Global Financial Crisis: Causes, Consequences and India’s … · 2001-01-01 · RAKESH MOHAN Distinguished Consulting Professor Stanford University Former Deputy Governor, Reserve

RAKESH MOHAN

Distinguished Consulting Professor

Stanford University

Former Deputy Governor, Reserve Bank of India

at

Central Bank of Argentina

August 31 – September 1, 2009

Global Financial Crisis:

Causes, Consequences and India’s Prospects

0

Scheme of Presentation

1

� Global Financial Crisis

� Impact on India/Asia

� Difference between US/Europe and India/Asia

� RBI’s Policy Response and Impact

� Lessons from the Crisis and Emerging Challenges

Global Financial Crisis (1)

2

� 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)

Global Financial Crisis (2)

3

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.

Note: (-) indicates deficit.

Global Financial Crisis (3)US Monetary Policy (1)

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� Volatility in monetary policy in advanced economies

� Again very loose MP in US – likely surge in capital flows to EMEs?

Effective Federal Fund Rate in the US


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� Aggregate demand exceeded output; large current a/c deficit; mirrored in large surpluses in China and elsewhere


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

Global Financial Crisis (6)Capital Flows to EMEs

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

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Global Financial Crisis (7)Worsening Global Economic Outlook

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Growth Forecast of IMF (per cent)

Apr-08 Jul-08 Oct-08 Jul-09

Region 2008 2009 2008 2009 2008 2009 2008 2009

Advanced Countries

1.3 1.3 1.7 1.4 1.5 0.5 0.8 -3.8

EMEs 6.7 6.6 6.9 6.7 6.9 6.1 6.0 1.5

World 3.7 3.8 4.1 3.9 3.9 3.0 3.1 -1.4

Global Trade Volume (Goods and Services)

World 3.7 3.8 4.1 3.9 3.9 3.0 2.9 -12.2


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Impact on India/Asia (1)Trends in Capital Flows - India

US $ Billion

Component 2007-08 2008-09

Foreign Direct Investment to India 34.2 35.0

Portfolio Investment (net) 29.6 -14.0

External Commercial Borrowings (net) 22.6 8.2

Short-term Trade Credits (net) 17.2 -5.8

Total capital flows (net) 108.0 9.1

Memo:

Current Account Balance -17.0 -29.8

Valuation Gains (+)/Losses (-) onForeign Exchange Reserves

18.4 -37.7

Foreign Exchange Reserves (variation) 110.5 -57.7

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Impact on India/Asia (2)Key Macro Indicators - India

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Growth, per cent

Indicator 2007-08 2008-09

Real GDP Growth 9.0 6.7

Industry 7.4 2.6

Services 10.8 9.4

Government 6.8 13.1

Exports (US $B) 28.9 5.4

Imports (US $B) 35.2 14.3

Gross Fiscal Deficit /GDP 2.7 6.0

Stock Market Average (BSE Sensex) 16,569 12,366

Rs.per US$ 40.24 45.92

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Per cent Real GDP Growth

Country 2007 2008 2009 (IMF Proj.)

China 13.0 9.0 7.5

India 9.3 7.3 5.4

Indonesia 6.3 6.1 3.5

Korea 5.1 2.2 -1.8

Malaysia 6.3 4.6 -4.5

Philippines 7.2 4.6 0.0

Taiwan 5.7 0.1 -7.5

Thailand 4.9 2.6 -3.0

Source: IMF

Impact on India/Asia (3)

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Openness and Real GDP Slowdown in Asian EMEs


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Per cent Select Bank Ratios (end-2008)

Country

Loans to

Domestic Deposits

Loans to

Total Liabilities

Foreign Liabilities to

Domestic Deposits

China 0.69 0.68 0.01

Hong Kong 0.50 0.28 0.78

India 0.82 0.79 0.07

Indonesia 0.80 0.75 0.07

Korea 1.36 1.05 0.30

Malaysia 0.96 0.86 0.11

Philippines 0.78 0.69 0.14

Singapore 0.85 0.51 0.66

Taiwan 0.77 0.71 0.08

Thailand 0.98 0.94 0.04

Vietnam 0.98 0.91 0.07

Sources: Asian Development Outlook 2009, Asian Development Bank; Reserve Bank of India


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Banking Sector Indicators in EMEs

Per centCapital to

Risk-weighted Assets RatioNon-Performing Loans to

Total Loans

Country 1998 2000 2005 2008 1998 2000 2005 2008

China 12.8 a 13.5 2.5 8.2 n.a. 29.8 b 9.8 2.5

India 11.6 11.1 12.8 13.0 14.4 12.7 5.2 2.3

Indonesia -13.0 21.6 19.3 16.8 48.6 18.8 7.6 3.5

Korea 8.2 10.5 13 10.9 7.4 6.6 1.2 1.1

Malaysia 11.8 12.5 13.7 12.6 18.6 15.4 9.6 5.1

Philippines 17.7 16.2 17.6 15.5 19.5 19.5 `10.3 5.2

Thailand 10.9 11.9 13.2 15.3 42.9 17.7 9.1 6.5

Source: Global Financial Stability Report, IMF (various issues).Note: a: Data pertain to 1999;. b: Data pertain to 2001; n.a.: not available.



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Differences Between Financial Crisis

in US/Europe and India/Asia (1)

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� What has not happened in India/Asia:

• No subprime

• No toxic derivatives

• No bank losses threatening capital

• No bank credit crunch

• No mistrust between banks



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� Our Problems (India)

• 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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� 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. Billion

2008-09 BE

2008-09 Actual

2009-10 BEGross 1,765 3,186 4,910

Net 1,130 2,985 3,979

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� India’s 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

Differences Between Financial

Crisis in US/Europe and India/Asia (4)

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� India’s Approach to Managing Financial Stability (2)

• Financial sector, esp. 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

• 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

Differences Between Financial

Crisis in US/Europe and India/Asia (5)


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Actual/Potential Release of Primary Liquidity

Measure/FacilityRs.

BillionMonetary Policy Operations (1 to 3)1. Cash Reserve Ratio (CRR) Reduction of 400bps 1,600

2. Open Market Operations 801

3. MSS Unwinding/De-sequestering 1,556

Extension of Liquidity Facilities (4 to 8)

4. Term Repo Facility 600

5. Increase in Export Credit Refinance 2666. Special Refinance Facility for SCBs (Non-RRB) 3857. Refinance Facility for SIDBI/ NHB/EXIM Bank 160

8. Liquidty Facility for NBFCs through SPV 250

Total (1 to 8) 5,617

Memo:Statutory Liquidty Ratio (SLR) Reduction of 100bps 400

RBI’s Policy Response and Impact (1)Measures since Mid-September, 2008 (1)

Additionally:

� 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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� Managing Forex liquidity

• Interest rate ceilings raised on non-resident Indian deposits

• Norms relaxed on external commercial borrowings

• Allowing corporates to buy back foreign currency convertible bonds

• Rupee-dollar swap facility for banks with overseas branches


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� Huge supply of liquidity

� No liquidity constraints

� Flexible liquidity modulation

� Host of instruments

� No dilution of collateral


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� Orderly functioning of Indian financial markets ensured

� Cumulative potential primary liquidity impact: 10.6 % 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

RBI’s Policy Response and Impact (4)Impact of Measures

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(per cent)

Wholesale Price Inflation Mar 08 Jun 08 Sep 08 Dec 08 Jul 09

All commodities 7.8 12 12.1 5.9 -1.2

Of which:

Primary articles 9.7 11 12 11.6 4.96

Fuel 6.8 16.3 16.5 -0.7 -10.1

Manufactured products 7.3 10.9 10.5 6.2 -0.1

Consumer Price Inflation Mar 08 Jun 08 Sep 08 Dec 08 Jun 09

Agricultural labourers 7.9 8.8 11 11.4 11.5

Rural labourers 7.6 8.7 11 11.4 11.3Urban non-manual employees

6 7.3 9.5 9.8 9.7

Industrial workers 7.9 7.7 9.8 9.7 8.6

RBI’s Policy Response and Impact (5)Inflation in India


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Lessons and Emerging Challenges (1)

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� 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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� Need to revisit conventional wisdom on relationship between monetary policy and asset prices

� Important to take monetary and regulatory actions in tandem

• Functions should rest with central banks

� “Central banks should adopt a broader macro-prudential view, taking into account in their decisions asset price movements, credit booms, leverage, and the build up of systemic risk. The timing and nature of pre-emptive policy responses to large imbalances and large capital flows needs to be re-examined” (IMF, 2009b)

Lessons and Emerging Challenges (2)Monetary Policy and Asset Prices

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� Volatile capital flows due in part by push factors from monetary policy of advanced economies

• Necessitates management of capital accounts by EMEs

� Optimal response is a combination of (CGFS, 2009)

• Sound macroeconomic policies

• Prudent debt management

• Exchange rate flexibility

• Effective management of the capital account

• Appropriate levels of reserves as self-insurance

• Development of resilient domestic financial markets

• Combination is country-specific; no “one size fits all”

Lessons and Emerging Challenges (3)Management of Capital Flows by EMEs

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� Liquidity issues are equally important as capital adequacy

� Need to fix regulatory loopholes to avoid regulatory arbitrage

� Need strong regulation but also flexibility for financial sectorto expand and meet financing needs of growing economies

� Regulatory authorities approach would have to be dynamic and adjust in response to changing economic environment

Lessons and Emerging Challenges (4)Financial Regulation

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� Continuous need to adapt monetary management to the needs of fast growing and increasingly open economies

� Financial deepening and increasing monetization

• 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

� Further development of financial markets

� Large capital inflows in recent years

• Need to manage the impossible trinity

Lessons and Emerging Challenges (5)Monetary Policy in EMEs (1)

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� Sustained interest rate differential 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

� 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?

Lessons and Emerging Challenges (6)Monetary Policy in EMEs (2)

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� Combined fiscal deficit in India

• Very high by international standards

• Contributes to the persistence of an interest rate differential with the rest of the world

• Constrains progress to full capital account convertibility

• Self-imposed rule-based fiscal correction needs to be consolidated and carried forward

� Indian policy approach to current account liberalization

• Distinction between debt and equity flows

• Liberalization of debt flows can lead to arbitrage flows

• Ceilings on debt flows appropriate

Lessons and Emerging Challenges (7)India (1)

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� India’s 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

Lessons and Emerging Challenges (9)India (2)

Thank You

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Documents

Global Financial Crisis: Causes, Consequences and India’s … · 2001-01-01 · RAKESH MOHAN Distinguished Consulting Professor Stanford University Former Deputy Governor, Reserve