Indian Economy has seen paradigm shift in its structure and working since independence when we adopted the mixed economy model but it did not yield the desired result since the mixed economy model was only in letter but not in spirit. The result was that the entire model which was focusing on “Public Sector Units (PSU)” did not go well since at the end of 1980’s the entire economy was bleeding with huge deficits in the balance of payments which virtually collapsed. In 1990, the Indian economy had to mortgage 67 tons of gold with Bank of England and had to take a loan of $ 2 billion from the International Monetary Fund. The then Prime Minister, Late Mr.
P V Narsimha Rao and the then Finance Minister Dr.Manmohan Singh went to the World Bank and IMF. This ushered new era of reforms what was called as the LPG (Liberalization, Privatization and Globalization) as the private sector and the foreign players were allowed to enter the economy and the License Raj was abolished. This led to several reforms that took place in the Indian economy which can be described as under: 1992 — FII were allowed in Indian stock market 1993 — Private Sector Mutual Funds were allowed 1996 — Dematerialization Act was passed 2000 — Derivatives Market was launched 2003 — Commodities Market was launched 2008 — Currency Derivatives were launchedThe reforms led to huge amount of investments coming in the capital market which took the SENSEX to all time high in the year 2008 January with the SENSEX touching 21206 points on 10th January 2008. The last 10 years has seen world economy passing through very tough phase as the Global Economies integration is like a double edged sword. It has benefits of globalization and at the same time side effects of financial contagion. The year 2003 saw the Indian Bull market picking up and 2004 saw the Congress coming back to power after the “Indian Shinning” campaign failed to attract the voters. The period from 2004 to 2008 was golden for the entire world economy and Indian stock market zoomed with SENSEX giving high return year after year.
Year FII Registered SENSEX Returns 2003 517 63.78 % 2004 637 9.56% 2005 823 40.70% 2006 993 46.82% 2007 1219 45.
50% 2008 1594 -52.86% 2009 1706 75.38% 2010 1747 14.
65% 2011 1750 -24.65% 2012 1752 25% 2013 1755 8% 2014 1757 32.1% The real economy was also performing well with the GDP touching all time high of 9.3 % in 2007-08. In 2008 January when the SENSEX was at all time high, the other markets of the world were also touching their all time high and thus there was global flush of liquidity hitting the world markets. The year 2008 saw the world economy sliding into recession as the world largest economy the USA, having Sub-prime Crisis.The World and Indian Economy in December 2014 World Economy: The Indian stock market has been witnessing some kind of turbulence since the macro economic data coming from the world markets are having mixed bag.
The economy of USA is coming on track with Fed announcement that they would have a wait and watch approach for the interest rates to rise. USA has registered GDP growth of 5 % which is at 11 years high. USA has been able to create more than 2 lakh jobs every month for the last six months. The borrowing of the Fed is at 7 years low.
This has gone well as markets globally reacted positively. The news from other major economies has not been so kind with Japan which is facing recession though they increased their stimulus from 60 trillion yen to 80 trillion yen. Japan is facing recession as their demand and consumption has been decreasing since the average age of Japanese’s is 50 years and thus problem of “AGING” population. China is heading for slow down as its GDP growth projection has come down and its industrial production has come down to 4.2 % which is at 27 months low. This creates fear that the world largest consumer of commodities is slowing down. The Euro zone is still not clear how it is going to address the mounting debt issues with Greece, Spain and Italy as their Debt to GDP ratios have become unmanageable. The recent Russian problem has taken the world on toll as Russia is in nearly default like situation.
The fall in the oil prices is also creating havoc since Ruble has crashed and the Russia is on the verge of default. Any such event creates huge issue for the world economy and may take the world economy back into recessions. Indian Economy: The Indian economy saw the biggest change in the May 2014 when for the first time in 30 years there has been a government with full majority. This is the biggest reform that has taken place in the history of India.This is far less than what Indian economy has an average of 8 % in the last 10 years. The Government in its mid economy review has stated that GDP would be at 7.5%. The FII has been on selling spree as the year end comes and they are busy closing their books.
FII has made net investment of $ 16.5 billion in 2018 as compared to $ 24 billion in 2017.The biggest benefit today India has is the strong stable government which has absolute majority in the parliament. This will ensure that all the reforms are passed in the parliament and thus are implemented. In the last six months, the way government has been able to install confidence comes from the fact that Rs. 90,000 crores have been invested into Indian stock markets.Theinflation has now come to down to 4 % which is a really a positive surprise and now the RBI should use this opportunity to start reducing the interest rates which is the catalyst for the consumption and demand in the economy. In the year 2019, RBI should start reducing the interest rates which would bring down the cost of capital which would help the corporate sector to expand and this would also lead to job creation.
India needs to create 1.5 crore jobs every year for next 20 years to get the benefit of the demographic dividend. The Indian economy has been struggling for quite some time. The fall in the crude prices have been a big benefit for the Indian economy as we import 77 % of the total crude oil requirement. Though the Current Account Deficit has increased from 1.7 % of GDP to 2.1% of GDP but this has been due to rise in gold imports.
The fiscal deficit is still a challenge for the government since currently it is at 3.53 % and the government is trying its best to stick to 3.1 % target. But it is most likely to get breached since government expenditure has already reached 90% of the target and still 3 months are there for the fiscal year to be complete. Thus, the silver line is that the government is all set the initiate reforms and ensure that the global investors have confidence in our system and they invest for long terms.
Campaign like the ‘Make In India’ gives the much needed push to the manufacturing sector. Since, in 1992 the share of manufacturing sector was 14.6% in GDP and in 2018 it is at 16% in GDP. This needs to go up as that would lead to employment generation.2016:Position of Indian Economy The Indian GDP grew at 7.
6 % which is officially the fastest growing economy in the world as China; the earlier competitor could make GDP growth of 6.8% only. But the rise in the GDP number were mixed as other set of macroeconomic indicators were weak with the IIP coming to -1.3 %, the core sector data which contributes 38 % in IIP index is at -3.2 % and the CPI inflation rising to 5.69% indicating that the road ahead for RBI to cut interest rates would be a difficult one. The corporate profitability is not good since most of the major corporate are facing losses as their balance sheet is highly leveraged. The core questions is that with the Indian economy still performing far better than the world economies, still there is much to be done at the grass root level.
The biggest challenge is that “JOB CREATION” since Indian economy is offering the benefits of Demographic Dividend, Domestic Consumption coupled with high savings as the key factors to the foreign investors. But the key question is can we create 1.5 crore jobs every year. The Economy needs to create more jobs in the manufacturing sector since the contribution of the manufacturing sector was 14.
6% in GDP in 1992 and even in 2015 it has been 14.9%. Thus, there has been complete stagnancy in the manufacturing sector.
If the “Make In India” campaign has to succeed then the Government will have to do lot in terms of “Ease of Doing Business” a reality and make procedural norms very easy to start up new business. Today, India has the third largest number of startup companies pegged at 4300 which is after US and UK. The need of the hour is to ensure that thesestartup gets enough seed and working capital so that they are able to survive first 3 years. This would ensure that more entrepreneurs are created and thus it would in turn more jobs at the grass root level.US Interest Rates: The US economy is steadily coming out of woods since the unemployment rate has come down to 5.5 % which was at all time high of 9.8%. The Fed is losely watching the economy to see that whether they are now in position to increase the interest rates.
The rise in the interest rates sends shivers to the emerging markets since when the Fed increase interest rates, there could be flow of capital from emerging countries back to USA. This could see fall in the emerging stock markets. The USA has kept interest rates at 1.65% and we may see rise in interest rates in 2019 end. The US economy is growing well since their macroeconomic indicators are indicating that economy is coming on track.
If USA increases the interest rates, then it would be first time in the last eight years, they would increase the interest rates. This would mean a lot for the global capital flows. Once the interest rates starts rising, then the fear is that the emerging economies would also be forced to increase the interest rates otherwise the interest rate arbitrage would become less and institutions may prefer to invest in USA. The key aspect with the US is that there is lot of ease in doing business and this is the key reason that it can attract lot of investments from the emerging economies back to US. The US Economy remains the undisputed leader of the Super Economy Age.
Though, the country was hit hard early by the twin disasters of 9/11 and the 2008 financial meltdown, it has largely recovered emotionally as well as economically. Soon after the bust, the US economy has started growing at 3 % considerably higher than its developed world counterparts. In the second quarter of 2014, their GDP grew at 4.6 %. The unemployment in the USA which had touched all time high of 10 % in 2009 came to 5.5% in 2013-2014. The house prices in the USA were up by 10.7% over the previous years with 99 out of 100 top cities again showing increases in the price.
The stock markets of USA also soared by the summer of 2014, both the DOW Jones and the S&P 500 hit record highs. Though the share of the USA in the world GDP has declined, its nominal GDP remains the world’s largest, measuring more than $ 17 trillion in 2014. It occupies the third biggest landmass, its military is huge and fearsome and its culture exports from Hollywood movies and rap music to mass market fashion and fast food franchise reach every corner of the world. From the demographic view point also, the American fertility rate is around 2 % and the United Nations expects the population to grow 30 % between 2010 and 2050 because of large part of immigration. Most of the population growth would be in the young adult demographics, full of able and eager workers, the number of Americans aged between 22 and 24 years will jump from 22 million to 25 million. This would be another major sustainable growth factor in the USA economy.China, Japan and Europe in doll drums: The IMF has predicted that the Japan share in the world GDP based on purchasing power parity will reduce from 5.
6% in 2012 to 4.8% in 2017. An ageing workforce and lower birth rate would mean that its population currently tenth in the world is expected to decline very fast from 127.
5 million in 2013 to 97 million by 2050. Nor do the Europe dominant 20th century powers Germany and Britain qualify on their own for Super Economy. The 28 nations of European Union, edges out America the third biggest population with more than 505 million people in 2012 and long standing cultural cachet. The European Union is characterized by the fact that it lacks a unified foreign policy backed by a single military, an fiscal inconsistency have spawed debilitating debt crisis from Ireland to Greece. Lower birth rates, staggering unemployment, an unwieldy bureaucracy and terminal welfare dependency further compromise its ability to match the US in the global pull.
CHINA CONCERNS THE INDIAN ECONOMY Key facts about Economy of China:- 1. Their Debt to GDP ratio is a 282% 2. Their banks have NPA Of 30 % 3. The wealthy Chinese’s have borrowed funds from banks and invested in the stock market of China. This was key reason for market to crash when their regulator increased margin money in the future option segment. 4.
China has depreciated its currency once again by 1.5% which would make the Chinese goods more competitive and flood the world markets with Chinese products. 5. Investment lead model has created Excessive capacity in the Chinese economy.
Key facts about political strategy of China:- 1. China has invested $ 1.1 trillion in USA Treasury bills which is key risk politically since any pressure from USA would mean that China may threaten to pull out this currency. 2. China has strategically forced Zimbabwe to accept its currency as formal currency. China forgone the loan of $ 40 billion it has given to Zimbabwe and also supported the current election of the Zimbabwe president. China has entered the 54 nations African continent which is key risk.
3. Chinese currency has been accepted by IMF in its reserve currency. This is huge step even after the weakness of the Chinese economy coming out in public. Chinese economy had adopted the “Tidal Wave Investment” theory which was aimed to create massive infrastructure and but this lead to excessive capacity creation. There are many towns in China which have been labeled as “Ghost Towns” since they have infrastructure but no people to use it. The Chinese economy has been lead by “Investment Lead Model” but the investment has been made with leverage capital which is the root cause of the failure of the model. The Debt to GDP ratio has been pegged at 282 % which is alarmingly high and thus the Chinese economy will take long time to recover from this situation.
China has been the biggest producer and consumer of important metals like the Steel, Aluminum and copper and thus the economy seems to have major effect on the world commodity cycle.WORLD ECONOMYON TENTER HOOKSUS ECONOMY – REASONS TO WORRY • US Economy GDP in the last quarter has grown only by 0.7% • In spite of printing $ 3.6 trillion in quantitative easing and $ 6 trillion of public debt, the full year GDP for the US economy is only 2.4% and not even 2.5 % which is major source of worry • The demand for Loan from Industry that is big and medium industrial houses has fallen by 12.7% • The demand for loan from small industries has fallen by 11.
5% • Though US has created jobs but there is no hike in the pay rolls of the employees which means that the consumption is not going to rise anytime soon • US will not be in hurry to raise the interest rates any time soon because the risk is that its own economy may slip back into recession. • US Economy Debt to GDP ratio at 103 % The US economy though has been able come back with a bang as their unemployment is at 4 decades low at 5.1 % but there is no rise in the wages. The fear is that after the rate hike in December 2015, will the economy be able to sustain the GDP growth rate and thus what would be the road ahead. The problem is that alone US cannot pull the world economy in spite of its contribution of 23 % in the World GDP. The US in spite of printing so much of currency is still not confident that whether the GDP growth would be sustainable or not, creates big issues for the world economy especially Indian stock markets.Europe – No ray of hope 1.
The Debt to GDP ratio of Europe is at 92.3 % 2. Greece has Debt to GDP ratio of 177%, Spain has 120% and Italy has 160% 3. IMF has not said it would no longer be part of the troika that is IMF, European Union and European Central Bank which had created war chest for these troubled economy.
4. The unemployment rate in Eurozone is at 25 % which is key risk The Greece issue which the world was witnessing since the 2011 when the Eurozone crisis came out, took a ugly turn when the Greece government went for the public referendum in which more than 60 % of the voters came with “NO” for the bailout terms offered by the international creditors. This effectively meant that the Greece was not willing to go for more of austerity measures. The banks in Greece have run out of cash and Greece missed the payment deadline of paying Euro 1.6 billion on 30th June 2015 to IMF. The Finance Minister of Greece resigned. The Prime Minister is adamant that the no new austerity measures would be made applicable since that could push the economy back into more recession. The Eurozone is still struggling with the high Debt to GDP ratio of its key members like Greece and there is no clear indicator, how this problem of over leverage is going to get solved.
The ECB recently announcing that if required the stimulus could be given again and up till March 2017 which clearly shows that ECB does not want to take any chance of the economy going back into recession. Eurzone problem has been since 2011 and even at the end of 5 years, there seems no clear solution to the debt laden economies.Japan – Still struggling 1. They have started with negative interest rates 2. The economy is printing 80 trillion yen but no respite as demand not picking up 3.
Debt to GDP ratio at 229%The world third largest economy is facing “AGING POPULATION” which is the most acute problem faced by them since the economy is not coming out of “Deflation” which means that even if the prices have crashed out there is no real demand picking up. The kind of debt they have accumulated is very high and difficult to manage.Impact on Indian Economy: The impact of Greece crisis may not much in the real sense for Indian economy since there is no direct business between Greece and India. The following table gives tabular analysis: Rank Country % share in India’s total Trade 1 China 9.5 2 USA 8.5 3 UAE 7.8 4 Saudi Arab 5.2 5 Switzerland 3.
1 6 Germany 2.7 7 Hong Kong 2.5 8 Indonesia 2.5 9 South Korea 2.
4 10 Singapore 2.3 92 Greece 0.1 Source: Ministry of Commerce, YES BANK Limited, July 2015 The above table clearly shows that the impact of Greece on Indian economy is very minimal since the share of trade withIndia is only 0.1%. The Indian economy is not likely to be affected by theGreece impact since the actual trade between both the countries is very limited. One has to understand that in term of impact of other economies, China has more impact since it is the biggest trading partner with India. The impact on the Indian stock market is relatively high since there is panic selling which takes place whenever there is internationally negative news. The key risk is that China would flood the international markets with cheap products and this would harm many Indian companies.
For instance, the tyre made by CEAT is costing Rs. 20,000 but the same type of tyre is exported by China to India for Rs. 12000. The Indian stock markets have been behaving as “High Beta” market with huge volatility. The Indian stock market rises very fast when there is good news at the international front and when there is any negative news, the market falls like pin of cards. There is complete control of the Foreign Institutional Investors on the Indian stock market. The FII starts selling from the equities market and money goes into other asset class for instance “Gold” which is considered as a “Safe Heaven” from the investment perspective.Risk with Indian Economy: Stock market crashes: The Indian stock market is witnessing heavy FII outflows of Rs.
14400 crores in 2016. This means that Indian markets can further go down with FII selling getting aggressive in the coming days. This puts pressure on the stock maket as the retail investors simply goes out of the market and at the same time the entire investment sentiment goes for a toss.
In 2015, Indian stock markets received only $ 3 billion from FII vs $ 20 billion average in each of the last 3 years. The only fact saved Indian stock markets were that mutual funds were able to collect Rs. 90,000 crores in equity schemes highest in the last 10 years. Rupee Depreciation: The Indian rupee has started depreciating sharply.
The currency once breaks 68 level, can see free fall in the value of rupee. The currency traders will take this opportunity and put trades more on the rupee which will further depreciate the Indian currency. The oil factor is a blessing in disguise since if the oil starts rising then the current account deficit which is currently 1.3% of GDP would rise fast. IMF projects oil to bounce back to 52 $ to 55 $ in 2016.Role of BRIC Economies: With the advanced economies losing ground to the BRICS which South Africa joined in 2010, rounding out the acronym have emerged as the Super Economy hopeful of the twenty first century. Together the BRICS account for 40 % of the world population and 30 % of the world GDP comes from this BRICS economy in terms of the purchasing power parity.
In 2014, IMF had done research which shows that the original BRIC combined with the next three biggest emerging markets like Mexico, Indonesia and Turkey had surpassed the G7 of advanced economies in GDP measured at the purchasing power parity. The key aspect of these emerging economies is the young population which ensures that there is sustainable GDP growth rate in these economies. China: In 2013, China accounted for 15.8% of global GDP but by 2017 IMF expects that the share of China will rise to 18 % in world GDP while that of USA and EU will fall to 16%. China has steadily increases its defense expenditure to $ 171 billion in 2013, a 7.4 % increase from the previous years. The recent slowdown in China has send shivers across global economies with its GDP falling to 7.1 % lowest in last 6 years.
The Chinese stock market in June 2015 came down by 30 % in one and half months when the margin in their stock market was increased by the regulator. This shows that there are inherent problems in the Chinese economy. China falling fertility rate over the past thirty years, has shrunk from 2.6 births per woman to 1.56 combined with lingering effects of the government “one child” policy which has created a situation that there would large number of pensioners but not young population to earn and support the economy. There is a huge possibility that “China will grow old before it becomes rich.”China devalues its currency: China in a desperate attempt to revive its economy devalued its currency by 2 % which was lowest in the last 3 years in August 2015. This event sent shockwaves to the global markets and economy.
The world economy got a knee jerk reaction since China would flood the world markets with its cheap products and competitive currency. This led to many emerging markets currency fall like pin of cards. Though the rupee also depreciated and crashed above 65 levels, it was still strong as compared to other currency of the world. China is world’s largest consumer and producer of steel, aluminum and copper which are very vital commodities. The slowdown in the Chinese market could pull trigger for the global markets also to crash since China is the world second biggest economy after USA. China’s contribution in the global GDP is 9.3% and China is the biggest trade partner with India having 9.
5 % of the total India foreign trade. Currency Close rate YTD % fall Brazil Real 3.48 23.69 Turkish Lira 2.86 18.27 Malaysian Ringgit 4.
10 14.69 Indonesia Rupia 13822.0 10.38 South Africa Rand 12.
89 10.21 South Korea Won 1182.81 7.76 Russian Ruble 65.28 6.97 Indian Rupee 65.32 3.48 China Rembini 6.
39 2.96 Source: Economic Times dated 20th August 2015 The above table clearly shows that from the start of the year 2015, there has been fall in currencies all over the world. The fact that Indian rupee has crossed 65.71 level on 21st August which was fresh 2 year low made by the rupee. It is a matter of concern since if the oil had been trading at 80 to 90 $ per barrel, our Current Account Deficit would have blasted. India imports around 80 % of the total crude oil requirement. This leads to significant pressure on the overall balance of payment also.
The global fear is from the fact that the devaluation of the rupee would also lead to global currency war since the world economies would desperately try to devalue its currency to make their exports more competitive. This would lead to currency war like situation and thus create panic in the world markets. South Africa: South Africa recovered steadily from the 2008 crisis whereby its economy grew at 3.1% in 2010 and 3.
6 % in 2011 but unfortunately its economy collapsed in 2013 when the GDP came down to 1.9%. South Africa contributes less than 1 % in the world GDP. South Africa is too small as it is at 28th rank in population and 25th rank in land mass and too remove to exert much influence globally. Russia: Russia’s GDP has fallen drastically as the Russian economy accounts for only 3 % of the world GDP.
The population of Russia which is the 9th largest in the world is shrinking fast, hampered by low fertility rate and high mortality rates stemming from poor health issues and alcohol related problems. Russia has also low growth in science and technology with barely 0.1% of the worldwide patents. Brazil Brazil the fifth biggest nation in both landmass and population has potential.
It has the benefit of booming middle class, low unemployment and high level of foreign investment. It economy has been able to revive from the 2008 crash with growth hitting a 24 year high of 7.5 % in 2010. But again the economy has slowed down and its GDP has been near to 2 % coupled with inflation, mounting deficits and weak currency. India: Indian economy which is on the path to become super economy is virtually assured. The population currently world second biggest, at 1.
25 billion is expected to overtake China in 2028. The United Nation expects that the population of India would expand for several decades before peaking at 1.6 billion and falling to 1.5 billion by 2100 while in case of China it would start declining by 2030 shrinking to 1.
1 billion by 2100. The key feature of the Indian economy is the young population as more than half of the Indian are under 25 years of age and two thirds under 35 years. In the year 2020 India’s population median age would be 29 years which would be the lowest in the world.
This means that there would be assured labor force for the next many decades which means that domestic spending would be continuous in the economy. This would ultimately mean that the GDP would be rising sustainably and the Indian markets would be very attractive for the foreign investors. The very fact that in 2008 Global Financial Crisis and the Eurozone Crisis of 2011, when the world economy GDP grew at lukewarm pace of 1 to 2 % GDP, Indian economy was able to show growth rate of 7.5 % which itself is very remarkable.
This clearly shows that India has all the potential to become the super economy power in the coming years. The main obstacle in India economy is that of implementation of reforms and policy stability and tax laws. The issues like the Vodafone Retrospective Tax matter and the MAT issue on the FII have dented the image of India as an International Investment destination. The 2G scam and cancelling of mines was on something which has shaken the faith of the foreign investors in our economy.SECTION 2 Global Economy — What Went Wrong That Lead To Global Financial Crisis. The world Economy has seen one of the toughest times in recent past due to the global recession which started from USA Subprime Crisis and then took the shape of global recession. The following question comes to our mind when we talk of global recession: 1.
Is the world economy so fragile? 2. Is US Economy so influential? 3. Is Economies of the world getting so much integrated? 4. What lessons do we derive from such a crisis? The world Economy has expanded significantly after the Second World War. The expansion in these economies have been largely due to leverage capital. The very fact that the world economy has still not come out of effects of Subprime and Eurozone Crisis is that they are still struggling to come out of woods.
The Debt to GDP ratio which is the core indicator of how the world economies are leveraged can be seen in the below table: Country Debt to GDP ratio World Average 69% India 57% USA 103% European Union 92.3% Greece 144% Spain 120% Italy 160% China 200% Japan 229% Source:www.tradingeconomics.com The above stats indicate that the global economies have more of leverage capital rather than the equity capital. This is the main reason why the developed economies are still facing the problems and not coming out of woods. The main reason is that accumulation of more of debt capital which could not be utilized in an efficient manner which has led to default like situation and ultimately affected the world economy. Let’s try to answer the questions posted above. 1.
Is the world economy so fragile? The world economy has integrated in a much stronger way than ever before since the cross border transactions are increasing. This has created ripple effects in the world economy. The integration of the global economies has led to a scenario where, whenever there is an economic crisis in one part of the world, the others are affected due to the dollar flows in the global financial markets. The US economy which led the world into recession has been due to the global pull out of equity capital from the emerging markets.
The US economy contributes 23 % in the world GDP and it is the largest Economy with $ 16 trillion size. In 1999, the share of US economy in the world economy was 29 %. The US has its own problems whose seeds were sown much earlier in 2001 when there was WTC attack and the US economy was slowing down. The US Fed Reserve started to reduce the interest rates in 2001 from 5 % to 1 % by having 18 consecutive times rate cut. The US banks gave loans to the tune of $ 3.3 trillion dollars without having proper credit analysis of the borrowers. The underlying assumption of the US bankers was that if the loan taker does not pay, bank would auction his house since there was housing bubble in USA and prices were quoting very high.
But in 2007, when the repayment schedule started, there were huge defaults and as a result lakhs of houses came for auction. This lead to the fall in the prices of houses and as a result the banks incurred huge losses since they could not get their capital back. The Collateral Debt obligations and the rating agencies which had rated,became just obsolete papers. The investment banks and companies were shut down resulting into the job losses of lakh of Americans. The biggest blow came when 158 years old Lehman Brothers, which was the largest Investment Bank in USA and the fourth largest in the world, declared bankruptcy. This led to global credit crisis as the flow of money virtually froze and this led to huge amount of capital getting blocked. The entire world went into recession. The key argument lies in the fact that the US dollar is having its presence felt in the international markets.
When there is movement of dollar from one part of the world to other, there is lot of volatility which takes place in the global economy. The liquidity aspect which the world has witnessed in the last couple of years seems to have created a psychological fear which to some extent is real since when this liquidity dries up, to what extent would we be able to ensure that global growth still continues. The key aspect that comes to mind is that the world today is lot more integrated in terms of economic transactions rather then what it was earlier. In the coming years, what we foresee is that world would become a global village and economic policies would affect each other rather than just focusing on domestic issues of one’s country. 2. Is US Economy so influential? This question always rises when the world has some kind of economic concern. USA has always dominated the world economy in terms of its size and ability to attract the dollar flows.
The entire world saw the influence of USA in 2008 when actually the Subprime Crisis was an economic problem of their economy but it took the whole world into recession. The issue underlying is that dollar which is not only their home currency but it is also the world currency. Whenever there is dollar pull out from the global markets, the capital markets have crashed all over the world. There is huge integration of the world economies as the flow of capital has increased from one country to another.USA has been able to make the highest impact due to the following reasons: 1) US Economy is worth $ 16 trillion in size which makes it the largest economy in the world. 2) It contributes 23 % of the world GDP means that it is almost accounting for one fourth of the world economy.
3) Dollar is an international currency. The above three reasons make USA the most powerful economy in the world in terms of its influence on the world economy. The 2008 Global Financial Crisis which started from US and then spread to the world economy is the best example of how USA has the power to take the world economy into recession.
The Indian Stock markets tumbled like pin of cards with FII selling stocks worth Rs. 52000 crores and INDEX crashing from 21206 levels on 10th January 2008 to 7697 levels on 24th October 2008. 3. Is Economies of the world getting so much integrated? The world economies and the capital markets are much more integrated today than ever before. This is very evident from the fact that whenever there is news positive or negative from the global economies like USA, EU, Japan or China, the Indian Stock markets reacts in an impulsive way. There have been many instances when our markets have come down heavily due to the global news flows. The Foreign Institutional Investors (FIIs) who take cue from the global markets are quick enough to adjust asset allocation by withdrawing money from equity markets and investing in gold as an asset class.
For instance on 20th June 2013, when the Fed for the first time announced that they would wind up the Quantitative Easing, the FII in India sold shares worth Rs. 2100 crores in just few hours and the SENSEX was down by 575 points, gold and silver crashed and rupee depreciated by 1 % in one trading session. In 2010, when there was Tsunami in Japan, the metals in commodity exchanges in India had continuously hit the lower circuit and had crashed and the metal stocks in exchanges also came down heavily. In 2015 January, when there was news that Greece is likely to exit the Eurozone due to payment defaults, FII sold shares worth Rs. 1700 crore in one day and SENSEX was down by 855 points, the biggest fall since June 2009. As the world economies grow and integrate there has been ripple effect of the event that takes place in one economy on the rest of the world.
4. What lessons do we derive from such a crisis? One thing that is evidently visible is that Indian real economy is much more resilient than our capital markets. Our stock markets are much more dependent on the global flow which creates systemic risk for Indian financial system. For instance, in 2008, when the FII pulled out the money from our markets, the SENSEX tanked and gave negative return of 52 % while in 2011 the same thing happened during the Eurozone Crisis when the markets gave negative 26 % return. The gist of the problems comes from the fact that the developed nations like US, European Union, Japan have expanded based on their leverage capital. Their Debt to GDP ratio is very high which shows that they have huge financial obligations and now they are not in a position to repay back. The failure of US gains like Lehman Brothers, Bear Stern prove this fact beyond any doubt.
The developed nations have expanded their economy based on leverage effect but the fact of the matter is that one day the borrowed capital has to be paid back which is the key challenge for all these economies. Indian economy is relatively very much insulated since our Debt to GDP ratio is only 57 % as compared to even global average of 69%. The healthy saving rate of our country which is in the range of 30 % has acted as shield as people have ownership money and less of borrowed money.
The corporate India balance sheets are also less leveraged. The debt equity ratio of the corporate world was 0.33 in 2007 and in 2013 it reached to 0.67 which is still very less as compared to global counter parts. The lesser the leverage the better it is.
Companies in India like Kingfisher Airlines, Deccan Chronicle, DLF have eroded share holders wealth since these companies also took huge amount of debt and then they were unable to pay back and as a result the share tanked. The shareholders incurred huge losses as the share price tanked like anything.SECTION 3 Eurozone Crisis — What Lessons Were Learnt?European Union formed the Euro on 1st January 1999. The objective was to have one single currency so that the international trade between the European countries develops exponentially. The objective was very noble but the very fact that in order to have one single successful currency, there is also a need to have harmonization of the monetary and fiscal policies. Unfortunately, this did not happen at the Eurozone. The result was that in 2011, the five countries which are the part of the Eurozone namely Portugal, Italy, Ireland, Greece and Spain (PIIGS) were still not out of woods.
There is growing problems in these economies and as a result the world markets also gets shivers whenever there is some bad news about the economy. The main issue in the Eurozone is the Debt to GDP ratio of these economies which is completely debt driven. For instance, the Debt to GDP ratio of Greece is 177%, Spain 120%, Italy 160% which obviously make them more vulnerable to default kind of situation. The kind of debt taken by these economies is so high that now it is next impossible for them to come out of this situation.In 2011, when the crisis had triggered, the austerity measures announced included that government would go for spending cuts so that their deficits go down but that created huge problems. In slow down when you reduce the expenditure, the economy further slows down and creates huge unemployment.
This then becomes vicious cycle and it is very difficult to come out of this situation. The solution that was offered in 2011 by IMF, EU and Bank of England is that they created a war chest of 500 billion Euro to bail out any country which faces the payment crisis. In fact, even in 2015 there are talks that Eurozone may still increase their stimulus support to bail out economies. The major issue with Eurozone is that here the governments are on the verge of defaults which creates the risk that the world economy may be pushed back into recession. This is the major risk which the world economy faces. The most common solution talked is that of monetary stimulus but one needs to understand that when the currency is printed and flows into global financial system it has its own problems.
The situation then is too much money is chasing too few goods and thus, the problem of inflation is created.Greece was ultimately given third bailout package of 86 billion Euros with the lenders insisting that Greece introduces more reforms in the economy. January 2015: On 26th January 2015, Greece elections saw the opposition parties have won the elections under Alexis Tsipras of Syriza party who was against the Anti-Austerity measures. They want to restructure the debt of Greece which certainly would be challenge. The Euro had touched 11 year low which is a major concern as Greece is on the verge of default. Their unemployment ratio is 62 % and Greece faces the risk of running out of cash in March 2015 and it has to make payment of 6 to 7 billion Euros in July 2015 which is going to be very big challenge.
The possible exit of Greece would create pressure on the global markets, as other countries like Italy and Spain would also then may resort to exiting from the Eurozone. This could create questions about the stability of EURO as a currency and would create pressure among the global stock markets and the world economy may be pushed back to slow down. There is huge degree of integration among the world economies. The new government had been given four months extension subject so they are able to convince the international lenders about the reforms process they are going to initiate. The key issue in case of Greece is that if they withdraw from the European Union then what is the implication on the Eurozone. The stability of the Euro currency would itself come on stake. In March 2015, the Eurozone had accepted the reforms agenda given by Greece and as a result the Greece government then got the extension of four months. This resulted that for the time being the Eurozone matter had settled.
SECTION 4 Indian Capital Markets— The MeltdownEmerging Issues In Finance— Global Financial Challenges — India’s Position The Indian Stock market had witnessed the meltdown during the Global Financial Crisis of 2008, Eurozone crisis of 2011 and Chinese Economic crisis of 2015. The way the Indian stock markets fell like pin of cards was the result of heavy FII selling during all the crisis. The FII are holding shares worth $ 328 billion and have around 51 % of the free float market capitalization. This gives them huge power to influence the movement of Indian stock market. In fact during 2008 Global Financial Crisis, the FII had sold shares worth Rs. 52000 crores and this made the markets come down from 21206 to 7697. During 2011 Eurozone Crisis the Indian stock market again fell by 24.65% and during Chinese crisis of 2015 the Indian Sensex gave negative return of 5 %.
All the crisis show that whenever there is crisis at the global level, the Indian markets are affected in a big way. This can also attributed to the fact that Indian investors are not investing in the Indian stock market. Out of 125 crore population, only 2.
5 crore demat accounts are registered with SEBI which shows that miniscule part of the population is investing in the stock market. The global financial crisis is rooted in the sub-prime crisis in U.S.A. During the boom years, mortgage brokers attracted by the big commission encouraged buyers with poor credit to accepthousing mortgages with little or no down payment and without creditcheck. A combination of low interest rates and large inflow of foreign funds during the booming years helped the banks to create easy credit conditions for many years.
Banks lent money on the assumptions that housing price would continue to rise. Also, the real estate bubble encouraged the demand for houses as financial assets.Banks and financial institutions later repackaged these debts with other high risk debts and sold them to worldwide investors creating financial instruments called Collateral Debt Obligations (CDOs). With the rise in interest rate, mortgage payments increased and defaults among the subprime category of borrowers increased accordingly. Through the securitization of mortgage payments, a recession developed in the housing sector and consequently it was transmitted to the entire US economy and rest of the world. The financial credit crisis has moved US and the global economy into recession. Indian economy has also been affected by the spillover effects of the global financial crisis. Great saving habit among people, strong fundamentals, strong conservative and regulatory regime have saved Indian economy from going out of gear, though significant parts of the economy have slowed down.
Industrial activity, particularly in the manufacturing and infrastructure sectors decelerated. The financial crisis has some adverse impact on the IT sector. Exports had declined in absolute terms in October.Higher inputs costs and dampened demand havedented corporate margins while the uncertainty surrounding the crisis has affected business confidence.To summarize, reckless subprime lending, loose monetary policy of US, expansion of financial derivatives beyond acceptable norms and greed of Wall Street has led to this exceptional global financial and economic crisis.
Thus, the global credit crisis of 2008 highlights the need to redesign both the global and domestic financial regulatory systems not only to properly address systematic risk but also to support its proper functioning (i.e financial stability).Such design requires: 1) Well managed financial institutions with effective corporate governance and risk management system. 2) Disclosure requirements sufficient to support market discipline. 3) Proper mechanisms for resolving problem institution and 4) Mechanisms to protect financial services consumers in the event of financial Institutions failure.Introduction The last 10 years has been phenomenal for the World Economy.
The first part of the last decade was characterized by global prosperity and huge surge in liquidity. But the second part from 2008 to 2013 witnesses two major crisis that were the Global Financial Crisis and the Eurozone Crisis. The global financial crisis took the whole world economies into recession which was the biggest recession after the greater depression of 1929. The world economy is still struggling to fully come out of this shock. In 2011, the Eurozone had also met a crisis whereby there was sovereign crisis in the five European nations which again took the world economy for a rude shock. In both the events, the stock markets globally crashed and India was not an exception.
Rather our stock markets went for nose dive falls with the BSE SENSEX giving huge negative returns and the investors getting their portfolios returns crashing. Indian Economy In the last 10 years, the average GDP of Indian Economy has been in the range of 7.5 % to 8 % while the world GDP grew at around 2.5 % to 2.8%. Currently, the Indian GDP slipped to 4.6 % which was 10 year low. In 2014, September quarter saw the GDP rising to 5.
7 % but one of the key reasons for the rise in the GDP was due to huge spending by the Government which was 9.9% v/s 3.3% earlier.
Global Financial CrisisThe Global Financial Crisis originated with the US Sub Prime Crisis which took the whole world into recession. The seeds of the Sub Prime Crisis were sown right from 2001 when the US economy started reducing the interest rates and US banks lend more than $ 3 trillion to anyone and everyone who applied for the loan. This was based on the housing bubble.
In 2007 there was huge default in the repayments of loans, the houses were auctioned by the banks. The law of demand and supply came into action whereby the prices of the houses also crashed since there was huge supply of houses. This lead to the closure of large number of banks which became bankrupt, the largest was the Lehman Brothers”World Economy facing Tough Times” The global financial markets are witnessing one of the worst times ever in the history with the Eurozone problems not taking any positive turn. Also on the domestic front, the inflation and interest rates have created havoc with corporate profitability in September 2011 going down by 34.9 %. The US, which is world largest economy having size of $ 16 trillion faced high unemployment of 9.8 %. In spite of printing $ 3.
6 trillion the full year GDP of US in 2015 has grown only by 2.4 %. The global G7 countries borrowing cost has gone up to $ 7.6 trillion with around $ 200 billion getting matured in 2012. This creates severe financial implication on the real economies and also on the stock markets as FII and Hedge funds would resort to safe heaven asset classes like gold and silver. Borrowing cost of Developed Countries Country Debt in US $ Japan 3000 US 2783 Italy 428 France 367 Germany 285 Canada 211 Brazil 169 UK 165 China 121 India 57 Russia 13 Source: The Economic Times, Mumbai dated 4th January 2012.Unemployment ratein Eurozone The Eurozone is facing lot of problems as far as the employment data shows that unemployment is rising.
This has far reaching implications on these economies as spending power of the people would come down which in turn would drag the GDP on the downward side. The Debt to GDP ratio of Greece is 144 %, Germany 78 %, France 83.5 % and UK 76 % which shows that these economies are loaded with debt and it would take long time to restructure these economies and bring them back on track. Country Unemployment(%) Austria 4.0 Germany 5.5 Czech Republic 6.7 Sweden 7.4 UK 8.
3 Italy 8.6 France 9.8 Poland 10 Hungary 10.7 Ireland 14.
6 Greece 18.8 Spain 22.9 Source: The Economic Times, Mumbai dated 9th January 2012The Sensex has returned gains of 30% in 2014 Have a look at the Sensex Performance in each of the calendar year from 2008 to 2014.Sensex Trend in Calendar Years 2008 to 2014Year Open High Low Close Movement PercentageMovement2008 20325 21207 7697 9647 (10678) (53)2009 9721 17531 8047 17465 7744 802010 17473 21109 15652 20509 3036 172011 20622 20665 15136 15455 (5167) (25)2012 15535 19612 15358 19427 3892 252013 19513 21484 17449 21171 1657 82014 21222 28822 19963 27499 6277 30Analysis of the above table: The above table can be analyzed with respect the fall in the index as a result of the FII flows going out the economy. • Heavily down post Lehman Disaster in 2008, only to fabulously recover in 2009 by a whopping 80% from a low base. When the markets on 24th October 2008, touched 7697 the BSE SENSEX was down 1200 points and the PE ratio the index had touched low of 8.
This was paradoxical since an economy which was continuously growing at 8 % cannot have its index trading at low of 8, so there was huge amount of value buying that came and the index closed at 200 points in negative territory. This showed that that how fragile is the Indian stock market, which completely dances to the tune of the FII which decide the direction of the markets. Many stock brokers witnessed large number of retrenchment and hardly there was any hiring done in the financial services area. • Up again but relatively more rationally in 2010. • Down by 25% in 2011 only to be back up by 25% in 2012. The year 2011 was characterized by the Eurozone crisis which showed that the again the Indian markets were affected by the international events as FII pulled out the money. The Indian markets gave negative return again which was second biggest fall in terms of the market return.
This proved one thing very clearly that when there is an international problem, the Indian markets tend to succumb to the pressure and they fall like pin of cards. • Flat to moderately up in 2013 (year full of scams and corruption). The year was one of the worst years for the economy since our GDP touched 4.6 % which was at 10 year low, marked with rupee which had touched 68 levels. This was the worst case scenario for the economy and the markets were also nervous.
The only silver line was coming elections in which the markets were anticipating as a big change. • Now up 30% in 2014, in salutation of a change in government from the Congress led UPA to a BJP led NDA. The year 2014 saw the biggest change in the history of Indian political scene. A non-congress led government with thumping majority came to power.
This ensured that the economic reforms would be rolled out with key reforms like the Land Acquisition Bill and the GST. The government rolled out projects like ‘Skill India’, ‘Jan DhanYojana’, ‘Make in India’ which definitely provides a new sense of direction to the economy with the core focus on job creations. The job creation is the single biggest challenge that our economy is facing today and we need to address this immediately. India needs to create 1.5 crore jobs every year for next 20 years to get the benefits of demographic dividend.The above table clearly shows that in the year 2008 when there was Global Financial Crisis and in 2011 when there was Eurozone crisis, Indian Stock Markets performed poorly as the money was pulled out by the Foreign Institutional Investors.
The fall in the markets was very sharp and the Indian investors’ wealth was completely wiped out. But the interesting fact is that in both the crisis, India’s real economy performed very well. In fact in 2008, Indian GDP grew at 6.
3 % as compared to world average of 1.5 % and also in 2011 during the Eurozone crisis, the Indian economy performed with 7.1% GDP while the world economy was near 2 % GDP. This shows that Indian economy has lot of resilience and was able to show the growth rate even when the world economy was dull.The above table indicates that the volatility in the Indian stock market was due to the global events which in turn pull out the liquidity from the markets. The fall in the stock market clearly shows that the dollar which flows in the global financial markets is the key trigger for the markets to rise and fall.
SENSEX falls like pin of cardsThe date of 24th August 2015 would be remembered for quite some time in the history of the Indian capital markets. The world markets would also remember this date since all the global capital markets were down by 3 to 5 % and Indian markets were no exception. The Indian stock market tumbled more than 1700 points and Nifty came down by more than 500 points in single trading session. The FII were net sellers to the tune of Rs. 5275 crores and this lead to huge fall in the markets, though the DII were net buyers to the tune of Rs.
4097 crores. The fall was with volumes of Rs. 40,000 crores which was 40 % more than the previous trading day. This was once again the clear example that whenever there is a negative event at the global markets or economy, the Indian stock market falls like the pin of cards. This shows that the impact of FII selling is very high on our markets and they virtually control the working of the Indian markets. The fall in the SENSEX was the most since July 2009 and the mid caps stocks were hit the worst with the fall being recognized as the worst since July 2008. This shows that the Indian institutions are not in a position to absorb the kind of aggressive selling done by the FII and they are not in a position to counter the FII selling.
The global stock markets have also integrated to great extent with US NASDAQ Futures getting suspended and US Treasury dropping below 2 %. The Dow Jones opened 1000 points down which shows the fear impact which the China market has created in the world economy. The US markets had its worst fall of 777 points on 29th September 2008. This is the best example that the world stock markets are highly integrated.The European markets are also trading 5 % lower and the SGX Nifty which is the bench mark to the Indian markets also suggested that Indian markets would go for a free fall. The Indian markets have been referred as the “High Beta” market since they rise very fast when there is good news in the global market and they fall like the pin of cards when there is bad news in the global markets. The dependency on the FII is the vital aspect of the Indian stock market. They rise and fall as per the inflows of the FII.
The only way to reduce the dependence of the FII flows it that we need to have more retail participation in the markets either in the form of mutual funds or direct investment by the retail clients. There are around 2.66 crore investor DEMAT accounts but the issue is that their activation ratio is very less that means that the number of investors trading in the market on any given day is very less.The below table shows that when the world markets crashed and lost more than $ 12 trillion in market capitalization, Indian markets contribution was very less. The key contributors in the global sell off were USA and China which together accounted for 60 % of the fall.
CountryYTD Fall% % contribution fall in world markets World -6.25 —- USA -7.32 21.00 China 1.15 41.00 Japan 2.44 11.85 Hong Kong -9.80 14.00 UK -5.08 2.12 France 2.66 0.43 Germany -2.85 0.18 Canada 20.28 1.82 India -7.57 3.70 Source: The Economic Times dated 27th August 2015World markets corrected by $ 12 trillion in 2015 but India accounted for only 3.7 % of total loss.The above table reconfirms the fact that the Indian markets are more affected by the global events rather then they affecting the global markets. This again proves the fact that the moment FII sell the shares, the Indian markets are gone for a toss. In last 6 trading sessions, FII sold shares worth Rs. 13000 crores. On Wednesday 27th August, 2015 when the Sensex fell by 317 points, FII sold shares worth Rs. 2345 crores. The fall in the markets attribute to the growing integration of the Indian markets with that of the world markets.India’s USPIndian Economy has been able to perform very well in the global financial crisis of 2008 when the world economy grew at 1 to 2 % GDP while Indian Economy grew at 6.8 % which shows the resilience of the Indian economy even when there is downtrend in the world economy. The three main strength of our economy are as under which would ensure that Indian growth story would remain live for many years to come.• 70 % of working population below 35 years of age:This ensures that there is huge pool of working population which translate into consumption and demand in the economy. The spending results into the disposable incomes rising and this create demand for goods and services in the economy. The GDP of any country which is function of demand would depend on the spending power of the people. The young working population ensures that there is no dearth of spending and this would mean that economy continues to clock good growth rate.• Inherent consumption and not export oriented: Indian economy has been inherent consumption oriented economy with 86 % of the total production getting consumed in the country itself and exports accounting for only 14 %. This ensures that even if the world economy slows down, India is in self sufficient position and in no case would face any slowdown. The EU, China and Japan all are export oriented and this was evident that when US slowed down, these economies immediately came into the recession.• Our saving rate is 37 % highest in world (World Avg. 24 %): Indians are known for their saving rates and which has been the highest in the world as saving results into capital formation and capital formation results into investments. This phenomenon of Indians to save has helped the economy sail through the tough times in 2008 and also in 2011.SECTION 5 Banks’ Lending — The Trigger Point for CollapseIndian Banking industry has stood the test of the times and the credit goes to none other but the RBI who has always been cautious when it comes to lending norms. The RBI has been much appreciated even by the agencies like the World Bank and IMF after the global crisis since none of the Indian banks had any financial strain when the whole world was struggling. Banks are the back bone to any financial system and if there is something wrong in the banking sector, then the whole financial system has to suffer. Indian Economy was protected during the 1997 South East Asian Crisis when the Asian economies had collapsed as they had allowed Full Capital Account Convertibility while RBI still has not allowed that and we have only partial capital account convertibility. The Global Crisis which had been triggered due to the reckless lending done by USA investment banks led the whole world into the crisis. The key question which arises about how the banking system had dealt with the global crisisare: 1. Why wasIndiabeen hit by the crisis? 2. How wasIndia been hit by the crisis? 3. How RBI responded to the challenge?1.Why hasIndia been hit by the crisis?The first argument goes as follows: TheIndian banking system has had no direct exposure to thesub-prime mortgage assets or to the failed institutions.It hasvery limited off-balance sheet activities or securitized assets.In fact, our banks continue to remain safe and healthy. So, the enigma ishow can India be caught up in a crisis when it has nothing much to do with any of the maladies that are at the core ofthe crisis.The second reason for dismay is that India’s recent growth has been driven predominantly by domesticconsumption anddomestic investment.External demand, as measured by merchandize exports, accounts for lessthan 15 per centof our GDP. The question then is,even if there is a global downturn, why should India be affected when itsdependence onexternaldemandis so limited?The answer to both the abovefrequently-asked questions lies inglobalization. First, India’s integration intothe worldeconomy over thelast decade has been remarkably rapid.Integration into the world implies more than justexports. Going by the common measure of globalization, India’s two-way trade (merchandizeexportsplus imports), asaproportionofGDP, grew from 21.2per cent in 1997-98, the year of the Asian crisis, to 34.7 per centin 2007-08.Second,India’s financial integration with the worldhas been as deepas India’s trade globalization, if not deeper.If we take an expanded measure of globalization, that istheratio oftotal external transactions (gross current account flowsplusgrosscapital flows)to GDP,this ratiohas more than doubled from 46.8 per cent in 1997-98 to 117.4per cent in 2007-08.Importantly, the Indian corporate sector’s access to external funding has markedly increased in thelast five years. Some numbers will help illustratethe point. In the five-year period 2003-2008, the share of investment in India’s GDP rose by 11 %points.Corporate savings financed roughly half of this, buta significant portion ofthe balancefinancing came from external sources.While funds were available domestically,they were expensive relative to foreign funding.On the other hand, in a global market awash with liquidity and on the promise of India’s growth potential,foreign investors were willing to takerisks andprovide funds at a lower cost.Theyear (2007-08),for example,India received capital inflows amounting to over 9 %ofGDP as against a current account deficit in the balance of payments of just 1.5 % of GDP. These capital flows,in excessof the current account deficit,evidence the importance of external financing and the depth of India’s financial integration.So, the reason India has been hit by the crisis, despite mitigating factors, is clearly India’s rapid and growing integration into the global economy.2.How Has India Been Hit By the Crisis?The contagion of the crisis has spread to India throughall the channels – the financial channel, the real channel, and importantly,as happens in all financial crisis,the confidence channel.Let us first look at the financialchannel.India’sfinancial markets – equity markets, money markets, forexmarketsand creditmarkets -had all come under pressurefroma number of directions.First,as a consequence of thegloballiquidity squeeze,Indianbanks andcorporates foundtheir overseas financing drying up, forcingcorporates to shifttheir creditdemand tothe domestic banking sector.Also, in theirfrantic search for substitute financing,corporates withdrew their investmentsfrom domesticmoney market mutual funds putting redemption pressure on the mutual fundsanddown the lineonnon-banking financial companies (NBFCs) where the MFs had investeda significant portion of their funds.Thissubstitution ofoverseas financingby domestic financingbrought both money markets and credit markets under pressure.Second, the forex market cameunder pressure becauseof reversal of capital flows as partof the global deleveraging process. Simultaneously, corporates wereconverting thefunds raised locally into foreign currency to meet their externalobligations.Both these factors put downwardpressure onthe rupee.Third, the Reserve Bank’s intervention in the forex market to manage the volatility inthe rupeefurther added to liquidity tightening.Now lets turn tothe real channel. Here,the transmission of the global cues to the domestic economy has been quite straight forward – through theslump in demand for exports. The United States, European Union and the Middle East, which account for three quarters of India’s goods and services trade, are in a synchronized down turn.Service export growthisalso likelytoslow in the near term as the recession deepens andfinancial services firms – traditionally large users ofoutsourcing services –are restructured. Remittances from migrant workerstoo are likely to slowas theMiddle Eastadjusts to lower crude prices and advanced economies go into a recession.Beyond the financial and real channels of transmission as above,the crisis also spread through the confidence channel.In sharp contrast to global financial markets,whichwent into a seizureon account of a crisis of confidence,Indianfinancial markets continued to function in an orderly manner.Nevertheless,the tightenedglobal liquidity situation in the period immediately following the Lehman failure in mid-September 2008,coming asit didon top of a turn in the credit cycle, increasedthe risk aversion of the financial system and made banks cautious about lending.Thepurpose of the above explanation is to show how, despite not being part of the financial sector problem,India has been affected by the crisis through the pernicious feedback loops between external shocks and domestic vulnerabilitiesbyway ofthe financial, real and confidencechannels.3.How Have RBIResponded to the Challenge?The failure of Lehman Brothers in mid-September was followedin quicksuccession by several other large financial institutions coming under severe stress. This madefinancial marketsaroundtheworld uncertain and unsettled. This contagion,spread to emerging economies, and to India too.Both thegovernment and the Reserve Bank of India responded to the challenge inclose coordinationand consultation.Themain plankofthe government response was fiscal stimulus while the Reserve Bank’s action comprised monetaryaccommodation andcounter cyclical regulatory forbearance.• Monetary policy responseThe Reserve Bank’s policy response was aimed at containing thecontagion from the outside – to keep the domestic money andcredit markets functioning normally andsee that the liquidity stress did not triggersolvency cascades.In particular,targeted three objective