Global Financial Crisis and its Impact on the Indian Economy — Document Transcript

7/31/2019 Global Financial Crisis and its Impact on the Indian Economy Document Transcript

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Global Financial Crisis and its Impact on the Indian

Economy Document Transcript

1. GLOBAL FINANCIAL CRISIS AND ITSIMPACT ON THE INDIAN ECONOMY In a

time of crisis we all have the potential to

morph up to a new level and do things

we never thought possible Stuart Wilde

2. Shradha Diwan, IBS Kolkata, Class of2010 Global Financial Crisis and its impact

on the Indian Economy Author: 20TH

MAY, Shradha Diwan 2009 08 BS 0003170 IBS Kolkata Class of 2010

Organization: INSTITUTE OF

INTERNATIONAL TRADE, KOLKATA 2

3. Shradha Diwan, IBS Kolkata, Class of2010 Authorization This report is

submitted as a partial fulfillment of the

requirement of MBA Program at IBS,Kolkata. 3

4. Shradha Diwan, IBS Kolkata, Class of2010 Acknowledgements I would like to

express my heartfelt gratitude to Dr. D.R.

Agarwal, Director, Institute of International

Trade, for giving me the opportunity to

work with the organization, and for beingmy guide and mentor during the tenure

of my internship at the Institute. I would

also like to take the opportunity to thank

Mr. Anurag Agarwal, Director, Board of

Studies, Institute of International Trade,

for the valuable advice, inputs, and

support he has given me during the

composition of this report. I am grateful


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to Dr. Rachana Chattopadhyay, my faculty

guide at ICFAI Business School (IBS),

Kolkata, for her constant guidance and

encouragement during the entire tenureof the Summer Internship Program. 4

5. Shradha Diwan, IBS Kolkata, Class of2010 Table of Contents 1. EXECUTIVE

SUMMARY

.........................................................................................

................................. 7 2. INTRODUCTION

.........................................................................................

............................................ 9 3.

UNDERSTANDING BUSINESS CYCLES

.........................................................................................

......... 12 4. BACKGROUND OF THE CRISIS

.........................................................................................

.................... 13 5. CAUSE OF THE CRISIS: The

Financial Crisis: How it happened

............................................................ 14 6.

IMPACT OF THE CRISIS

.........................................................................................

............................... 16 7. INDIA AND THE

FINANCIAL CRISIS

.........................................................................................

............. 19 7.1. Global Liquidity Crunch and

the Indian Economy

....................................................................... 20 7.2.

Decreased Consumer demand affecting

exports........................................................................

23 7.3. The Financial Crisis and the Indian

IT Industry

........................................................................... 25

7.4. The Financial Crisis and Indias


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Financial Markets:

..................................................................... 28 8.

BAIL-OUT PACKAGES AND RBI INITIATIVES

.........................................................................................32 8.1. Indias response to the Crisis

.........................................................................................

......... 33 9. OUTLOOK FOR THE INDIAN

ECONOMY..................................................................

............................. 35 10. LIMITATIONS OF

THE STUDY

.........................................................................................

.................. 37 11. ENTREPRENEURSHIP IN

TIMES OF FINANCIAL CRISIS

..................................................................... 38 11.1.

Early-Stage Entrepreneurial Activity Rates

and Per Capita GDP .............................................

41 12. REFERENCES

.........................................................................................

........................................... 42 5

6. Shradha Diwan, IBS Kolkata, Class of2010 List of Illustrations Figure 1: Business

Cycles; Source: Seguin Financial Group

........................................................................ 12

Figure 2: Ratio of Gross Domestic Savings

to GDP

.....................................................................................

21 Figure 3: Ratio of Gross National

Savings to GDP

.......................................................................................

21 Figure 4: Source- Ministry of

Communications and Information

Technology, Govt. of India .................... 25

Figure 5: Source- Ministry of


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Communications and Information

Technology, Govt. of India .................... 25

Figure 6: Foreign Exchange Reserves held

by the RBI. Source: The HinduBusinessLine .......................... 29 Figure 7:

Rupees per US Dollar; Source: The Hindu

BusinessLine ..............................................................

29 Figure 8: Sensex Daily Movements;

Source: The Hindu BusinessLine

........................................................ 29 Figure 9:

Foreign Investment; Source: The HinduBusinessLine

................................................................. 30 Figure

10: Cumulative FII Investments in Equity;

Source: The Hindu BusinessLine

................................... 30 Figure 11: FIIs and

the Stock Market; Source: The Hindu

BusinessLine ..................................................... 31

Figure 12: Foreign Investment and Change

in Reserves; Source: The Hindu

BusinessLine ....................... 31 6

7. Shradha Diwan, IBS Kolkata, Class of2010 1. EXECUTIVE SUMMARY The world

economy is engaged in a spiraled

mortgage crisis, starting in the United

States, which is carving the route to the

largest financial shock since the Great

Depression. A loss of confidence by

investors in the value of securitized

mortgages in the United States was the

beginning of a financial crisis that swept

the global economy off its feet. The major

financial crisis of the 21st century involves


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esoteric instruments, unaware regulators,

and nervous investors. Starting in the

summer of 2007, the United States

experienced a startling contraction inwealth, triggered by the subprime crisis,

thereby leading to increase in spreads,

and decrease in credit market functioning.

During boom years, mortgage brokers,

enticed by the lure of big commissions,

talked buyers with poor credit into

accepting housing mortgages with little orno down payment and without credit

checks. Higher default levels, particularly

among less credit- worthy borrowers,

magnified the impact of the crisis in the

financial sector. The ability to raise cash,

i.e. liquidity, is an essential component for

the markets and for the economy as a

whole. The freezing liquidity has closed

shops of a large number of credit

markets. Interest rates had been rising

across the world, even rates at which

banks lend to each other. The freezing up

of the financial markets eventually lead to

a severe reduction in the rate of lending,

followed by slow and drastically reduced

business investments, paving the way for

a nasty recession in the overall economic

state of the globe. A collapse of trust

between market players has decreased the

willingness of lending institutions to risk

money. The bursting of the housing

bubble has caused a lot of AAA labeled


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investments to turn out to be junk.

Nervous investors have been sending

markets plunging down. Markets all over

the world including those of Britain,Germany, and Asia, had to confront all-

time low figures since the past couple of

years or more. Britain also witnessed the

so-called bursting of the Brown

Bubble, in the form of the highest

personal debt per capita in the G7,

combined with an unsustainable rise inhousing prices. The longest period of

expansion, which Britain claimed to be

undergoing, eventually revealed itself 7

8. Shradha Diwan, IBS Kolkata, Class of2010 as an illusion. The illusion of rising

to prosperity had been maintained by

borrowing to spend, often in the form of

equity withdrawal from increasingly

expensive houses. The bubble ultimately

burst, exposing Britain to the most serious

financial crisis since the 1920s. This brings

a lot of misery to the home owners who

are set to see the cost of mortgages soar

following the deepening of the banking

crisis and the Libor the rate at which

banks lend to each other. The impact of

the crisis is more vividly observable in the

emerging markets which are suffering

from one of their biggest selloffs.

Economies with disproportionate offshore

borrowings (like that of Australia) are

adversely affected by the western financial


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and how the Indian economy and the

Reserve Bank of India have responded to

the crisis. The recommendations include

the outlook for the Indian economy in thewake of the economic turmoil. The project

concludes with an analysis of

Entrepreneurship in times of the financial

crisis and a swift overview of the various

aspects of entrepreneurship which can

help in the revival of a plummeting

economy. 8 9. Shradha Diwan, IBS Kolkata, Class of

2010 2. INTRODUCTION The Indian

economy is experiencing a downturn after

a long spell of growth. Industrial growth is

faltering, the current account deficit is

widening, foreign exchange reserves are

depleting, and the rupee is depreciating.

The crisis originated in the United States

but the Indian government had reasons to

worry because there was a potential

adverse impact of the crisis on the Indian

banks. Lehman Brothers and Merrill Lynch

had invested a substantial amount in

Indian banks, who in turn had invested

the money in derivatives, leading to

exposure of even the derivatives market

to these investment bankers. Public Sector

Unit (PSU) banks of India like Bank of

Baroda had significant exposure towards

derivatives. ICICI faced the worst hit. With

Lehman Brothers having filed for

bankruptcy in the US, ICICI (Indias largest


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private bank), survived a rumor during the

crisis which argued that the giant bank

was slated to lose $80 million (Rs. 375

crores), invested in Lehmans bondsthrough the banks UK subsidiary. Even

Axis Bank was affected by the meltdown.

The real estate sector in India was also

affected due to Lehman Brothers real

estate partner having given Rs 7.40 crores

to Unitech Ltd., for its mixed use

development project in Santa Cruz.Lehman had also signed a MoU with

Peninsula Land Ltd, an Ashok Piramal real

estate company, to fund the latters

project amounting to Rs. 576 crores. DLF

Assets, which holds an investment worth

$200 million, is another major real estate

organization whose valuations are affected

by the Lehman Brothers dissolution. The

impact of the crisis on the Indian

economy has been studied here forth and

the study is chiefly focused on 4 major

factors which affect the Indian economy

as a whole. These are: (i) Availability of

global liquidity (ii) Decreased consumer

demand affecting exports (iii) The

Financial Crisis and the Indian IT Industry

(iv) The Financial Crisis and Indias

Financial Markets 9

10. Shradha Diwan, IBS Kolkata, Class of2010 Availability of Global Liquidity for

India in times of Financial Crisis: The main

source of Indian prosperity had been


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Foreign Direct Investment (FDI). American

and European companies were bringing in

truck-loads of dollars and Euros to get a

piece of pie of Indian prosperity. Lessinflow of foreign investment will lead to a

dilution of the element of GDP driven

growth. India is in no position to ever

return this money because it has used the

same in subsidizing the petroleum

products and building low quality

infrastructure. Liquidity is the majordriving force of the stock market

performances observed in emerging

markets. Markets such as those of India

are especially dependent on global

liquidity and international risk appetite.

The initial stage of the crisis witnessed

rising interest rates across global

economies. Rising interest rates tend to

have a negative impact on global liquidity,

and subsequently equity prices, as funds

may move into bonds or other money

market instruments. Even though there are

threats for the Indian economy due to the

global liquidity crunch, they are all

oriented for the long term. Any short term

liquidity concern will be taken care of by

the high rate of household and corporate

savings in the country. The Indian

economy can certainly rely on its piggy

bank to address its short-term liquidity

demands as the government is taking

measures to channelize large sums of


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household savings lying unused in

physical assets into the more productive

financial sector. Thus, the Indian economy

will be relatively unaffected by the globalliquidity crunch. Indian companies which

had access to foreign funds for financing

their trading activities are the worst hit.

Foreign funds will be available at huge

premiums but will be limited to the blue-

chip companies, thus leading to Reduced

capacity of expansion leading to supplypressure Increased interest rates which will

affect corporate profitability Increased

demand for domestic liquidity which will

put interest rates under pressure

Decreased consumer demand affecting

exports: Consumer demand has

plummeted drastically in developed

economies, leading to a reduced demand

for Indian goods and services, thus

affecting Indian exports. Export oriented

units are the worst hit; thus impacting

employment 10

11. Shradha Diwan, IBS Kolkata, Class of2010 Trade gap has been widening due to

the reduced exports, leading to pressure

on the rupee exchange rate The Financial

Crisis and Indian I.T. Industry In India, IT

companies, with nearly half of their

revenues coming from financial and

banking service segments, are close

monitors of the financial crisis across the

world. The IT giants which had Lehman


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that in the globalized world, no country

can exist as an island, insulated from the

twists and turns of the global economy;

growth prospects of emerging economieshave been undermined by the cascading

financial crisis, though there certainly exist

significant variations across the countries.

11

12. Shradha Diwan, IBS Kolkata, Class of2010 3. UNDERSTANDING BUSINESS

CYCLES Business Cycle or Economic Cyclerefers to economy-wide fluctuations in

production or economic activity over

several months or years. These cycles are

characteristic features of market-oriented

economies whether in the form of the

alternating expansions and contractions

which characterize a classic business cycle,

or the alternating speedups and

slowdowns that mark cycles in growth. A

recession occurs when a decline

however initiated or instigated occurs in

some measure of aggregate economic

activity and causes cascading declines in

the other key measures of activity.1 Thus,

when a dip in sales causes a drop in

production, triggering declines in

employment and income, which in turn

feeds back into a further fall in sales, a

vicious cycle results and a recession

ensues. This domino effect of the

transmission of the economic weakness,

from sales to output to employment to


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and which in turn is banked and loan to

other debtors. Due to this, a small

contraction in lending can lead to a

dramatic contraction in money supply. Thepresent global meltdown is a culmination

of several factors, the most important

being irrational and unsustainable

consumption in the West particularly in

United States disproportionate to its

income by consistent borrowings fueled

by savings and surpluses of the Eastparticularly China and Japan. The second

important factor is the greed of the

investment bankers who induced housing

loans by uncontrolled leveraging on an

optical illusion of increasing prices in the

housing sector. The third important factor

is the failure of the regulating agencies

who ignored the warning signals arising

out of the ballooning debts, derivatives

and financial innovation on the

assumption that the Collateral Debt

Obligation (CDO), the Credit Default

Swapping (CDS) and Mortgaged Backed

Securities (MBS) would continue to remain

safe with the mortgage guarantees

provided by Government Sponsored

Enterprises (GSEs) namely Fannie Mae and

Freddie Mac which had enjoyed the

political patronage since inception. There

are other several factors including shadow

banking system, financial leveraging by

the investment bankers and lack of


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adequate disclosures in the financial

statements leading to fallacious ratings by

the rating agencies. The global financial

crisis is the unwinding of the debt bubblesbetween 2007 and 2009. On December 1

2008, the National Bureau of Economic

Research (NBER) officially declared that

the U.S. economy had entered recession

in December, 2007. The financial crisis has

moved into an Industrial crisis now as

countries after countries are sharingnegative results in their manufacturing

and services sectors. 13

14. Shradha Diwan, IBS Kolkata, Class of2010 5. CAUSE OF THE CRISIS: The

Financial Crisis: How it happened The

current crisis has been linked to the sub-

prime mortgage business, in which US

banks give high-risk loans to people with

poor credit histories. These and other

loans, bonds, or assets are bundles into

portfolios or Collateralized Debt

Obligations (CDOs) and sold to investors

across the globe. Falling housing prices

and rising interest rates led to high

numbers of people who could not repay

their mortgages. Investors suffered losses

and hence became reluctant to take on

more CDOs. Credit markets froze and

banks became reluctant to lend to each

other, not knowing how many bad loans

and non-performing assets could be on

their rivals books. The crisis began with


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the bursting of the United States housing

bubble and high default rates on sub-

prime mortgages and adjustable rate

mortgages (ARM). The foreclosuresexceeded 1.3 million during 2007 up 79%

for 2006 which increased to 2.3 million in

2008, an 81% increase over 2007. Financial

product called mortgaged backed

securities (MBS) which in turn derive their

value from the mortgage installment

payments and housing prices had enabledfinancial institutions and investors around

the world to invest in U.S. housing

markets. Major banks and financial

institutions which had invested in such

MBS incurred losses of approximately US

$ 435 billion as of July 2008 which has

mounted further and is now near to the

value of US $ 1 trillion. The value of all

outstanding residential mortgage owed by

US households was US$ 10.6 trillion as of

Mid 2008 of which $ 6.6 trillion were held

by mortgaged pools Consisting of

Collectivized debt 14

15. Shradha Diwan, IBS Kolkata, Class of2010 obligation (CDO) already mortgage

backed securities (MBS) (CDO and MBS)

and the remaining US$ 3.4 trillion by

traditional depository institutions. The

owners of stock in US corporation alone

has suffered loss of about US$ 8 trillion

between 1 January and 11 October 2008

as the value of their holding declined


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from US $ 20 trillion to US $ 12 trillion.

The first catastrophe took place when

Bear Stearns was sold to JP Morgan at a

throw away price in April 2008. Thebiggest adverse impact was on Fannie

Mae (The Federal National Mortgage

Association) and Freddie Mac (the Federal

Home Loan Mortgage Corporation); the

two Government Sponsored Enterprises

(GSEs) were granted a very quick bailout

package by the US Treasury. A recordbreaking level of mortgage foreclosures

took place for the subprime mortgages.

This led to a sharp decline in the value of

securities which were based on these

mortgages. Most of the investment

bankers including Fannie Mae and Freddie

Mac reached to the brink of bankruptcy.

When homeowners default, the payments

received by MBS and CDO investors

decline and the perceived credit risk rises.

This has had a significant adverse effect

on investors and the entire mortgage

industry. The effect is magnified by the

high debt levels (financial leverage)

households and businesses have incurred

in recent years. Finally, the risks associated

with American mortgage lending have

global impacts, because a major

consequence of MBS and CDOs is a closer

integration of the USA housing and

mortgage markets with global financial

markets. 15


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16. Shradha Diwan, IBS Kolkata, Class of2010 6. IMPACT OF THE CRISIS The global

financial crisis is already causing a

considerable slowdown in most developedcountries. Governments around the world

are trying to contain the crisis, but many

suggest the worst is not yet over. Stock

markets are down more than 40% from

their recent highs. Investment banks have

collapsed, rescue packages are drawn up

involving more than a trillion US dollars,and interest rates have been cut around

the world in what looks like a coordinated

response. Leading indicators of global

economic activity, such as Rate of

unemployment shipping rates, are

declining at alarming rates. hikes to 8.9%

in the US: 539,000 jobs lost The

continuous development of the crisis had

prompted fears of a global economic

collapse. Retail sales in the US have

plunged to historic lows and business and

consumer US GDP shrinks by 8.1%

confidence are at their lowest levels. Most

of the companies have reported steep

decline in sales due to the slackened in

the first Quarter demand in the market.

The rate of unemployment in the United

States has skyrocketed to 8.9% with the

loss of a total of 539,000 jobs. US GDP

shrunk 6.1% in the first US Foreclosures

spike quarter; the fall in GDP is recorded

despite an increase in consumer spending


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in the economy which is trying to 32% in

April, 2009 recuperate from the crisis. The

fourth quarter of the previous year had

recorded the highest contraction in GDPsince the past 25 years the economy

contracted by 6.3%. US Home Prices fall

14% in first quarter In the classical

economics scheme of things, the free

market economy is set to correct itself

when it verges away from full

employment. This was proven to beuntrue in the 1930s Great Depression

when up to a fourth of the workers in the

US were out of work. Quoting US

Economist Paul Krugman, as noted in New

York Times column, 1. The bursting of the

housing bubble has led to a surge in

defaults and foreclosures, which in turn

has led to a plunge in mortgage-backed

securities assets whose value ultimately

comes from mortgage payments. 16

17. Shradha Diwan, IBS Kolkata, Class of2010 2. These financial losses have left

many financial institutions with too little

capital too few assets compared with

their debt. This problem is especially

severe because everyone took on so much

debt during the bubble years. 3. Because

financial institutions have too little capital

relative to their debt, they havent been

able or willing to provide the credit the

economy needs. 4. Financial institutions

have been trying to pay down their debt


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by selling their assets, including those

mortgage-backed securities, but this

drives asset prices down and makes their

financial condition even worse. Thisvicious cycle is what some call the

paradox of deleveraging. 3 On October

11, 2008, the head of the International

Monetary Fund (IMF) warned that the

world financial system was teetering on

the "brink of systemic meltdown" The

sequence of the event can be summarizedas below for understanding at a glance.

Bear Stearns was acquired by J.P. Morgan

Chase in March 2008 for $1.2 billion. The

sale was conditional on the Fed's lending

Bear Sterns US$29 billion on a

nonrecourse basis. The Government

Sponsored Enterprises (GSEs) Fannie Mae

and Freddie Mac were both placed in

conservatorship in September 2008. The

two GSEs have more than US$ 5 trillion in

mortgage backed securities (MBS) and

other debt outstanding. Merrill Lynch was

acquired by Bank of America in

September 2008 for $50 billion. Scottish

banking group HBOS agreed on 17

September 2008 to an emergency

acquisition by its UK rival Lloyds TSB, after

a major decline in HBOS's share price

stemming from growing fears about its

exposure to British and American MBSs.

The UK government made this takeover

possible by agreeing to waive its


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competition rules. 3 Global Meltdown:

Road Ahead, Dr. D.R. Agarwal, Institute of

International Trade 17

18. Shradha Diwan, IBS Kolkata, Class of2010 Lehman Brothers declared

bankruptcy on 15 September 2008, after

the Secretary of the Treasury Henry

Paulson, citing moral hazard, refused to

bail it out. AIG received an $85 billion

emergency loan in September 2008 from

the Federal Reserve, which AIG is expectedto repay by gradually selling off its assets.

In exchange, the Federal government

acquired a 79.9% equity stake in AIG.

Washington Mutual (WaMu) was seized in

September 2008 by the USA Office of

Thrift Supervision (OTS). Most of WaMu's

untroubled assets were to be sold to J.P.

Morgan Chase. UK: 5000 businesses

registered for British bank Bradford &

Bingley was nationalized on bankruptcy in

Q1 29 September 2008 by the UK

government. The government assumed

control of the bank's 50 billion mortgage

and loan portfolio, while its deposit and

IMF: Economic Crisis to branch network

are to be sold to Spain's Grupo Santander.

cost $ 4 trillion In October 2008, the

Australian government Germany sees GDP

announced that it would make AU$4

billion available plunge 3.8%, worst to

nonbank lenders unable to issue new

loans. After drop in 40 years discussion


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with the industry, this amount was

increased to AU$8 billion. GDP of Euro

Area falls In November 2008, the U.S.

government announced by 1.6% it waspurchasing $27 billion of preferred stock

in Citigroup, a USA bank with over $2

trillion in assets, and warrants on 4.5% of

its common stock. The preferred stock

carries an 8% dividend. This purchase

follows an earlier purchase of $25 billion

of the same preferred stock usingTroubled Asset Relief Program (TARP)

funds. 18

19. Shradha Diwan, IBS Kolkata, Class of2010 7. INDIA AND THE FINANCIAL CRISIS

The global financial crisis has not left India

unscathed. Over the last seven months,

growth has slipped dramatically - to 5.3%

in the last quarter of calendar year 2008 -

from over 9% in the previous four years.

The contagion of the crisis has spread to

India through all the channels the

financial channel, the real channel, and

importantly, as happens in all financial

crises, the confidence channel. The

slowdown is likely to have a large and

immediate impact on employment and

poverty. Informal surveys suggest

significant job losses. Job creation is likely

to remain a key concern as new entrants

to the labor force - relatively better

educated and with higher aspirations -

continue to put pressure on the job


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market. The country has the option of

turning the crisis into an opportunity. The

most binding constraints to growth and

inclusion will need to be addressed:improving infrastructure, developing the

small and medium enterprises sector,

building skills, and targeting social

spending at the poor. Systemic

improvements in the design and

governance of public programs are crucial

to get results from public spending.Improving the effectiveness of these

programs - that account for up to 8-10%

of GDP - will therefore be an important

part of the challenge. The impact of the

crisis on the Indian economy has been

studied here forth and the study is chiefly

focused on 4 major factors which affect

the Indian economy as a whole. These are:

(i) Availability of global liquidity (ii)

Decreased consumer demand affecting

exports (iii)The Financial Crisis and the

Indian IT Industry (iv) The Financial Crisis

and Indias Financial Markets 19

20. Shradha Diwan, IBS Kolkata, Class of2010 7.1. Global Liquidity Crunch and the

Indian Economy The Indian banking

system was gauged as being relatively

immune to the factors that had lead to

the turmoil in the global banking industry.

The problems of the global banks arose

mainly due to the sub-prime mortgage

lending and investments in complex


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collateralized debt obligations (CDOs)

whose values were sharply eroded.

Confidence-related issues had also

affected banks across the globe due tothe freeze in the inter-bank lending

market. Indian banks had limited

vulnerability on both counts. The reasons

for tight liquidity conditions in the Indian

markets during the earlier stages of the

crisis were quite different from the factors

driving the global liquidity crisis. Largeselling by foreign institutional investors

(FIIs) and the subsequent interventions by

the Reserve Bank of India (RBI) in the

foreign currency market, continuing

growth in advances, and earlier increases

in the Cash Reserve Ratio (CRR) to contain

inflation are some of the reasons that

accelerated the Indian liquidity crunch.

Thousands of investors, big and small,

have been hurt by the Indias Household

and downward plunge of the Indian stock

market. It will also Corporate Savings will

have broader implications for Indias

financial system and fuel the domestic the

future savings and investment patterns.

economy at a time Cautious investors had

started to diversify away from bank when

the global deposits and cash over the past

few years, and had moved to liquidity

crunch is equities, mutual funds and

insurance products. The current market

turmoil is driving them back to the safety


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back of increased fiscal prudence.

However, the current economic situation is

putting pressure on both corporate

profitability and the public finances,ensuring that savings in these two sectors

are unlikely to grow as rapidly as in the

past. Household savings will therefore

remain crucial to sustaining a strong

savings rate. India will be relatively

unaffected by the global liquidity crisis

because the large fund of Indiashousehold savings which stood at

Rs9.85trn (US$192bn) in 2006/07, will

remain available to fuel domestic growth.

At an aggregate level, households in India

had net savings of Rs 9, 53,212 crore in

financial and physical assets in 2007-08 or

19.9% of the GDP, estimated at current

market prices. In the preceding year, it

was Rs 8, 24,493 crore, or 20.2% of the

GDP. Thus, as GDP rose 14.4% at current

market prices, net savings of the

households grew 15.6%.The Indian

government is trying to hasten the shift of

Indias physical savings, still locked up in

unproductive physical assets such as

houses, durables, and jewellery, into

financial assets. The household savings

can be channelized into the countrys

debt, equity, and infrastructure finance

markets. This would not only deepen and

stabilize the financial markets but also

reduce the governments social-security


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burden. It is evident from the graph

shown alongside that the ratio of gross

domestic savings to the GDP of the

country has been increasing over theyears. Influx of these household savings

into the countrys debt, equity, and

infrastructure finance markets will certainly

help in the deepening and stabilization of

Figure 2: Ratio of Gross Domestic Savings

to GDP financial markets. Gross National

Savings also include all foreignremittances into India which add to the

domestic savings. A positive trend in the

ratio further strengthens the fact that

India is self- sufficient in the short-term

with regard to any immediate liquidity

demand. 21 Figure 3: Ratio of Gross

National Savings to GDP

22. Shradha Diwan, IBS Kolkata, Class of2010 India's savings rate and investment

rate for FY08 shows that on both counts

the country is well placed not just relative

to its own historical record, but also

relative to other economies. India's

savings rate at present is higher than all

other regions of the world, except

developing Asia and Middle East. The

country's investment rate showed sharp

acceleration during the period FY02-07 to

surpass the average of all major regions

of the world in FY07. However, according

to a report5, factors which could weigh

down the rate of domestic savings to a


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moderate 33.0% and further to 32.8%

during FY09 and FY10 respectively from

around 37.7% in FY08 are: Lower

corporate profitability Significant wideningof fiscal deficit Erosion in value of financial

and physical assets Most Asian economies

have been models of prudence. While

American and European households were

borrowing up to the hilt, Asian ones were

tucking away their savings. While rich-

country banks were piling into ever-riskierassets, Asian banks kept their holdings of

such assets small. And while America and

Britain were sucking up the worlds

savings, Asian governments piled up vast

stocks of foreign reserves. The long-term

trends in the savings of the country are a

clear indicator of the fact that even if

Indias savings and investment rates

undergo a cyclical reduction in FY09, by

next fiscal (FY10) these rates should still

be around 30%, with 6% growth in the

second half of FY10. 5 Dun and

Bradstreets Indian Economy Outlook

2009-10 22

23. Shradha Diwan, IBS Kolkata, Class of2010 7.2. Decreased Consumer demand

affecting exports Some of the sharpest

declines in output during the global

recession have been suffered by the

strongest economies of Asia. It is feared

that due to their heavy dependence on

exports, some of these economies may


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not see the face of recovery until demand

rebounds in America and Europe. In

October 2008, India registered its first

every year-over-year decline in exports (of15%), following growth of 35% in the

previous five months. Indian shipments

declined 33.3% in March from a year

earlier, the biggest fall since the last 14

years. Goods exports dropped 33% from a

year earlier to $11.5 billion in April 2009.

This was the biggest fall since April 1995.Exports slid 21.7% in February. Indias

exports, which account for 15% of the

economy, grew 3.4% to $168.7 billion in

the fiscal year ended March 31, missing a

$200 billion target set by the government,

before the collapse of the Lehman

Brothers Holding Inc. accelerated the

world financial and economic slump. The

government expects exports to total to

$170 billion in the year that started April

1. According to estimates from the

Federation of Indian Export Organizations,

falling overseas sales may cost India about

10 million jobs. Asia is A high fiscal

deficit and a high current account deficit

are a threat to economic stabilitywhich

is the main reason why international

suffering from credit rating agencies have

brought the countrys debt close to junk

two recessions: status. a domestic one

Asias export driven economies had

benefited more than any other as well as


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an region from Americas consumer boom,

so its manufacturers were external one.

bound to be hit hard by the sudden

downward lurch. Asia is suffering fromtwo recessions: a domestic one as well as

an external one. Domestic demand had

been expected to cushion the blow of

weaker exports, but instead it was hit by

two forces. First, the surge in food and

energy prices in the first half of 2008

squeezed companies profits andconsumers purchasing power. Food and

energy account for a larger portion of

household budgets in Asia than in most

other regions. Second, in several countries,

including China, South Korea and Taiwan,

tighter monetary policy intended to curb

inflation choked domestic spending

further. With hindsight, it appears that

Chinas credit restrictions to cool its

property sector worked rather too well.6 6

Report by Frederic Neumann and Robert

Prior-Wandesforde, HSBC economists 23

24. Shradha Diwan, IBS Kolkata, Class of2010 In the first quarter of 2009, trade

between India and the United States

declined by 23.47% in value to $8.2

billion, as compared to $10.69 billion in

the comparable period last year.

Shipments of Indian natural pearls,

precious and semi-precious 12% of Indias

stones, and pharmaceutical products, all

recorded a decline causing Indian exports


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to the US to drop by 22.63% to $5.22

billion in Q1 of total exports of 2009.

According to data from the US

International Trade Commission, Indianexports to the US were $6.75 billion

during Q1 of 2008. $168.7 billion in US

exports to India also declined by 24.9% in

Q1 of 2009; it FY2008-09 went amounted

to $2.69 billion as compared to $3.94

billion in Q1 of 2008. to the US. Indias

exports to the US were recorded to be$25.86 billion in 2008 and imports from

the US were $ 17.33 billion. 12% of Indias

total exports of $168.7 billion in FY2008-

09 went to the US. The Indian Gems and

Jewellery sector was significantly affected

by the reduced demand in the United

States and Europe. Overseas sales of

Indias gem and jewellery items expanded

at a seven-year low rate of 1.45% and

stood at $21 billion in 2008-09, as exports

contracted sharply in the last six months

of the year. This lead to about 200,000 job

losses in the sector, especially of artisans

engaged in polishing diamonds. The fall in

exports was caused by lowering of

demand in overseas markets for luxury

items in the backdrop of the ongoing

global recession. Exports of cut and

polished diamonds dipped 8.24% to

$13.02 billion. This pulled down the

overall growth trade of the sector as

diamonds accounts for 62 per cent of the


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not only contributed significantly to

export earnings and GDP but also

emerges as a major source of

employment generation in the country.Besides, the information technology (IT)

sector has served as a fertile ground for

the growth of new entrepreneurial ideas

with innovative corporate practices and

has been instrumental in reversing the

brain drain, raising Indias brand equity

and attracting foreign direct investment(FDI) leading to other associated benefits.

Economists have long noted that services

in general are cheaper in developing

countries than in developed countries. An

abundant supply of labor the major

input in the production of services in

developing countries, leading to low

wages is the chief factor that accounts for

the low cost of producing services. India,

with its large pool of skilled manpower,

has emerged as a major exporter of IT

software and related services, Figure 5:

Source- Ministry of Communications and

Information Technology, 4: such as

business process Govt. of India

outsourcing (BPO). In fact, one of the

notable achievements in India during the

last decade has been the emergence of an

internationally competitive IT software and

service sector (see Figure 4). With the

recent emergence of business process

outsourcing delivered over the Internet,


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the so- called IT enabled services (ITES-

BPOs) as a major source of employment

and foreign exchange, The impact of the

global financial crisis, rooted in the UnitedStates, on the Indian IT sector can be

easily gauged from the fact that

approximately 61% of the Indian IT

sectors revenue were from clients in the

US. 58% of the revenue contribution of

the top five players who account for 46%

of the IT industrys revenues is from USclients. Approximately 30% of the industry

revenues are estimated from financial

services (see Figure 5). 25

26. Shradha Diwan, IBS Kolkata, Class of2010 The US financial services and

insurance sector (BFSI Banking, Financial

Services, and Insurance) was one of the

earliest adopters of the trend of

outsourcing along with Indias biggest IT-

outsourcing firms. Large outsourcing

chunks were created by the US BFSI which

made the Indian IT players learn from

their experience. Price negotiations and

increased commitments on the service

level raised the share of US Figure 5:

Source Ministry of Communication and

Information financial services revenue as a

Technology percentage of total revenues

for the Top 3 Indian players from 25% to

38% between 1999 and 2008. Indian

companies were appreciated by the US

clients for their flexibility, good quality


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delivery and giving a key lever in

managing their selling, general, and

administrative expenses (SG&A) and time

to market by freeing up more critical ITresources. Indian players were essentially

partners in taking some of the fixed costs

out of their SG&A. Because there was no

partnering of Indian firms with the

financial services entities at any closer

level, like tying up of their invoices with

the clients business outcomes, the Indianplayers were saved from a much worse

impact of the crisis. The slowing US

economy has seen 70% of firms

negotiating lower rates with their

suppliers and nearly 60% are cutting back

on contractors. Due to a squeezed

budget, only about 40% of the companies

plan to increase their use of offshore

vendors. The US financial crisis has put the

growth of the Indian It industry in the

short-to-medium-term in an uncertain

position. Growth numbers of IT companies

were revised down by 2-3% after

sentiment started building up against the

US financial sector at the time of the Q1

results. A worse downward revision is

expected this quarter as well, though

some larger players like TCS, and Satyam

have denied any larger impact of the

crisis. Some factors offsetting the revenue

slowdown are: Favorable Rupee-dollar

exchange rate Growth de-risking through


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operations will be much larger, but, over

the medium to long term, there will be a

huge gain for them from the increase in

outsourcing and off-shoring in thefinancial sector. However, short-term pain

alongside the US slowdown is inevitable.

Financial Crisis and the Satyam Saga: In

the light of the debacle of the Satyam

Computer Services, the current financial

crisis has brought the issue of audit

committee effectiveness to the fore inIndia. Satyam, Indias fourth largest

computer software exporter, after years of

vastly inflated profits, was shattered and

exhausted when the shocking reality of

Satyams operating margin of 24% being

false was brought to the forefront its

operating margins were a meager 3%.

Satyam worked with more than a third of

the Fortune 500, and claimed good

financial health. Satyam has a remarkably

small promoter shareholding of 8.6%.

They had 61.57% shareholding by

institutions of which 46.86% is made up of

foreign institutional investors (FIIs). The

financial crisis also struck the company at

a time when there were growing

suspicions related to the Maytas issue.

Satyam was not able to maintain its

inflated figures in the wake of the crisis

and hence, its majestic accounting fraud

was brought to the forefront.

Opportunities for Indias IT sector: 1. Make


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the growth vs. profitability tradeoff early

on during the slowdown: profitability

levers are still available if growth is

sacrificed when required, and managedwell 2. Utilize some of the unavoidable

fixed costs for implementing investment

ideas that have been on the backburner

and could not be done away with due to

high utilization 3. M&A opportunities exist

in the US, both in financial sector and

non-financial sector 4. Intellectual Property(IP) and product related investments in

the US should be assessed and made 5.

Operational efficiencies can be adhered to

especially in an attractive labor market

and an environment of budget

spend/uncertainty 27

28. Shradha Diwan, IBS Kolkata, Class of2010 7.4. The Financial Crisis and Indias

Financial Markets: Despite the vanishing

foreign institutional investors (FIIs), the

Indian markets remained resilient and

stayed afloat. Investors sentiments have

been significantly impacted by the US

financial crisis. The tendency of investors

to withdraw from risky markets has

resulted in significant capital outflows that

have led to a liquidity crunch putting

pressure on the Indian stock market. The

Indian economy continues to show good

health because of the strength of its

domestic drivers, like infrastructure

projects, SME Decline in RBIs (small and


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some important macroeconomic variables.

Three such indicators stand out in terms

of their sudden deterioration since the

middle of last year: (i) Decline in theforeign exchange reserves held by the

Reserve Bank of India (ii) Fall in the

external value of the rupee, especially vis-

-vis the US dollar (iii) Decline in the stock

market indices Measures taken by the RBI

to stop depreciation of the Rupee led to a

steep decline in its foreign exchangereserves. Factors which also contributed to

the decline were the revaluation in foreign

currencies and large scale pullout by

foreign institutional investors. 28

29. Shradha Diwan, IBS Kolkata, Class of2010 Figure 6 shows how the foreign

exchange reserves, which had been

increasing steadily over the past few years,

started declining after June 2008. Not that

the earlier build-up of reserves reflected

any great macroeconomic strength, since

unlike China it was not based on current

account surpluses. Instead, the Indian

economy experienced an inflow of hot

Figure 6: Foreign Exchange Reserves held

by the RBI. money, especially in the form

of Source: The Hindu BusinessLine

portfolio capital investment of FII. But that

movement of FIIs was in turn related to

the sudden collapse of the rupee, shown

in Figure 7. Early in March 2009 the rupee

even breached the line of Rs 51 per dollar.


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anymore either) as the need to cover

losses that have been incurred in sub-

prime mortgages and other asset markets

in the North, and to ensure liquidity fortransactions as the credit crunch began to

bite. Whatever the causes, the impact on

the domestic stock market has been sharp

and direct. Since the Indian stock market

is still relatively shallow, and FII activities

play a disproportionately 30

31. Shradha Diwan, IBS Kolkata, Class of2010 sharp role in determining the

movement of the indices, it is not

surprising that this flow has been

associated with the overall decline in stock

market valuations. As Figure 11 shows, the

Sensex has moved generally in the same

direction as net FII inflows. In fact,

movements in the latter have been much

sharper and more volatile, suggesting that

domestic investors have played a more

stabilizing role over this period. Figure 11:

FIIs and the Stock Market; Source: The

Hindu BusinessLine Overall foreign

investment flows (including both FII and

direct investment) have also played a role

in determining the level of external

reserves. Figure 12 shows the pattern in

aggregate net foreign investment and

change in reserves since April 2007. Once

again, the two move together. However, in

this case, foreign investment has been less

volatile than Figure 7: Foreign Investment


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significant new financial commitments,

with the U.S. government having pledged

more than $11.6 trillion on behalf of

American taxpayers over the past 20month, far in excess of the aggregate of

the several bailout packages announced

or dolled out in the past, as may be

evident from the following figures: Past

Event US$ billion Invasion of Iraq 597 Life

Time Budget of NASA 851 S & L Bailouts

of 1980s 256 Louisiance Purchase 217Korean War 454 The U.S. Treasury also

added $200 billion to its support

commitment for Fannie Mae and Freddie

Mac, the countrys two largest mortgage-

finance companies. The Government of

China had also announced a financial

package of US$ 585 billion to pump prime

the economy by making huge public

investment and by providing subsidies to

protect domestic economy which is

otherwise exposed to external market and

is likely to be severely affected because of

the cuts in imports by all the major

importing countries. 32

33. Shradha Diwan, IBS Kolkata, Class of2010 8.1. Indias response to the Crisis As

the contagion of the financial system

collapse across the world spread towards

India, and into it, the government and the

Reserve Bank of India (RBI) responded to

the challenge in close coordination and

consultation. The main plank of the


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government to seek relaxation from the

fiscal targets and two fiscal stimulus

packages were launched in December

2008 and January 2009. These fiscalstimulus packages, together amounting to

about 3% of GDP, included: Additional

public spending, particularly capital

expenditure, government guaranteed

funds for infrastructure spending Cuts in

indirect taxes, Expanded guarantee cover

for credit to micro and small enterprises,and Additional support to exporters.

These stimulus packages came on top of

an already announced expanded safety-

net for rural poor, a farm loan waiver

package and salary increases for

government staff, all of which too should

stimulate demand. The cumulative amount

of primary liquidity potentially available to

the financial system through these

measures is over US$ 75 billion or 7% of

GDP. Taking the signal from the policy

rate cut, many of the big banks have

reduced their benchmark prime lending

rates. Bank credit has expanded too, faster

than it did last year. 34

35. Shradha Diwan, IBS Kolkata, Class of2010 9. OUTLOOK FOR THE INDIAN

ECONOMY India is witnessing a mixed

result with respect to its growth prospects

in the wake of the global economic

downturn. Real GDP growth has

moderated to 6.6% and is projected to


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input costs for corporates (iii) Fiscal space

will open up for infrastructure spending as

the decline in global crude prices and

naphtha prices will reduce the amount ofsubsidy given to the oil and fertilizer

companies (iv) Imports are expected to

shrink more than exports; this will keep

the current account deficit at modest

levels (v) Indias sound banking system

has helped to sustain the financial market

stability to a large extent -well capitalizedand prudently regulated (vi) Overseas

investors are confident about the Indian

economy due to comfortable levels of

foreign reserves 35

36. Shradha Diwan, IBS Kolkata, Class of2010 (vii) The negative impact of the

wealth loss effect in the capital markets

that have plagued the advanced countries

will not affect India because majority of

Indians stay away fro asset and equity

markets (viii) Institutional credit for

agriculture will also remain unaffected

because of Indias mandated priority

sector lending (ix) Agriculture sector of

India will be further insulated from the

crisis due to the governments farm waiver

package (x) Indias development of social

safety programs over the years (e.g. the

rural employment guarantee program),

will protect the poor and migrant classes

from the ill effects of the global crisis

Therefore, once the global economy


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begins to recover, Indias turn around will

be sharper and swifter, backed by its

strong financial system and regulatory

norms. The present global crisis has takenthe shape of the Great depression of 1929

at least in US and Japan. The biggest

losers will be US, Japan and China. The

biggest gainers may be India, Brazil and

few other developing countries with their

own domestic savings and domestic

market. The world will have to undergothe impact in different forms, somewhere

it will be economic slowdown, somewhere

recession and somewhere depression. 36

37. Shradha Diwan, IBS Kolkata, Class of2010 10. LIMITATIONS OF THE STUDY The

current project discusses key issues of the

Indian economy that cropped up as the

global economy is swaying in its worst

economic downturn. Though the major

factors have been discussed, yet there

exist more issues which have not been

detailed due to time constraints. As the

economies across the globe try to protect

themselves from the hazards of the crisis,

they are trying to maintain domestic

demand and protect their domestic

industry from foreign invasions, lest their

own economy might destabilize. This has

been giving rise to Protectionism and

rising incidences of countries resorting to

protectionist measures have been

recorded at the World Trade Organization.


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impacts of the crisis are a test of the

financial market stabilities and regulations

across the global economy; the

corrections that will be made have beenlong overdue. 37

38. Shradha Diwan, IBS Kolkata, Class of2010 11. ENTREPRENEURSHIP IN TIMES

OF FINANCIAL CRISIS Entrepreneurship

can be technically defined as a process of

starting new organizations or revitalizing

mature organizations, particularly newbusinesses, generally in response to

identified opportunities. Jean-Baptiste Say,

a French economist who first coined the

word entrepreneur in about 1800, said:

The entrepreneur shifts economic

resources out of an area of lower and into

an area of higher productivity and greater

yield. The dictionary definition of

entrepreneur reads as a person who

organizes and manages any enterprise,

esp. a business, usually with considerable

initiative and risk; and also an

employer of productive labor; contractor.

The propensity to take risks and the desire

to create wealth are some qualities

possessed by entrepreneurs that define

their entrepreneurship. Entrepreneurs are

ruthlessly opportunistic; they would

persevere with a business plan at a time

when others are chasing full-time

employment opportunities. The act of

innovation holds prime importance; the


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before reaping the harvests of an

endeavor is indispensable. Those who are

driven by the desire for a windfall should

prepare themselves for disappointment.Aspiring entrepreneurs should realize that

the receding economy offers them the

best time to start a company. The market

is full of talented people looking for new

opportunities. The opportunity cost of

letting go of an attractive and high-paying

job is very low as there is a generaldecline in employment opportunities

across the globe. Moreover, the ordinary

costs of doing a business are depressed.

Space, equipment, and any other

resourceful asset were never available at

such low investments. Raising finance in

times of the credit crunch is a tough task,

but what should be kept in mind is that

competitive pressures are much lower

during downturns and it becomes

relatively easier to establish ones

company as the leader. Advertising and

other marketing expenditures are very low

and its easy to make a mark when

relatively few in the market are trying to

do so. Being the holder of a private

company, the entrepreneur would not

have to worry about quarter-to-quarter

performance and the investors would also

have a long term perspective. Time is

another critical aspect. A business, at its

inception, needs to do a lot of market


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research, research of potential customers,

product designing and building, and also

look for investors and financing

opportunities. What is not expected froma start-up is the potential to start selling

as soon as it is conceived. Therefore, the

current slump in demand across global

economies is a non-entity with respect to

a start-up. Moreover, any new business

initially sells to the early adopters whose

buying patterns are independent of theeconomic state of the environment. 39

40. Shradha Diwan, IBS Kolkata, Class of2010 Therefore, the initial customer base

is not susceptible to economic cycle

changes and the business can head off for

a great start. Poorly capitalized start-ups

can cope with the grinding recession by

reallocating their existing financials and

keeping non-essential activities out of

operations. Focus should be on the more

important features and marketing costs

should be cut down to a minimum unless

it is proven to give a positive return on

investment. Money from all payments

which can be deferred should be put into

more productive areas of the business.

Even well capitalized start-ups need to

keep themselves buckled up and cut costs

wherever possible. However, it should be

borne in mind that ruthless slashing of

marketing costs does a lot of harm in the

future when companies have to spend a


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lot more than they saved in order to

recover. Therefore, a balanced and

judiciously thought out approach should

be followed. Entrepreneurship has thepotential to drive an economy out of the

economic turmoil. It creates new jobs,

generates revenue, advances innovation,

enhances productivity, and improves

business models and processes.

Entrepreneurship has never been as vital

for an economy as it is today. The risksand rewards go hand-in-hand. A company

should keep its strategic thinking flexible

enough to manage uncertain times and

should have the aptitude to look beyond

the crisis. History has demonstrated time

and again that entrepreneurship and new

companies is the way to bolster a flagging

economy. Giants like Microsoft,

Genentech, Gap, and The Limited were all

founded during recessions. Companies

which started off in the Depression

include Hewlett- Packard, Geophysical

Service (now Texas Instruments), United

Technologies, Polaroid, and Revlon. A

plummeting economy helps initiators to

develop a business which has the tenacity

to survive though difficult times and which

is relatively unaffected by a cycle of

bankruptcies. 40

41. Shradha Diwan, IBS Kolkata, Class of2010 11.1. Early-Stage Entrepreneurial

Activity Rates and Per Capita GDP AO:


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Angola IR: Iran AR: Argentina IS: Iceland

BA: Bosnia & IT: Italy Herz. JM: Jamaica BE:

Belgium JP: Japan BO: Bolivia KR: Rep. of

BR: Brazil Korea CL: Chile LV: Latvia CO:Colombia MK: Macedonia DE: Germany

MX: Mexico DK: Denmark NL: Netherlands

DO: Dominican NO: Norway Rep. PE: Peru

EC: Ecuador RO: Romania EG: Egypt RU:

Russia ES: Spain SI: Slovenia FI: Finland TR:

Turkey FR: France UK: United GR: Greece

Kingdom HR: Croatia US: United HU:Hungary States IE: Ireland UY: Uruguay IL:

Israel YU: Serbia IN: India ZA: South Africa

Source: GEM Adult Population Survey

(APS) and IMF: World Economic Outlook

Database (October 2008 edition) From the

above statistic, it is clear that countries

with similar geographic backgrounds and

customs tend to cluster together. At the

lower end of the early-stage

entrepreneurial activity, a group of EU-15

countries is situated close together.

Countries in Eastern Europe and Central

Asia are mainly situated at the left-hand

side, below the fitted curve even though

over the years they appear to move

towards the curve. People in these

countries are not as much engaged in

entrepreneurial activity as citizens of Latin

American countries, the Caribbean, and

Angola with similar levels of per capita

GDP. Wealthier countries at the upper

right-hand side are industrialized countries


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(2009). The Return of Depression

Economics and the Crisis of 2008. W.W.

Norton Company Limited xvii. The global

financial crisis and developing countries;Overseas Development Institute xviii.

Embassy of India Washington DC

(website) xix. Ministry of Communications

and Information Technology Statistics xx.

The World Bank Development

Economics Database xxi. The Reserve Bank

of India Press Releases, Handbook ofStatistics; Special Reports 42

Global Financial Crisis and its Impact on the Indian Economy — Document Transcript

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