Global Financial Crisis and its Impact on the Indian Economy

GLOBAL
FINANCIAL
CRISIS AND ITS
IMPACT ON THE
INDIAN
ECONOMY

“In a time of crisis we
all have the potential to
morph up to a new level
and do things we never
thought possible” –
Stuart Wilde

Shradha Diwan, IBS Kolkata, Class of 2010

Global Financial Crisis and its impact
on the Indian Economy

Author:

20TH MAY, Shradha Diwan
2009
08 BS 000 3170

IBS Kolkata

Class of 2010

Organization:

INSTITUTE OF INTERNATIONAL TRADE,
KOLKATA

2


Authorization

―This report is submitted as a partial fulfillment of the requirement of
MBA Program at IBS, Kolkata.‖

3


Acknowledgements
I would like to express my heartfelt gratitude to Dr. D.R. Agarwal, Director, Institute of International
Trade, for giving me the opportunity to work with the organization, and for being my guide and mentor
during the tenure of my internship at the Institute.

I would also like to take the opportunity to thank Mr. Anurag Agarwal, Director, Board of Studies,
Institute of International Trade, for the valuable advice, inputs, and support he has given me during the
composition of this report.

I am grateful to Dr. Rachana Chattopadhyay, my faculty guide at ICFAI Business School (IBS), Kolkata,
for her constant guidance and encouragement during the entire tenure of the Summer Internship Program.

4


Table of Contents

1. EXECUTIVE SUMMARY .......................................................................................................................... 7

2. INTRODUCTION ..................................................................................................................................... 9

3. UNDERSTANDING BUSINESS CYCLES .................................................................................................. 12

4. BACKGROUND OF THE CRISIS ............................................................................................................. 13

5. CAUSE OF THE CRISIS: The Financial Crisis: How it happened ............................................................ 14

6. IMPACT OF THE CRISIS ........................................................................................................................ 16

7. INDIA AND THE FINANCIAL CRISIS ...................................................................................................... 19

7.1. Global Liquidity Crunch and the Indian Economy ....................................................................... 20
7.2. Decreased Consumer demand affecting exports........................................................................ 23
7.3. The Financial Crisis and the Indian IT Industry ........................................................................... 25
7.4. The Financial Crisis and India’s Financial Markets: ..................................................................... 28
8. BAIL-OUT PACKAGES AND RBI INITIATIVES ......................................................................................... 32

8.1. India’s response to the Crisis .................................................................................................. 33
9. OUTLOOK FOR THE INDIAN ECONOMY............................................................................................... 35

10. LIMITATIONS OF THE STUDY ........................................................................................................... 37

11. ENTREPRENEURSHIP IN TIMES OF FINANCIAL CRISIS ..................................................................... 38

11.1. Early-Stage Entrepreneurial Activity Rates and Per Capita GDP ............................................. 41
12. REFERENCES .................................................................................................................................... 42

5


List of Illustrations
Figure 1: Business Cycles; Source: Seguin Financial Group ........................................................................ 12

Figure 2: Ratio of Gross Domestic Savings to GDP ..................................................................................... 21

Figure 3: Ratio of Gross National Savings to GDP ....................................................................................... 21

Figure 4: Source- Ministry of Communications and Information Technology, Govt. of India .................... 25

Figure 5: Source- Ministry of Communications and Information Technology, Govt. of India .................... 25

Figure 6: Foreign Exchange Reserves held by the RBI. Source: The Hindu BusinessLine .......................... 29

Figure 7: Rupees per US Dollar; Source: The Hindu BusinessLine .............................................................. 29

Figure 8: Sensex Daily Movements; Source: The Hindu BusinessLine ........................................................ 29

Figure 9: Foreign Investment; Source: The Hindu BusinessLine ................................................................. 30

Figure 10: Cumulative FII Investments in Equity; Source: The Hindu BusinessLine ................................... 30

Figure 11: FIIs and the Stock Market; Source: The Hindu BusinessLine ..................................................... 31

Figure 12: Foreign Investment and Change in Reserves; Source: The Hindu BusinessLine ....................... 31

6


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

7


as 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
world‘s 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.

8


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 (India‘s 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 Lehman‘s bonds through
the bank‘s UK subsidiary. Even Axis Bank was affected by the meltdown.

The real estate sector in India was also affected due to Lehman Brother‘s 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 latter‘s 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 India‘s 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

10


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.

11


3. 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.1
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.

The phases of the business cycle Figure 1: Business Cycles; Source: Seguin Financial Group
are characterized by changing
employment, industrial productivity, and interest rates.

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.2

1
Economic Cycle Research Institute, New York, Pami Dua
2
En.wikipedia.org/wiki/Business_cycle
12


4. 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.

13


5. CAUSE OF THE CRISIS: The Financial Crisis: How it happened

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
value of all outstanding residential mortgage owed by US households was US$ 10.6 trillion as of
Mid 2008 of which $ 6.6 trillion were held by mortgaged pools Consisting of Collectivized debt
14


obligation (CDO) already mortgage backed securities (MBS) (CDO and MBS) and the remaining
US$ 3.4 trillion by traditional depository institutions.

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.

15


6. 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 1930‘s 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.

16


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 haven‘t
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.’

3
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.

3
Global Meltdown: Road Ahead, Dr. D.R. Agarwal, Institute of International Trade
17


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.
UK: 5000 businesses
registered for
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.
cost $ 4 trillion

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.

GDP of Euro Area falls
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.

18


7. 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) Availability of global liquidity

(ii) Decreased consumer demand affecting exports

(iii)The Financial Crisis and the Indian IT Industry

(iv) The Financial Crisis and India‘s 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
India’s Household and downward plunge of the Indian stock market. It will also
Corporate Savings will have broader implications for India‘s financial system and
fuel the domestic the future savings and investment patterns.
economy at a time 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.
globe. 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 economies—with a few exceptions such as Malaysia (38%) and Chile (35%).4

Yet India's household sector (including some small businesses) continues to account for the lion's
share—some 70%—of savings. The last five years have seen a surge in corporate savings as

4
From the Economist Intelligence Unit Briefing, Economist.com

20


companies became more competitive and increased their profitability. That has been
accompanied by a rise in public-sector 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 India‘s
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 India‘s 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 country‘s debt, equity, and infrastructure finance markets. This would not
only deepen and stabilize the financial markets but also reduce the government‘s 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 country‘s debt, equity,
and infrastructure finance
markets will certainly help in the
deepening and stabilization of
Figure 2: Ratio of Gross Domestic Savings to GDP 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.

21

Figure 3: Ratio of Gross National Savings to GDP


India's savings rate and investment rate for FY08 shows that on both counts the country is well
placed not just relative to its own historical record, but also relative to other economies. 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 world‘s 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
India’s 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.

5
Dun and Bradstreet’s Indian Economy Outlook 2009-10
22


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.

India‘s 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 stability—which is the main reason why international
suffering from
credit rating agencies have brought the country‘s debt close to junk two recessions:
status. a domestic one
Asia‘s export driven economies had benefited more than any other as well as an
region from America‘s 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 China‘s credit restrictions to cool its
property sector worked rather too well.6

6
Report by Frederic Neumann and Robert Prior-Wandesforde, HSBC economists
23


In the first quarter of 2009, trade between India and the United States declined by 23.47% in
value to $8.2 billion, as compared to $10.69 billion in the comparable period last year.

Shipments of Indian natural pearls, precious and semi-precious
12% of India’s 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.
$168.7 billion in
US exports to India also declined by 24.9% in Q1 of 2009; it
FY2008-09 went
amounted to $2.69 billion as compared to $3.94 billion in Q1 of 2008.
to the US.
India‘s exports to the US were recorded to be $25.86 billion in 2008
and imports from the US were $ 17.33 billion. 12% of India‘s total
exports of $168.7 billion in FY2008-09 went to the US.

The Indian Gems and Jewellery sector was significantly affected by the reduced demand in
the United States and Europe. Overseas sales of India‘s 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.7

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 FY10.8

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 Bradstreet’s India Economic Outlook, 2009-10
24


7.3. The Financial Crisis and the Indian IT Industry

India‘s 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 India‘s 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. India, with its large
pool of skilled manpower, has
emerged as a major exporter of
IT software and related services,
Figure 5: Source- Ministry of Communications and Information Technology,
4: such as business process
Govt. of India outsourcing (BPO). In fact, one
of the notable achievements in India during the last decade has been the emergence of an
internationally competitive IT software and service sector (see Figure 4).

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 sector‘s revenue were
from clients in the US. 58% of the revenue contribution of the top five players who account for
46% of the IT industry‘s revenues is from US clients. Approximately 30% of the industry
revenues are estimated from financial services (see Figure 5).

25


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 India‘s biggest
IT-outsourcing firms. Large outsourcing
chunks were created by the US BFSI
which made the Indian IT players learn
from their experience. Price negotiations
and increased commitments on the
service level raised the share of US
Figure 5: Source – Ministry of Communication and Information financial services revenue as a
Technology percentage of total revenues for the Top
3 Indian players from 25% to 38% between 1999 and 2008.

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 client‘s 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 2-3% 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:
Favorable 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.
26


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, India‘s fourth
largest computer software exporter, after years of vastly inflated profits, was shattered and
exhausted when the shocking reality of Satyam‘s 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 India’s 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
27


7.4. The Financial Crisis and India’s 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 RBI’s
(small and medium enterprises) sector exports and good yielding
from the agricultural sector. Forex Reserves

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 man‘s 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 depositor‘s interest is highly protected by
Government of India.

In the US, the investment banks are dependent on institutional investor‘s 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 India
(ii) Fall in the external value of the rupee, especially vis-à-vis the US dollar
(iii) 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.

28


Figure 6 shows how the foreign
exchange reserves, which had been
increasing steadily over the past
few years, started declining after
June 2008. Not that the earlier
build-up of reserves reflected any
great macroeconomic strength,
since unlike China it was not based
on current account surpluses.
Instead, the Indian economy
experienced an inflow of hot
Figure 6: Foreign Exchange Reserves held by the RBI. money, especially in the form of
Source: The Hindu BusinessLine portfolio capital investment of FII.

But that movement of FIIs was in
turn related to the sudden collapse of
the rupee, shown in Figure 7. Early
in March 2009 the rupee even
breached the line of Rs 51 per dollar.
There are those who argue that this
depreciation is positive since it will
help exports, but conditions
prevailing in the world trade market,
with falling export volumes and
values, does not give rise to much
optimism in that context. Figure 7: Rupees per US Dollar; Source: The Hindu BusinessLine

India currently has a current account deficit, including a large trade deficit and also quite
significant factor payments abroad. The falling rupee implies rising factor payments (such as
debt repayment and profit repatriation) in rupee terms, which is not good news for many
companies for the balance of payments.

Associated with all this is the
evidence of falling business
confidence expressed in the stock
market indicators. The Sensex
(Figure 8) had reached historically
high levels in the early part of 2008,
capping an almost hysterical rise
over the previous three years in
which it more than tripled in value.
But it has been plummeting since
29
Figure 8: Sensex Daily Movements; Source: The Hindu BusinessLine


then, with high volatility around an overall declining trend such that its levels in early March
were below the levels attained in December 2005.

Role of Foreign Investors:

Figure 9 tracks the changes in total
foreign investment, split up into
direct investment and portfolio
investment, over a period since
April 2007. It is evident that both
have shown a trend of increase
followed by decline. FDI has been
more stable with relatively
moderate fluctuations (even though
it does include some portfolio-type
investments that get categorized as
Figure 9: Foreign Investment; Source: The Hindu BusinessLine FDI). It peaked in February 2008
and thereafter it has been coming
down but is still positive.
Portfolio investment has been extremely volatile and largely negative (indicating net outflows)
since the beginning of 2008, and this
has dominated the overall foreign
investment trend.

As a result, as is evident from Figure
10, the cumulative value of stock of
Indian equity held by FIIs fell quite
sharply, by 24% between May 2008
and February 2009. This is not likely
to be due to any dramatically
changed investor perceptions of the
Indian economy, since if anything
GDP growth prospects in India Figure 60: Cumulative FII Investments in Equity; Source: The Hindu
BusinessLine
remain somewhat higher than in
most other developed or emerging markets. Rather, it is because portfolio investors have been
repatriating capital back to the US and other Northern markets.

This reflects not so much as a flight to safety (for clearly US securities are not safe anymore
either) as the need to cover losses that have been incurred in sub-prime mortgages and other asset
markets in the North, and to ensure liquidity for transactions as the credit crunch began to bite.

Whatever the causes, the impact on the domestic stock market has been sharp and direct. Since
the Indian stock market is still relatively shallow, and FII activities play a disproportionately

30


sharp role in determining the movement of the indices, it is not surprising that this flow has been
associated with the overall decline in stock market valuations.

As Figure 11 shows, the Sensex
has moved generally in the same
direction as net FII inflows. In fact,
movements in the latter have been
much sharper and more volatile,
suggesting that domestic investors
have played a more stabilizing role
over this period.

Figure 11: FIIs and the Stock Market; Source: The Hindu BusinessLine

Overall foreign investment flows
(including both FII and direct
investment) have also played a role in
determining the level of external
reserves. Figure 12 shows the pattern
in aggregate net foreign investment
and change in reserves since April
2007.

Once again, the two move together.
However, in this case, foreign
investment has been less volatile than Figure 7: Foreign Investment and Change in Reserves; Source: The
the change in reserves, suggesting that Hindu BusinessLine
other components of the balance of
payments have been important as well. The changes in external commercial borrowing are likely
to be significant.

In addition, the possibilities of domestic investors moving their funds out should not be
underestimated. The recently liberalized rules for capital outflow by domestic residents have led
to outflows that are not insignificant, even if still relatively small.9

9
Global Crisis and Indian Finance, C.P.Chandrasekhar and Jayati Ghosh, The Hindu BusinessLIne
31


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 government‘s 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 from the following figures:

Past Event US$ billion

Invasion of Iraq 597

Life Time Budget of NASA 851

S & L Bailouts of 1980s 256

Louisiance Purchase 217

Korean War 454

The U.S. Treasury also added $200 billion to its support commitment for Fannie Mae and
Freddie Mac, the country‘s 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.

32


8.1. India’s 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 government‘s response was fiscal stimulus
while the RBI‘s action comprised monetary accommodation and counter cyclical regulatory
forbearance.

The RBI‘s policy response was to keep the domestic money and credit markets functioning
normally and see that the liquidity stress did not trigger solvency cascades. RBI‘s targets can be
classified into 3 prime directions: (Duvvuri Subbarao, Governor)10

(i) To maintain a comfortable rupee liquidity position
(ii) To augment foreign exchange liquidity
(iii) 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) Reduced the policy interest rates aggressively and rapidly
(ii) Reduced the quantum of bank reserves impounded by the central bank
(iii) 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 currency deposits
by non-resident Indians
(ii) Substantially relaxed the External Commercial Borrowings (ECB) regime for
corporates
(iii) Allowed access to foreign borrowing to non-banking financial companies and
housing finance companies

10
Duvvuri Subbarao, Governor RBI, Speech delivered at the Symposium on "The Global Economic Crisis and
Challenges for the Asian Economy in a Changing World" in Tokyo
33


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 Government‘s 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 safety-net 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.

34


9. 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 India‘s GDP, and has been the country‘s
prime growth engine for the last five years, is slowing, mainly in construction, transport and
communication, trade, hotels and restaurants sub-sectors.

According to recent data, demand for bank credit has been slackening despite sufficient liquidity
in the system.

India‘s 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 contributed by slowing domestic demand.
(ii) Decline in inflation should prove to be positive for reviving consumer demand and
reducing input costs for corporates
(iii) Fiscal space will open up for infrastructure spending as the decline in global crude
prices and naphtha prices will reduce the amount of subsidy given to the oil and
fertilizer companies
(iv) Imports are expected to shrink more than exports; this will keep the current account
deficit at modest levels
(v) India‘s sound banking system has helped to sustain the financial market stability to a
large extent -well capitalized and prudently regulated
(vi) Overseas investors are confident about the Indian economy due to comfortable levels
of foreign reserves

35


(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 of India‘s
mandated priority sector lending
(ix) Agriculture sector of India will be further insulated from the crisis due to the
government‘s farm waiver package
(x) India‘s 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, India‘s 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.

36


10. 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 self-sufficient economy. The Chinese economy is reeling from the
global drop in exports; China‘s 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 sources
may vary slightly

(ii) 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 option.

(iii) 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.

37


11. 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
38


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 start-up 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 high-paying 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 one‘s company as the
leader. Advertising and other marketing expenditures are very low and it‘s 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.

39


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.

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11.1. Early-Stage Entrepreneurial Activity Rates and Per Capita GDP

AO: Angola IR: Iran
AR: Argentina IS: Iceland
BA: Bosnia & IT: Italy
Herz. JM: Jamaica
BE: Belgium JP: Japan
BO: Bolivia KR: Rep. of
BR: Brazil Korea
CL: Chile LV: Latvia
CO: Colombia MK: Macedonia
DE: Germany MX: Mexico
DK: Denmark NL: Netherlands
DO: Dominican NO: Norway
Rep. PE: Peru
EC: Ecuador RO: Romania
EG: Egypt RU: Russia
ES: Spain SI: Slovenia
FI: Finland TR: Turkey
FR: France UK: United
GR: Greece Kingdom
HR: Croatia US: United
HU: Hungary States
IE: Ireland UY: Uruguay
IL: Israel YU: Serbia
IN: India ZA: South Africa

Source: GEM Adult Population Survey (APS) and IMF: World Economic Outlook Database
(October 2008 edition)

From the above statistic, it is clear that countries with similar geographic backgrounds and
customs tend to cluster together.

At the lower end of the early-stage entrepreneurial activity, a group of EU-15 countries is
situated close together.

Countries in Eastern Europe and Central Asia are mainly situated at the left-hand side, below the
fitted curve – even though over the years they appear to move towards the curve. People in these
countries are not as much engaged in entrepreneurial activity as citizens of Latin American
countries, the Caribbean, and Angola with similar levels of per capita GDP.

Wealthier countries at the upper right-hand side are industrialized countries outside the EU –
with Ireland as a notable exception.

Japan‘s rate of early-stage entrepreneurial activity has, over the years, been consistently lower
than the fitted curve, but has been increasing in recent years and is now very similar to the EU-
average.

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12. REFERENCES

i. Economic Cycle Research Institute, New York, Pami Dua
ii. En.wikipedia.org/wiki/Business_cycle
iii. Global Meltdown: Road Ahead, Dr. D.R. Agarwal, Institute of International Trade
iv. From the Economist Intelligence Unit Briefing, Economist.com
v. Dun and Bradstreet‘s Indian Economy Outlook 2009-10
vi. Report by Frederic Neumann and Robert Prior-Wandesforde, HSBC economists
vii. Business Standard
viii. Wall Street Journal
ix. Financial Express
x. Dun and Bradstreet‘s India Economic Outlook, 2009-10
xi. Global Crisis and Indian Finance, C.P.Chandrasekhar and Jayati Ghosh, The Hindu
BusinessLine
xii. Journal: Duvvuri Subbarao, Governor RBI, Speech delivered at the Symposium on "The
Global Economic Crisis and Challenges for the Asian Economy in a Changing World" in
Tokyo
xiii. Harvard Business Review, South Asia, www.hbrasia.org
xiv. Global Crisis News, www.globalcrisisnews.com
xv. Paul Krugman: Blog
xvi. Krugman, Paul (2009). The Return of Depression Economics and the Crisis of 2008.
W.W. Norton Company Limited
xvii. The global financial crisis and developing countries; Overseas Development Institute
xviii. Embassy of India – Washington DC (website)
xix. Ministry of Communications and Information Technology – Statistics
xx. The World Bank – Development Economics Database
xxi. The Reserve Bank of India – Press Releases, Handbook of Statistics; Special Reports

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