Sub Prime Housing Loan Bubble Crisis happened in US in second half of 2007 with the burst of the housing bubble. IT bubble burst in 2001had already led to recession in the US To get the economy out of recession, US Federal Reserve cut interest rates to increase the liquidity or money supply in the economy thereby encouraging consumers to borrow. Crisis happened due to sub prime housing loans given on a large scale by American banks and widespread mortgage defaults. Banks that held the sub prime mortgage loans sold them to other banks and investors through a financial innovation called CDO (collateralized debt obligations) securities which were backed by a host of mortgage assets. To make them safe for investment and increase their marketability, the CDOs were given high ratings by credit agencies. American and European intermediaries such as banks, pension funds, mutual funds invested heavily in these complex securities (CDO) unaware of the risks involved.
Sub Prime Housing Loan Bubble Those who bought these securities had in turn borrowed heavily from banks and financial institutions to make investment in them. Fall of housing prices in 2007 led to defaults in payment schedules by borrowers, as a result of which value of sub prime housing securities and CDO’s declined. Banks and investment funds which had invested millions in these securities suffered heavy losses leading to liquidity crunch. As a result of huge losses investment institutions like Lehman Brothers became bankrupt. September 2008 saw the “Top 5” of Wall Street succumbing to sub prime losses, Lehman Bros filed for bankruptcy, Merill Lynch was merged with Bank of America, Goldman Sachs and Morgan Stanley converted into commercial banks and Bear Stearns was acquired by JP Morgan Chase. Lack of proper regulation of financial institutions, banks and stock markets in a free market system led to the creation of complex and non transparent securities (CDO). Problem of liquidity and credit crunch led to the stock market crash in US and Europe. Share prices and capital value of many companies tumbled.
Sub Prime Housing Loan Bubble Investor confidence shrunk and credit markets around the world gradually dried up. Erosion of capital base of banks and FIs, led to adversely affecting liquidity and flow of credit to companies and end consumers. Lines of credit to corporates dried up even for working capital requirements thereby affecting employees and suppliers and stalling of ongoing investment projects. Banks stopped giving credit to consumers and corporates, negatively impacting consumption demand and investment leading to a slowdown in economic growth in US and countries around the world. Subsequently, Federal Reserve and other banks injected substantial liquidity in the markets by means of lowering interest rates or bailing out financial institutions. Due to globalisation with its free flow of capital and goods between US and other countries, countries closely integrated with the US heavily suffered. Exports of European and Asian countries to US were affected leading to decline in output of export goods and subsequent job losses in these countries too.
Impact of Global Financial Crisis onIndia Stock market crash Depreciation of Indian Rupee Liquidity crunch in the Banking sector Impact on Indian Economic Growth Slowdown in the Manufacturing Sector Balance of Payments
Impact of Global Financial Crisis onIndia: Stock Market Crash Following eruption of financial crisis, stock markets of US and other European countries crashed and it’s effect spilled over to India and the Indian stock market was also badly hit. To meet liquidity requirement of parent companies, Investors (FIIs) started selling shares of Indian companies held by them. In the last few years, FIIs had invested massively in the equity shares of Indian companies ranging from consumer goods to infrastructure industries. As a result of the buying spree by FIIs, share prices rose, with the Sensex reaching the peak of around 21,000 in Jan 2008. Around this time (Jan 2008), share prices in US and European markets started falling sharply and the problem of liquidity and credit crunch assumed grave proportions which led to FIIs selling shares held by them in the Indian stock market. The Sensex started tumbling and fell to the 9000 mark in Nov 2008 ie 60% fall since Jan 2008. This caused huge losses to Indian companies and investors. FIIs sold more than $13 billion worth of shares of Indian companies in 2008 and repatriated them to their home countries. This also led to a decline in foreign exchange reserves held by RBI.
Impact of Global Financial Crisis onIndia: Depreciation of Indian Rupee Revenue got by sale of shares by FIIs was converted to dollars in order to facilitate the repatriation of the money to the home country. This led to an increase in the demand for dollars. Rupee-dollar exchange rate being determined by demand for and supply of currencies, the increase in demand for dollars caused an appreciation of US dollar in rupee terms, ie rupee depreciated against US dollar. Indian importers also demanded dollars to pay for the import of goods. Indian banks doing foreign operations also bought US dollars in India to keep their foreign exchange operations afloat as due to the credit crunch their was hardly any lending happening in foreign countries. This further raised the demand for dollars causing fast depreciation of the rupee in Sept – Nov 2008. The value of Indian rupee depreciated from Rs. 39.4 for a dollar in 2007 to Rs. 50.6 in Nov 2008. This depreciation did make our exports cheaper and imports more expensive.
Impact of Global Financial Crisis on India:Liquidity crunch in the Banking Sector Large outflow of dollars led to depreciation of rupee, to prevent depreciation of rupee and maintain exchange rate stability, Reserve Bank of India intervened and supplied dollars from its foreign exchange reserves and got rupees in return. With this too much depreciation of the rupee was prevented but in the process quantity of rupees with the banking system declined in turn causing liquidity problem in the Indian banking system and affecting the credit flow to the industry. Affected credit flow impacted the credit availability for working capital and fixed investment requirements by the industry. Risk aversion by Banks in India also restricted credit flow to consumers for buying cars, houses etc.
Impact of Global Financial Crisis onIndia: Economic Growth in India With the US economy witnessing a slowdown in economic growth, its effect spilled over to Europe, Japan and other Asian countries, Britain, Germany, Italy……. IMF’s assessment was that the growth rate of the global economy was expected to hit 3% in 2008 and near zero in 2009. In Sept 2008, IMF also predicted lower growth of 7% for India as against over 9% growth in the previous years. Even though India’s economic growth depends more on domestic demand and is driven largely by domestic savings and investment, after 18 years of globalisation, our exports constitute 17% and imports 20% of GDP. There has been a fall in output of automobile, shipping and aviation industries, also export oriented units of textiles, leather, gems and jewellery have been hit by the global meltdown.
Impact of Global Financial Crisis on India:Slowdown in the Manufacturing Sector As per FICCI’s survey, the manufacturing sector comprising industries like textiles, metals and metal products, leather and leather products, jewellery and automobiles has seen a steep decline in production. Both domestic demand and declining export orders have been the cause of the slowdown. Other important cause was that banks were not willing to give credit and high input costs. Various industries were planning to downsize employment
Impact of Global Financial Crisis on India:Balance of Payments Globalization and adoption of export oriented strategy of growth has increased the dependence of the Indian economy in the external market. In 1990-91, exports were to the tune of 5.8% of GDP while in 2006-07 exports were approx. 14% of GDP. India’s foreign trade balance worsened in 2008-09 and registered a deficit of $60 billion in first half of 2008-09. Decline of exports was one of the main reasons. Also, depreciation of the rupee made our imports costlier
Indian Response to Financial Crisis –Monetary Policy Measures RBI for several months before the financial crisis had been increasing the cash reserve ratio and interest rates to curb the upward trend of inflation. However, it reversed its track from Oct 2008. To curb the depreciation of the Indian rupee the RBI sold billions of dollars in the foreign exchange market from its reserves. Due to the global financial crisis there was liquidity crunch in the money market which adversely affected the flow of credit to industries. In order to increase the liquidity, RBI cut the cash reserve ratio three times in Oct – Nov from 9% to 5.5%. With this approx Rs. 1,40,000 crores was infused in the banking system. Currently, the CRR is 6%. RBI also cut the statutory liquidity ratio from 25% to 24% which enabled banks to get Rs. 20,000 crores from RBI against Govt securities for lending to mutual funds.
Indian Response to Financial Crisis –Monetary Policy Measures Also, RBI released Rs. 25,000 crores to banks in connection with the farm loan waiver scheme. In this way about Rs. 2,00,000 crores has been infused to alleviate the pressures brought on by deterioration in global business environment. RBI also further sought to lower lending rates of banks in order to decrease the cost of borrowing. Repo rate was decreased from 9% to 4.75%. Lowering of repo rates was to ensure that banks lower their lending rates so that cost of borrowing from banks fall and more credit is created for investment by the companies and there is higher demand for durable consumer goods such as houses, cars etc. Banks had surplus cash with them.
Indian Response to Financial Crisis –Fiscal Stimulus In Dec 2008, GOI announced a fiscal stimulus package of over Rs. 30,000 crores and aimed towards increase of Government expenditure and cut of Central Excise Duty. The fiscal package was expected to help the growth of infrastructure projects, housing, textiles, automobiles etc. Expenditure on development of infrastructure plays an important role in boosting economic growth. The government hoped to implement infrastructure projects under public private partnership schemes. Infrastructure projects would in turn boost demand for steel, cement and other items. The government had reduced the Central Excise Duty by 4% on all commodities on which excise duty is levied. This would boost demand for cars, consumer durables, washing machines etc. provided manufacturers pass on the benefit to consumers.
Indian Response to Financial Crisis –Fiscal Stimulus Government allocated an additional Rs. 1400 crore to the textile industry for technology upgradation which in turn would make the Indian textile industry more competitive in the international market by lowering cost. Public sector banks announced a package for borrowers of home loans and reduced the home loan interest rates in order to boost demand for housing which would further have a multiplier effect on other industries like cement, steel, transport and also generation of employment. The fiscal stimulus also provided for subsidizing of interest costs of exporters. The Govt. would bear 2% of interest on loans taken by exporters subject to a minimum rate of 7%.This would help sectors such as handloom, textiles, leather, gems and jewellery.