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Response of the Reserve Bank of India (RBI) to the
Financial and Economic Crisis
Aleksandar Zaklan
While the Advanced Economies were in Crisis
Already…

India enjoyed GDP growth around 9% going into 2008

Main drivers: domestic investment, resulting from savings
rate of about 35% of GDP, and domestic consumption.

However, foreign investment and trade also contributed to
the expansion of the economy

India was integrating into the world economy


Trade share of GDP (exports + imports/GDP) went from 21.2% in
1997 to 34.7% by 2008

Foreign capital had been available and cheap and capital inflows
amounted to 9% of GDP by 2008
So in 2007 and going into 2008 the RBI was fighting
overheating rather than crisis
Ex Ante Measures by the RBI: Interest Rate
Policy
 Starting in early 2008 consumer inflation
started rising towards 10% per year
 In addition, a boom was under way in real
estate, in particular in commercial real
estate
 To maintain price stability the RBI pursued
a relatively tight monetary policy, and the
main policy rate, the repo rate, was raised
to 9% by the summer of 2008
Ex Ante Measures by the RBI: Micro and Macro
Prudential Policy

The RBI is also in charge of banking supervision,
and 70% of India’s banking system is stateowned, so the RBI has a lot of control over the
system

The RBI’s governor, Y.V. Reddy, took strong antiexpansionary regulatory measures:

Banks were not allowed to speculate with land

Banks were forced to maintain conservative lending
standards for mortgages and consumer loans

The RBI required fairly high capital reserves (12-14%)
Y. V. Reddy, the anti Greenspan
With the Lehman Brothers Default the Crisis
Reached India

The second-round effects of the crisis were transmitted
both through the financial and the real channel

Financial channel:


Liquidity dried up as foreign investors divested and put pressure
on the Rupee exchange rate

Domestic companies were cut off from foreign capital and turned
to a tightening domestic credit market
Real channel:

Demand for Indian exports dropped because of the recession in
advanced economies

Remittances from the Gulf region dropped because falling energy
prices diminished construction activity there
Ex Post Measures: Interest rate policy

Starting in the fall of 2008 the actions of the RBI
bacame highly expansionary

The repo rate (the rate which RBI charges banks
when they borrow from it) fell from 9% in
October 2008 to 4.75% currently

The reverse repo rate (the rate the RBI offers
banks for taking in the banks’ money) was cut
from 6% in December 2008 to 3.25% currently
Ex Post Measures: Aggregate Liquidity Supply
Operations

Ensuring Liquidity supply both in the foreign
exchange and the domestic markets was the
overarching goal of the RBI’s response to the
crisis

However, no particular emergency measures for
specific banks were needed, since no banks were
threatened by failure.
Ex Post Measures: Aggregate Liquidity Supply
Operations


Domestic liquidity:

The cash reserve ratio (CRR) was decreased from 9% at the end of 2008
to 5% currently

The statutory lending requirement (SLR) was lowered from 25% to 24%
of deposits

A number of special financing programs were set up, e.g. guaranteeing
credit to non-banking financial companies (NBFCs) and to micro, small
and medium sized companies (MSMEs)
Foreign exchange liquidity:

The RBI intervened massively in the foreign exchange market by selling
US dollar reserves to support the Rupee exchange rate

A rupee-dollar swap facility provided liquidity to commercial banks

External borrowing restrictions on corporations were relaxed

Repatriation of remittances was made easier for Indians living abroad
Conclusion

While the crisis is certainly having an impact, the impact
on India is muted compared to what is going on in
advanced economies and other emerging economies, e.g.
Eastern Europe

The RBI has taken pretty swift and decisive action against
the liquidity crunch, and is coordinating its actions with
the fiscal stimulus provided by the government

Overall, the fundamentals of the economy seem to be
sound, and given that the drivers of growth in India are
predominantly domestic, there should not be significant
damage to the country’s medium to long term economic
prospects