By

Scheme of Presentation

Global Financial Crisis

Impact on India

Difference between US/Europe and
India
 RBI’s Policy Response and Impact

Lessons from the Crisis

Medium-term Issues and Challenges

Scheme of Presentation
Global Financial Crisis

Impact on India

Difference between US/Europe and
India
 RBI’s Policy Response and Impact

Lessons from the Crisis

Medium-term Issues and Challenges


Proximate causes

Sub-prime lending

Originate and distribute model

Financial engineering, derivatives

Credit rating agencies

Lax regulation

Large global imbalances

Fundamental cause

Excessively accommodative monetary policy in the US and other advanced economies (2002-04)

Global Financial Crisis (2)
Current Account Balance (per cent to GDP)
Country
China
India
Russia
Saudi Arabia
United Arab
Emirates
United States
Memo:
Euro area
Middle East
1990-94 1995-99 2000-04
0.9
-11.7
8.3
-1.0
3.5
-2.4
4.6
-2.1
11.2
10.6
9.9
-4.5
2005 2006 2007 2008
1.4
1.9
2.4
7.2
9.5
11.0
10.0
-1.3
-1.3
0.5
-1.3
11.0
28.7
18.0
-5.9
-1.1
9.5
27.9
22.6
-6.0
-1.0
5.9
25.1
16.1
-5.3
-2.8
6.1
28.9
15.8
-4.7
n.a.
0.9
0.4
0.4
0.3
0.2
-0.7
-5.1
1.0
8.4
19.7
21.0
18.2
18.8
Source: World Economic Outlook Database, April 2009, International Monetary Fund.
Note: (-) indicates deficit.

US Monetary Policy (1)
7
6
5
4
3
9
8
2
1
0
Effective Federal Fund Rate in the US
•Volatility in monetary policy in advanced economies
•Large volatility in capital flows to EMEs
•Again very loose MP in US – likely surge in capital flows to EMEs?

US Monetary Policy (2)
•US Monetary policy too loose during 2002-04; aggregate demand exceeded output; large current a/c deficit; mirrored in large surpluses in China and elsewhere .

US Monetary Policy (3)

Large Fed cuts in 2007: strong boost to oil, other commodity and asset prices

Global Financial Crisis (3)
Capital Flows to Emerging Market Economies
800
600
400
200
0
-200
-400
-600
Direct investment, net
Other private capital flows, net
Private portfolio flows, net
Private capital flows, net
•Very large capital flows to EMEs –– now outflows in 2009 - large volatility - implications for monetary management and financial stability

Global Financial Crisis (7)
Worsening Global Economic Outlook
Region
Growth Forecast of IMF (per cent)
April 2008 July 2008 October 2008 April 2009
2008 2009 2008 2009 2008 2009 2008 2009
Advanced countries
EMEs
World
1.3
6.7
1.3
6.6
1.7
6.9
1.4
6.7
1.5
6.9
0.5
6.1
0.9
6.1
(-)3.8
1.6
3.7
3.8
4.1
3.9
3.9
3.0
3.2
(-)1.3
Global Trade Volume (Goods and Services)
World 3.7
3.8
4.1
3.9
3.9
3.0
3.3
-11.0

Scheme of Presentation

Global Financial Crisis

Difference between US/Europe and
India
 RBI’s Policy Response and Impact

Lessons from the Crisis

Medium-term Issues and Challenges

Component
Foreign Direct Investment to India
FIIs (net)
Period
April-February
April-March
External Commercial Borrowings (net) April- December
Short-term Trade Credits (net) April- December
Total capital flows (net) April- December
Memo :
Current Account Balance April- December
Valuation Gains (+)/Losses (-) on
Foreign Exchange Reserves
Foreign Exchange Reserves
(variation)
April- December
April-December
April-March
2007-08
27.6
20.3
17.5
10.7
82.0
-15.5
9.0
76.1
110.5
2008-09
31.7
-15.0
6.0
0.5
15.3
-36.5
-33.4
-53.8
-57.7

Indicator
Impact on India (2)
Key Macro Indicators
Period 2007-08
Real GDP Growth April-December
Industrial production April-February
Services April-December
Exports
Imports
GFD/GDP
Stock Market
(BSE Sensex)
Rs.per US$
April-March
April-March
April-March
April-March
April-March
9.0
8.8
10.5
28.4
40.2
2.7
16,569
40.24
2008-09
Growth, per cent
6.9
2.8
9.7
6.4
17.9
6.0
12,366
45.92

Scheme of Presentation

Global Financial Crisis

Impact on India
 RBI’s Policy Response and Impact

Lessons from the Crisis

Medium-term Issues and Challenges

Differences Between Financial Crisis in
US/Europe and India (1)

What has not happened here

No subprime

No toxic derivatives

No bank losses threatening capital

No bank credit crunch

No mistrust between banks

Differences Between Financial Crisis in
US/Europe and India (2)

Our Problems

Reduction in capital flows
 Pressure on BoP
 Stock markets
 Monetary and liquidity impact
Temporary impact on MFs/NBFCs (Sept-Oct)
Reduction in flow from non-banks
Perceptions of credit crunch

Differences Between Financial Crisis in
US/Europe and India (3)

Our Problems

Fiscal stress
 Oil, Fertiliser, Food subsidies
 Pay Commission, Debt waiver, NRE
 Stimulus packages
 GFD/GDP ratio: 5.5-6.0%
Large increase in market borrowings
Gross
Net
Rs. crore
2008-09 BE 2008-09 RE 2009-10 BE
1,76,453
1,13,000
3,42,769
3,29,649
3,98,552
3,08,647

Differences Between Financial Crisis in
US/Europe and India (4)
 India’s Approach to Managing Financial
Stability (1)

Current account: Full, but gradual opening up

Capital account and financial sector: More calibrated approach towards opening up.
 Equity flows encouraged;
 debt flows subject to ceilings and some end-use restrictions.
 Capital outflows: progressively liberalized.

Differences Between Financial Crisis in
US/Europe and India (5)
 India’s Approach to Managing Financial
Stability (2)

Financial sector, especially banks, subject to prudential regulation

 both liquidity and capital.
prudential limits on banks’ inter-bank liabilities in relation to their net worth;
 asset-liability management guidelines take cognizance of both on and off balance sheet items
 Basel II framework: guidelines issued.
 Dynamic provisioning
 NBFCs: regulation and supervision tightened - to reduce regulatory arbitrage.

Scheme of Presentation

Global Financial Crisis

Impact on India

Difference between US/Europe and
India
RBI’s Policy Response and Impact

Lessons from the Crisis

Medium-term Issues and Challenges

Measures since Mid-September, 2008 (1)

Expanding rupee liquidity

Reduction in CRR (400 bps) & SLR (100 bps)

Special Repo window under LAF for banks onlending to NBFCs, HFCs & MFS

Special Refinance to banks without collateral

Unwinding of MSS – buyback/desequestering

OMOs – pre-announced calendar

Cut in repo (425 bps) and reverse repo (275 bps) rates.

Existing instruments – enough flexibility

MSS and CRR – good, effective buffers of liquidity – both absorption and injection

Measures since Mid-September, 2008 (2)

Managing Forex liquidity

NRE and FCNR(B) deposits: interest rate ceilings raised

ECB norms relaxed

Allowing corporates to buy back FCCBs

Rupee-dollar swap facility for banks with overseas branches

Measures since Mid-September, 2008 (3)

Encouraging Flow of credit

Exporters:
 extension of period for export credit.
 Expansion in refinance

Dynamic provisioning
 Contracyclical adjustment of prudential norms

SIDBI and NHB: lendable resources expanded

Loan restructuring

Measures since Mid-September, 2008 (4)
Impact of Measures (1)

Measures ensuring orderly functioning of Indian financial markets
 Cumulative potential primary liquidity impact – over Rs. 4,90,000 crore (9 % of GDP)

Comfortable liquidity position since mid-November, 2008

LAF window in absorption mode.

Call rate within LAF corridor since November 3, 2008 – bottom of the corridor.

Gradual reduction in deposit and lending rates of banks .

Government yields:
 upward pressure from large market borrowing programme

Proactive management by RBI
 MSS unwinding
 Enhanced and pre-announced calendar for OMOs

Measures since Mid-September, 2008 (5)
Impact of Measures (2)
1 Call market
2
Item March
2008
September
2008
October
2008
Turnover (Rupees crore, average daily)
All money markets @
11,182
63,395
11,690
42,891
14,497
40,906
March
2009
11,909
81,821
Key Interest Rates (per cent)
3 Call market 7.37
10.52
9.90
4.17
4 All money markets @ 6.55
9.26
8.66
3.76
5 BSE Sensex 15946 13943 10550 8995
6
7
Rs. Per US $
10-year G-sec yield
40.36
7.69
45.56
8.45
48.64
7.85
51.23
6.56
8 Certificate of Deposits 10.0
11.6
10.0
7.0
9 Commercial Paper 10.4
12.3
14.7
8.9
10 Deposit rate (1-3 yrs)# 8.25-9.25
8.75-10.25
8.75-10.25
8.00-9.25
11 BPLR# 12.25-13.50
13.75-14.75
13.75-14.75
11.50-14.00
@: Call money, CBLO and market repo; #: Data pertain to PSBs.

1
2
3
Measures since Mid-September, 2008 (6)
Total Resource Flow from Banks and Non-banks
Item
Non-food Bank credit
Non-banks
Total flow of resources (1+2)
Rupees crore
2007-08 2008-09
4,44,807 4,14,902
3,35,698
7,80,505
2,64,138
6,79,040

Item
All commodities
Of which:
Primary articles
Fuel
Manufactured products
Measures since Mid-September, 2008 (7)
Inflation in India
March
2008
June 2008 September
2008
Wholesale price inflation
7.8
12.0
12.1
December
2008
5.9
(per cent)
March
2009
0.3
9.7
6.8
7.3
11.0
16.3
10.9
12.0
16.5
10.5
11.6
-0.7
6.2
3.5
-6.1
1.4
Consumer price inflation
7.9
8.8
11.0
11.4
10.8 (Feb) Agricultural labourers
Rural labourers
Urban non-manual employees
Industrial workers
7.6
6.0
7.9
8.7
7.3
7.7
11.0
9.5
9.8
11.4
10.8 (Feb)
9.8
9.9 (Feb)
9.7
9.6 (Feb)

Scheme of Presentation

Global Financial Crisis

Impact on India

Difference between US/Europe and
India
 RBI’s Policy Response and Impact
Lessons from the Crisis

Medium-term Issues and Challenges

Lessons from the Crisis

Avoid high volatility in monetary policy

Appropriate response of monetary policy to asset prices

Manage capital flow volatility

Look for signs of over leveraging

Active dynamic financial regulation


Capital buffers, dynamic provisioning
Look for regulatory arbitrage incentives/ possibilities

Scheme of Presentation

Global Financial Crisis

Impact on India

Difference between US/Europe and
India
 RBI’s Policy Response and Impact

Lessons from the Crisis
Medium-term Issues and Challenges

Medium-term Issues and Challenges (1)
Macroeconomic Indicators at a Glance
(Per cent)
1
1. Real GDP Growth
1950-51 to
1964-65
2
4.1
1965-66 to
1980-81
3
3.2
1980s 1990-91
4 5
5.6
5.3
1991/92 to
1996-97
6
5.7
1997/98 to
2002/03
7
5.2
2003/04
To
2007/08
8
8.7
Agriculture
Industry
2.9
6.7
2.1
4.2
4.4
6.4
4.0
5.7
3.7
7.0
0.9
4.1
4.4
8.4
Manufacturing
Services
2. Real GDCF/GDP
3. ICOR
6.6
4.9
3.9
4.2
5.8
6.3
4.8
5.9
13.5
19.2
20.2
24.4
3.3
6.0
3.6
4.6
7.5
6.4
22.5
4.0
3.9
7.8
24.1
4.6
9.1
10.3
31.4
3.6
4. Nominal GDCF/GDP
5. GDS/GDP
11.8
10.3
16.7
15.9
20.8
19.0
26.0
22.8
23.9
22.7
24.5
24.1
33.0
32.7
6. Saving-Investment Gap -1.5
-0.7
-1.8
-3.2
-1.2
-0.4
 Continuing increase in real GDP growth - Interregnum during the 1970s
-0.3
 Secular uptrend in domestic saving and investment -investment largely financed by domestic savings
 Continuation of growth in domestic savings necessary; fiscal prudence

Medium-term Issues and Challenges (2)
Fiscal Policy (1)

Combined fiscal deficit in India

Even before the recent setback: very high by international standards
 contribute to the persistence of an interest rate differential with the rest of the world,
 constrains progress towards full capital account convertibility.
 self imposed rule based fiscal correction needs to be consolidated and carried forward.

Medium-term Issues and Challenges (3)
Fiscal Policy (2)

Sustained interest rate differential also connected with the existence of a persistent inflation differential with the rest of the world.

A key challenge is to further reduce inflation expectations toward international levels.

Medium-term Issues and Challenges (4)
Monetary Policy (1)

A continuous need to adapt monetary management to the emerging needs of a fast growing and increasingly open economy.

Financial deepening and increasing monetisation.
 expansion of monetary aggregates departs from their traditional relationship with real
GDP growth.
 task of monetary management: manage such growth without endangering price or financial stability.

Medium-term Issues and Challenges (5)
Monetary Policy (2)

Further development of financial markets

Large capital inflows in recent years

Reserve Bank’s ability to manage the impossible trinity

Issues for monetary policy
 current account balance as a good guide to evaluation of the appropriate level of an exchange rate?
 to what extent should the capital account influence the exchange rate?
 implications of large current account deficits for the real economy?

Medium-term Issues and Challenges (6)
External Sector (1)

Optimal response to the large and volatile capital flows is a combination of (CGFS, 2009)
 sound macroeconomic policies
 prudent debt management
 exchange rate flexibility
 effective management of the capital account
 accumulation of appropriate levels of reserves as self-insurance and
 development of resilient domestic financial markets
 combination is country-specific; no “one size fits all”.

Medium-term Issues and Challenges (7)
External Sector (2)

Indian policy approach to CAL

Distinction between debt and equity flows

Higher inflation and interest rates in
India vis-a-vis advanced economies

Liberalisation of debt flows can lead to arbitrage flows

Ceilings on debt flows appropriate

Medium-term Issues and Challenges (8)
Financial Sector

Commercial banks robust
 Committee on Financial Sector Assessment (CFSA)
• Stability Assessment and Stress Testing
• Concerns about credit risk remain muted at present
Without Stress
CRAR (%)
Scenario - increase in NPA by:
100 per cent
CRAR (%)
150 per cent
CRAR (%)
Mar-08
Sept–08
13.0
12.5
•Note: CRAR = credit to risk-weighted assets ratio
11.6
11.1
11.0
10.6

Medium-term Issues and Challenges (9)
Conclusion
 India’s fundamentals remain strong

Financial sector robust

Monetary policy – sufficient instruments, flexible

Corporate sector not too leveraged – second round of restructuring going on – productivity gains

Foreign direct investment buoyant

Agriculture improving

Growth domestically financed
Indian economy should be able to recover fast and return to 9%+ growth path