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India and the Lessons of the
Global Financial Crisis
John Echeverri-Gent
Department of Politics
University of Virginia
[email protected]
March 15, 2011
I. India managed the crisis very well
relative to other emerging markets
• Though the crisis caused a bigger decline of growth in
2008 (4.5%) than the average (2.4%), India’s growth
rate (5.1%) remained higher than the average (4.7%)
(See Table 1)
• While the growth rate of all other countries declined in
2009, India’s GDP rebounded. The average GDP
growth for all other countries dropped from 4.7 to 1.
India’s increased from 5.1 to 7.7.
• India’s economy is projected to continue to grow. The
GOI’s Economic Survey projects that India’s GDP will
grow by 8% in 2009-10 and 8.6% in 2010-11.
TABLE 1 ANNUAL GDP GROWTH RATES FOR SELECTED LA AND ASIAN COUNTRIES
In percent
Annual
Country
2005
2006
2007
2008
2009 Average
Argentina
9.2
8.5
8.7
6.8
0.9
6.8
Brazil
3.2
4
6.1
5.1
-0.2
3.6
Chile
5.6
4.6
6.4
3.7
-1.7
3.7
China
11.3
12.7
14.2
9.6
9.1
11.4
India
9.3
9.4
9.6
5.1
7.7
8.2
Indonesia
5.7
5.5
6.3
6
4.5
5.6
Korea, Rep.
4
5.2
5.1
2.3
0.2
3.4
Malaysia
5.3
5.8
6.5
4.7
-1.7
4.1
Mexico
3.2
4.9
3.3
1.5
-6.5
1.1
Thailand
4.6
5.1
4.9
2.5
-2.2
3
Average
6.1
6.6
7.1
4.7
1
5.1
Source: World Development Indicators 2010
II. Two channels through which the
global crisis affected India
A. Trade
• India has become a more open economy in recent years with
its trade to GDP ratio increasing from 27.4% in 2000 to
46.3% in 2009. This ratio remains much below Asian
exporters with smaller economies such as South Korea
(103%) and Thailand (127%) but not that far behind China
(51.4%). (Kose and Prasad 2010, 134)
• India’s export growth at 19.8% 2000-07 and 29.7% in 2008
is considerably faster than the average for emerging and
developing economies (EDE’s) (16.9% and 25.3%) (See
Table 2)
• It share of world trade doubled from 2000-2009, a pace of
increase that is twice as great as that for EDE’s.
• In the wake of the global crisis, Indian exports (-15.2%) fared better
than the EDE average (-24.8%)
• Exports of all Asian countries in Table 2 – with the exception of
Malaysia – fared much better than EDE and world averages.
• The impact of the global crisis on Indian exports was limited by the
growing share of Asia in total Indian exports. From 2001-02 to
2010-11 (April-Sept) this share increased from 40% to 53.5%. (GOI
2011, 170) (See Figure 1)
• India’s economy was also helped by its $54 billion surplus in its trade
in services. (GOI 2011, 173) (See Figure 2)
• However, after years of rapid growth -- the compound annual growth
rate was 28.7% from 2000-01 to 2006-07 and 22% in 2007-08 -service export growth moderated to 17% in 2008-09. In 2009-10
exports declined by 9.6%. India’s surplus in service trade dropped
from $53.9 billion to $35.7 billion due to less in demand for business
(-7.5%) and financial services (-5.6%) and an increase in imports of
these services. (GOI 2011, 172-3)
Table 2: Selected Countries' Export Growth and Share of World Exports, 2000-2010
Value Compound Annual Growth
Share in World Exports (Percent) Change
US $ bn. Rate in Percent
Jan-June
Jan-June 2009/
2009 2000-07 2008 2009 2010 2000 2008 2009 2010 2000
China
1202 25.4 17.3 -15.9 35.1
3.9
8.9
9.7
10
5.8
So. Korea
362 11.6 13.6 -14.3 34.3
2.7
2.6
2.9
3.1
0.2
Mexico
230
7.3
7.3 -21.3 35.4
2.6
1.8
1.9
2
-0.8
India
165 19.8 29.7 -15.2 35.3
0.7
1.2
1.3
1.4
0.7
Malaysia
157
8.7 19.1 -24.9 36.9
1.5
1.3
1.3
1.4
-0.1
Brazil
153 16.5 23.2 -22.7 27.5
0.9
1.2
1.2
1.3
0.4
Thailand
152 12.1 12.9
-12 36.8
1.1
1.1
1.2
1.3
0.2
Indonesia
119
8.8 18.3
-18 38.1
1
0.9
1
1
0
EDE'S*
4572 16.9 25.3 -24.4 26.7 25.4 37.9
37 37.2 11.6
World
12358 11.7 15.9 -22.7
24
100
100
200
100
NA
* EDE's indicates emerging and developing countries
Source: Government of India, Ministry of Finance. Economic Survey of India, 2010-11. New Delhi: GOI, 2011 p. 162.
60%
Figure 1: Asia's Share of India's Total
Exports, 2001-02 to 2010-11
50%
40%
53.50%
30%
40%
20%
10%
0%
2001-02
2010-11*
Figure 2: India's Trade in Services, 2000-01 to 2009-10
120
100
US $ billion
80
60
40
20
0
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
Exports 16.3
17.1
20.8
26.9
43.2
57.7
73.8
90.3
106
95.8
Imports 14.6
13.8
17.1
16.7
27.8
34.5
44.3
51.5
52
60
Balance
1.7
3.3
3.6
10.1
15.4
23.2
29.5
38.9
53.9
35.7
Sectoral Share of the Indian
Economy, 2008-09
Services
64.2
Industry
18.7
Agriculture
17.1
B. Finance
• Was India’s success in managing the financial
crisis due to its capital controls?
• According to several indicators of de jure
capital account openness, (Table 3) India is
more closed than other emerging markets,
though it has been slowly catching up.
• Many contend that the lesson of India’s
experience is that countries should open their
capital account with great caution, if at all.
Others have argued that India’s experience
demonstrates the virtues of public sector banks
and limitations on foreign banks.
• Prasad (2009) argues that it is important to
consider de facto as well as de jure integration.
• Using the ratio the sum of gross external
liabilities and gross external assets to GDP as a
measure of de facto financial openness, Prasad
(2009) finds that though India’s ratio increased
from less than 20% of GDP in 1980 to just under
70% in 2006, it remains one of the least
financially integrated emerging market countries
Table 3: Measures of De Jure Capital Account Openness
Emerging Markets India
Min.
Median
Max.
Chinn Ito
1985
1995
2006
Edwards
1985
1995
2000
Miniane
1985
1995
2000
-1.8
-1.8
1.13
-1.13
0.09
0.03
2.54
2.54
2.54
-1.13
-1.13
-1.13
12.5
25
37.5
37.5
50
62.5
75
100
100
25
25
75
0.83
0.71
0.71
0.86
0.86
0.86
1
1
0.86
0.83
0.83
0.86
Note: The Chinn-Ito Index goes from -2.54 to 2.54, with higher scores indicating
more open capital accounts. The Edwards index ranges from 0 to 100 with
higer scores indicating more open capital accounts. The Miniane index runs
from 0 to 1 with lower scores indicating more open capital accounts.
Source: Rasad 2009. See also Chinn and Ito (2006), Edwards (2007), and Minane (2004).
How did the problems of global
financial come to India?
• Despite capital controls and relatively limited financial
integration, by 2007, India had an estimated 2104
multinational corporations (Sauvant and Pradhan 2010, 5)
with outward foreign direct investment flows peaking at
18.5 billion in 2008 (Unctad 2010) (See Figures 2 and 3)
• Patnaik and Shah (2010) and Aziz, Patnaik, and Shah
(2008) find that many Indian multinational (financial and
non-financial) corporations set up global treasury operations
in London in order to evade India’s capital controls and gain
access to the cheaper funds available from global markets.
• When Lehman Brothers failed on September 14, 2008,
liquidity in London dried up and the LIBOR-linked rates at
which the Indian firms borrowed skyrocketed.
Figure 2: India's Outward FDI, 1990-2009
20
18.5
18
17.2
16
14.9
14.3
US $ Billions
14
12
10
8
6
4
3
2
1.4
0.1
1.7
1.9
2002
2003
2.2
0.5
0
1990-99*
2000
* Annual Average
2001
2004
2005
2006
2007
2008
2009
Figure 3: Number of Outward Investing Indian
Firms, 1970-79 to 2000-07
2500
2104
Number of Firms
2000
1500
1257
1000
500
60
146
0
1970-79
1980-89
1990-99
2000-07
• With global credit no longer available at
reasonable prices, Indian multinationals turned to
the domestic money market, converting these
funds into dollars in order to meet their foreign
obligations.
• In the last quarter of 2008, capital leaving India
through banks and non-bank corporations
amounted to $10.8 billion, exceeding the overall
net capital outflow of $3.7 billion and the net
portfolio investment exodus of $5.8 billion.
(Patnaik and Shah 2010, 18)
– This caused the liquidity of domestic money markets
to tighten and interest rates to rise
– It also placed downward pressure on the rupee’s
exchange rate
• Local firms who placed short-term funds with
mutual funds because of tax advantages, began
redeeming their investments to meet their own
needs.
• The sell-off along with investors’ reevaluation of
Indian MNC’s and the flight of foreign capital to
less risk, resulted in a precipitous drop of prices
on the Indian equity market.
• Fortunately, Indian policy makers dealt with these
issues in a competent manner
• In the area of monetary policy, they lowered interest rates
and increased the supply of funds in the money markets
by reducing the reserve requirements for banks
• They enacted fiscal stimulus through the budget for FY
2009-10. This had a positive effect given that India’s
domestic market remains the main driver of its economy.
• India drew on its ample foreign reserves amounting to
$310 billion at the end of March 2008 to sell an estimated
$30 billion to limit the depreciation of the rupee.
• Before the crisis, the Reserve Bank of India (India’s
central bank), sensing the possibilities of a real estate
bubble, intervened to limit loans to land developers by
raising risk weights and provisioning requirements for
such loans.
III. India’s Debate Over the Lessons of
the Global Crisis
• The global crisis has given the debate popular
notoriety. Former RBI Governor Y.V. Reddy
published a best-selling book (2009)
expressing a conservative view advocating a
“calibrated approach” (2007)
• Nonetheless, baring other crises, the decisive
politics of reform is within the central
government bureaucracy pitting the Finance
Ministry versus the RBI.
Key issues include
• Capital account convertibility
• Whether foreigners should be allowed to invest in
Government of India securities
• Restrictions on foreign investment in India’s
financial sector
• The role of public banks
• Whether the RBI should “manage” the exchange
rate
• The degree to which the RBI should allow
innovation of financial products
IV. Concluding Remarks
• The global financial crisis strengthened the Reserve Bank
of India and its conservative approach
• India’s ambition to become a center for global financial
services (GOI 2007) will motivate more reforms.
• The Ministry of Finance has the upper hand. It has the
authority to appoint the Governor of the RBI, and in Fall
2008 it used it to replace the retiring conservative Y.V.
Reddy with the finance secretary D. Subbarao.
• Issues to watch are:
– Whether the politics of reform will enable India to
relax capital controls while minimizing the risks of
opening to foreign finance
– Whether the financial sector can develop the
regulatory capacity that facilitates innovation while
minimizing its risk
List of Works Cited
Aziz, Jahangir, Ila Patnaik, and Ajay Shah. 2008. “The current liquidity
crunch in India: Diagnosis and Policy Response,” New Delhi: National
Institute of Public Finance and Policy, Research Program on Capital
Flows and their Consequences. Available at:
http://www.mayin.org/ajayshah/PDFDOCS/APS2008_crisis_and_respo
nse.pdf.
Chinn, Menzie, and Hiro Ito. 2006. “What Matters for Financial
Development? Capital Controls, Institutions and Interactions,” Journal
of Development Studies 81:1, pp. 45-66.
Edwards, Sebastian. 2007. “Capital Controls, Sudden Stops and
Current Account Reversals,” in Sebastian Edwards (ed.) Capital
Controls and Capital Flows in Emerging Markets. Chicago: University
of Chicago Press, pp. 73-120.
Government of India. Ministry of Finance. 2011. Economic Survey,
2010-2011. Available at: http://indiabudget.nic.in/index.asp.
Government of India. Ministry of Finance. 2007. Report on Making
Mumbai an International Financial Centre. Available at:
http://finmin.nic.in/reports/.
Kose, M. Ayhan and Eswar S. Prasad. 2010. Emerging Markets:
Resilience and Growth Amid Global Turmoil. Washington, DC:
Brookings Institution.
Miniane, Jacques. 2004. “A New Set of Measures on Capital Account
Restrictions,” IMF Staff Working Papers 51:2. Available at:
http://imf.org/External/Pubs/FT/staffp/2004/02/miniane.htm.
Patnaik, Ila and Ajay Shah. 2010. “Why India choked when Lehman
broke,” New Delhi: National Institute of Public Finance and Policy,
Working paper 2010-63 (January) Available at:
http://www.nipfp.org.in/working_paper/wp_2010_63.pdf.
Prasad, Eswar. 2009. “Some New Perspectives on India’s Approach to
Capital Account Liberalization,” National Bureau of Economic Research
Working Paper 14658. Available at
http://www.nber.org/papers/w14658.
Reddy, Y.V. 2009. India and the Global Financial Crisis: Managing
Money and Finance. Delhi: Orient Black Swan.
Reddy, Y.V. 2007. “Converting a Tiger: Lessons from India’s
gradualist approach to capital account convertibility,” Finance and
Development 44: 1 (March) pp. 1-9.
Sauvant, Karl P., Jayaprakash Pradhan, Ayesha Chatterjee, and Brian
Harley. 2010. The Rise of Indian Multinationals: Perspectives on
Indian Outward Foreign Direct Investment New York: Palgrave.
UNCTAD. 2011. UNCTADSTAT Database. Available at:
http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx?sCS_refer
er=&sCS_ChosenLang=en>.
World Bank. 2011. World Development Indicators, 2010. Available at
http://data.worldbank.org/data-catalog/world-development-indicators