table of Contents

ACKNOWLEDGEMENT..................................................................................................2

EXECUTIVE SUMMARY................................................................................................4

PROJECT TOPIC.........................................................................................................4

OBJECTIVE...............................................................................................................4

SCOPE OF THE STUDY...............................................................................................4

METHODOLOGY.......................................................................................................4

INTRODUCTION...........................................................................................................5

SOUTH-EAST ASIAN CRISIS.........................................................................................5

PERSPECTIVE............................................................................................................5

REASONS BEHIND THE CRISIS....................................................................................6

EFFECTS ON ECONOMY...........................................................................................9

RELEVANCE WITH INDIAN ECONOMY......................................................................12

LESSONS FROM THE CRISIS.....................................................................................12

SUBPRIME CRISIS.......................................................................................................14

PERSPECTIVE..........................................................................................................14

REASONS BEHIND THE CRISIS..................................................................................14SECURITIZATION....................................................................................................15

ROLE OF CREDIT RATING AGENCY.........................................................................15

EFFECT OF SUBPRIME CRISIS.................................................................................17

EFFECTS ON INDIAN ECONOMY...............................................................................18

LESSONS FROM THE CRISIS.....................................................................................18

CONCLUSION.............................................................................................................19

REFERENCE...............................................................................................................20

Books:.....................................................................................................................20

Websites:..................................................................................................................20

Websites:


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EXECUTIVE SUMMARY

PROJECT TOPIC

The topic that we have worked on in the project includes the two major crises that hit the world

viz. South-East Asian crisis that affected the countries including China, Hongkong, Korea and

Sub-Prime crisis that affected the US. The first crisis started off in the year 1997-99. The crisisstarted in Thailand with the collapse of the Thai baht caused by the decision of the Thai

government to float the baht, cutting its peg to the USD, after exhaustive efforts to support it in

the face of the severe financial overextension that was in part real estate driven. At that point of

time Thailand acquired the burden of foreign debt that made the country effectively bankrupt

even before the collapse of its currency leading to serious repercussions later on. The second

most serious crisis that crashed in the US recently was sub-prime crisis. Sub-prime lending is the

practice of making loans to borrowers who do not qualify for the best market interest rates

because of their deficient credit history. The phrase also refers to banknotes taken on property

that cannot be sold on the primary market; including loans on certain types of investment

properties and certain types of self-employed persons. It led to the failure of one of the biggestbank in US i.e. Merrill Lynch. The various causes and effects of these two crises are discussed

later on in the project.

OBJECTIVE

The main objective of the project is the deep analysis of the above mentioned two crises that had

serious effect on the economy of the various south-east Asian countries. To study the various

causes that led to the economic devastation and various effects that shook the economy. To look

in to the various measures taken by every country to overcome these problems has been the main

area of study. We have focused on how the world recovered from its clutches and emerged as the

various powerful economies. And to suggest some measure which could have been, if adopted,would have made the situation better or prevented it.

SCOPE OF THE STUDY

We have tried to highlight different aspects of the South-East Asian financial crisis and sub-

prime crisis under the following topics- i)Perspective, ii)Reasons behind the crisis, iii)Effect on

economy iv) Relevance with Indian economy and v) Lessons from the crisis.

METHODOLOGY

The methodology that has been adopted by us is simple division of labor. All the group memberswere given an area which they were suppose to search thoroughly and establish various pros and

cons of it. Each member then worked on his/her part and we assembled the entire data after the

discussion of our respective portion. We met from time to time so as to help each other and to

know what the other member has found out. The best part of such approach was that each portion

allotted was discussed and analyzed thoroughly before incorporating in the project.


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INTRODUCTION

South-East Asian financial crisis and sub-prime crisis are examples of two big economic

debacles. The policy makers of nations and international regulatory authorities have many things

to learn from those crises in order to avoid such situations in future. We have discussed below

the reasons, effects and economic implications of those two financial crises to finally derive the

lessons.


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SOUTH-EAST ASIAN CRISIS

PERSPECTIVE

The South-East Asian Financial Crisis beginning in July 1997 spread all over the large

economies of South-East Asia and raised fears of a worldwide economic downturn. Thailand,Indonesia, South Korea were the countrys most affected by the crisis. Hong Kong, Malaysia,

Laos and the Philippines were also hurt by the slump. The People's Republic of China, India,

Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of

demand and confidence throughout the region.

In the late 1980s and early 1990s, the economies of maintained high attractive to foreign

looking for a high . As a result the region's economies received a large inflow of and

experienced a dramatic run-up in prices. At the same time, the regional economies of Thailand ,,

, , and experienced high growth rates( 8-12% GDP ) . This achievement was widely acclaimed as

the " ". But in the mid 1990s, capital inflow into those countries started declining and export

started losing competitive ness. The Balance of Payment situation worsened as a result of

increasing current account deficit.

The crisis first broke out in Thai land with the financial collapse of the Thai baht caused by the

decision of the Thai government to float the baht, cutting its peg to the USD. Previously the Thai

government had tried to keep the exchange rate fixed in terms of USD to save its currency (Baht)

from being devaluated on the face of drastic decline in exports and foreign investment. As the

crisis spread, most ofSouth-E ast Asia and Japan saw slumping currencies, devalued stock

markets and otherassetprices. In the large Asian economies, foreign debt-to-GDP ratios shot up

beyond 180% during the worst of the crisis.

The South-East Asian economic crisis had deep impact on the concerned nations. There were

high inflation, severe job cuts and political turmoil. In Indonesia,PresidentSuharto was forced to

step down in May 1998,after being 30 years in power, in the wake of widespread rioting that

followed sharp price increases caused by a drastic devaluation of the rupiah. In the Philippines

growth dropped to virtually zero in 1998. Singapore and Taiwan proved relatively insulated from

the shock, but both suffered serious hits in passing, the former more so due to its size and

geographical location between Malaysia and Indonesia. However, by 1999, South-East Asian

economy began to recover.

REASONS BEHIND THE CRISIS

There were several domestic and external reasons behind the South-East Asian economic crisis.

Those are discussed below under respective headings-

(i)Interest rate policy: During late 1980s and early 1990s US economy was passing through a

bad phase. Interest rate was kept low in US to encourage bank-borrowing and sustain output

growth. But in money market of US, the speculative demand for money was high due to low
http://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Indonesiahttp://en.wikipedia.org/wiki/South_Koreahttp://en.wikipedia.org/wiki/Hong_Konghttp://en.wikipedia.org/wiki/Malaysiahttp://en.wikipedia.org/wiki/Laoshttp://en.wikipedia.org/wiki/Philippineshttp://en.wikipedia.org/wiki/People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Taiwanhttp://en.wikipedia.org/wiki/Singaporehttp://en.wikipedia.org/wiki/Bruneihttp://en.wikipedia.org/wiki/Vietnamhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thai_bahthttp://en.wikipedia.org/wiki/Floating_currencyhttp://en.wikipedia.org/wiki/USDhttp://en.wikipedia.org/wiki/Southeast_Asiahttp://en.wikipedia.org/wiki/Japanhttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/President_of_Indonesiahttp://en.wikipedia.org/wiki/Suhartohttp://en.wikipedia.org/wiki/Fall_of_Suhartohttp://en.wikipedia.org/wiki/Riotinghttp://en.wikipedia.org/wiki/Rupiahhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Indonesiahttp://en.wikipedia.org/wiki/South_Koreahttp://en.wikipedia.org/wiki/Hong_Konghttp://en.wikipedia.org/wiki/Malaysiahttp://en.wikipedia.org/wiki/Laoshttp://en.wikipedia.org/wiki/Philippineshttp://en.wikipedia.org/wiki/People's_Republic_of_Chinahttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Taiwanhttp://en.wikipedia.org/wiki/Singaporehttp://en.wikipedia.org/wiki/Bruneihttp://en.wikipedia.org/wiki/Vietnamhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thailandhttp://en.wikipedia.org/wiki/Thai_bahthttp://en.wikipedia.org/wiki/Floating_currencyhttp://en.wikipedia.org/wiki/USDhttp://en.wikipedia.org/wiki/Southeast_Asiahttp://en.wikipedia.org/wiki/Japanhttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/President_of_Indonesiahttp://en.wikipedia.org/wiki/Suhartohttp://en.wikipedia.org/wiki/Fall_of_Suhartohttp://en.wikipedia.org/wiki/Riotinghttp://en.wikipedia.org/wiki/Rupiah


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interest rate, whereas transaction demand for money was less(Total money supply=Transaction

demand for money + Speculative demand for money).The emerging open economy of the South-

East Asian countries started playing its own role at that time. As the interest rates in those

countries were comparably higher, the speculative demand for money in US started being

converted into demand for high interest-earning bonds of those countries. Thus there was a high

net capital inflow into the South-East Asian countries during that period, resulting in high GDPgrowth (8%-12%).

The scenario started changing when US recovered from recession and the US Federal Reserve

Bank increased interest rate to curb inflation. The increased interest rate in US started pulling

back the capital from South-East Asian countries and initiated the much discussed crisis.

(ii)Exchange rate policy: Fixed exchange rate policy followed by the South-East Asian countries

prior to the financial crisis was one of the major catalysts behind the crisis. The exchange rates of

domestic currencies of those countries were pegged to USD. When there was a reverse fly of US

capital, the demand for domestic currency started falling. Consequently, exchange rate being

fixed, the exporters of those countries started facing tremendous pressure to reduce price in terms

of USD. Countries like China started giving tough competition with lower price in the export

market. Thus there was a huge shrink in exports from the South-East Asian countries. The result

was a sharply declining current account balance. Initially, particularly in Thailand, the

government tried to support its currency by selling out Dollar and buying home currency. But, by

doing so, they worsened the situation; the foreign reserve of the country declined. Lastly there

was no other way for the government except making the exchange rate floating. As a result, the

domestic currency (e.g.-Baht for Thailand) was abruptly devaluated and foreign reserve was

exposed to high degree of risk.

(iii)Lack of control on foreign investment: It is known that one of the ways to finance currentaccount deficit of a country is attracting foreign investment. But as soon as the South-East Asian

countries went into financial crisis, foreign investment started backing out from that region

leaving behind the countries under the threat of decreasing current account balance and foreign

reserve. Lack of control of the governments of the respective countries on inflow and outflow of

foreign capital took a toll on the economy of the whole region as a whole.

(iv)Dollarization: At the wake of globalization and liberalization interdependence of economy of

countries became prevalent. Most of the developing countries accepted US Dollar as their

foreign reserve currency. South-East Asian countries were not the exceptions to it. Dollarization

gave rise to dependence on US economy. The South-East Asian financial crisis, as discussedearlier, was closely related with the ups and downs of US economy and was largely influenced

by the economic policies and activities of US.

(v)Less growth in factor productivity: The demand-side analysis of the economy of countries

reveals only half of the whole story. To get a true picture of development, supply-side of

economy should be taken into consideration. If the factors of production (e.g-labour) are not

improved and upgraded, so as to keep pace with the ever changing competitive business


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environment, growth cannot be sustained over a long period of time. In 1994, Paul Krugman, a

noted economist, pointed out to the lack of technological, infrastructural improvement and work-

force upgradation in South-East Asian countries, even when others termed the surprising growth

of that part of the world as the Asian Economic Miracle. Soon it proved to be a fallacy.

(vi)The Hot Money bubble and poor structure of financial market : In the period of hugeinflux of foreign capital into the South-East Asian countries, speculation for quick profit among

the investors overrode the need of factual analysis of the situation. Money kept on pouring into

the financial securities market; market value of shares and other assets took a long ride. Poor

functioning of financial market helped formation of the hot moneybubble. Ultimately when the

crisis started, financial markets took no time to collapse.


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vii ) Crony Capitalism : The domestic political environment of the South-East Asian countries

became burden for real development. Development money went to those people closest to the

centers of power , not particularly to the best suited or most efficient ones. Thus, improvement of

total factor productivity was neglected in the growth phase of economy. Withdrawal of capital

from those countries in the crisis period did not require many calculations, as the alternative

destination US was way ahead in terms of productivity.

EFFECTS ON ECONOMY

Stagflation : Rapid

withdrawal of capital from

the South-East Asian

countries in the period of

financial crisis brought

down the GDP growth

drastically. Capital invested

over a period of seven years

was withdrawn within a

period of one year,

approximately. In Thailand

and Philippines Real GDP

growth came down close

to zero in the year 1997.

Additionally, devaluation of

home currency made the

situation more critical by

giving rise to inflation. So,

drastically reduced

GDP growth coupled

with inflation made the

economy stagnant.

Shaded areas indicate IMF staff


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(ii)Unemployment: As an inevitable effect of the reduced output level in the South-East Asian

countries, there was huge job cut. Loss of job means reduced disposable income and hence

reduced aggregate demand. So job cut worsened the situation further by bringing down the

equilibrium output through reduced aggregate demand.

(iii)E conomic stability of the nations under question: The decreasing current account balances

and deteriorating foreign reserve position of the South-East Asian countries had put those

nations economic stability under question. As a result, other parts of the world lost confidence

in mutual trade. Both private and public sectors suffered due to this.


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(iii)Devalued stock market & asset prices: We have discussed previously about the hot money

bubble created due to poor structure of financial securities market and the overwhelming

speculative force in the period of high growth of South-East Asian economy. Afterwards, when

the sign of crisis became clear, the demand in the financial securities market took a drasticdownturn. The result was a sharp devaluation of shares and other assets.

(iv) Panic among investors : Collapse of the financial securities market destroyed the spirit of the

investors totally. The panic among the investors increased the elasticity of investment(I=f-g.r;

r=interest rate, g=elasticity of investment) and thus brought down the equilibrium output further

as a result of decline in aggregate demand.

RELEVANCE WITH INDIAN ECONOMY

Opening up of Indian economy started in the year 1991. Before that, the South-East Asiancountries had already started being flooded with foreign investments. Starting the liberalization

process later saved India to some extent from being badly affected by the crisis. But obviously,

mutual trade with those countries was affected. The sectors which were based on exports to the

South-East Asian countries , suffered a lot. For an example, steel industry in India received a

blow due to the crisis. Essar Steel, one of the steel giants of India, had to face the fear of

bankruptcy when the South-East Asian crisis put a big question mark in front of the huge

expansion project undertaken by the company during that period. So India was not totally

free from the bad effects of the South-East Asian crisis.

Moreover, it was a learning time for India about the possible effects of liberalization on domestic

economy, before she could be all set to formulate and implement new sets of economic policies

useful in the changing global economic environment. In the next part of this discussion we will

see how sub-prime crisis in US in recent years took a toll on Indian economy. That reveals that

India could have taken better lessons from the South-East Asian crisis.

LESSONS FROM THE CRISIS

The South-East Asian financial crisis left behind a lot of lessons to learn for the liberalized

developing countries. The major lessons from the crisis are as follows-

(i)Liberalization and control on foreign investment: Foreign investment is one of the key

factors to sustain healthy GDP in the liberalized macroeconomic environment. Even US can

afford to have current account deficit only with the support of huge foreign investment. But the

developing countries should be careful in handling foreign investment. They should prefer FDIs

(Foreign Direct Investors) more and should lay down proper norms for the FIIs (Foreign

Institutional Investors) so that their entry and exit can be registered, measured and monitored by


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the government. Foreign investors should not be granted to take the home country economy for a

ride by withdrawing capital, whenever they like to do so.

(ii)Fixed exchange rate Vs Floating exchange rate : The negative effect of fixed exchange rate

policy in a liberalized economy was no longer unknown after the South-East Asian crisis. Both

high depreciation and high appreciation of home currency are bad. High depreciation of homecurrency creates high inflation, whereas highly appreciated home currency reduces the current

account balance and foreign reserve by hampering exports. The governments should let the

market dynamics play its own role in deciding the exchange rate for home currency. What the

government can do to maintain a balance in the exchange rate, is to intervene into the currency

market by selling or buying home currency whenever required.

(iii) Foreign reserve policy: The financial crisis has become an eye-opener for many of the

developing and developed countries, as far as foreign reserve policy is concerned.

Comparatively higher volatility of value of USD has been a noticed trend. This uncertainty

is not an ideally expected feature of a reserve currency. As a result, some countries are trying

to adopt an alternative currency as their foreign reserve currency. Countries under the European

Union have already adopted Euro as the common foreign reserve currency.

(iv)Policy rates, government policies and global environment: Difference between interest rates

in two countries may drag foreign capital towards the country with higher interest rate for a short

period of time, but that should not be taken as a shortcut to growth of output. In long run, the

difference in rate of return in two countries cannot be maintained. As a consequence, output

growth will be at stake. Apart from that, high interest rate always makes a portion of the output

crowd out. To make up that crowded out output, expansionary fiscal policy is to be undertaken.

All these should be taken into consideration in deciding economic policies of a country.

(v)Consideration of supply side of the economy: To sustain real growth of a country,

improvement oftotal factor productivity is vital. FDIs will be more interested in investing in

long term in a country where skilled labour is available, technology is up to the mark and

infrastructure is ready. Productivity is the major determinant of return on investment, not

rate of interest. So it is highly important for the developing countries to be attentive in

upgrading the factors of production available with them.

SUBPRIME CRISIS

PERSPECTIVE

The subprime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise inmortgage delinquencies and foreclosures in the United States, with major adverse consequencesfor banks and financial markets around the globe. The crisis, which has its roots in the closing


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years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses infinancial industry regulation and the global financial system.

Subprime mortgages are residential loans that do not conform to the criteria for primemortgages, and so have a lower expected probability of full repayment. This assessment isusually made according to the borrowers credit record and score, debt service-to-income DTI)

ratio, and/or the mortgage loan-to-value (LTV) ratio. Borrowers with low credits cores, DTIsabove 55 percent, and/or LTVs over 85 percent are likely to be considered subprime. So-calledAlt-A loans fall into a gray area between prime and subprime mortgages. These began as amore flexible alternative to prime loans, mainly for borrowers who met all of the credit score,DTI, and LTV prime criteria, but did not provide full income documentation.

Many USA mortgages issued in recent years were made to subprime borrowers, defined as those

with lesser ability to repay the loan based on various criteria. When USA house prices began to

decline in 2006-07, mortgage delinquencies soared, and securities backed with subprime

mortgages, widely held by financial firms, lost most of their value. The result has been a large

decline in the capital of many banks and USA government sponsored enterprises, tightening

credit around the world.

REASONS BEHIND THE CRISIS

Americans entered into the 21st century to face an economic recession due to a series of events:

Dot-Com bubble burst of the late nineties, Terrorist attacks of 9/11, Bankruptcies filed by large

corporations like Enron and WorldCom in 2001-02In order to provide a boost to the generally

declining American consumers confidence, the monetary policies were eased up, There were a

series of rate cuts by FED (in October 2002 the FED fund rates was 1.25%)

There was an overall global trending down of the long term interest rates at the same time Asian

Economies grew significantly and there was a lot of savings in the Asian Economies, as a result

of this the housing mortgage rates had come down which in turn created demand for new homes.

American households were encouraged by the policy makers to spend their way out of the

recession by creating a perception of wealth creation through a boom in the real estate and allied

sectors.

The booming housing prices also encouraged the Americans to engage in speculative

investments on rising house prices, this boom lasted till 2006 when the market was saturated due

to high prices of houses as a result, the housing market started to see a sharp decline ,at the same

time interest rate started rising.

As the interest rate started rising the subprime borrowers who did not have nice credit ratingstarted defaulting and The poor performance of these borrowers drove down the house sales and

induced a credit crunch by dragging down the value of hundreds of billions of dollars of

securities linked to subprime loans that were safe as long as the housing prices were going up

SECURITIZATION

Even with soaring house prices, banks probably would not have issued so much mortgage debt to

low quality borrowers without one big innovation that emerged in recent years,


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Securitization .Securitization has allowed banks to bundle many loans into a single tradable

security .This simple sounding innovation enabled banks to sell part of their loan risks to other

banks and investors (specially Investment banks, Hedge Funds, Pension Funds, Mutual Funds

etc.).Apart from securitization another derivative product which became very popular in the

housing mortgage market is Credit Default Swap A Credit Default Swap provides guarantee to

the investors who are unwilling to take the full credit risk.

ROLE OF CREDIT RATING AGENCY

Credit rating agencies, such as Moodys, Standard & Poor, and Fitch, are paid by financial

institutions to provide easy to read/understand ratings of the risk associated with various debt

instruments. Each Agency has its own scale of indicators and own models to determine default

risk. High ratings encouraged investors to buy securities backed by subprime mortgages, helping

finance the housing boom. The reliance on agency ratings and the way ratings were used to

justify investments led many investors to treat securitized products some based on subprime

mortgages as equivalent to higher quality securities


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Source: Wikipedia.com

EFFECT OF SUBPRIME CRISIS

The impact of the subprime crisis goes beyond the housing market. The largest share of the

risks of the mortgage back securities was lying with the big US/European investment and

commercial banks. The big investment banks were overleveraged. Their loan and investment

books are much bigger than their capital. These investment banks used their proprietary book

to lend others and invest.

They bought mortgage loans from other banks and then packaged them to sell bonds at a

higher price against the loan pool .The difference is the spread which the investment bank

earns. By selling these structured bonds, it raises money and frees capital, but when home

buyers started defaulting, these bonds lost their value. As an accounting practice the banks

and the investment banks who have invested in these derivative products are required to

maintain Mark-To-Market losses but an MTM loss can be provided only when there is a

market.

Most of these instruments are over the counter derivatives which were struck on a one to one

basis between two parties, there is no ready market for these instruments, therefore the banks

construct a model, feed the available market price of the variables related to the instrument

and try to arrive at what the market price of the derivatives could be or should be, this is an

artificial model generated price and called Mark-To-Model against Mark-To-Market.


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But when the banks/investment banks actually wanted to sell the derivatives, there were no

takers and even if there were buyers, they were ready to pay a fraction, In other words there

was a significant difference between the actual market price and the artificially generated

price by the model therefore when the banks or the investment banks end up selling the

instruments or unwinding the derivatives, the loss suffered was far in excess of the Mark-To-

Model loss, such extra losses on thousands of securities and multiple portfolios wiped out thecapital of the banks and investment banks, there were also disclosure issues Lehman

Brothers, in its last conference call with investors gave no clue that it was actually on the

brink American International Group (AIG), the worlds most sophisticated insurer proved to

be far from adept at managing its own risk, AIG got into derivatives in 1987 and a decade

later Credit Default Swap contract ideally insure against credit risk, AIGs superb credit

rating helped it to become a leading player. It often sold protection on other contracts (insure

others collaterized debt obligation). AIG was exposed to US housing market on other fronts

too. It had a mortgage insurance business, United Guarantee, which started making big losses

in 2007 It also had invested in mortgage-backed securities

As the effect of these many financial institutions went bankrupt in USA and whole economy

went in to downturn. The post of subprime crisis is that the global economy is into recession.

Companies are cutting their cost, there is a liquidity crunch in the market, job is being

slashed and the stock indices are on their lowest price.

EFFECTS ON INDIAN ECONOMY

The Indian economy suffered a lot due to subprime crisis, Indian economy suffered because

of the following reason

1. Due to slow down in USA the Indian export oriented companies which had its major

dealing from USA had to suffer due to slow down in demand. The biggest suffers were

the IT industry

2. Various Indian banks which has Branch in USA had to share because they even have

subprime lending

3. Many Hedge funds and FIIS started withdrawing money from the Indian market by

selling their stake in the company which they hold which lead to downfall in the Indian

companies.

4. The MNCS company started cutting jobs.

5. Indian companies having branches in USA have to suffer because of downturn in USA.

6. Indian Stock markets lost more than 50% in just one year and major stocks went to their

life time low.


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7. This incident brought crisis of confidence in Indian market and global market

LESSONS FROM THE CRISIS

Indian economy is among the 2nd fastest growing country in the world after china. India after

entering the phase of globalization has to suffer as the other country suffers. After having the

impact of South Asean crisis in the year 1998, India have to again have to suffer the impact of

Subprime crisis after 10yrs.

Indian economy suffered a lot because of USA downfall due to subprime crisis but this crisis

teaches India a lessons which it should learn and change its policies so that it doesnt have to

face consequences.

The main reason for subprime crises was that the loan was given without proper documentation

and identification and so this should be avoided by Indian banks and government should make

strict rules and regulation so that no loan can be passed without proper verification.

The USA government had differentiated rate for prime and subprime people which should be

avoided.

There was liquidity crunch in the market due to rise in interest rate in USA and so seeing these

Indian government and RBI should check the market condition before announcing any change in

interest and should calculate the post effect of its monetary and fiscal policy , they should bring

policies which will increase the confidence of people back .

The rise in price of real estate should be stopped and should be a upper cap on the rise in land

and building prices so that it can stop the bubble form being burst as it happened in USA and

also in Japan.

CONCLUSION

South-East Asian financial crisis in late 1990s and US sub-prime crisis in recent time give some

lessons for the policy makers of economy, though those two economic disasters are very

different in their nature. South-East Asian crisis mainly affected countries of that particular partof the world, whereas sub-prime crisis in US affected the world economy as a whole. This may

be justified by the fact that US is a major importing country and a targeted destination of huge

foreign capital due to its high factor productivity. On the other hand, most of the developing and

developed countries are highly dependent on US economy. So, in this era of globalization and

liberalization it should be one of the major concerns of the policy makers of countries like India

to look out for the ways to make the domestic economy independent, as far as possible and at the


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same time reap the fruits of liberalization. This may be best done by improving upon total factor

productivity. The government should take up systematic long term plans to do so. The success of

automobile industry in Japan is one of the best examples of implementation of strategic planning

to improve factor productivity. Apart from that, issues on corporate governance, implementation

of labor standards etc. are gaining importance day by day. India has the advantage of large

domestic market. The level of skill of Indian workforce, technology and infrastructure areimproving steadily. These are hopeful indications of a strong and stable future economy of our

country. We should take lessons from the past mistakes and limitations to improve our future

stand.


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REFERENCE

Books:

1. Principles of Macroeconomics by Soumyen Sikdar (Oxford University Press)

2. Global Business Environment- ICMR

Websites:

1. www.imf.org (website of the International Monetary Fund)

2. www.bloomberg.com

3. www.economictimes.com

4. www.reuters.in

5. Website of world bank
http://www.imf.org/http://www.bloomberg.com/http://www.economictimes.com/http://www.reuters.in/http://www.imf.org/http://www.bloomberg.com/http://www.economictimes.com/http://www.reuters.in/

Documents

Final - - Macro Economics Project