ALLIANCE UNIVERSITY, BANGALORE

Rise in Crisis, Fall in Economy:: In Indian

and world economy context (2009)
Submitted to:
Prof. Samik Shome

Submitted by: Group 3

Adrish Ray, Babar Shikoh, Karthik Krishna M, Prashanth S, Vidit Agarwal

This report is based on Indian & Global economic scenario at mid -2009, this comparative study is
based on two different reports, those are ‘The State of Indian Economy 2009-10’ by Indian
Council For Research On International Economic Relations and ‘World Economic Situation and
Prospect 2009: update as of mid-2009’ by United Nations, New York 2009.
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Index
A. Executive Summary.................................................................................................3

B. Case analysis............................................................................................................4

a. Effect of crisis..........................................................................................4

b. Steps for recovery....................................................................................6

c. Post crisis.................................................................................................7

C. Conclusion............................................................................................................... 8
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EXECUTIVE SUMMARY:

The global financial crisis badly affected Indian Economy bringing down its
GDP growth rate between 5.8 to 6.1 per cent in 2009-10, below the 6.7per
cent recorded in fiscal 2008-09.Indian economy facing bottlenecks like
industrial production, particularly the manufacturing sector, the adverse
impact of the fall in agricultural production due to a rainfall deficiency,
balance of payments. 2008 to 2010 saw changes in Fiscal and Monetary
policies to curb economic slow-down and inflation associated with it. The
balance of payments situation may also require policy attention despite a
narrowing of the current account deficit and a considerable capital
account surplus because of the appreciation of the rupee.

The world economy is expected to shrink by 2.6 per cent in 2009, after an
expansion of 2.1 per cent in 2008 and nearly 4 per cent per year during
the period 2004-2007. While a mild recovery is expected in 2010, risks
remain on the downside. This makes the global economy trends towards
rising unemployment, halting in progress towards poverty reduction and
other Millennium Development goals. While the crisis originated in
developed countries, which are also leading the economic downturn,
developing countries are also being hit hard through capital reversals,
rising borrowing costs, collapsing world trade and commodity prices, and
subsiding remittance flows.
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CASE ANALYSIS

EFFECTS OF CRISIS:

Indian Context::
In INDIA the reversal of capital flows started in January 2008 through a
massive disinvestment
by FII from India’s equity markets which led to a crash in stock
markets(net FII disinvestment of US$13.3billion). This was followed by a
massive slowdown in external commercial borrowing by India’s
companies, trade credit and banking inflows from April 2008. The crisis
struck the foreign exchange markets by May 2008 and the rupee fell by
about 20 per cent from May to
November 2008. By mid-September 2008, the crisis gripped India’s money
market. The drying
up of funds in the foreign credit markets led to a virtual cessation of
external commercial borrowing for India, including the access to short-
term trade finance. The collapse of the stock market ruled out the
possibility of companies raising funds from the domestic stock market.
Indian banks also lost access to funds from abroad, a sinter-bank
borrowing seized up in the US and Europe and banks had to send funds to
their branches abroad in those countries. All these put heavy pressure on
domestic banks, leading to a liquidity crisis from mid-September to end-
October 2008.

The growth in GDP dropped to 5.8 per cent during the second half
of2008-09 from 7.8 per cent in the first half. The manufacturing sector,
was the most severely affected. Industrial growth plunged to 1.9 per
cent in the second half of 2008-09from 6.1 per cent in the first half and
manufacturing growth collapsed to -0.3 percent in the second half from
5.3 per cent in the first half. The services sector as a whole had been
resilient up to the third quarter of 2008-09 but
later showed signs of weakness with its growth declining to 8.6 per cent in
the last quarter of 2008-09 and further to 7.8 per cent in the first quarter
of 2009-10.Manufacturing value added, which was already slowing down
since the beginning of 2007-08, registered a negative growth of -0.3 per
cent in the second half of 2008-09 (year-on-year) in sharp contrast to a
positive 5.3 per cent growth in the first half.

As manufacturing demand fell after the external shock, production also

fell but by more than the fall in demand; this could only occur by
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drawing down inventory levels. Against an annual average rise at

about 17 percent during 2002-08, inventories declined by 14 per cent in
2008-09. The sharp deterioration in manufacturing production in the
second half of 2008-09 can be seen
to be related to this huge inventory adjustment.

The fiscal deficit shot up to 8.9 per cent of GDP (10.7 per cent
including off-budget bonds against 5 per cent in2007-08) and the primary
surplus turned into a deficit of 3.5 per cent of GDP. The public debt,
however, declined marginally to 74.7 per cent of GDP. Budget estimates
for 2009-10 indicate a further worsening in the current year with the fiscal
deficit rising to 10.2 per cent of GDP, primary deficit to 4.5 per cent and
debt ratio deteriorating to 76.6 per cent. This has raised afresh the
issue of India’s fiscal stability and debt sustainability.

Inflation measured in terms of the WPI peak data 12.9 per cent in early
August 2008 and remained high for some time. From mid-September till
end-October 2008, the economy was in the grip of a serious liquidity crisis
and credit crunch. In India inflation is concentrated in food items and what
India have is “food inflation” and not a general inflation. This does not
appear entirely correct when India examine the CPI (IW) inflation by
product group as given in. For products like ‘personal care and effects’
and other miscellaneous items, the rates of inflation have touched 12 per
cent and 20 per cent respectively in June2009.

India’s balance of payments underwent major shifts in 2008-09 that

resulted from the trans mission of the direct impact of the global crisis to
India. The current account deficit shot up to 2.6 per cent of GDP in
2008-09 from 1.5 per cent of GDP in 2007- 08. The impact on the capital
account was more pronounced as the capital account surplus dropped
from a record high of 9.2 per cent of GDP in 2007-08 to a meagre 0.8 per
cent of GDP in 2008-09.

Global Context::

In case of world economy it is the biggest downturn came after the second
world war era, where the World Gross Product(WGP) could fall by 2.6% in
2009 whereas even in 2008 this has a positive growth of 2.1%, and nearly
4% for previous successive 4 years(2004-2007). This can be recovered in
2010 by 2.3%, but still the risk remains due to several reasons. As the
developing countries are being hit hard, the developed countries are also
be severely affected. A more prolonged global recession is possible, if the
vicious circle between financial destabilization and retrenchment in the
real economy cannot be sufficiently contained and farther-reaching,
concerted global policy actions are not taken. If we take a closer look,
then we can see that, he downturns of developed economies, economies
in transition & developing economies are serially -3.9%, -5.1%, 1.4% in
2009.
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This global economic downturn effects adversely in several ways, like

rising unemployment, setting backs in progress towards poverty reduction
and other Millennium Development Goals, sharp declining in private
capital inflow, rising costs of external financing, collapsing of world trade,
subsiding of remittances. Now if we take an analytical view to these
situations then we can see that –

The deepening of the global financial crisis entails a heavy toll on

employment worldwide. Rapid increase in unemployment in already seen
in 2008 & expected to be worsen in 2009(50 million), but practically
situation went more wrong & make the figure double, common problems
was also under employment side by side. According to past experience it
can assume that it will take 4-5 year (2011-2015) to get back previous
unemployment level.

The reduction in employment and income opportunities no doubt will lead

to a considerable slowdown in progress towards poverty reduction and the
fight against hunger, because the production is less, poverty is increasing
as well as unemployment is on rise. Seeing the terrific side of recession
people are not spending and as a result the people in the production are
losing their jobs, and the most affected are the people at the lower end of
the segment which comprise mainly of female workers. This problem can
push 103 million people into poverty as estimated by DEPS and this can
cause severe damages to east, south Asian, Africa and Latin countries and
this further can result in the slowdown in progress towards the other
millennium development goals.

Net private capital inflows to emerging economies was dropped by 50% (1

trillion to 500 billion) in 2008 and also expected to drop by again 50% in
2009. Among all the components of net private capital inflows, the
sharpest drop was in bank lending to emerging economies, which mainly
effects the economies which are in transition. The equity market also
faced a drastic sell off by international investors, which results a sudden
crash in share market in January 2008. Institutional investors in developed
countries are expected to continue reducing their exposure in emerging
economies, while international banks may further curtail their cross-border
lending. External financing costs for emerging economies and other
developing countries have surged since late 2008.

The sharpest declines in trade have been observed among Asian

economies, the largest annual decline since the Great Depression of the
1930s. Sharp declines in commodity prices compound the adverse impact
for many developing countries, especially those heavily dependent on
primary exports. Food and energy-importing countries may see their
terms of trade improve, although in most cases, this gain will be more
than offset by the collapse in export demand, rising costs of borrowing
and/or falling remittance flows. In the face of the severe global financial
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crisis, however, particularly in Latin America and the Caribbean, South

Asia and some CIS countries, such as the Republic of Moldova, Kyrgyzstan
and Tajikistan, although the decline is expected to be much smaller than
that of other foreign-exchange earnings.

STEPS FOR RECOVERY:

However, three factors helped India to cope with the crisis and soften the
blow. They are: (1) the robust, well-capitalised and well-regulated financial
sector; (2) gradual and cautious opening up of the capital account; and (3)
the large stock of foreign reserves. India’s GDP growth declined to 5.8 per
cent (year-on-year)in the second half of 2008-09 from 7.8 per cent in the
first half

Through successive steps, the RBI brought down the CRR from 9 to 5 per
cent, SLR from 25 to 24 per cent, the repo rate from 9 to 4.75 per cent
and reverse repo rate from 6 to 3.25 per cent.

The major policy response to the crisis came in the form of loosening
monetary policy and administering fiscal stimulus packages. There were a
few other measures like there taxation of external commercial borrowing
rules, raising the cap of FII investment in debt and the permission given to
India Infrastructure Financing Company Limited(IIFCL) to float tax-free
bonds for infrastructure funding, etc.

The central bank also opened refinance facilities for banks, SIDBI, NHB,
EXIM Bank besides introducing a liquidity facility for NBFCs through a
special purpose vehicle (SPV), and increasing export credit refinance. The
potential release of primary liquidity by the central bank since mid-
September 2008 has been massive at about Rs. 5617 billion amounting to
about 9.5 per cent of GDP. The RBI also made dollar swap arrangements
for branches of Indian banks in the US and Europe facing shortage of
dollar funds with the seizing up of the inter-bank markets. There were also
off budget items like the issue of oil bonds and fertiliser bonds which had
to be added to give a true picture of fiscal deficit in 2008-09.

We have to take concerted action will be needed in four major areas to make up for the
estimated decline in global aggregate demand and to increase the overall WGP.

1) Further decisive and cooperative action is needed to restore the financial health of banks,
especially in developed countries.

2) The fiscal stimulus measures should be better coordinated and aligned with global
sustainable development objectives.

3) Fundamental reforms of the international financial system are needed to overcome the
systemic flaws which caused this crisis in the first place and in order to guard against future
crises.
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4) New framework for global economic

POST CRISIS:

Growth improved slightly to 6.1 per cent in the first quarter of 2009-
10.Industrial growth picked up to 5.0per cent in the first quarter of 2009-
10 and manufacturing to 0.4 per cent. Government consumption growth,
on the other hand, rose steeply to 35.9 per cent in the second half of
2008-09 from just0.9 per cent in the first half and 7.4 per cent in 2007-08
(Chart 7). The sharp rise in government consumption growth cushioned
the drop in growth of other components of aggregate demand and
prevented a larger fall in GDP growth in the second half of2008-09.

In the first quarter of 2009-10, manufacturing recovered somewhat

showing a growth of 3.4 per cent. The index of industrial production
(IIP) further validates the revival of manufacturing by showing a
manufacturing growth of 7.4 percent in July 2009 and 10.2 per cent in
August.

CONCLUSION:

The policies taken by Indian government has controlled the declining GDP up to an extend
but future growth and production can only be forecasted by using various models. Indian
government also included various projection model for GDP growth and related risk and
challenges to it. Accounting of agricultural and non-agricultural can help India in having a
cap over GDP growth rate. High inflation which has emanated from the
agricultural shock andmay be spreading to non-food products, will pose a
big policy challenge. Indian economy further needs accounting of other
extraneous factors (effecting GDP and economic growth). Monetary
policies and fiscal policies are associated tools available with government
to come out of this slow-down.
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We have found that slowdown in Indian economy has come due to global financial crisis,
which in turn kick off monetary crisis in India, leading to current high inflation rate. Hence
Indian economy has now become a part of global economy.
From analysis of both the cases, it is clear that reforms in monetary and fiscal policy of many
governments are not able to stave off recession.
The prospects for economic recovery in the region in 2010 will be highly dependent on global
conditions. Should the world economic recession prolong and commodity prices weaken
further, exports will stay down, causing further balance-of-payments problems, weakening
national currencies and discouraging capital inflows.

Other impacts are as follows

• Spill-over effects through financial markets are hitting strongest on the middle-income
countries
• All developing countries are affected through slowing trade.
• Primary exporters are also seeing deterioration in terms of trade
• Low-income, net food and oil-importers are seeing improving terms of trade, but are
suffering mainly through reduced demand for exports.
• Falling remittances are affecting many small developing economies
• Balance of payments constraints are emerging in growing number of countries and
vast reserves are quickly evaporating

Hence, India should participate in those areas which in turn boost global aggregate demand
and to increase the overall World Gross Product.