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Global Financial Crisis:
Causes, Consequences and
India’s Prospects
By
RAKESH MOHAN
Deputy Governor
Reserve Bank of India
At
Annual General Meeting of
Indian Banks’ Association
May 11, 2009
Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and
India
Lessons from the Crisis
Medium-term Issues and Challenges
Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and
India
Lessons from the Crisis
Medium-term Issues and Challenges
Global Financial Crisis (1)
 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)
Current Account Balance (per cent to GDP)
Country
1990-94 1995-99 2000-04
China
1.4
1.9
2.4
India
-1.3
-1.3
0.5
Russia
0.9
3.5 11.2
Saudi Arabia
-11.7
-2.4 10.6
United Arab
Emirates
8.3
4.6
9.9
United States
-1.0
-2.1
-4.5
Memo:
Euro area
n.a.
0.9
0.4
Middle East
-5.1
1.0
8.4
Source: World Economic Outlook Database, April 2009, International Monetary Fund.
Note: (-) indicates deficit.
2005
7.2
-1.3
11.0
28.7
2006
9.5
-1.1
9.5
27.9
2007
11.0
-1.0
5.9
25.1
2008
10.0
-2.8
6.1
28.9
18.0
-5.9
22.6
-6.0
16.1
-5.3
15.8
-4.7
0.4
19.7
0.3
21.0
0.2
18.2
-0.7
18.8
Global Financial Crisis (4)
9
8
7
6
5
4
3
2
1
0
Effective Federal Fund Rate in the US
Jan-90
Dec-90
Nov-91
Oct-92
Sep-93
Aug-94
Jul-95
Jun-96
May-97
Apr-98
Mar-99
Feb-00
Jan-01
Dec-01
Nov-02
Oct-03
Sep-04
Aug-05
Jul-06
Jun-07
May-08
Per cent
US Monetary Policy (1)
•Volatility in monetary policy in advanced economies
•Large volatility in capital flows to EMEs
•Again very loose MP in US – likely surge in capital flows to EMEs?
Global Financial Crisis (5)
US Monetary Policy (2)
•US Monetary policy too loose during 2002-04; aggregate
demand exceeded output; large current a/c deficit;
mirrored in large surpluses in China and elsewhere.
Global Financial Crisis (6)
US Monetary Policy (3)
 Large Fed cuts in 2007: strong boost to oil, other
commodity and asset prices
Global Financial Crisis (3)
Capital Flows to Emerging Market Economies
800
600
200
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
-200
1982
0
1980
US $ billion
400
-400
-600
Direct investment, net
Other private capital flows, net
Private portfolio flows, net
Private capital flows, net
•Very large capital flows to EMEs –– now outflows in 2009 - large
volatility - implications for monetary management and financial stability
Global Financial Crisis (7)
Worsening Global Economic Outlook
Growth Forecast of IMF (per cent)
Region
April 2008
July 2008 October 2008 April 2009
2008 2009 2008 2009
Advanced
countries
EMEs
World
World
2008 2009
1.3
1.3 1.7 1.4
1.5
0.5
6.7
6.6 6.9 6.7
6.9
6.1
3.7
3.8 4.1 3.9
3.9
3.0
Global Trade Volume (Goods and Services)
3.7
3.8 4.1 3.9
3.9
3.0
2008
2009
0.9 (-)3.8
6.1
1.6
3.2 (-)1.3
3.3
-11.0
Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and
India
Lessons from the Crisis
Medium-term Issues and Challenges
Impact on India (1)
Trends in Capital Flows
Component
Period
2007-08
2008-09
Foreign Direct Investment to India
April-March
34.4
33.6
FIIs (net)
April-March
20.3
-15.0
External Commercial Borrowings (net) April- December
17.5
6.0
Short-term Trade Credits (net)
April- December
10.7
0.5
Total capital flows (net)
April- December
82.0
15.3
Current Account Balance
April- December
-15.5
-36.5
Valuation Gains (+)/Losses (-) on
Foreign Exchange Reserves
April- December
9.0
-33.4
April-December
76.1
-53.8
110.5
-57.7
Memo:
Foreign Exchange Reserves
(variation)
April-March
Impact on India (2)
Key Macro Indicators
Indicator
Period
2007-08
2008-09
Growth, per cent
Real GDP Growth
April-December
Industrial production April-March
9.0
6.9
8.5
2.4
Services
April-December
10.5
9.7
Exports
April-March
28.4
6.4
Imports
April-March
40.2
17.9
GFD/GDP
April-March
2.7
6.0
Stock Market
(BSE Sensex)
April-March
16,569
12,366
Rs.per US$
April-March
40.24
45.92
Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe
and India
Lessons from the Crisis
Medium-term Issues and Challenges
Differences Between Financial Crisis in
US/Europe and India (1)
 What has not happened here
No subprime
 No toxic derivatives
 No bank losses threatening capital
 No bank credit crunch
 No mistrust between banks

Differences Between Financial Crisis in
US/Europe and India (2)
 Our Problems

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
Differences Between Financial Crisis in
US/Europe and India (3)
 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. crore
2008-09 BE
2008-09 RE
2009-10 BE
Gross
1,76,453
3,42,769
3,98,552
Net
1,13,000
3,29,649
3,08,647
Differences Between Financial Crisis in
US/Europe and India (4)
 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 (5)
 India’s Approach to Managing Financial
Stability (2)

Financial sector, especially 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 take
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.
Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and
India
Lessons from the Crisis
Medium-term Issues and Challenges
Lessons from the Crisis
 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
Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and
India
Lessons from the Crisis
Medium-term Issues and Challenges
Medium-term Issues and Challenges (1)
Macroeconomic Indicators at a Glance (Per cent)
1
1. Real GDP Growth
Agriculture
Industry
Manufacturing
Services
2. Real GDCF/GDP
3. ICOR
4. Nominal GDCF/GDP
5. GDS/GDP
1950-51
to
1964-65
2
1965-66
to
1980-81
3
1980s
4
4.1
3.2
2.9
6.7
2003/04
To
2007/08
1990-91
5
1991/92
to
1996-97
6
1997/98
to
2002/03
7
5.6
5.3
5.7
5.2
8.7
2.1
4.2
4.4
6.4
4.0
5.7
3.7
7.0
0.9
4.1
4.4
8.4
6.6
4.9
13.5
3.3
3.9
4.2
19.2
6.0
5.8
6.3
20.2
3.6
4.8
5.9
24.4
4.6
7.5
6.4
22.5
4.0
3.9
7.8
24.1
4.6
9.1
10.3
31.4
3.6
11.8
10.3
16.7
15.9
20.8
19.0
26.0
22.8
23.9
22.7
24.5
24.1
33.0
32.7
8
-1.5
-0.7
-1.8
-3.2
-1.2
-0.4
-0.3
 Continuing increase in real GDP growth - Interregnum during the 1970s
 Secular uptrend in domestic saving and investment -investment largely financed
by domestic savings
 Continuation of growth in domestic savings necessary; fiscal prudence
6. Saving-Investment Gap
Medium-term Issues and Challenges (2)
Fiscal Policy (1)
 Combined fiscal deficit in India
 Even before the recent setback: very high
by international standards
 contribute to the persistence of an interest
rate differential with the rest of the world,
 constrains progress towards full capital
account convertibility.
 self imposed rule based fiscal correction
needs to be consolidated and carried
forward.
Medium-term Issues and Challenges (3)
Fiscal Policy (2)
 Sustained interest rate differential also
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.
Medium-term Issues and Challenges (4)
Monetary Policy (1)
 A continuous need to adapt monetary
management to the emerging needs of a fast
growing and increasingly open economy.
 Financial deepening and increasing monetisation.
 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.
Medium-term Issues and Challenges (5)
Monetary Policy (2)
 Further development of financial markets
 Large capital inflows in recent years
 Reserve Bank’s ability to manage the
impossible trinity
 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?
Medium-term Issues and Challenges (6)
External Sector (1)
 Optimal response to the large and volatile
capital flows is a combination of (CGFS, 2009)







sound macroeconomic policies
prudent debt management
exchange rate flexibility
effective management of the capital account
accumulation of appropriate levels of reserves as
self-insurance and
development of resilient domestic financial markets
combination is country-specific; no “one size fits
all”.
Medium-term Issues and Challenges (7)
External Sector (2)
 Indian policy approach to CAL
 Distinction between debt and equity
flows
 Higher inflation and interest rates in
India vis-a-vis advanced economies
 Liberalisation of debt flows can lead to
arbitrage flows
 Ceilings on debt flows appropriate
Medium-term Issues and Challenges (8)
Financial Sector

Commercial banks robust
 Committee on Financial Sector Assessment (CFSA)
•Stability Assessment and Stress Testing
•Concerns about credit risk remain muted at present
Scenario - increase in NPA by:
Without Stress
100 per cent
150 per cent
CRAR (%)
CRAR (%)
CRAR (%)
Mar-08
13.0
11.6
11.0
Sept–08
12.5
11.1
10.6
•Note: CRAR = credit to risk-weighted assets ratio
Medium-term Issues and Challenges (9)
Conclusion
 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
Thank You