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The Indian Economy In Time Of Crisis: An Analysis

In this exclusive The Golden Investor article Charmi Shah provides us with an analytic overview of Indian financial policy during crises. In this article Charmi Shah tries to analyze how India recovered from the global financial crisis and the steps that are being taken by the government to overcome the pandemic.

India, like other developing countries, was not impacted by the subprime crisis that originated in the United States. The subprime crisis did not affect India as it was not directly related to it. The direct exposure of Indian banks to global subprime assets was insignificant. India did not have direct exposure to the crisis, even though the effects had been felt through exchange rate channels, liquidity conditions and in the export sector. The other noteworthy impact was the slump in business and consumer confidence leading to decrease in investment and consumer demand. India had opened its economy in 1990’s making it vulnerable to global financial and economic crises. The major problem India tried to solve during the time of crisis was to maintain confidence in the market. The government had put tremendous efforts to improve human capital development in areas of primary education, research and development and healthcare.

2007-2008 – The Global Financial Crisis

There was a large capital inflow which peaked up in the early 2007, the Reserve Bank of India (RBI) had to sterilize the liquidity impact. The monetary conditions were tightened in early 2008 due to higher domestic demand and elevated global commodity prices, with higher policy rates. Looking at the domestic situation during the global financial crisis financial markets remained generally stable with conditions of abundant liquidity and interest rates moderated in almost all segments of the financial system. The public sector banks decreased their deposit rates, particularly at the upper end of the range for various maturities. Speaking of the global scenario, there was a sudden fall in credit market confidence in late July 2007 brought on by the spread of risks from exposure to the US sub-prime mortgages with credit crunch spreading into corporate bond markets and equity markets. Later the external environment changed during the Lehman failure. Indian banks were not directly exposed, but like other major Emerging Market Economy (EME), there were massive capital outflows by portfolio investors. There was humongous pressure in the foreign exchange market. A large part of foreign reserves of the RBI was lost as a result of this.

The Indian government, to boost the demand, had announced three focused stimulus packages, such as, reduction in taxes and stimulus to the export sector. The government had to raise public spending to boost the economy and control the fiscal deficit to avoid its ill effects. The revenue deficit escalated from 4.2% to 8.5%. Along with these were the issues of oil which shot up the fiscal deficit. The debt % of GDP in 2007-08 was 75.1. The deterioration in the fiscal position of the central and state governments had impacted public sector saving and investment.

To deal with the liquidity crunch the monetary stance underwent an brusque change in the second half of financial year 2008. The RBI responded to the emergent situation by facilitating monetary expansion through decreases in the Cash Reserve Ratio, Repo Rate and Reverse Repo Rates, and the statutory liquidity ratio. The Repo Rate was reduced by 400 basis points. It was done in five parts from 9.0 to 5.0 percent in early 2009. RBI tried to maintain adequate liquidity in the market to indemnify for financial outflows in the economy. Measures were taken to avoid the penetration of crisis in the banking system. The government tried to uplift the domestic demand by expanding the fiscal budget to compensate for the monetary tightening. These measures taken up by the government increased the expenditures considerably after the crisis.

Figure 1 - Current RBI Policy Rates
Figure 1 – Current RBI Policy Rates

The post crisis analysis of the trends in foreign direct investment flows at the global level as well as across regions/countries suggests that India had generally attracted higher FDI-flows which is in line with its robust domestic economic performance and gradual liberalization of the FDI policy as part of the cautious capital account liberalization process. Even during the global crisis, FDI-inflows to India did not show as much moderation as was the case at the global level as well as in other EME. However, when the global FDI-flows to Emerging Market Economies recovered during 2010-11, FDI-flows to India remained sluggish despite relatively better domestic economic performance ahead of global recovery. A study suggested that institutional factors, such as, policy uncertainty are causing the slowdown in FDI-inflows to India despite robustness of macroeconomic variables. Major EME showed that FDI was significantly influenced by openness, growth prospects, macroeconomic sustainability, labour costs and uncertainty in government policy.

The economic shock of the COVID-19 pandemic inevitably invites comparisons to the global financial crisis. If we compare the spread, both crisis have emerged from the most leading economies. The level of uncertainty is same. Concisely, the subprime crisis and Lehman brothers collapsing resulted in unpleasant international financial relationships and surge in uncertainty. Similar, is the situation today. The present situation has showed us India’s dependence for various products produced only in other countries. Financial institutions, under-capitalized banks were a stumbling block in 2008 whereas they could now be a solution to the problem. These crises are similar in certain respects but very different in others. Governments have again intervened with monetary and fiscal policy to counter the downturn and provide temporary income support to businesses and households, similar to 2008-09. But restrictions on movement and social distancing to slow the spread of the disease has directly affected labour supply, transport and travel in ways they were not during the financial crisis. Complete sectors are shut down, including hotels, restaurants, non-essential retail trade, tourism and significant shares of manufacturing. In the current scenario forecasting requires strong assumptions about the progress of the disease and a greater reliance on estimated rather than reported data.

2020 And Beyond – The COVID-19 Crisis

The first case of COVID-19 in India was reported at the end of January. The crisis later hit the Indian economy leading to the first lockdown at the end of March until today. Global economic activity has come to a near standstill as COVID-19 related lockdowns and social distancing are imposed across a widening strip of affected countries. It has proved to be considerable human suffering and economic disruption. This pandemic has hit the Indian economy when the growth was at its lowest recorded numbers. This has taken the edge off investments. The economic growth projections for the financial year 2020-21 slumped to 0.8%, as shown by the FITCH ratings.

Due to the pandemic the unemployment has shot up to 27.1%, highest recorded. The migrant workers have lost their jobs as construction sites have been closed. The most vulnerable section are the daily wage earners followed by house help, tailors etc. These people are unable to afford necessities due to the lock down. As these migrant workers are back to their hinterlands it could be a major concern for the micro, small and medium sized enterprises. The Indian export sector would be impacted worse by the pandemic than the global financial crisis. It is observed that trade could be worse in sectors with complex value chains. The Indian economy comprises of a major problem of income inequality, which is worsening due to the pandemic. One percent of the Indian population holds more than 70% of wealth. All these issues together form a big threat to the Indian economy.

The government has come up with giant spending to solve the above problems due to the pandemic and has shown some resilience. Relief packages were announced post the first phase of lockdown for migrant workers, house helpers and people living below the poverty line. Three measures were taken in order to infuse liquidity in the system. The monetary policy committee has reduced the rates in the fourth quarter of 2019-2020. The repo-rate stands at 4.40% and the bank rate at 4.65%, rather high compared to western rates, but for India it is the lowest rate in almost a decade. The government has also announced an emergency healthcare package of Rs 15,000 crore specifically for individual protection equipment for medical personnel. A huge package of 20 Lakh Crore is announced for overall development and recovery of the economy from the pandemic. Consumers have also been nudged to buy local products. Due to the massive spending done by the Finance ministry the Indian government increased the petrol and diesel tax rates by 3 rupees to increase revenue, taking advantage of the sharp fall in crude oil prices.

Figure 2 - WTI Future Oil Prices
Figure 2 – WTI Future Oil Prices
Figure 3 - USD-Ruppee Exchange Rate
Figure 3 – USD-Ruppee Exchange Rate

The consumer behaviour post the outbreak can not be predicted. The expectations of consumer behaviour in the automobile sector is positive as preference for traveling by private transport would be greater than public transport. E-commerce sector is also expecting a massive increase in consumer shopping due to reduced willingness for physical shopping. Post-lockdown consumers would still be concerned about health and hygiene resulting in a gigantic change in supply chains as well as consumer behavior is expected In India.

Disclaimer: These comments on latest the Indian economy are of Charmi Shah personally. The comment is her personal opinion and thus does not necessarily reflect her employers opinion on the topic.

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