1. Introduction:

In market economies, financial crises periodically appear. If such crises are not combated or if they go deeper, it may cause huge embarrassment to the policymakers to offer easy policy prescriptions.

In fact, no easy solution is available to periodic crisis like recession or depression in capitalist economics. In fact, the search for correctives still continues.

The Great Depression of 1930s brought in Keynes’ fiscal policy measures in the limelight, as opposed to the classical monetary policy measures.

Since monetary policy could not prevent the downhill of the global economy in the 1930s, fiscal policy used at that time relieved the entire world largely.


But crises reappeared in the US economy in 1998, although its ferocity was not compa­rable at the moment with the 1930s’ Depres­sion. Anyway, the US economy experienced another economic turmoil in 2007-08—the big­gest since 1929. The US financial crises sent shockwaves to the different financial centres all around the globe, causing disappointment in the functioning of the capitalist market economies.

Meanwhile, this turmoil has now already assumed a bigger proportion as its impacts are now being felt greatly not only in the economies of the USA, Europe, and other major capitalist countries, but also poor de­veloping countries of Asia and Africa. Any economic crisis originating in any part of the globe travels to the other parts, as the global economy today is more well-knit and inte­grated.

It is observed that market fundamen­tals are at fault—most of the world economies are heading towards disaster. In other words, as usual, historically, today’s financial crisis in the capitalistic market economy has been caused by the excess liquidity growth.

In this sense, the current financial mayhem is not dif­ferent from that of the past. The Indian economy—being an integral part of the glo­bal competitive economy—could not remain insulated from this economic chaos emanat­ing from credit liquidity crunch.

2. From Inflation to Re­cession in India in 2008:

Actually speaking, recessionary tendencies developing during the mid-2008 in India had been categorically poohpoohed by the policymakers arguing that the ‘economic fun­damentals of the country were right’. In fact, the situation at that time was not one of opti­mism. First, inflation (largely caused by the global unprecedented rise in the prices of pe­troleum products and foodgrains) re-hit the Indian economy in August 2008 when it soared to a height of 12.91 p.c.—a record price increase almost after 15 years.


To minimise the impacts of inflation on general masses, the Reserve Bank of India turned on a slew of monetary policy measures. By the end-Janu­ary 2009, it is evident that inflation is no longer any concern. In fact, economic cataclysm in the form of recession was showing its ugly head during September-October 2008.

Such recession caused the SENSEX to climb down to a record level of less than 10,000 marks, as contrasted to 21,000 just in the month of June- July 2008. Indian people heard recessionary ring-bells tolling a dirge! In fact, because of low aggregate demand following recessionary trends, inflation has come under control now.

Meanwhile, a second incident coupled with the global recession made all economic calculations topsyturvy. Under its impact, every thing—both inflation and recession— went behind the curtain. This is the 26/11 in­cident—the terror attack in Mumbai. This in­cident gave some sort of breathing space to the policy mandarins to put the issue of reces­sion at the flipside for at least 10-15 days. But now the issue of recession has again come to the front.


The financial mayhem—the incident of bank failures, terrific job-cuts in automo­bile industry mainly, sagging exports, etc., in the USA continues without any brake. Ex­perts apprehend that the US economy may languish in importance and in terms of global power her position may not be unassailable, if the present trend is not arrested soon. India is no less in a better position; if the present trend is any guide. Let us hope that, in terms of global spread and impacts on the global economy, the present holocaust will not be comparable to the Great Depression of 1929- 33—at least in India.

3. Search for Causes of Recession in the USA:

It has been said that the excess liquidity growth caused by recent financial innovations like securitisation of mortgages set the ball rolling to a downward journey. To be more specific, a sub-set of crises emerged from the excess liquidity crisis. In the USA, it came to the notice when the realty sector zoomed up much higher than anticipated—because of improperly secured loans by banks.

(i) Sub-prime Crisis?

It is said that the current financial chaos in the US economy is largely caused by sub-prime mortgage loans. Such loans are indeed risky as these are given to people whose credit-worthiness is always of dubious nature. According to the banking standards, these people are not worthy of getting loans. Banks hesitate in giving loans to the defaulting customers.

Meanwhile, the culture of consumerism developed over the years spurred the financial institutions to provide loans with higher risk higher the risk greater the profit. The banks and other institutions started giving loans at a certain rate of interest to another one who divided huge loan into smaller ones and gave them as housing loans at a still higher interest rate. This higher interest rate is called the sub-prime rate.

This sub-prime home loan market bubble in the USA exposed the pervasive weaknesses in the financial deregulation and the global financial system in a reckless manner. Sub- prime crisis caused by defaulting mortgage payments in housing loans sanctioned but not based on any prudential norms did the early damage in the USA.

In fact, such defaulting payments have had cascading effects on the financial system and the real economy causing the GDP to decline and unemployment to rise, incidence in the rise of bankruptcy of banking institutions, and so on. The final effect was felt on the stock market when it crashed. The US Government came out with a bail out package. But by the end of January 2009, the US economy is really in doldrums.

The US GDP shrunk by 0.5 p.c. in the third quarter of the year 2008 the biggest fall since 2001. Spending on non-durable goods say food and clothing declined by 6.4 p.c. in the third quarter of 2008 the largest drop since 1950. Nearly 2.6 million US people lost their jobs in 2008 the worst since the termination of the World War II.

The slowdown in the US economy has, of course, spillover effects on the other economies of the world, including India. Impacts of US recession on other economies of the globe are being felt now— since the global economy is shrinking due to interlinked interdependent problems originating in the financial markets. Confidence in global credit markets is really at stake. A kind of recession-deflation vicious cycle is operating.

(ii) Is India Trapped in Recession?

The clouds of the global recession loom large in the skies of India. There is a strong evidence that the GDP growth rate in 2008-09 is ex­pected to grow around 7 p.c. a lower one than what had been projected earlier. How­ever, this is just the forecast based on the cur­rent trends.


If current trends deteriorate fur­ther, the GDP growth would slip down even to a lower level. Industrial activity including the automobile industry, infrastructure sec­tors, service sectors, tourism, banking and other financial services, etc., are all showing signs of deceleration. In fact, the decline of the service sector—prime growth engine in the current decade particularly housing con­struction (realty sector), transport and com­munications, hotels and restaurants, etc., is a great source of anxiety. Export trade has suf­fered a decline after a lapse of seven years. Stock prices tumbled to less than 9000 mark.

Although banking crisis did not come to the surface on a grand scale because of State-banking in the banking industry, the financial in­stitutions have been experiencing severe li­quidity crisis. Employment situation in export- oriented industries (consequent upon the slump in the export market), IT sector (caused by a decline in the outsourcing business), and realty sector is really grim. The current global economic downturn has impacted India lnc’s investment with promoters shelving 420 projects worth more than Rs. 2,09,000 crore in 2008.

On the positive side, inflation has been greatly eased by the end of January 2009. Most important reason is the dramatic decline in the global oil prices in January 2009 to $35 per barrel as against $140 per barrel about six months ago. Although this has been moderating inflation in India, low oil prices failed to stimulate aggregate demand to help to combat recessionary tendencies all over the globe. Thus the problem of recession lies elsewhere.

4. Monetary-Fiscal Policy Measures:

It is argued that between the two—inflation and recession—recession is more dangerous than inflation. Above all, the market cannot be left to itself to correct the current malaise— the economic meltdown. Thus, what is needed is the serious and strong intervention on the part of the monetary authority as well as the government. That is to say, both monetary policy and the fiscal policy are required to be employed so that further downhill of the economy can be arrested.


Anyway, since mid-September 2008, the RBI has been devising its monetary policy measures to inject additional liquidity in the economy so as to enable banks to lend money for productive purposes and priority areas without injuring the quality of lending.

In fact, before December 2008, interventions and rescue plans to arrest the current financial mayhem in India are mostly monetary policy instruments. RBI has so far made four rounds of rate cuts of CRR, repo rate, and reverse reporate through which almost Rs. 60,000 crore have been injected—called ‘helicopter money’ by Milton Friedman as an emergency distribution of finance—since the global crisis deepened in September 2008 consequent upon the collapse of the various financial institutions in the USA led by Lehman Brothers.

As on 20 January 2009, CRR stands at 5 p.c., repo rate 5.5 p.c., and reverse repo rate 4 p.c., So far, it has released Rs. 3,20,000 crore into the system and thus signalling a soft interest rate regime. The RBI has been providing liquidity support to the various financial institutions so that retail and corporate borrowers, micro and small enterprises, realty sector, exporters do not experience credit crunch. Loan to the realty sector is being considered as the ‘priority sector’.

However, whether such injection of additional credit will ultimately boost aggregate demand for credit depends how far the commercial banks respond to the rate cuts by lowering their own lending rates and borrowers perceive a favourable investment climate in the economy.

Fiscal Policy Measures:


As monetary policy measures of the RBI could not stimulate aggregate demand as it desired, a fiscal stimulus was provided by the Government in 7 December 2008. Fiscal Stimulus I package cost the Government to the extent of Rs. 31,000 crore, four percentage point cut in excise duty and an additional plan spending of Rs. 20,000 crore.

Indian Infrastructure Finance Company Limited (IIFCL)—acting as refinancier for loans to the core sector—has been asked to borrow Rs. 30,000 crore by issuing tax-free bonds. It is hoped that such will enable infra­structure financing of Rs. 7,50,000 crore in the coming months. The expansion of infrastruc­ture investment in the Public-Private partici­pation area is an important part of the effort to mount a countercyclical thrust.

Fiscal Stimulus II package, announced in 2 January 2009, is expected to provide an ad­ditional fund of Rs. 20,000 crore in a variety of ways: removal of interest ceilings on Exter­nal Commercial Borrowings (ECBs), allowing realty companies to use ECBs to develop inte­grated townships, creation of a Special Pur­pose Vehicle (SPV) to provide more funds (Rs. 25,000 crore) against investment grade papers to non-banking financial companies (NBFIs), enabling State Governments to borrow an additional sum of Rs. 30,000 crore from the market.

In addition, the Government has restored the Duty Entitlement Pass Book (DEPB) scheme at pre November 2008 levels so that exporters can claim a higher amount of tax paid on imports used to make export prod­ucts. The RBI intends to provide a credit of Rs. 5,000 crore to EXIM Bank through which credit will flow to the exporters.

The credit target of public sector banks has been hiked to meet the credit needs of the economy. The Government has also decided to offer sops not only to the exporters but also to the small scale sector, besides raising the level of production for cement and steel sectors a tad.

It has drawn up schemes to incentivise purchase of com­mercial vehicles. Because of gloom in indus­trial activity and hence slower growth of in­dustrial output and the resultant low tax re­ceipts, the Government will have to forego ap­proximately Rs. 40,000 crore during this fiscal year.

5. Conclusion:


Whether and how far the present monetary and fiscal policy stimulus will help in stabilising the economy is to be seen in the months ahead. Further, exporters are unhappy about the quantum of fiscal stimulus—since such is inadequate to stimulate demand enough. Further, all the commitments made by the Government are not always obliged.

Above all, banks are now experiencing surplus funds instead of liquidity crunch following the liquidity infusions to the extent of Rs. 3-lakh crore into the system. But the low demand or few takers of credit seems to be causing supply-side issues to lenders. Anyway, the success of policy measures largely depends on a variety of factors, and, most importantly, the global condition.