THE GLOBAL FINANCIAL CRISIS OF

2008 AND ITS IMPACT ON THE

INDIAN ECONOMY Literature Review

Paper No. CH 6.3 (b)

Submitted for partial fulfilment towards requirement of

BCom (Hons.) course

MOHAMED ARSHAD

Roll No. 58

University Roll No.

Tutorial Group D16

2014-15

Under the supervision of Prof. NAVEEN MITTAL

DECLARATION BY STUDENT

This is to certify that the material embodied in this study entitled

The Global Financial Crisis of 2008 and its impact on the Indian Economy

is based on my own research work and my indebtedness to other publications has

been acknowledged at the relevant places.

This study has not been submitted elsewhere either wholly or in part for award of

any degree.

MOHAMED ARSHAD

DECLARATION BY TEACHER IN-CHARGE

This is to certify that the project titled

The Global Financial Crisis of 2008 and its impact on the Indian

Economy done by Mohamed Arshad

is a part of his academic curriculum for the degree of BCom (Hons). It has no

commercial implication and is done only for academic purpose.

Prof. Aruna Jha Prof. Naveen Mittal (Teacher In-charge) (Mentor)

TABLE OF CONTENTS

1. INTRODUCTION

2. REVIEW OF LITERATURE

3. CONCLUSION

4. BIBLIOGRAPHY

CHAPTER 1: INTRODUCTION

1.1 INTRODUCTION

The Global Financial Crisis was a nationwide banking emergency that coincided with the US

mortgage crisis of December 2007 June 2009. It was triggered by a large decline in home

prices, leading to mortgage delinquencies and foreclosures and the devaluation of housing-

related securities. Declines in residential investment preceded the recession and were followed

by reductions in household spending and then business investment. Spending reductions were

more significant in areas with a combination of high household debt and larger housing price

declines.

The expansion of household debt was financed with mortgage-backed securities (MBS)

and collateralized debt obligations (CDO), which initially offered attractive rates of return due

to the higher interest rates on the mortgages; however, the lower credit quality ultimately caused

massive defaults. While elements of the crisis first became more visible during 2007, several

major financial institutions collapsed beginning with Lehman Brothers in September 2008, with

significant disruption in the flow of credit to businesses and consumers and the onset of a severe

global recession.

There were many causes for the crisis, with commentators assigning different levels of blame to

financial institutions, regulators, credit agencies, government housing policies, and consumers,

among others. A proximate cause was the rise in subprime lending. The percentage of lower-

quality subprime mortgages originated during a given year rose from the historical 8% or lower

range to approximately 20% from 2004 to 2006, with much higher ratios in some parts of the

U.S. A high percentage of these subprime mortgages, over 90% in 2006 for example,

were adjustable-rate mortgages. These two changes were part of a broader trend of lowered

lending standards and higher-risk mortgage products. Further, U.S. households had become

increasingly indebted, with the ratio of debt to disposable personal income rising from 77% in

1990 to 127% at the end of 2007, much of this increase mortgage-related.

As adjustable-rate mortgages began to reset at higher interest rates (causing higher monthly

payments), mortgage delinquencies soared. Securities backed with mortgages, including

subprime mortgages, widely held by financial firms globally, lost most of their value. Global

investors also drastically reduced purchases of mortgage-backed debt and other securities as part

of a decline in the capacity and willingness of the private financial system to support

lending. Concerns about the soundness of US credit and financial markets led to tightening credit

around the world and slowing economic growth in the US and Europe.

The crisis had severe, long-lasting consequences for the U.S. and European economies. The US

entered a deep recession, with nearly 9 million jobs lost during 2008 and 2009, roughly 9% of

the workforce. One estimate of lost output from the crisis comes to "at least 40% of 2007 gross

domestic product". U.S. housing prices fell nearly 30% on average and the U.S. stock market fell

approximately 50% by early 2009. As of early 2013, the U.S. stock market had recovered to its

pre-crisis peak but housing prices remained near their low point and unemployment remained

elevated. Economic growth remained below pre-crisis levels. Europe also continued to struggle

with its own economic crisis, with elevated unemployment and severe banking impairments

estimated at 940 billion between 2008 and 2012.

Financial market conditions continued to worsen during 2008. By August 2008, financial

firms around the globe had written their holdings of subprime related securities by US$501

billion. The IMF estimated that financial institutions around the globe would eventually have to

write off $1.5 trillion of their holdings of subprime MBSs. About $750 billion in such losses had

been recognized as of November 2008. These losses wiped out much of the capital of the world

banking system. Banks headquartered in nations that have signed the Basel Accords must have

so many cents of capital for every dollar of credit extended to consumers and businesses. Thus

the massive reduction in bank capital just described has reduced the credit available to businesses

and households.

The crisis hit a critical point in September 2008 with the failure, buyout or bailout of the largest

entities in the U.S. shadow banking system. Investment bank Lehman Brothers filed bankruptcy,

while Merrill Lynch was purchased by Bank of America. Investment banks Goldman

Sachs and Morgan Stanley obtained depository bank holding charters, which gave them access to

emergency lines of credit from the Federal Reserve. Government-sponsored enterprises Fannie

Mae and Freddie Mac were taken over by the federal government. Insurance giant AIG, which

had sold insurance-like protection for mortgage-backed securities, did not have the capital to

http://en.wikipedia.org/wiki/Financial_institutionshttp://en.wikipedia.org/wiki/Financial_institutionshttp://en.wikipedia.org/wiki/Basel_Accordshttp://en.wikipedia.org/wiki/Capital_requirementhttp://en.wikipedia.org/wiki/Shadow_banking_systemhttp://en.wikipedia.org/wiki/Lehman_Brothershttp://en.wikipedia.org/wiki/Merrill_Lynchhttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Goldman_Sachshttp://en.wikipedia.org/wiki/Goldman_Sachshttp://en.wikipedia.org/wiki/Morgan_Stanleyhttp://en.wikipedia.org/wiki/Fannie_Maehttp://en.wikipedia.org/wiki/Fannie_Maehttp://en.wikipedia.org/wiki/Freddie_Machttp://en.wikipedia.org/wiki/AIG

honor its commitments; U.S. taxpayers covered its obligations instead in a bailout that exceeded

$100 billion.

Further, there was the equivalent of a bank run on other parts of the shadow system, which

severely disrupted the ability of non-financial institutions to obtain the funds to run their daily

operations. During a one-week period in September 2008, $170 billion were withdrawn from

US money funds, causing the Federal Reserve to announce that it would guarantee these funds

up to a point. The money market had been a key source of credit for banks (CDs) and

nonfinancial firms (commercial paper). The TED spread, a measure of the risk of interbank

lending, quadrupled shortly after the Lehman failure. This credit freeze brought the global

financial system to the brink of collapse.

In a dramatic meeting on September 18, 2008, Treasury Secretary Henry Paulson and Fed

Chairman Ben Bernanke met with key legislators to propose a $700 billion emergency bailout of

the banking system. Bernanke reportedly told them: "If we don't do this, we may not have an

economy on Monday." The Emergency Economic Stabilization Act, also called the Troubled

Asset Relief Program (TARP), was signed into law on October 3, 2008.

In a nine-day period from Oct. 1-9, the S&P 500 fell a staggering 251 points, losing 21.6% of its

value. The week of Oct. 6-10 saw the largest percentage drop in the history of the Dow Jones

Industrial Average - even worse than any single week in the Great Depression.

The response of the US Federal Reserve, the European Central Bank, and other central banks

was dramatic. During the last quarter of 2008, these central banks purchased US$2.5 trillion of

government debt and troubled private assets from banks. This was the largest liquidity injection

into the credit market, and the largest monetary policy action, in world history. The governments

of European nations and the US also raised the capital of their national banking systems by $1.5

trillion, by purchasing newly issued preferred stock in their major banks. On Dec. 16, 2008, the

Federal Reserve cut the Federal funds rate to 0-0.25%, where it has remained since then; this

period of zero interest-rate policy is unprecedented in U.S. history.

http://en.wikipedia.org/wiki/Bank_runhttp://en.wikipedia.org/wiki/Money_fundhttp://en.wikipedia.org/wiki/Certificate_of_deposithttp://en.wikipedia.org/wiki/Commercial_paperhttp://en.wikipedia.org/wiki/TED_spreadhttp://en.wikipedia.org/wiki/Henry_Paulsonhttp://en.wikipedia.org/wiki/Ben_Bernankehttp://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Acthttp://en.wikipedia.org/wiki/Troubled_Asset_Relief_Programhttp://en.wikipedia.org/wiki/Troubled_Asset_Relief_Programhttp://en.wikipedia.org/wiki/S%26P_500http://en.wikipedia.org/wiki/Dow_Jones_Industrial_Averagehttp://en.wikipedia.org/wiki/Dow_Jones_Industrial_Averagehttp://en.wikipedia.org/wiki/Great_Depressionhttp://en.wikipedia.org/wiki/Federal_Reservehttp://en.wikipedia.org/wiki/European_Central_Bankhttp://en.wikipedia.org/wiki/Preferred_stockhttp://en.wikipedia.org/wiki/Federal_funds_ratehttp://en.wikipedia.org/wiki/Zero_interest-rate_policy

1.2 MOTIVATION FOR THE STUDY

The Global Financial Crisis of 2008 was a turning point in the economic history of the world; the

meltdown cost tens of millions of people their savings, their jobs, and their homes.

Economists generally watch the activities of the different aspects of the financial sector of the

country to facilitate smooth functioning of the country. But, when they fail to predict the

forthcoming crisis, the entire economy is affected.

In this case, the crisis had its repercussions on the entire world mainly because of

interdependencies of the globalized world. The worst impacts were seen on the European

economy; in fact the meltdown paved the way for the beginning of the Euro crisis. The crisis had

also affected the macroeconomic policies of most of the third world countries including India

and China.

Therefore, some of the fundamental motives behind the study conducted are as follows:

To establish a reasonable understanding of the reasons due to which the meltdown in the

Wall Street began.

To ascertain how the crisis actually affected the entire US economy despite it being one

of the strongest and the most powerful economy in this era.

To obtain general awareness on how big corporates and banks were rescued from

bankruptcy to save the economy from further destruction.

To know about the precautionary measures being taken by the U.S Government to

prevent occurring of any such crisis in future.

To find out the impact of the Global Financial Crisis on Indian economy and other

developing nations.

CHAPTER 2: REVIEW OF LITERATURE

2.1 CAUSES OF THE CRISIS

The crisis can be attributed to a number of factors pervasive in both housing and credit markets,

factors which emerged over a number of years. Causes proposed include the inability of

homeowners to make their mortgage payments (due primarily to adjustable-rate mortgages

resetting, borrowers overextending, predatory lending, and speculation), overbuilding during the

boom period, risky mortgage products, increased power of mortgage originators, high personal

and corporate debt levels, financial products that distributed and perhaps concealed the risk of

mortgage default, bad monetary and housing policies, international trade imbalances, and

inappropriate government regulation. Excessive consumer housing debt was in turn caused by

the security, credit, and collateralized de+bt obligation sub-sectors of the finance industry, which

were offering irrationally low interest rates and irrationally high levels of approval to subprime

mortgage consumers because they were calculating aggregate risk using Gaussian

copula formulas that strictly assumed the independence of individual component mortgages,

when in fact the credit-worthiness of almost every new subprime mortgage was highly correlated

with that of any other because of linkages through consumer spending levels which fell sharply

when property values began to fall during the initial wave of mortgage defaults. Debt consumers

were acting in their rational self-interest, because they were unable to audit the finance industry's

opaque faulty risk pricing methodology.

Among the important catalysts of the subprime crisis were the influx of money from the private

sector, the banks entering into the mortgage bond market, government policies aimed at

expanding homeownership, speculation by many home buyers, and the predatory lending

practices of the mortgage lenders, specifically the adjustable-rate mortgage, 228 loan, that

mortgage lenders sold directly or indirectly via mortgage brokers. On Wall Street and in the

financial industry, moral hazard lay at the core of many of the causes.

In its "Declaration of the Summit on Financial Markets and the World Economy," dated 15

November 2008, leaders of the Group of 20 cited the following causes:

During a period of strong global growth, growing capital flows, and prolonged stability earlier

this decade, market participants sought higher yields without an adequate appreciation of the

http://en.wikipedia.org/wiki/Bond_markethttp://en.wikipedia.org/wiki/Predatory_lendinghttp://en.wikipedia.org/wiki/Speculationhttp://en.wikipedia.org/wiki/Balance_of_tradehttp://en.wikipedia.org/wiki/Collateralized_debt_obligationhttp://en.wikipedia.org/wiki/Finance_industryhttp://en.wikipedia.org/wiki/Subprime_mortgagehttp://en.wikipedia.org/wiki/Subprime_mortgagehttp://en.wikipedia.org/wiki/Gaussian_copulahttp://en.wikipedia.org/wiki/Gaussian_copulahttp://en.wikipedia.org/wiki/Subprime_lendinghttp://en.wikipedia.org/wiki/Moral_hazardhttp://en.wikipedia.org/wiki/G20_major_economies

risks and failed to exercise proper due diligence. At the same time, weak underwriting standards,

unsound risk management practices, increasingly complex and opaque financial products, and

consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers,

regulators and supervisors, in some advanced countries, did not adequately appreciate and

address the risks building up in financial markets, keep pace with financial innovation, or take

into account the systemic ramifications of domestic regulatory actions.

Federal Reserve Chair Ben Bernanke testified in September 2010 regarding the causes of the

crisis. He wrote that there were shocks or triggers (i.e., particular events that touched off the

crisis) and vulnerabilities (i.e., structural weaknesses in the financial system, regulation and

supervision) that amplified the shocks. Examples of triggers included: losses on subprime

mortgage securities that began in 2007 and a run on the shadow banking system that began in

mid-2007, which adversely affected the functioning of money markets. Examples of

vulnerabilities in the private sector included: financial institution dependence on unstable sources

of short-term funding such as repurchase agreements or Repos; deficiencies in corporate risk

management; excessive use of leverage (borrowing to invest); and inappropriate usage of

derivatives as a tool for taking excessive risks. Examples of vulnerabilities in the public sector

included: statutory gaps and conflicts between regulators; ineffective use of regulatory authority;

and ineffective crisis management capabilities. Bernanke also discussed "Too big to fail"

institutions, monetary policy, and trade deficits.

During May 2010, Warren Buffett and Paul Volcker separately described questionable

assumptions or judgments underlying the U.S. financial and economic system that contributed to

the crisis.

These assumptions included:

1) Housing prices would not fall dramatically;

2) Free and open financial markets supported by sophisticated financial engineering would

most effectively support market efficiency and stability, directing funds to the most

profitable and productive uses;

3) Concepts embedded in mathematics and physics could be directly adapted to markets, in

the form of various financial models used to evaluate credit risk;

http://en.wikipedia.org/wiki/Ben_Bernankehttp://en.wikipedia.org/wiki/Bank_runhttp://en.wikipedia.org/wiki/Shadow_banking_systemhttp://en.wikipedia.org/wiki/Repurchase_agreementshttp://en.wikipedia.org/wiki/Too_big_to_failhttp://en.wikipedia.org/wiki/Warren_Buffetthttp://en.wikipedia.org/wiki/Paul_Volcker

4) Economic imbalances, such as large trade deficits and low savings rates indicative of

over-consumption, were sustainable; and

5) Stronger regulation of the shadow banking system and derivatives markets was not

needed.

The U.S. Financial Crisis Inquiry Commission reported its findings in January 2011. It

concluded that "the crisis was avoidable and was caused by: Widespread failures in financial

regulation, including the Federal Reserves failure to stem the tide of toxic mortgages; Dramatic

breakdowns in corporate governance including too many financial firms acting recklessly and

taking on too much risk; An explosive mix of excessive borrowing and risk by households and

Wall Street that put the financial system on a collision course with crisis; Key policy makers ill

prepared for the crisis, lacking a full understanding of the financial system they oversaw; and

systemic breaches in accountability and ethics at all levels.

2.2 SHOCKS OF THE CRISIS ON INDIAN ECONOMY

Though in the beginning Indian official denied the impact of US meltdown affecting the Indian

economy but later the government had to acknowledge the fact that US financial crisis will have

some impact on the Indian economy.

2.2.1 CRASH ON STOCK MARKET

The immediate impact of the US financial crisis has been felt when Indias stock market started

falling. On July 23, 2007, the SENSEX touched a new high of 15,733 points. On July 27, 2007

the SENSEX witnessed a huge correction because of selling by Foreign Institutional Investors

and global cues to come back to 15,160 points by noon. Following global cues and heavy selling

in the international markets, the BSE SENSEX fell by 61512 points in a single day on August 1,

2007.

http://en.wikipedia.org/wiki/Shadow_banking_systemhttp://en.wikipedia.org/wiki/Financial_Crisis_Inquiry_Commission

2.2.2 IMPACT ON INDIAN/FOREIGN EXCHANGE RATES

Over the last decade it has been fashionable to invest increasing quantities of money in these

economies. Financial flows have also been instrumental in accelerating the growth of local

domestic credit. Money flows are now in the process of reverting back to base and the chart

below of the Indian rupee is a good example in which this effect on a currency can be observed.

Between 2002 and 2008 the rupee rose against the dollar (i.e. fewer to the dollar) reflecting

inward investment, and after the Lehman Crisis it started to fall as the money-tide reversed.

Since then the rupee has lost almost 40% of its value. It is also clear from this chart that the

primary trend for the rupee has been firmly down for some time.

The trade deficit is reaching at alarming proportions. Because of workers remittances, NRI

deposits, FII investment and so on, the current deficit is at around $10 billion. But if the

remittances dry up and FII takes flight, then we may head for another 1991 crisis like situation, if

our foreign exchange reserves depletes and trade deficit keeps increasing at the present rate.

Further, the foreign exchange reserves of the country has depleted by around $57 billion to $253

billion for the week ended October 31, 2008.

2.2.3 IMPACT ON INDIAS EXPORTS

With the US and several European countries slipping under the full blown recession, Indian

exports have run into difficult times, since October. Manufacturing sectors like leather, textile,

gems and jewelry have been hit hard because of the slump in the demand in the US and Europe.

Further India enjoys trade surplus with USA and about 15 per cent of its total export in 2006-07

was directed toward USA. Indian exports fell by 9.9 per cent in November 200814, when the

impact of declining consumer demand in the US and other major global market, with negative

growth for the second month, running and widening monthly trade deficit over $10 billion.

2.2.4 IMPACT ON INDIAS JEWELLERY, TOURISM

Again reduction in demand in the OECD countries affected the Indian gems and jewellery

industry, handloom and tourism sectors. Around 50,000 artisans employed in jewellery industry

have lost their jobs as a result of the global economic meltdown. Further, the crisis had affected

the Rs. 3000 crores handloom industry and volume of handloom exports dropped by 4.6 per cent

in 2007-08, creating widespread unemployment in this sector. Exchange rate depreciation with

the outflow of FIIs, Indias rupee depreciated approximately by 20% against US dollar and stood

at Rs. 49 per dollar at some point16, creating panic among the importers. The overall Indian IT-

BPO revenue aggregate is expected to grow by over 33 per cent and reach $64 billion by the end

of current fiscal year (FY200). Over the same period, direct employment to reach nearly 2

million, an increase of about 375000 professionals over the previous year. IT sectors derives

about 75 per cent of their revenues from US and IT-ITES (Information Technology Enabled

Services) contributes about 5.5 per cent towards Indias total export17. So the meltdown in the

US will definitely impact IT sector. Further, if Fortune 500 hundred companies slash their IT

budgets, Indian firms could adversely be affected.

2.3 GLOBALIZED WORLD

India has been hit by the global meltdown; it is clearly due to Indias rapid and growing

integration into the global economy. The strategy to counter these effects of the global crisis on

the Indian economy and prevent the latter from any further collapse would require an effective

departure from the dominant economic philosophy of the neo-liberalism. The first such departure

should be a return to Food first doctrine, not only to ensure food security of the large population

but also due to the fact the food production will be more profitable given the current signs of a

shrinking market for export oriented commercial crops. The other important initiatives that needs

to be adopted is the building of institution based on the principle of cooperation that will provide

an alternative frame work of livelihood generation in the rural economy as opposed to the

dominant logic of markets under capitalism. Institutions like cooperative markets and credit

cooperative can go a long way in addressing the lack of economically viable producer prices

primary sector.

Such an alternative policy to tackle the consequences of the financial crisis will require effective

Keynesian policies in the form of increased public expenditure at the rural and urban

infrastructure. To sum up we can say that the global financial recession which started off as a a

sub-prime crisis of USA has brought all nations including India into its fold. The GDP growth

rate which was around none percent over the last four year has slowed since the last quarter of

2008 owing to deceleration in employment export, import tax GDP ratio reduction in capital

inflows and significant outflows due to economic slowdown. The demand for bank credit is also

slackening despite comfortable liquidity in the system. Once calm and confidence are restore in

the global markets, economic activity in India will recover sharply. Yet there will be a period of

painful adjustment which is inevitable.

2.3.1 STABILITY OF THE INDIAN ECONOMY

Thus the global financial crisis made a hit in the Indian economy. After severe uncertainties in

various sectors such as IT industry in India, Financial market in India, Non availability of global

funds and impact in the export business have given broader outlook to the impact of the global

financial crisis, starting from US and how it had en route to India. All the fields were discussed

with several insights on how the various industries have been affected by this economic

downturn, some had opportunities to grow and some were flattened, since the Indian economy is

one of the emerging economies in the world, which recorded to be the least affected by this

economic crunch. Even government faced a wide range a problems during this credit crunch. The

Indian Government and The Reserve Bank of India, worked collaboratively with consultation

and coordination, after initiating and implementing various processes, rules and acts, kept this

huge economic problem under control. Thus the global economic crisis is inevitable till the

economy of the developed, developing countries become stable and self-sustainable. The effects

of the economic downturn are a test to check the financial stabilities in market and regulations

across the global economy.

After watching so many positive points We Indians can ourselves that we are quite in a safer

place in comparison to many countries economy. To conclude lets hope for a stronger India by

rectifying all its economic weaknesses after this so called financial crunch. Hence, the growth of

the public sector and the narrow reliance on financial services for growth needs to change, with

manufacturing and exporters having particular attention paid to them. After watching so many

positive points We Indians can ourselves that we are quite in a safer place in comparison to many

developed countries economy.

To conclude, we are tempted to use a popular aphorism; the Chinese character for Crisis

represents two symbols Danger and Opportunity. The choice is ours.

2.3.2 CAPITAL INFLOWS

The surge in capital flows to developing countries in recent years is supply-driven and not

warranted by the financing needs in these countries. This supply-side driven surge of capital has

three kinds of effects:

(i) it results in a situation where financial decisions in these countries are increasingly made by

international firms seeking environments and pursuing strategies similar to that in their countries

of origin, necessitating fundamental changes in financial policies and regulatory structures;

(ii) it increases financial vulnerability in these countries resulting in periodic crisis that can have

damaging effects on the real economy; and

(iii) it leads to macroeconomic adjustments that reduce the fiscal and monetary autonomy of the

governments and the central banks in these countries, with potentially adverse consequences for

economic growth. If developing countries want to avoid such outcomes in the current

environment, the only option they have is that of adopting domestic policies that restrict the

volume and the nature of capital inflows into their economies.

2.3.3 MACROECONOMIC PERSPECTIVES

The present crisis situation is often compared to the Great Depression of the late 1920s and the

early 1930s. True, there are some similarities. However, there are also some basic differences.

The crisis has affected everyone at this time of globalization. Regardless of their political or

economic system, all nations have found themselves in the same boat. Thus, first time world is

facing truly global economic crisis. Around the world stock markets have fallen, large financial

institutions have collapsed or been bought out, and governments in even the wealthiest nations

have had to come up with rescue packages to bail out their financial systems. The cause of the

problem was located in the fundamental defect of the free market system regarding its capacity

to distinguish between enterprise and speculation and hence, in its tendency to become

dominated by speculators, interested not in the long-term yield assets but only in the short-term

appreciation in asset values. Weak and instable financial systems in some countries increased the

intensity of crisis. India which was insulted from the first round of the crisis partly owing to

sound macroeconomic management policies became vulnerable to the second round effects of

global crisis. The immediate effects were plummeting stock prices, loss of forex reserves,

deprecation of Indian rupee, outflow of foreign capital and a sharp tightening of domestic

liquidity. Later effects emerged from a slowdown in domestic demand and exports. However,

Indias banking system has been considerably less affected by the crisis than banking system in

US and Europe32. The single most important concern that Indian government needed to be

addressed in the crisis situation was the liquidity issue. The RBI had in its arsenal a variety

instruments to manage liquidity, viz., CRR, SLR, OMO, LAF, Refinance and MSS. Through the

judicious combination of all these instruments, the RBI was able to ensure more than adequate

liquidity in the system. At the same time it was also ensured that the growth in primary liquidity

was not excessive. The pressure on financial market has been eased, although there is some

evidence of an increase in the non-performing loans. However, the financial system has been

more risk averse. The decline in global fuel prices and other commodity prices has helped the

balance of payments and lowered the inflation level. This has created the space for monetary

easing as well as providing better scope for fiscal stimulus. The monetary and fiscal stimulus

package is expected to contain the downward slide in demand in 2009 while providing a good

basis for recovery in 2010. However, there are many examples of policy failures (structural and

macro-management) that contributed towards the pre-crisis slowdown and magnified the

negative impact of the slowdown. For example, the reason behind the slowdown in export

growth in the pre-crisis period seems to be largely policy related. Ignoring all economic logic

and international experiences, the government went in for large-scale liberalization of FIIs. This,

apart from inflating stock market bubble, let to a significant strengthening of Indian rupee and

posed a serious hurdle to the countrys export growth.

2.3.4 INDIA STILL REGULATED

Many lessons can be learned from the recent subprime crisis. Those lessons have not been

systematically addressed, perhaps because everyone has been busy with fighting the fire. This

is not a normal crisis period, and hence, no normal post crisis recovery was expected. The

financial wizards seem to remain overly optimistic that the crisis will be followed by a normal

economic recovery so that life can get back to normalcy. The US meltdown which shook the

world had little impact on India, because of Indias strong fundamental and less exposure of

Indian financial sector with the global financial market. Perhaps this has saved Indian economy

from being swayed over instantly. Unlike in US where capitalism rules, in India, market is

closely regulated by the SEBI, RBI and government.

2.3.4 THE HOUSING BUBBLE

The economic problems leading to the recession began with a housing price bubble in many

parts of the country and a coincident stock market bubble. These problems evolved into the

financial crisis. Following very large declines in the stock market in September and October,

2008, we fielded our first survey which we called the Financial Crisis survey because at that time

the news was dominated by the financial problems in the banking sector, the stock market bust,

and the housing market. Unemployment had been increasing but it was still at a relatively

modest 6.9%. Although we were not in the field to capture the immediate effects of the largest

part of the stock and housing declines, those prices did decline for a few more months following

our first survey, so we were able to observe at least some immediate effects. Even as prices in

the housing market stabilized and the stock market partially recovered, the unemployment rate

continued to increase, reaching 10.1% in October 2009. The financial crisis became the Great

Recession. Many people approaching retirement suffered substantial losses in their retirement

accounts: indeed in the November 2008 survey, 25% of respondents aged 50-59 reported they

had lost more than 35% of their retirement savings, and some of them locked in their losses prior

to the partial recovery in the stock market by selling out. Some persons retired unexpectedly

early because of unemployment, leading to a reduction of economic resources in retirement

which will be felt throughout their retirement years. Some younger workers who have suffered

unemployment will not reach their expected level of lifetime earnings and will have reduced

resources in retirement as well as during their working years. Spending has been approximately

constant since it reached its minimum in about November, 2009. Short-run expectations of stock

market gains and housing prices gains have recovered somewhat, yet are still rather pessimistic;

and, possibly more telling, longer-term expectations for those price increases have declined

substantially and have shown no signs of recovery. The implication is that long-run expectations

have become pessimistic relative to short-run expectations. Expectations about unemployment

have improved somewhat from their low point in May 2009 but they remain high: they predict

that about 18% of workers will experience unemployment over a 12 month period.

2.4 UNHAPPY IN THEIR OWN WAY

Tolstoy famously begins his classic novel Anna Karenina with Every happy family is alike, but

every unhappy family is unhappy in their own way. While each financial crisis no doubt is

distinct, they also share striking similarities, in the run-up of asset prices, in debt accumulation,

in growth patterns, and in current account deficits. The majority of historical crises are preceded

by financial liberalization, as documented in Kaminsky and Reinhart (1999). While in the case of

the United States, there has been no striking de jure liberalization, there certainly has been a de

facto liberalization. New unregulated, or lightly regulated, financial entities have come to play a

much larger role in the financial system, undoubtedly enhancing stability against some kinds of

shocks, but possibly increasing vulnerabilities against others. Technological progress has plowed

ahead, shaving the cost of transacting in financial markets and broadening the menu of

instruments. Perhaps the United States will prove a different kind of happy family. Despite many

superficial similarities to a typical crisis country, it may yet suffer a growth lapse comparable

only to the mildest cases. Perhaps this time will be different as so many argue. Nevertheless, the

quantitative and qualitative parallels in run-ups to earlier postwar industrialized-country financial

crises are worthy of note. Of course, inflation is lower and better anchored today worldwide, and

this may prove an important mitigating factor. The United States does not suffer the handicap of

a fixed exchange rate system. On the other hand, the apparent decline in U.S. productivity

growth and in housing prices does not provide a particularly favorable backdrop for withstanding

a credit contraction. Another parallel deserves mention. During the 1970s, the U.S. banking

system stood as an intermediary between oil-exporter surpluses and emerging market borrowers

in Latin America and elsewhere.

2.4.1 INDIAS GDP

The short-run outlook for the Indian economy is unclear. Real GDP growth has shown strong

signs of slipping. Even the most dynamic service sector has been facing a slowdown. Exports

and industrial growth are down as is credit off take.

The stimulus packages announced by the government and the Reserve bank of India have had

their desired effect. For example, the Indian auto industry, which was heading towards a decline

recorded positive growth of 0.71 per cent in total vehicle sales in fiscal 200809. In terms of

components of the auto industry domestic passenger car sales rose by 1.31 per cent to 1, 219,473

up from 1,203, 733 units in the previous year, similarly sales of two wheelers recorded positive

growth. There is widespread optimism that the services and manufacturing sector will also record

reasonable growth. The sharp fall in the rate of inflation has provided room for more aggressive

interest rate cuts by the Reserve Bank of India. Indias banking system remains robust, although

the burden of servicing the larger debt because of the stimulus packages will not be insignificant.

Furthermore, although equity markets have registered steep declines the wealth impact on

domestic residents is limited since a large number of Indians do not participate in equity markets.

Assuming that the global economy starts picking up in 200910, which it shows some signs of

doing, and provided developed countries do not resort to widespread protectionism, the Indian

economy should be in a good position to register a strong comeback. Given that the stimulus

packages have already imposed a significant fiscal burden, the new central government would

need to eschew undue populism, failing which high fiscal deficits could again restrict Indias

growth between potential as was the case in the mid to late 1990s. However, the chances of this

happening are lower now. The Indian economy has certainly grown in terms of sophistication

and depth since the 1990s. On balance, there is reason to be guardedly optimistic about the

Indian economy in the short run.

2.4.2 AFTERMATHS OF THE CRISIS

The likelihood of an economic slowdown in the world economy will mean a slowdown in

economic performance in most developing countries during 2009. The epicenter of the financial

crisis is in the US and EU, and this is also where the most substantial economic slowdown will

be experienced. Although developing countries will be affected in the form of lower growth,

higher unemployment and poverty, and changes in inequality, it has been argued in this paper

that there are many and various channels for the impact to affect countries differently, depending

on the extent to which they are vulnerable to particular channels. Smaller, highly indebted

countries significantly dependent on the US economy will be most severely affected. However,

many developing countries, from many in Africa to the large emerging markets of Brazil, China

and India, will continue to grow at relatively strong rates, cushioning the impact for others. The

financial crisis has occurred at a time when many developing economies have been enjoying

years of good growth, and this together with improved macroeconomic management (many

countries have learned important lessons during the previous financial crises) have resulted in

more robust economies in the developing world (there are, of course, exceptions). So this

analysis suggests a more optimistic prognosis of the current situation. It is unlikely to turn out to

be a crisis of the same magnitude as the great depression. Indeed, the US and EU countries have

introduced and will continue introduce appropriate countercyclical policies that will in all

likelihood reverse further declines in stock and housing prices, and that will boost investment

and growth. In line with this more optimistic prognosis, it may be possible for many individual

developing countries to manage the impact of the crisis through appropriate policy responses.

Just as fundamental as the need for appropriate short-term crisis management is the need for

developing countries to further their financial development. Despite progress over the past

decade, much remains to be done. This crisis has shown how important credit and risk-

management institutions are to economic growth, and it has shown how important appropriate

institutions (including appropriate regulation) are for the correct functioning of the financial

sector. It has also shown how important the international financial architecture, including

international cooperation, is for mitigating financial crisis.

CHAPTER 3: CONCLUSION

The study concludes that the financial crisis can be to an important extent attributed to failures

and weaknesses in corporate governance arrangements. When they were put to a test, corporate

governance routines did not serve their purpose to safeguard against excessive risk taking in a

number of financial services companies. A number of weaknesses have been apparent. The risk

management systems have failed in many cases due to corporate governance procedures rather

than the inadequacy of computer models alone. In other cases, boards had approved strategy but

then did not establish suitable metrics to monitor its implementation. Company disclosures about

foreseeable risk factors and about the systems in place for monitoring and managing risk have

also left a lot to be desired even though this is a key element of the Principles.

Accounting standards and regulatory requirements have also proved insufficient in some areas

leading the relevant standard setters to undertake a review. Last but not least, remuneration

systems have in a number of cases not been closely related to the strategy and risk appetite of the

company and its longer term interests.

The US meltdown which shook the world had little impact on India, because of Indias strong

fundamental and less exposure of Indian financial sector with the global financial market.

Perhaps this had saved the Indian economy from being swayed over instantly. Unlike in US

where capitalism dominates the market, in India, market is closely regulated by the SEBI, RBI

and government.

Top executives in the Wall Street walked away with their personal fortunes intact. The

executives had hand-picked their boards of directors, which handed out billions in bonuses after

the government bailout. The major banks grew in power and doubled anti-reform efforts.

Academic economists had for decades advocated for deregulation and helped shape U.S. policy.

They still opposed reform after the 2008 crisis. Many of these economists had conflicts of

interest, collecting sums as consultants to companies and other groups involved in the financial

crisis.

http://en.wikipedia.org/wiki/Board_of_directors

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