GLOBAL FINANCIAL CRISIS AND IMPACT ON ECONOMY

1. EXECUTIVE SUMMARY
The world economy is engaged in a spiraled mortgage crisis, starting in the
United States, which is carving the route to the largest financial shock since
the Great Depression.
A loss of confidence by investors in the value of securitized mortgages in the
United States was the beginning of a financial crisis that swept the global
economy off its feet. The major financial crisis of the 21st century involves
esoteric instruments, unaware regulators, and nervous investors. Starting in
the summer of 2007, the United States experienced a startling contraction in
wealth, triggered by the subprime crisis, thereby leading to increase in
spreads, and decrease in credit market functioning. During boom years,
mortgage brokers, enticed by the lure of big commissions, talked buyers with
poor credit into accepting housing mortgages with little or no down payment
and without credit checks. Higher default levels, particularly among less
credit- worthy borrowers, magnified the impact of the crisis in the financial
sector.
The ability to raise cash, i.e. liquidity, is an essential component for the
markets and for the economy as a whole. The freezing liquidity has closed
shops of a large number of credit markets. Interest rates had been rising
across the world, even rates at which banks lend to each other. The freezing
up of the financial markets eventually lead to a severe reduction in the rate of
lending, followed by slow and drastically reduced business investments,
paving the way for a nasty recession in the overall economic state of the
globe.
A collapse of trust between market players has decreased the willingness of
lending institutions to risk money. The bursting of the housing bubble has

caused a lot of AAA labeled investments to turn out to be junk. Nervous

investors have been sending markets plunging down. Markets all over the
world including those of Britain, Germany, and Asia, had to confront all-time
low figures since the past couple of years or more.
Britain also witnessed the so-called bursting of the Brown Bubble, in the
form of the highest personal debt per capita in the G7, combined with an
unsustainable rise in housing prices. The longest period of expansion, which
Britain claimed to be undergoing, eventually revealed itself an illusion. The
illusion of rising to prosperity had been maintained by borrowing to spend,
often in the form of equity withdrawal from increasingly expensive houses.
The bubble ultimately burst, exposing Britain to the most serious financial
crisis since the 1920s. This brings a lot of misery to the home owners who
are set to see the cost of mortgages soar following the deepening of the
banking crisis and the Libor the rate at which banks lend to each other.
The impact of the crisis is more vividly observable in the emerging markets
which are suffering from one of their biggest selloffs. Economies with
disproportionate offshore borrowings (like that of Australia) are adversely
affected by the western financial crunch. Globalization has ensured that none
of the economies of the world stay insulated from the financial crisis in the
developed economies.
Contrary to the decoupling theory, emerging economies too have been hit
by the crisis. According to the decoupling theory, even if advanced
economies went into a downturn, emerging economies would remain
unscathed because of their substantial foreign exchange reserves, improved
policy framework, robust corporate balance sheets, and a relatively healthy
banking sector. In a rapidly globalizing world, the decoupling theory was
never totally persuasive.

The decoupling theory stands totally invalidated today in the face of

capital flow reversals, sharp widening of spreads on sovereign and corporate
debt and abrupt currency depreciations.
The Project:
In the subsequent parts of the project, several issues will be discussed which
will provide a detailed account of the origin of the crisis and the ripple effect
of economic downturn of the worlds largest economy which engulfed even
the fast growing emerging economies into the crisis. The impact of the crisis
on the Indian economy will also be dealt with. The main aim of the study is
to find relevant answers to questions like why and how India has been hit by
the crisis and how the Indian economy and the Reserve Bank of India have
responded to the crisis. The recommendations include the outlook for the
Indian economy in the wake of the economic turmoil. The project concludes
with an analysis of Entrepreneurship in times of the financial crisis and a
swift overview of the various aspects of entrepreneurship which can help in
the revival of a plummeting economy.

2. INTRODUCTION
The Indian economy is experiencing a downturn after a long spell of
growth. Industrial growth is faltering, the current account deficit is
widening, foreign exchange reserves are depleting, and the rupee is
depreciating.
The crisis originated in the United States but the Indian government had
reasons to worry because there was a potential adverse impact of the
crisis on the Indian banks. Lehman Brothers and Merrill Lynch had
invested a substantial amount in Indian banks, who in turn had invested

the money in derivatives, leading to exposure of even the derivatives

market to these investment bankers.
Public Sector Unit (PSU) banks of India like Bank of Baroda had
significant exposure towards derivatives. ICICI faced the worst hit. With
Lehman Brothers having filed for bankruptcy in the US, ICICI (Indias
largest private bank), survived a rumor during the crisis which argued that
the giant bank was slated to lose $80 million (Rs. 375 crores), invested in
Lehmans bonds through the banks UK subsidiary. Even Axis Bank was
affected by the meltdown.
The real estate sector in India was also affected due to Lehman Brothers
real estate partner having given Rs 7.40 crores to Unitech Ltd., for its
mixed use development project in Santa Cruz. Lehman had also signed a
MoU with Peninsula Land Ltd, an Ashok Piramal real estate company, to
fund the latters project amounting to Rs. 576 crores. DLF Assets, which
holds an investment worth $200 million, is another major real estate
organization whose valuations are affected by the Lehman Brothers
dissolution.
The impact of the crisis on the Indian economy has been studied here
forth and the study is chiefly focused on 4 major factors which affect the
Indian economy as a whole.
These are:
(i)
Availability of global liquidity
(ii)
Decreased consumer demand affecting exports
(iii) The Financial Crisis and the Indian IT Industry
(iv) The Financial Crisis and Indias Financial Markets 9

Availability of Global Liquidity for India in times of Financial

Crisis:

The main source of Indian prosperity had been Foreign Direct Investment
(FDI). American and European companies were bringing in truck-loads of
dollars and Euros to get a piece of pie of Indian prosperity. Less inflow of
foreign investment will lead to a dilution of the element of GDP driven growth.
India is in no position to ever return this money because it has used the same in
subsidizing the petroleum products and building low quality infrastructure.

Liquidity is the major driving force of the stock market performances observed
in emerging markets. Markets such as those of India are especially dependent on
global liquidity and international risk appetite. The initial stage of the crisis
witnessed rising interest rates across global economies. Rising interest rates
tend to have a negative impact on global liquidity, and subsequently equity
prices, as funds may move into bonds or other money market instruments.

Even though there are threats for the Indian economy due to the global liquidity
crunch, they are all oriented for the long term. Any short term liquidity concern
will be taken care of by the high rate of household and corporate savings in the
country. The Indian economy can certainly rely on its piggy bank to address
its short-term liquidity demands as the government is taking measures to
channelize large sums of household savings lying unused in physical assets into
the more productive financial sector. Thus, the Indian economy will be
relatively unaffected by the global liquidity crunch.

Indian companies which had access to foreign funds for financing their trading
activities are the worst hit. Foreign funds will be available at huge premiums but
will be limited to the blue-chip companies, thus leading to

 Reduced capacity of expansion leading to supply pressure

Increased interest rates which will affect corporate profitability
Increased demand for domestic liquidity which will put interest rates
under pressure

Decreased consumer demand affecting exports:

Consumer demand has plummeted drastically in developed economies, leading
to a reduced demand for Indian goods and services, thus affecting Indian
exports.
Export oriented units are the worst hit; thus impacting employment
Trade gap has been widening due to the reduced exports, leading to
pressure on the rupee exchange rate

The Financial Crisis and Indian I.T. Industry

In India, IT companies, with nearly half of their revenues coming from
financial and banking service segments, are close monitors of the financial crisis
across the world. The IT giants which had Lehman Brothers and Merrill Lynch
(ML) as their clients are Tata Consultancy Services (TCS), Wipro, Satyam, and
Infosys Technologies. HCL escaped the loss to a great extent because neither
Lehman Brothers nor ML was its client.

Impact on Financial Markets:

The outflow of foreign institutional investment from the equity market has been
the most immediate effect of the crisis on India. Foreign Institutional Investors
(FIIs) have been major sellers in Indian markets as they need to retrench assets
in order to cover losses in their home countries, thus being forced to seek
havens of safety in an uncertain environment.

Given the importance of FII investment in driving Indian stock markets and the
fact the cumulative investment by FIIs stood at $66.5 billion at the beginning of
2008, the pullout of $11.1 billion during the first nine-and-a-half months of
2008 triggered a collapse in stock prices. 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 FIIs also led to a sharp depreciation of the rupee. While this
depreciation may be good for the Indian exports which have been adversely
affected by the slowdown in global markets, it is not so good for those who
have accumulated foreign exchange payment commitments.

The financial crisis has reinstated the notion that in the globalized world, no
country can exist as an island, insulated from the twists and turns of the global
economy; growth prospects of emerging economies have been undermined by
the cascading financial crisis, though there certainly exist significant variations
across the countries.

UNDERSTANDING BUSINESS CYCLES

Business Cycle or Economic Cycle refers to economy-wide fluctuations in

production or economic activity over several months or years. These cycles are
characteristic features of market-oriented economies whether in the form of
the alternating expansions and contractions which characterize a classic
business cycle, or the alternating speedups and slowdowns that mark cycles in
growth.
A recession occurs when a decline however initiated or instigated occurs in
some measure of aggregate economic activity and causes cascading declines in
the other key measures of activity. Thus, when a dip in sales causes a drop in
production, triggering declines in employment and income, which in turn feeds
back into a further fall in sales, a vicious cycle results and a recession ensues.
This domino effect of the transmission of the economic weakness, from sales to
output to employment to income, feeding back into further weakness in all of
these measures in turn, is what characterizes a recessionary downturn.

In the Keynesian view, business cycles reflect the possibility that the economy
may reach short- run equilibrium at levels below or above full employment. If

the economy is operating with less than full employment, i.e., with high
unemployment, then in theory monetary policy and fiscal policy can have a
positive role to play rather than simply causing inflation or diverting funds to
inefficient uses.

BACKGROUND OF THE CRISIS

A disorderly contraction in wealth and money supply in the market is the basic
cause of a financial crisis, also known as a credit crunch. The participants in an
economy lose confidence in having loans repaid by debtors, leading them to
limit further loans as well as recall existing loans.

Credit creation is the lifeblood of the financial/banking system. Credit is created

when debtors spend the money and which in turn is banked and loan to other
debtors. Due to this, a small contraction in lending can lead to a dramatic
contraction in money supply.

The present global meltdown is a culmination of several factors, the most

important being irrational and unsustainable consumption in the West
particularly in United States disproportionate to its income by consistent
borrowings fueled by savings and surpluses of the East particularly China and
Japan.

The second important factor is the greed of the investment bankers who induced
housing loans by uncontrolled leveraging on an optical illusion of increasing
prices in the housing sector.

The third important factor is the failure of the regulating agencies who ignored
the warning signals arising out of the ballooning debts, derivatives and financial
innovation on the assumption that the Collateral Debt Obligation (CDO), the
Credit Default Swapping (CDS) and Mortgaged Backed Securities (MBS)
would continue to remain safe with the mortgage guarantees provided by
Government Sponsored Enterprises (GSEs) namely Fannie Mae and Freddie
Mac which had enjoyed the political patronage since inception.

There are other several factors including shadow banking system, financial
leveraging by the investment bankers and lack of adequate disclosures in the
financial statements leading to fallacious ratings by the rating agencies.

The global financial crisis is the unwinding of the debt bubbles between 2007
and 2009. On December 1 2008, the National Bureau of Economic Research
(NBER) officially declared that the U.S. economy had entered recession in
December, 2007. The financial crisis has moved into an Industrial crisis now as
countries after countries are sharing negative results in their manufacturing and
services sectors.

CAUSE OF THE CRISIS: The Financial Crisis:

The current crisis has been linked to the sub- prime mortgage business, in which
US banks give high-risk loans to people with poor credit histories.

These and other loans, bonds, or assets are bundles into portfolios or
Collateralized Debt Obligations (CDOs) and sold to investors across the globe.
Falling housing prices and rising interest rates led to high numbers of people
who could not repay their mortgages. Investors suffered losses and hence
became reluctant to take on more CDOs. Credit markets froze and banks
became reluctant to lend to each other, not knowing how many bad loans and
non-performing assets could be on their rivals books.
The crisis began with the bursting of the United States housing bubble and high
default rates on sub- prime mortgages and adjustable rate mortgages (ARM).
The foreclosures exceeded 1.3 million during 2007 up 79% for 2006 which
increased to 2.3 million in 2008, an 81% increase over 2007.
Financial product called mortgaged backed securities (MBS) which in turn
derive their value from the mortgage installment payments and housing prices
had enabled financial institutions and investors around the world to invest in
U.S. housing markets. Major banks and financial institutions which had
invested in such MBS incurred losses of approximately US $ 435 billion as of
July 2008 which has mounted further and is now near to the value of US $ 1
trillion.
The owners of stock in US corporation alone has suffered loss of about US$ 8
trillion between 1 January and 11 October 2008 as the value of their holding
declined from US $ 20 trillion to US $ 12 trillion. The first catastrophe took
place when Bear Stearns was sold to JP Morgan at a throw away price in April
2008. The biggest adverse impact was on Fannie Mae (The Federal National
Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage
Corporation); the two Government Sponsored Enterprises (GSEs) were granted
a very quick bailout package by the US Treasury. A record breaking level of
mortgage foreclosures took place for the subprime mortgages. This led to a

sharp decline in the value of securities which were based on these mortgages.
Most of the investment bankers including Fannie Mae and Freddie Mac reached
to the brink of bankruptcy. When homeowners default, the payments received
by MBS and CDO investors decline and the perceived credit risk rises. This has
had a significant adverse effect on investors and the entire mortgage industry.
The effect is magnified by the high debt levels (financial leverage) households
and businesses have incurred in recent years. Finally, the risks associated with
American mortgage lending have global impacts, because a major consequence
of MBS and CDOs is a closer integration of the USA housing and mortgage
markets with global financial markets.

IMPACT OF THE CRISIS

The global financial crisis is already causing a considerable slowdown in most

developed countries. Governments around the world are trying to contain the
crisis, but many suggest the worst is not yet over. Stock markets are down more
than 40% from their recent highs. Investment banks have collapsed, rescue
packages are drawn up involving more than a trillion US dollars, and interest
rates have been cut around the world in what looks like a coordinated response.
Leading indicators of global economic activity, such as Rate of unemployment
shipping rates, are declining at alarming rates. hikes to 8.9% in the US: 539,000
jobs lost
The continuous development of the crisis had prompted fears of a global
economic collapse. Retail sales in the US have plunged to historic lows and
business and consumer US GDP shrinks by 8.1% confidence are at their lowest
levels. Most of the companies have reported steep decline in sales due to the
slackened in the first Quarter demand in the market. The rate of unemployment
in the United States has skyrocketed to 8.9% with the loss of a total of 539,000
jobs. US GDP shrunk 6.1% in the first US Foreclosures spike quarter; the fall in
GDP is recorded despite an increase in consumer spending in the economy
which is trying to 32% in April, 2009 recuperate from the crisis. The fourth
quarter of the previous year had recorded the highest contraction in GDP since
the past 25 years the economy contracted by 6.3%. US Home Prices fall 14%
in first quarter
In the classical economics scheme of things, the free market economy is set to
correct itself when it verges away from full employment. This was proven to be
untrue in the 1930s Great Depression when up to a fourth of the workers in the
US were out of work.

Quoting US Economist Paul Krugman, as noted in New York Times column,

1. The bursting of the housing bubble has led to a surge in defaults and
foreclosures, which in turn has led to a plunge in mortgage-backed securities
assets whose value ultimately comes from mortgage payments.
2. These financial losses have left many financial institutions with too little
capital too few assets compared with their debt. This problem is especially
severe because everyone took on so much debt during the bubble years.
3. Because financial institutions have too little capital relative to their debt, they
havent been able or willing to provide the credit the economy needs.
4. Financial institutions have been trying to pay down their debt by selling their
assets, including those mortgage-backed securities, but this drives asset prices
down and makes their financial condition even worse. This vicious cycle is what
some call the paradox of deleveraging.

On October 11, 2008, the head of the International Monetary Fund (IMF)
warned that the world financial system was teetering on the "brink of systemic
meltdown" The sequence of the event can be summarized as below for
understanding at a glance.
Bear Stearns was acquired by J.P. Morgan Chase in March 2008 for $1.2
billion. The sale was conditional on the Fed's lending Bear Sterns US$29 billion
on a nonrecourse basis.
The Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac
were both placed in conservatorship in September 2008. The two GSEs have
more than US$ 5 trillion in mortgage backed securities (MBS) and other debt
outstanding.

Merrill Lynch was acquired by Bank of America in September 2008 for $50
billion.
Scottish banking group HBOS agreed on 17 September 2008 to an emergency
acquisition by its UK rival Lloyds TSB, after a major decline in HBOS's share
price stemming from growing fears about its exposure to British and American
MBSs. The UK government made this takeover possible by agreeing to waive
its competition rules
Lehman Brothers declared bankruptcy on 15 September 2008, after the
Secretary of the Treasury Henry Paulson, citing moral hazard, refused to bail it
out.
AIG received an $85 billion emergency loan in September 2008 from the
Federal Reserve, which AIG is expected to repay by gradually selling off its
assets. In exchange, the Federal government acquired a 79.9% equity stake in
AIG.
Washington Mutual (WaMu) was seized in September 2008 by the USA Office
of Thrift Supervision (OTS). Most of WaMu's untroubled assets were to be sold
to J.P. Morgan Chase
British bank Bradford & Bingley was nationalized on bankruptcy in Q1 29
September 2008 by the UK government. The government assumed control of
the bank's 50 billion mortgage and loan portfolio, while its deposit and IMF:
Economic Crisis to branch network are to be sold to Spain's Grupo Santander.
In October 2008, the Australian government Germany sees GDP announced that
it would make AU$4 billion available plunge 3.8%, worst to nonbank lenders
unable to issue new loans. After drop in 40 years discussion with the industry,
this amount was increased to AU$8 billion.

In November 2008, the U.S. government announced by 1.6% it was purchasing

$27 billion of preferred stock in Citigroup, a USA bank with over $2 trillion in
assets, and warrants on 4.5% of its common stock. The preferred stock carries
an 8% dividend. This purchase follows an earlier purchase of $25 billion of the
same preferred stock using Troubled Asset Relief Program (TARP) funds.

INDIA AND THE FINANCIAL CRISIS

The global financial crisis has not left India unscathed. Over the last seven
months, growth has slipped dramatically - to 5.3% in the last quarter of calendar
year 2008 - from over 9% in the previous four years. 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.
The slowdown is likely to have a large and immediate impact on employment
and poverty. Informal surveys suggest significant job losses. Job creation is
likely to remain a key concern as new entrants to the labor force - relatively
better educated and with higher aspirations - continue to put pressure on the job
market.
The country has the option of turning the crisis into an opportunity. The most
binding constraints to growth and inclusion will need to be addressed:
improving infrastructure, developing the small and medium enterprises sector,
building skills, and targeting social spending at the poor. Systemic
improvements in the design and governance of public programs are crucial to
get results from public spending. Improving the effectiveness of these programs
- that account for up to 8-10% of GDP - will therefore be an important part of
the challenge.

The impact of the crisis on the Indian economy has been studied here forth and
the study is chiefly focused on 4 major factors which affect the Indian economy
as a whole. These are:
(i)
(ii)
(iii)
(iv)

Availability of global liquidity

Decreased consumer demand affecting exports
The Financial Crisis and the Indian IT Industry
The Financial Crisis and Indias Financial Markets 19

7.1. Global Liquidity Crunch and the Indian Economy

The Indian banking system was gauged as being relatively immune to the
factors that had lead to the turmoil in the global banking industry. The problems
of the global banks arose mainly due to the sub-prime mortgage lending and
investments in complex collateralized debt obligations (CDOs) whose values
were sharply eroded. Confidence-related issues had also affected banks across
the globe due to the freeze in the inter-bank lending market. Indian banks had
limited vulnerability on both counts.
The reasons for tight liquidity conditions in the Indian markets during the earlier
stages of the crisis were quite different from the factors driving the global
liquidity crisis. Large selling by foreign institutional investors (FIIs) and the
subsequent interventions by the Reserve Bank of India (RBI) in the foreign
currency market, continuing growth in advances, and earlier increases in the
Cash Reserve Ratio (CRR) to contain inflation are some of the reasons that
accelerated the Indian liquidity crunch.
Thousands of investors, big and small, have been hurt by the Indias Household
and downward plunge of the Indian stock market. It will also Corporate Savings
will have broader implications for Indias financial system and fuel the
domestic the future savings and investment patterns.

Cautious investors had started to diversify away from bank when the global
deposits and cash over the past few years, and had moved to liquidity crunch is
equities, mutual funds and insurance products. The current market turmoil is
driving them back to the safety of bank- aggravating the deposits, reducing the
amount of capital available to other economic downturn in instruments and
possibly retarding the growth of the other parts of the financial-services industry
as a whole.
India's high savings rate has been a crucial driver of its economic boom,
providing productive capital and helping to fuel a virtuous cycle of higher
growth, higher income and higher savings. Since the 1990s, the gross domestic
savings rate has risen steadily from an average of 23% to an estimated high of
35% in the 2006/07 fiscal year (April-March). The latter rate compares very
favorably not only with developed economies (the US and the UK have savings
rates of around 14%), but also with other emerging economieswith a few
exceptions such as Malaysia (38%) and Chile (35%).
Yet India's household sector (including some small businesses) continues to
account for the lion's sharesome 70%of savings. The last five years have
seen a surge in corporate savings as companies became more competitive and
increased their profitability. That has been accompanied by a rise in publicsector savings on the back of increased fiscal prudence. However, the current
economic situation is putting pressure on both corporate profitability and the
public finances, ensuring that savings in these two sectors are unlikely to grow
as rapidly as in the past. Household savings will therefore remain crucial to
sustaining a strong savings rate.
India will be relatively unaffected by the global liquidity crisis because the
large fund of Indias household savings which stood at Rs9.85trn (US$192bn)
in 2006/07, will remain available to fuel domestic growth. At an aggregate

level, households in India had net savings of Rs 9, 53,212 crore in financial and
physical assets in 2007-08 or 19.9% of the GDP, estimated at current market
prices.
In the preceding year, it was Rs 8, 24,493 crore, or 20.2% of the GDP. Thus, as
GDP rose 14.4% at current market prices, net savings of the households grew
15.6%.The Indian government is trying to hasten the shift of Indias physical
savings, still locked up in unproductive physical assets such as houses, durables,
and jewellery, into financial assets. The household savings can be channelized
into the countrys debt, equity, and infrastructure finance markets. This would
not only deepen and stabilize the financial markets but also reduce the
governments social-security burden.
It is evident from the graph shown alongside that the ratio of gross domestic
savings to the GDP of the country has been increasing over the years.
Influx of these household savings into the countrys debt, equity, and
infrastructure finance markets will certainly help in the deepening and
stabilization financial markets.
Gross National Savings also include all foreign remittances into India which
add to the domestic savings. A positive trend in the ratio further strengthens the
fact that India is self- sufficient in the short-term with regard to any immediate
liquidity demand.
India's savings rate at present is higher than all other regions of the world,
except developing Asia and Middle East. The country's investment rate showed
sharp acceleration during the period FY02-07 to surpass the average of all major
regions of the world in FY07.

However, according to a report5, factors which could weigh down the rate of
domestic savings to a moderate 33.0% and further to 32.8% during FY09 and
FY10 respectively from around 37.7% in FY08 are:
Lower corporate profitability
Significant widening of fiscal deficit
Erosion in value of financial and physical assets
Most Asian economies have been models of prudence. While American and
European households were borrowing up to the hilt, Asian ones were tucking
away their savings. While rich-country banks were piling into ever-riskier
assets, Asian banks kept their holdings of such assets small. And while America
and Britain were sucking up the worlds savings, Asian governments piled up
vast stocks of foreign reserves.
The long-term trends in the savings of the country are a clear indicator of the
fact that even if Indias savings and investment rates undergo a cyclical
reduction in FY09, by next fiscal (FY10) these rates should still be around 30%,
with 6% growth in the second half of FY10.

7.2. Decreased Consumer demand affecting exports

Some of the sharpest declines in output during the global recession have been
suffered by the strongest economies of Asia. It is feared that due to their heavy
dependence on exports, some of these economies may not see the face of
recovery until demand rebounds in America and Europe.
In October 2008, India registered its first every year-over-year decline in
exports (of 15%), following growth of 35% in the previous five months. Indian
shipments declined 33.3% in March from a year earlier, the biggest fall since
the last 14 years.
Goods exports dropped 33% from a year earlier to $11.5 billion in April 2009.
This was the biggest fall since April 1995. Exports slid 21.7% in February.
Indias exports, which account for 15% of the economy, grew 3.4% to $168.7
billion in the fiscal year ended March 31, missing a $200 billion target set by
the government, before the collapse of the Lehman Brothers Holding Inc.
accelerated the world financial and economic slump. The government expects
exports to total to $170 billion in the year that started April 1.
According to estimates from the Federation of Indian Export Organizations,
falling overseas sales may cost India about 10 million jobs.
Asia is A high fiscal deficit and a high current account deficit are a threat to
economic stabilitywhich is the main reason why international suffering from
credit rating agencies have brought the countrys debt close to junk two
recessions: status. a domestic one Asias export driven economies had benefited
more than any other as well as an region from Americas consumer boom, so its
manufacturers were external one. bound to be hit hard by the sudden
downward lurch.
Asia is suffering from two recessions a domestic one as well as an external one.

Domestic demand had been expected to cushion the blow of weaker exports, but
instead it was hit by two forces. First, the surge in food and energy prices in the
first half of 2008 squeezed companies profits and consumers purchasing
power. Food and energy account for a larger portion of household budgets in
Asia than in most other regions. Second, in several countries, including China,
South Korea and Taiwan, tighter monetary policy intended to curb inflation
choked domestic spending further. With hindsight, it appears that Chinas credit
restrictions to cool its property sector worked rather too well.
Shipments of Indian natural pearls, precious and semi-precious 12% of Indias
stones, and pharmaceutical products, all recorded a decline causing Indian
exports to the US to drop by 22.63% to $5.22 billion in Q1 of total exports of
2009. According to data from the US International Trade Commission, Indian
exports to the US were $6.75 billion during Q1 of 2008.
The Indian Gems and Jewellery sector was significantly affected by the reduced
demand in the United States and Europe. Overseas sales of Indias gem and
jewellery items expanded at a seven-year low rate of 1.45% and stood at $21
billion in 2008-09, as exports contracted sharply in the last six months of the
year. This lead to about 200,000 job losses in the sector, especially of artisans
engaged in polishing diamonds.
The fall in exports was caused by lowering of demand in overseas markets for
luxury items in the backdrop of the ongoing global recession.
Exports of cut and polished diamonds dipped 8.24% to $13.02 billion. This
pulled down the overall growth trade of the sector as diamonds accounts for 62
per cent of the overseas sales. The drop in expansion of gems and jewellery
exports in 2008-09 was cushioned by a 23.6% growth in gold jewellery, which
stood at $6.85 billion as against $5.54 billion in the year-ago period.

Dun & Bradstreet (D&B) expects exports to be around US$ 178 billion in
FY09, which is approximately US$ 22 billion lower than the Government's
target, owing to economic downturn witnessed in India's key export markets.
D&B, however, expects exports to witness some revival during the second half
of FY10, when the world economy begins to stabilize. D&B expects exports to
grow around 14% to US$ 203 billion during FY10.
India and the other Asian economies will have to brace themselves up for the
sharply reduced consumption in the United States over an extended period,
following the global financial crisis, and change the export-dependent structure
of its economies and create more regional demand to drive their growth. 7 rd
Business Standard, 23 April, 2009 8 Dun and Bradstreets India Economic
Outlook, 2009-10 24

7.3 The Financial Crisis and the Indian IT Industry

Indias emergence as a globally competitive supplier of software and services
has attracted world-wide attention. The software and service sector not only
contributed significantly to export earnings and GDP but also emerges as a
major source of employment generation in the country. Besides, the information
technology (IT) sector has served as a fertile ground for the growth of new
entrepreneurial ideas with innovative corporate practices and has been
instrumental in reversing the brain drain, raising Indias brand equity and
attracting foreign direct investment (FDI) leading to other associated benefits.
Economists have long noted that services in general are cheaper in developing
countries than in developed countries. An abundant supply of labor the major
input in the production of services in developing countries, leading to low
wages is the chief factor that accounts for the low cost of producing services.
With the recent emergence of business process outsourcing delivered over the
Internet, the so- called IT enabled services (ITES-BPOs) as a major source of

employment and foreign exchange, The impact of the global financial crisis,
rooted in the United States, on the Indian IT sector can be easily gauged from
the fact that approximately 61% of the Indian IT sectors revenue were from
clients in the US. 58% of the revenue contribution of the top five players who
account for 46% of the IT industrys revenues is from US clients.
The US financial services and insurance sector (BFSI Banking, Financial
Services, and Insurance) was one of the earliest adopters of the trend of
outsourcing along with Indias biggest IT-outsourcing firms. Large outsourcing
chunks were created by the US BFSI which made the Indian IT players learn
from their experience.
Indian companies were appreciated by the US clients for their flexibility, good
quality delivery and giving a key lever in managing their selling, general, and
administrative expenses (SG&A) and time to market by freeing up more critical
IT resources. Indian players were essentially partners in taking some of the
fixed costs out of their SG&A. Because there was no partnering of Indian firms
with the financial services entities at any closer level, like tying up of their
invoices with the clients business outcomes, the Indian players were saved
from a much worse impact of the crisis. The slowing US economy has seen 70%
of firms negotiating lower rates with their suppliers and nearly 60% are cutting
back on contractors. Due to a squeezed budget, only about 40% of the
companies plan to increase their use of offshore vendors. The US financial crisis
has put the growth of the Indian It industry in the short-to-medium-term in an
uncertain position. Growth numbers of IT companies were revised down by 23% after sentiment started building up against the US financial sector at the
time of the Q1 results. A worse downward revision is expected this quarter as
well, though some larger players like TCS, and Satyam have denied any larger
impact of the crisis.

Some factors offsetting the revenue slowdown are:

Favourable Rupee-dollar exchange rate

Growth de-risking through Europe
Growth in non-financial verticals
Growth through counter-cyclical new business (countercyclical to US
slowdown)

New outsourcing opportunities will also be provided by merger activities as

newly-merged entities may have to look at additional or new providers to
support the integration work with a broader global presence considering the
large size of combined business operations.
In addition to Mergers and Acquisitions, financial institutions will also be on the
look-out for ways to reduce their SG&A costs quickly which will opt for
outsourced solutions that affect the cause efficiently and effectively.
Efficiencies Indian IT companies continue to be made of the same DNA as
during the dotcom days, and measures to shore up efficiencies are already
underway since we saw the exchange rate hit 39 to the Dollar. Some of those
gains are permanent since the processes have not been rolled back after the
Rupee started depreciating. Potential measures are voluntary salary cuts,
complete moratorium on salary raises, travel reduction, tightening of promotion
spends, just-in-time hiring, and hire-after-contract.
While we have looked mainly at IT, the ITES sector is joined at the hip with IT
industry, but with its own flavors. The impact in financial services operations
will be much larger, but, over the medium to long term, there will be a huge
gain for them from the increase in outsourcing and off-shoring in the financial
sector. However, short-term pain alongside the US slowdown is inevitable.

Financial Crisis and the Satyam Saga:

In the light of the debacle of the Satyam Computer Services, the current
financial crisis has brought the issue of audit committee effectiveness to the fore
in India.
Satyam, Indias fourth largest computer software exporter, after years of vastly
inflated profits, was shattered and exhausted when the shocking reality of
Satyams operating margin of 24% being false was brought to the forefront its
operating margins were a meager 3%. Satyam worked with more than a third of
the Fortune 500, and claimed good financial health. Satyam has a remarkably
small promoter shareholding of 8.6%. They had 61.57% shareholding by
institutions of which 46.86% is made up of foreign institutional investors (FIIs).
The financial crisis also struck the company at a time when there were growing
suspicions related to the Maytas issue. Satyam was not able to maintain its
inflated figures in the wake of the crisis and hence, its majestic accounting fraud
was brought to the forefront.

Opportunities for Indias IT sector:

1. Make the growth vs. profitability tradeoff early on during the slowdown:
profitability levers are still available if growth is sacrificed when required, and
managed well
2. Utilize some of the unavoidable fixed costs for implementing investment
ideas that have been on the backburner and could not be done away with due to
high utilization
3. M&A opportunities exist in the US, both in financial sector and non-financial
sector
4. Intellectual Property (IP) and product related investments in the US should
be assessed and made
5. Operational efficiencies can be adhered to especially in an attractive labor
market and an environment of budget spend/uncertainty

7.4. The Financial Crisis and Indias Financial Markets:

Despite the vanishing foreign institutional investors (FIIs), the Indian markets
remained resilient and stayed afloat. Investors sentiments have been
significantly impacted by the US financial crisis. The tendency of investors to
withdraw from risky markets has resulted in significant capital outflows that
have led to a liquidity crunch putting pressure on the Indian stock market.
The Indian economy continues to show good health because of the strength of
its domestic drivers, like infrastructure projects, SME Decline in RBIs (small
and medium enterprises) sector exports and good yielding from the agricultural
sector.
The cause behind US economy debacle is that the US investment Depreciation
of banks are extremely over leveraged and solely dependent on whole the Rupee
sale finances. This led to their demise. But such is not the case with Indian
Banks. The common mans deposits are more in India and Decline in Stock they
have the trust on the Banks, because all most all the Banks are Market Indices
nationalized and the depositors interest is highly protected by Government of
India.
In the US, the investment banks are dependent on institutional investors funds.
These investments are highly volatile and always search for high returns on
their deposits. They look for Demand-based investments and not time-based
investments. Therefore, whenever the returns from one market start dipping,
they move their investment to re-invest in those markets which would offer a
better return, or take a defensive stance until the market regains momentum.
Domestic banking in India is generally secure, especially because nationalized
banking remains at the core of the system. Even so, there exist signs of fragility
and inadequacy within the banking sector. The effects of the global crisis have
directly impacted some important macroeconomic variables. Three such

indicators stand out in terms of their sudden deterioration since the middle of
last year:
(i)

Decline in the foreign exchange reserves held by the Reserve Bank of

(ii)
(iii)

India
Fall in the external value of the rupee, especially vis--vis the US dollar
Decline in the stock market indices

Measures taken by the RBI to stop depreciation of the Rupee led to a steep
decline in its foreign exchange reserves. Factors which also contributed to the
decline were the revaluation in foreign currencies and large scale pullout by
foreign institutional investors.

8. BAIL-OUT PACKAGES AND RBI INITIATIVES

Financial markets in the United States and around the world are in a state of dire
emergency and they require urgent and decisive action. Some key parts of the
credit market were on the verge of a deadlock, resulting not just in the collapse
of major financial institutions but also in credit disruption that has been severely
weakening the long-term prospects of non-financial companies.
There was a need for swift action to deal with the toxic mortgage-backed
securities that had been causing credit markets to seize up. The Federal
governments effort to support the global financial system have resulted in
significant new financial commitments, with the U.S. government having
pledged more than $11.6 trillion on behalf of American taxpayers over the past
20 month, far in excess of the aggregate of the several bailout packages
announced or dolled out in the past, as may be evident.
The U.S. Treasury also added $200 billion to its support commitment for Fannie
Mae and Freddie Mac, the countrys two largest mortgage-finance companies.

The Government of China had also announced a financial package of US$ 585
billion to pump prime the economy by making huge public investment and by
providing subsidies to protect domestic economy which is otherwise exposed to
external market and is likely to be severely affected because of the cuts in
imports by all the major importing countries.

8.1. Indias response to the Crisis

As the contagion of the financial system collapse across the world spread
towards India, and into it, the government and the Reserve Bank of India (RBI)
responded to the challenge in close coordination and consultation. The main
plank of the governments response was fiscal stimulus while the RBIs action
comprised monetary accommodation and counter cyclical regulatory
forbearance.
The RBIs policy response was to keep the domestic money and credit markets
functioning normally and see that the liquidity stress did not trigger solvency
cascades. RBIs targets can be classified into 3 prime directions: (Duvvuri
Subbarao, Governor)
(i)
(ii)
(iii)

To maintain a comfortable rupee liquidity position

To augment foreign exchange liquidity
To maintain a policy framework that would keep credit delivery on track
so as to arrest the moderation in growth

The previous period has forced RBI to adopt tightened monetary policies in
response to heightened inflationary pressures. However, the RBI changed its
approach to handle the current scenario and eased monetary constraints in
response to easing inflationary pressures and moderation in growth in the
current cycle.

The following were the conventional measures of the RBI:

(i)
(ii)
(iii)

Reduced the policy interest rates aggressively and rapidly

Reduced the quantum of bank reserves impounded by the central bank
Expanded and liberalized the refinance facilities for export credit

To manage Foreign Exchange, the RBI

(i)

Made an upward adjustment on interest rate ceiling on the foreign

(ii)

currency deposits by non-resident Indians

Substantially relaxed the External Commercial Borrowings (ECB)

(iii)

regime for corporates

Allowed access to foreign borrowing to non-banking financial
companies and housing finance companies

RBI also took unconventional measures as a response to the liquidity scenario:

(i) Indian banks were given the rupee-dollar swap facility to give them comfort
in managing their short-term funding requirements
(ii) An exclusive refinance window, as also a special purpose vehicle, was made
available for supporting non-banking financial companies
(iii)The lendable resources available to apex finance institutions for refinancing
credit extended to small industries, housing and exports, was expanded

The Central Governments Fiscal Responsibility and Budget Management

(FRBM) Act, enacted to bring in fiscal discipline by imposing limits on fiscal

and revenue deficit, proved to be the road map to fiscal sustainability at the time
of the crisis. The emergency provisions of the FRBM Act were invokes by the
central government to seek relaxation from the fiscal targets and two fiscal
stimulus packages were launched in December 2008 and January 2009.
These fiscal stimulus packages, together amounting to about 3% of GDP,
included:
Additional public spending, particularly capital expenditure, government
guaranteed funds for infrastructure spending
Cuts in indirect taxes,
Expanded guarantee cover for credit to micro and small enterprises, and
Additional support to exporters.
These stimulus packages came on top of an already announced expanded safetynet for rural poor, a farm loan waiver package and salary increases for
government staff, all of which too should stimulate demand.
The cumulative amount of primary liquidity potentially available to the
financial system through these measures is over US$ 75 billion or 7% of GDP.
Taking the signal from the policy rate cut, many of the big banks have reduced
their benchmark prime lending rates. Bank credit has expanded too, faster than
it did last year

OUTLOOK FOR THE INDIAN ECONOMY

India is witnessing a mixed result with respect to its growth prospects in the
wake of the global economic downturn. Real GDP growth has moderated to
6.6% and is projected to grow at the same rate in 2009-10.
The Services sector too, which accounts for 57% of Indias GDP, and has been
the countrys prime growth engine for the last five years, is slowing, mainly in
construction, transport and communication, trade, hotels and restaurants subsectors.
According to recent data, demand for bank credit has been slackening despite
sufficient liquidity in the system. Indias exports, which account for 15% of the
economy, grew 3.4% to $168.7 billion in the fiscal year ended March 31,
missing a $200 billion target set by the government.
Corporate margins have been dented due to higher input costs and dampened
demand; business confidence has been affected by the uncertainty around the
economic condition. The Index of Industrial production has been showing a
negative growth and the demand for investment is decelerating.
India, though, certainly has some advantages in addressing the fallout of the
crisis:
(i)

Headline inflation, as measured by the wholesale price index, has

fallen sharply; inflation has declined faster than expected. Key factors
behind the disinflations have been commodity prices and a part of it is

(ii)

contributed by slowing domestic demand.

Decline in inflation should prove to be positive for reviving consumer

(iii)

demand and reducing input costs for corporates

Fiscal space will open up for infrastructure spending as the decline in
global crude prices and naphtha prices will reduce the amount of

(iv)

subsidy given to the oil and fertilizer companies

Imports are expected to shrink more than exports; this will keep the
current account deficit at modest levels

(v)

Indias sound banking system has helped to sustain the financial

market stability to a large extent -well capitalized and prudently

(vi)

regulated
Overseas investors are confident about the Indian economy due to

comfortable levels of foreign reserves

(vii) The negative impact of the wealth loss effect in the capital markets
that have plagued the advanced countries will not affect India because
majority of Indians stay away fro asset and equity markets
(viii) Institutional credit for agriculture will also remain unaffected because
(ix)

of Indias mandated priority sector lending

Agriculture sector of India will be further insulated from the crisis due

(x)

to the governments farm waiver package

Indias development of social safety programs over the years (e.g. the
rural employment guarantee program), will protect the poor and
migrant classes from the ill effects of the global crisis

Therefore, once the global economy begins to recover, Indias turn around will
be sharper and swifter, backed by its strong financial system and regulatory
norms.
The present global crisis has taken the shape of the Great depression of 1929 at
least in US and Japan. The biggest losers will be US, Japan and China. The
biggest gainers may be India, Brazil and few other developing countries with
their own domestic savings and domestic market. The world will have to
undergo the impact in different forms, somewhere it will be economic
slowdown, somewhere recession and somewhere depression.

LIMITATIONS OF THE STUDY

The current project discusses key issues of the Indian economy that cropped up
as the global economy is swaying in its worst economic downturn. Though the
major factors have been discussed, yet there exist more issues which have not
been detailed due to time constraints.

As the economies across the globe try to protect themselves from the hazards of
the crisis, they are trying to maintain domestic demand and protect their
domestic industry from foreign invasions, lest their own economy might
destabilize. This has been giving rise to Protectionism and rising incidences of
countries resorting to protectionist measures have been recorded at the World
Trade Organization.
India has been recorded to initiate the maximum number of anti-dumping
investigations against goods exported into the country. America is propagating
its Buy American campaign in order to help itself become a more selfsufficient economy. The Chinese economy is reeling from the global drop in
exports; Chinas economy is highly industrialized and a significant fraction of
its GDP is accounted for by its exports to the United States.
Therefore, apart from internal factors that have affected global economies,
there are critical external factors and trade behavior that dictate the nations
across the globe to resort to measures to help themselves. The discussion of
such issues in detail has not been made a part of the report at hand, though a
significant amount of information has been analyzed and studied for the same.

Apart from these, there may be some technical flaws like:

(i)

The accuracy and reliability of the data collected data across different

(ii)

sources may vary slightly

The measurability of the factors relating to the crisis across a global scale
may not be thorough considering all the factors would not be a feasible

(iii)

option.
Opinion biasness may also exist.

The study of the global financial crisis is inexhaustible, and it will continue as
long as the world economy does not become self-sustainable again. The
impacts of the crisis are a test of the financial market stabilities and regulations
across the global economy; the corrections that will be made have been long
overdue

ENTREPRENEURSHIP IN TIMES OF FINANCIAL CRISIS

Entrepreneurship can be technically defined as a process of starting new
organizations or revitalizing mature organizations, particularly new businesses,
generally in response to identified opportunities. Jean-Baptiste Say, a French
economist who first coined the word entrepreneur in about 1800, said: The
entrepreneur shifts economic resources out of an area of lower and into an area
of higher productivity and greater yield.
The dictionary definition of entrepreneur reads as a person who organizes and
manages any enterprise, esp. a business, usually with considerable initiative and
risk; and also an employer of productive labor; contractor. The propensity to
take risks and the desire to create wealth are some qualities possessed by
entrepreneurs that define their entrepreneurship.
Entrepreneurs are ruthlessly opportunistic; they would persevere with a business
plan at a time when others are chasing full-time employment opportunities. The
act of innovation holds prime importance; the size of the company is a
secondary aspect to that. Entrepreneurs have traditionally faced the shortage of
finance, not of ideas. Moreover, the human capital is also a critical aspect of an
organization. The growing industry of venture capitalists has greatly fostered
entrepreneurship across the globe. Talented people in an organization make the
core machinery of ideas and execution. To establish themselves, businesses
need to put forward substantial value propositions and a clear path to achieving
their set goals and objectives. Above all, intellectual capital is the chief

component of entrepreneurship; human capital and monetary capital fall after

that. The information age makes it even easier for ordinary people to start
business now.
Entrepreneurship is a stimulator of economic growth and social cohesiveness.
The globalization of entrepreneurship is raising the bar of competitiveness for
all the players. Once-closed economies like India and China have opened up to
enterprisers and entrepreneurs from all over the globe. Innovative entrepreneurs
carry more weight because of their ability to create more jobs.
The economic downturn has put the global economy in an awkward situation.
The motives of established entrepreneurs are being questioned and their
disastrous results are being scorned off at. In the wake of scandals over
established figures like Enron, and Satyam, things have become more difficult
for start-ups. Potential entrepreneurs are lured towards a safe and secure
government job and are becoming increasingly apprehensive of taking the risk
of venturing into an unknown territory. Risk, the lifeblood of the entrepreneurial
economy, is becoming something to be avoided.
However, the current financial crisis also brings with itself some unprecedented
opportunities that can prove to be a resource haven for the upcoming and new
entrepreneurs. Those who are planning to start and manage a new business will
now encounter a fresh set of values and a need to go back to the basics of
managing a business. Though the crisis does not put forth an appealing
landscape for entrepreneurs, yet those with rational expectations will face no
dearth of opportunities or ideas or innovations. The average life cycle of a startup from inception to exit will be much longer over 5 years chiefly due to
reduced mergers and acquisitions and late initial public offerings. Persistence
and commitment are the need of the hour and the willingness to wait with
patience before reaping the harvests of an endeavor is indispensable. Those who

are driven by the desire for a windfall should prepare themselves for
disappointment.
Aspiring entrepreneurs should realize that the receding economy offers them the
best time to start a company. The market is full of talented people looking for
new opportunities. The opportunity cost of letting go of an attractive and highpaying job is very low as there is a general decline in employment opportunities
across the globe.
Moreover, the ordinary costs of doing a business are depressed. Space,
equipment, and any other resourceful asset were never available at such low
investments. Raising finance in times of the credit crunch is a tough task, but
what should be kept in mind is that competitive pressures are much lower
during downturns and it becomes relatively easier to establish ones company as
the leader. Advertising and other marketing expenditures are very low and its
easy to make a mark when relatively few in the market are trying to do so.
Being the holder of a private company, the entrepreneur would not have to
worry about quarter-to-quarter performance and the investors would also have a
long term perspective.
Time is another critical aspect. A business, at its inception, needs to do a lot of
market research, research of potential customers, product designing and
building, and also look for investors and financing opportunities. What is not
expected from a start-up is the potential to start selling as soon as it is
conceived.
Therefore, the current slump in demand across global economies is a non-entity
with respect to a start-up. Moreover, any new business initially sells to the
early adopters whose buying patterns are independent of the economic state of
the environment.

Therefore, the initial customer base is not susceptible to economic cycle

changes and the business can head off for a great start.
Poorly capitalized start-ups can cope with the grinding recession by
reallocating their existing financials and keeping non-essential activities out of
operations. Focus should be on the more important features and marketing costs
should be cut down to a minimum unless it is proven to give a positive return on
investment. Money from all payments which can be deferred should be put into
more productive areas of the business. Even well capitalized start-ups need to
keep themselves buckled up and cut costs wherever possible. However, it
should be borne in mind that ruthless slashing of marketing costs does a lot of
harm in the future when companies have to spend a lot more than they saved in
order to recover. Therefore, a balanced and judiciously thought out approach
should be followed.
Entrepreneurship has the potential to drive an economy out of the economic
turmoil. It creates new jobs, generates revenue, advances innovation, enhances
productivity, and improves business models and processes. Entrepreneurship
has never been as vital for an economy as it is today. The risks and rewards go
hand-in-hand. A company should keep its strategic thinking flexible enough to
manage uncertain times and should have the aptitude to look beyond the crisis.
History has demonstrated time and again that entrepreneurship and new
companies is the way to bolster a flagging economy. Giants like Microsoft,
Genentech, Gap, and The Limited were all founded during recessions.
Companies which started off in the Depression include Hewlett- Packard,
Geophysical Service (now Texas Instruments), United Technologies, Polaroid,
and Revlon. A plummeting economy helps initiators to develop a business
which has the tenacity to survive though difficult times and which is relatively
unaffected by a cycle of bankruptcies.