Impact of Financial Crisis on India

Topics: Monetary policy, Central bank, Foreign exchange market Pages: 10 (3342 words) Published: September 4, 2011
Central banks recognize that financial stability can be jeopardised even if there is price and macroeconomic stability. What is needed is not more regulation but sharper regulation of the financial system” - DEEPAK MOHANTY (executive director at RBI). Introduction

Banking and financial crisis have been a common phenomenon throughout the modern economic history of mankind. Since the great depression of 1929, the world has witnessed hundreds of such crisis and the frequency of the crisis has increased over time. According to a World Bank study of 2001, there were as many as 112 systemic banking crises from the late 1970s until 2001. Most of them, including the current one, have shared some common features: each started with a hasty process of financial sector reforms, which not only created a vacuum in terms of regulations but also deteriorated the basic economic fundamentals though massive inflows of foreign capital and finally ended up with a change in investor expectations and a consequent mess in the financial markets. Although, India was able to avoid the first round of adverse effects on account of its banks not being overly exposed to sub-prime lending, the second-round impact however, affected India quite badly. After a long spell of growth, the Indian economy is experiencing a downturn. Industrial growth is faltering, inflation remains at double-digit levels, the current account deficit is widening, foreign exchange reserves are depleting and the rupee is depreciating. The Sensex fell from its closing peak of 20,873 on January 8 2008, to less than 10,000 by October 17, 2008.

The withdrawal by the FIIs led to a sharp depreciation of the rupee. In this uncertain environment, banks and financial institutions concerned about their balance sheets have been cutting back on credit, especially the huge volume of housing, automobile and retail credit provided to individuals. The trade deficit during the April-August has shot up to a $49.1 billion from a level of $34.5 billion in the corresponding months of the previous fiscal. Employment is worst affected during financial crisis. Impact of financial crisis on India: WHY?

India, like most other emerging market economies, has so far, not been seriously affected by the recent financial turmoil in developed economies. The Indian banking system has no direct linkage with the sub-prime mortgage assets or failed institution moreover the growth in Indian industries are mostly driven by domestic consumption and expenditure, foreign demands as measured in terms of merchandise exports account for less than 15% of the GDP, so the question arises why was India affected by the crisis? The answer to this situation is Globalization. The Indian economy is now a relatively open economy, despite the capital account not being fully open. Following facts revel this; •The current account, as measured by the sum of current receipts and current payments, amounted to about 53% of GDP in 2007-08, up from about 19% of GDP in 1991-92. •The capital account, the sum of gross capital inflows and outflows increased from 12% of GDP in 1990-91 to around 64% in 2007-08. •The ratio of total external transactions (gross current account flows plus gross capital flows) to GDP, this ratio has more than doubled from 46.8 per cent in 1997-98 to 112.4 % in 2008-09. With this degree of openness, developments in international markets are bound to affect the Indian economy and policy makers have to be vigilant in order to minimize the impact of adverse international developments on the domestic economy. Impact of financial crisis on India: HOW?

With the increasing integration of the Indian economy and its financial markets with rest of the world, the country gets coupled with the downside risks from these international developments. Impact on Balance of Payments

The main impact of the global financial turmoil in India has emanated from the significant change experienced in the...

References: • International Monetary Fund (2009a) “Group of Twenty: Note by the Staff of International Monetary Fund”.
o (2006b), “Evolution of Central Banking in India”, Reserve Bank of India Bulletin, June
o (2007), “India 's Financial Sector Reforms: Fostering Growth While Containing Risk”, Reserve Bank of India Bulletin, December.
• Bernanke, Ben (2009), “The Crisis and the Policy Response”, Stamp Lecture at London school of Economics, January 13. Available at
• Committee on the Global Financial System (2009), Report of the Working Group on Capital flows to Emerging Market Economies (Chairman: Rakesh Mohan), Bank for International Settlements, Basel.
• World Bank (2008), Global Development Finance 2008: The Role of International Banking, World Bank Mohan, Rakesh (2006a), “Coping with Liquidity management in India : A Practitioner’s View”, Reserve Bank of India Bulletin, April.
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