Global Meltdown And India
An Insight
Economic Meltdown : The Beginning
The term that we all used to come across very often in the recent past was
global economic meltdown.
This has gained the attention of all intellectuals, economists, and scholars
to debate on this and to come up with sound understanding about the
matter concerned. Every now and then we are filled up with curiosity
intended to find out causes, which are held responsible for such severe
financial crisis.
There is near unanimity that the recent global economic crisis had its
roots from the mortgage market crisis in the United States of America,
USA.
The crisis began with the bursting of the US financial system and high
default rates on “subprime” and adjustable rate mortgages in 2005-2006.
By late 2006, interest rates had begun to rise with housing prices dropping
moderately as re-financing became more difficult.
The global financial crisis started to show its effects in the middle of 2007
and to 2008.
All world stock markets had fallen, large financial institutions had been
collapsed or bought out.
SUBPRIME LENDING
The mortgage market in the US is fuelled by what they refer to as
“subprime” lending. Subprime lending is the practice of lending, basically
in the form of mortgages for the purchase of residences, to borrowers who
do not meet the usual criteria of borrowing the money at the cheapest
prevailing market rate of interest.
The root cause of the crisis was primarily an unregulated, undisciplined
environment dealing with mortgage lending to subprime borrowers. Since
the borrowers did not have adequate repaying capacity and also because
subprime borrowing had to pay two-to-three percentage point’s higher rate
of interest and they have a history of default, the situation became worse.
But once the housing market collapsed, the lender institutions saw their
balance-sheets go into red.
Starting in Wall Street, others followed quickly. With soaring profits, all
wanted in, even if it went beyond their area of expertise.
Banks borrowed even more money to lend out so they could create more
securitization.
Some banks didn’t need to rely on savers as much then, as long as they
could borrow from other banks and sell those loans on as securities; bad
loans would be the problem of whoever bought the securities.
Some investment banks like Lehman Brothers got into mortgages, buying
them in order to securitize them and then sell them on.
Some banks loaned even more to have an excuse to securitize those loans.
Running out of whom to loan to, banks turned to the poor; the subprime,
the riskier loans.
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Rising house prices led lenders to think it wasn’t too risky; bad loans
meant repossessing high-valued property. Subprime and “self-certified”
loans (sometimes dubbed “liar’s loans”) became popular, especially in the
US.
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Some banks evens started to buy securities from others.
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Collateralized Debt Obligations (even more complex forms of
securitization) spread the risk but were very complicated and often hid the
bad loans. While things were good, no one wanted bad news.
CONCEPT OF 5CS & C-A-M-P-A-R-I OF CREDIT RISK ANALYSIS
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In credit risk analysis, every loan request is subjected to the 5Cs of credit:
Capital, Character, Capacity, Collateral and Condition. Another tool, which
is referred by C-A-M-P-A-R-I: Character, Ability, Margin, Purpose, Amount,
Repayment, and Insurance.
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Credit risk analysis suggests that only after an acceptable score based on
the above tools, lender should decide how much money to lend or even
they may deny lending if score is below standards. But these are
deliberately jettisoned under the subprime regime. If a mortgage-borrower
is not able to make repayments as and when due, the lender can take
possession of the residence acquired using the mortgage proceeds, in a
process called foreclosure.
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A redeeming feature of the recent crisis was that magnitude of this crisis
was much lesser than that of the Great Depression of the 1930s when
unemployment rate in the United States exceeded 25 percent. But this time
it was at 8.6 percent and was predicted to remain around 10-11 percent till
the end ofs 2009.
ECONOMIC MELTDOWN BECAME GLOBAL: PHASE OF SEVERE
CRISIS
The extent of the problems had been so severe that some of the world’s largest
financial institutions had collapsed. Others were bought out by their
competition at low prices and in other cases, the governments of the wealthiest
nations in the world resorted to extensive bailout and rescue packages for the
remaining large banks and financial institutions.
The total amounts that governments had spent on bailouts were just sky rocket.
From a world credit loss of $2.8 trillion in October 2009, US taxpayers alone
spent some $9.7 trillion in bailout packages and plans, according to Bloomberg.
$14.5 trillion, or 33%, of the value of the world’s companies had been wiped out
by this crisis. The UK and other European countries had spent some $2 trillion
on rescues and bailout packages.
It should be noted that during the debilitating Asian financial crisis in the late
1990s, Asian nations affected by short-selling complained, without success
that currency speculators operating through hedge funds or through the
currency operations of commercial banks and other financial institutions were
attacking their currencies through short selling and in doing so, bringing the
rates of the local currencies far below their real economic levels.
However, when they complained to the Western governments and
International Monetary Fund (IMF), they dismissed the claims of the Asian
governments, blaming it on their own economic mismanagement instead.
Other governments moved to try and reassure investors and savers that their
money is safe. In a number of European countries, for example, governments
tried to increase or fully guarantee depositors’ savings. In other cases, banks
were nationalized (socializing profits as well as costs, potentially.)
There seemed a little sympathy and even increased resentment for workers
working in the financial sector, as they were seen as having gambled with
other people’s money, and hence lives, while getting fat bonuses and pay
rises for it in the past. Although in raw dollar terms the huge pay rises and
bonuses were small compared to the magnitude of the problem. Such
practices were given encouragement in the past and the type of culture it
created, had angered so many people.
ROLE OF DEVELOPED ECONOMIES AND MELTDOWN
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Many blamed the greed of Wall Street for causing the problem in the first
place because it was in the US, the most well known banks, institutions and
ideologues that pushed for the policies that caused the problems.
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The crisis became so severe that after the failure and buyouts of major
institutions, the Bush Administration offered a $700 billion bailout plan for
the US financial system.
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This bailout package was controversial because it was unpopular with the
public, seen as a bailout for the culprits while the ordinary person would be
left to pay for their folly.
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The US House of Representatives initially rejected the package as a result,
sending shock waves around the world. It took a second attempt to pass the
plan, but with add-ons to the bill to get the additional congressmen and
women to accept the plan.
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However, as former Nobel Prize winner for Economics, former Chief
Economist of the World Bank and university professor at Columbia
University, Joseph Stiglitz, argued, the plan “remains a very bad bill”
THE ECONOMIC CRISIS & THIRD WORLD NATIONS
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The rise in food prices as well as the knock-on effects from the financial
instability and uncertainty in industrialized nations was having a
compounding effect.
High fuel costs, soaring commodity prices together with fears of global
recession worried many developing country analysts
Countries in Asia were increasingly worried about what was happening in
the West.
A number of nations urged the US to provide meaningful assurances and
bailout packages for the US economy, as that would have a knock-on
effect of reassuring foreign investors and helping ease concerns in other
parts of the world.
Asia has had more exposure to problems stemming from the West.
Many Asian countries had seen their stock markets suffer and currency
values going down. Asian products and services are also global, and a
slowdown in wealthy countries means increased chances of a slowdown
in Asia and the risk of job losses and associated problems such as social
unrest.
WIDESPREAD IMPACT OF MELTDOWN & INDIA
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Banks with shaken confidence in lending money at higher interest rates
with unfavourable conditions were affected considerably.
The Sensex dipped below the 9000-mark to a low of 8941, and was down
700 points at 9071. ( as on 24 Oct’ 2008)
People found their mortgages or borrowing harder to pay, this meant
repaying could not be easy for them.
Many sectors faced the credit crunch and higher costs of borrowing led to
job cuts. As people were forced to reduce their consumption in order to
face and bear present economic thrust, at the same time businesses were
struggling to survive leading to further fears of job losses.
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There was belief that the crisis has hit the advanced economies and will
have very less effect on the emerging economies like India, and this was
due to the fact that the emerging economies have continuously believed in
maintaining substantial foreign exchange reserves, have an updated and
improved policy framework, robust corporate balance sheets and a
relatively healthy banking sector.
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Our banking system did not have any direct exposure to the mortgage
drama or to the sub-prime crisis or to the failed financial institutions.
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The major banks of India have very limited off-balance sheet activities or
securitized assets, so they continue to be safe and healthy.
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The other fact which is a healthy sign of our economic system is that the
substantial growth India showed in the past one decade was driven by
domestic consumption and domestic investment and India’s dependence
on external demand has been very limited and this can be estimated by the
merchandise export which accounts for less than 15 % of our GDP.
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These fundamental strengths are still in place and will continue to be so.
But, now there is a definite dent in the growth curve of India and this is
inevitable because in the last one year investments and exports were
considerably low.
India’s financial integration into the global economy is deeper than what it
seems to be on the surface. The Indian corporate sector has largely
borrowed from developed economies because funds are available at a
lower cost in comparison to domestic one.
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In 2007-08 India had received a capital inflows amount to over 9% of GDP’s
as against the account deficit in the balance of payments of just 1.35% of
GDP.
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The crisis had an impact on India because of its integration into global
economy.
The crisis was contagious causing pressure to India’s financial market and
hampering the confidence level of investors.
We have seen that the Government and RBI have closely worked to reduce
the overwhelming impact of recession on our country by keeping
comfortable rupee liquidity position, augmenting foreign exchange, and
maintaining a policy framework that would keep credit delivery on track so
as to ensure balanced growth.
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Among the many unconventional measures taken by the RBI the most
important one was the rupee-dollar swap facility for Indian banks to give
them a comfort in managing their short-term foreign funding requirement.
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The overall outcome of the monetary measures taken by the RBI or the
Government since mid September 2008 was that it enabled to keep the
Indian financial market function in an orderly manner.
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The environment was ever optimistic that India would recover through the
crisis more rapidly than the developed countries and as we discussing
here, it has already moved towards full recovery.
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The government conceded that half a million jobs had been eliminated
during the last one year, in the "globalised" sectors of the economy,
including the textile, gem and jewelry, and auto industries and in business
processing units across the globe.
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The impact of the crisis was very evident on the job market here.
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Commerce Minister Kamal Nath had warned at the initial phase of
recession that 1.5 million jobs in export-oriented industries could be
eliminated.
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There was a period where painful adjustments were required and it was in
the hands of the government and RBI to manage the adjustments so that
the people face as little pain as possible.
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It has seen that financial meltdown directly leads to social meltdown and
that affect the overall health of a nation. However, once the global
economy began to recover, India turned around faster than expected
because it has strong fundamentals and untapped growth potential.
CONCLUSION
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It’s a widespread understanding that indiscipline and inappropriate ways
to lend money, merely to show future returns and profitability, were the
reasons in the background of the crisis.
It is quite significant to know that possibility of another economic
meltdown can not be overruled and this time the intensity of crisis would
be much severe, so the policy makers across the globe need to respond
accordingly.
There were instances where the Governments and Central banks across
the countries had responded to this economic crisis through big,
aggressive and unconventional measure, but we yet could not able to see
the desired result.
The world economic crisis continued to have toiled the Indian economy,
damaging both its immediate and long-term prospects. The social
meltdown is triggered by the job losses across most of the organizations,
causing family break-ups, mental breakdown etc.
Therefore, it can be suggested that concrete measures must be taken by
governments to strengthen present economic and financial system with
intention to avoid such severe mishappening in coming days.
Thank You