Impact of Recession on Indian Economy

Topics: Subprime mortgage crisis, Monetary policy, Financial services Pages: 9 (2678 words) Published: November 9, 2010
Impact of Recession on Indian Economy

Table of Contents
Reason for Recession to occur2
Channel through which recession got transmitted to India from US3
Effect of recession on different sectors4
Impact on Indian Economy6
Steps that government took to tackle recession9

Reason for Recession to occur

What happened was this: banks were approached by thousands of possible new home owners asking for loans. This was during a period where the United States real estate market was climbing fast, and the value of homes was rising quickly. The banks approved these ‘bad’ or ‘sub-prime’ mortgages under the mentality that if the new home owners were to foreclose, the property would have a higher value than what it originally was due to the climbing real estate market, meaning that the bank would not lose money but make a profit! What actually happened was that the real estate market crashed, and banks were out of pocket due to the massive numbers of foreclosures on mortgages occurring. This set off the global financial crisis, which led to a global economic downturn and the recession in most developed countries. All that because of some bad debts in the States! What went wrong?

* Increasing pressure of inflation lead to higher interest rate. (Interest Rate cycle turned around middle of 2007) * As result cycle of taking loans and consumer spending practically stopped. * Demand for homes dropped due to rise in interest rates. People with low credit profile (to whom sub-prime loans were given) came under pressure and started defaulting. * Housing prices came down (the basic calculation of mortgage players of increase in property prices went wrong) and mortgage players failed to provide cover for the mortgage loans when sub-prime borrowers started defaulting. * Easy liquidity gradually started vanishing from the system. * Fore closures increased which further put pressure on housing prices. * Ever increasing defaults by borrowers and slump in housing prices forced mortgage players to write off these loans of large amount. * US Fed has already spent $900 billion in taking over failing companies due to sub-prime crisis and has announced bail-out package of $700 bn. * Major players in the US has already announced huge write offs in excess of $500 billion due to sub-prime.

US Housing Price Trend

As we can see, housing prices doubled between 2002 to Q1 of 2006

Channel through which recession got transmitted to India from US The contagion of the crisis has spread to India through all the channels – the financial channel, the real channel, and importantly, as happens in all financial crises, the confidence channel. 1. Financial Channel:  India's financial markets - equity markets, money markets, forex markets and credit markets - had all come under pressure from a number of directions.  First, as a consequence of the global liquidity squeeze, Indian banks and corporate found their overseas financing drying up, forcing corporate to shift their credit demand to the domestic banking sector. Also, in their frantic search for substitute financing, corporate withdrew their investments from domestic money market mutual funds putting redemption pressure on the mutual funds and down the line on non-banking financial companies (NBFCs) where the MFs had invested a significant portion of their funds. This substitution of overseas financing by domestic financing brought both money markets and credit markets under pressure.  Second, the forex market came under pressure because of reversal of capital flows as part of the global deleveraging process. Simultaneously, corporate were converting the funds raised locally into foreign currency to meet their external obligations.  Both these factors put downward pressure on the...
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