Let us make in-depth study of India’s response to financial crisis.
Monetary Policy Measures:
Our response to the global financial turmoil has been both monetary and fiscal. The RBI which for several months before has been increasing cash reserve ratio and interest rates to fight against inflation reversed its monetary policy from Oct. 2008.
The RBI took several steps to prevent fast depreciation of Indian rupee due to massive capital outflow by FIIs by selling billions of dollars in the foreign exchange market from its reserves. But for RBI intervention, the value of rupee would have gone much below Rs. 52 for a US dollar.
The problem raised by global financial crisis was diagnosed as the lack of liquidity in the money market which adversely affected the flow credit to industries. Therefore, to increase liquidity of the banking system, RBI cut cash reserve ratio (CRR) four times in 0ct.2008 to January 2009 by 400 basis points (i.e. by 4 percentage points) from 9 per cent to 5 per cent. With this the RBI infused liquidity of Rs. 1, 60,000 crores in the banking system.
Besides, RBI reduced statutory liquidity ratio (SLR) from 25 per cent to 24 which enabled banks to get Rs. 20,000 crores from RBI against Government securities for lending to mutual funds. Besides, RBI released Rs. 25,000 crores to the banks in connection with the farm waiver scheme of the Central Government. It may be noted further that banks can also borrow from RBI through repo window of liquidity adjustment facility (LAF) scheme of RBI.
Besides, unwinding of some market stabilisation scheme was also undertaken to increase liquidity with the banks. In this way about Rs. 2,00,000 crores had been infused into the domestic money market to alleviate the pressures brought on by deterioration in global financial environment. With infusion of this adequate liquidity in the system through various measures the banks could provide credit to the industries for financing working capital and fixed investment projects. This was expected to boost industrial growth which had slackened in the last few months.
However, it was felt that to fulfill the needs of credit of the companies, mere infusion of more liquidity was not enough unless the lending rates of banks were lowered to reduce the cost of borrowing. To achieve this, repo rate – the rate at which banks borrow from RBI for a short time and used as a policy signal – was cut five times by 4 percentage point from 9 per cent to 5 per cent in Oct. 2008.
As a result of this various Indian banks (including SBI) reduced their prime lending rate (PLR) to around 12 to 12.5 per cent. With this banks lower their lending rates so that cost of borrowing from the banks fell and more credit was created for investment by the companies and there was more demand for durable consumer goods such as houses, cars etc.
Besides, RBI cut reverse repo rate, which is the overnight rate of interest at which banks park their surplus funds with the RBI to 4 per cent. This was meant to encourage banks to give credit to business enterprises for investment and to consumers for buying houses, cars etc. rather than keeping surplus liquid funds with RBI.
However, reports from banks (in March 2009) revealed that though liquidity had eased in the system and banks had lowered their lending rates but credit to industries did not pick up to the extent it was expected to happen. As a result, most banks were sitting on surplus cash. This showed due to global meltdown and its adverse effects on various sectors of the Indian economy banks became risk averse and were not willing to lend for fear of defaults by the borrowers.
Besides easy monetary policy it was emphasized that a fiscal stimulus to overcome recession and slowdown in economic growth was needed. This fiscal stimulus is in keeping with Keynesian macroeconomics as Keynes emphasized increase in government expenditure to get rid of depression in the nineteen thirties. To keep growth momentum and to ensure 7 per cent growth rate in 2008-09 the Indian Government came out with three fiscal stimulus packages which involved increase in Government expenditure and cut in indirect taxes to boost both consumption demand and investment demand.
The first fiscal stimulus package announced on Dec. 6, 2008 involved increase in Government expenditure by Rs. 30,700 crore. This increase in Government expenditure was meant to help growth of infrastructure, textiles (which is a major employer of labour force) exports, housing, automobiles, and small and medium enterprises.
An important measure in the first fiscal stimulus package was all-round cut in excise duty (CENVAT) to raise the demand for goods and services. This 4% cut in excise duty was estimated to result in revenue loss of Rs. 8700 crore to the Government.
Further, to counter the slump in exports due to global financial crisis, the first fiscal package provided for subsidizing interest costs of exporters. It was hoped that lower interest costs of exporters would make the Indian exports more competitive. In order to give further boost to the exports, an additional fund of Rs. 1100 crore had also been provided to ensure full refund of duties including service tea paid on inputs.
In the first week of January 2009, it was felt that global recessionary conditions were still very strong which would adversely after growth of the Indian economy, the second fiscal stimulus package was announced on Jan. 2,2009. While the first fiscal stimulus package focused on direct increase in Government expenditure the second fiscal stimulus package sought to improve or facilitate supply of finance to some organizations.
For thus purpose in this second package to increase expenditure on infrastructure was sought by providing finance to non-banking finance Companies (NBFCs) dealing exclusively with infrastructure finance. For this purpose the public sector company Indian Infrastructure Finance Company (IIFC) was allowed to borrow Rs. 30,000 crore from the market by issuing tax-free bonds that would be used to assist in funding of projects worth Rs. 75000 crore.
Secondly, a higher depreciation rate of 50 per cent for Commercial Vehicles (CVs) like trucks, buses and vans bought in the period, January-March 2009 was allowed. Besides, an extra line of credit to non-banking financial companies (NBFCs) for purchase of CVs and assistance by it for purchase of buses for urban transport system under governmental urban renewal scheme. All these steps were expected to boost demand for CVs which had been badly hit by economic slowdown.
Further measures taken in this second stimulus package related to providing an indirect push to realty and infrastructure sectors by removing exemption from countervailing duties (CVDs) along with special CVDs for steel and cement, the two important inputs for real estate and infrastructure sectors.
Besides, in order to ensure that Indian corporate sector get cheaper funds from abroad, in the second stimulus package the government increased the limit on investment by foreign institutional investors (FIIs) in rupee denominated corporate bonds issued by the Indian companies from $8 billion to $15 billion. It was hoped that the above measures in the second fiscal stimulus package would result in additional credit supply of Rs. 56000 crore.
The Third Fiscal Stimulus Package:
In this third package announced on Jan. 24, 2009 the government sought to boost demand by cutting central excise duty, service tax and customs duty. This was estimated to cost the exchequer Rs. 29,100 crores.
The measures announced in this fiscal stimulus were:
1. Central excise duty was slashed further by 2 per cent from 10 per cent to 8 per cent. Along with this the earlier 4% cut in central excise duty announced in Dec. 2008 was extended beyond March 31, 2009. It was expected that if this cut in excise duty was actually passed on to the consumers by manufacturers, this would lead to the reduction in prices and therefore stimulate demand for goods.
2. As a further measure to boost demand, service tax was also cut across the board by 2 percentage point from 12 per cent to 10 per cent.
3. To provide relief to the power sector naptha imported for generation of electricity was fully exempted from basic customs duty beyond March 2009.
The above fiscal stimulus packages were bound to increase domestic demand in the economy and helped in achieving 6.8 per cent rate of growth of the Indian economy in the fiscal year 2008-09 and 8 per cent in 2009-10 and 8.6 per cent in 2010-11. This was also expected to help in generating more employment opportunities and thereby prevent the problem of unemployment from getting more worse. Due to fiscal stimulus it was expected that fiscal deficit to rise to more than 6 per cent of GDP.
However, in times of recessionary conditions, the higher fiscal deficit is an appropriate counter-cyclical policy. It is worth noting that increase in Government expenditure causes increase in aggregate income not only equal to the amount by which it is increased but has also a multiplier effect.
The manifold increase in aggregate income or GDP, as a result of increase in Government expenditure is called Government expenditure multiplier which plays an important role in expansion in national income in an economy when productive capacity is not fully utilised due to deficiency of aggregate demand.
Recovery of the Indian Economy:
From the slowdown caused by global financial crisis Indian economy recovered in the second- half of the year 2009-10 as a result of Government’s fiscal stimulus measures and accommodative expansionary monetary policy of the RBI. The Indian economy recovered from the crisis first due to increase in Government expenditure under fiscal stimulus and later due to pick-up in private consumption and investment demand as a result of multiplier effect of increase in Government expenditure, especially incurred on infrastructure projects.
The growth of GDP which had reached over 9 per cent for three successive years prior to the crisis dipped to 6.7 per cent in 2008-09 but again rose to 8.6 per cent in the year 2009-10 and to 9.3% in 2010-11. However, due to slowdown in the US and other developed countries, lower growth of agriculture due to weak monsoon and European debt crisis India’s growth will fell to 6.2 per cent or in 2011-12.
The growth of industry which had fallen to 3.7 per cent in 2008-09 rose to 8 per cent in 2009-10 and 2010-11 but again fell to 7 per cent in 2011-12. Agriculture after registering a very low growth of 1.6% in 2008-09 and 0.4 per cent in 2009- 10 achieved a high growth of 6.6 per cent in 2010-11. The lower growth of agriculture in 2008-09 and 2009-10 caused high food inflation in India in 2009-10 with which India is still persisting.
Exports and Foreign Investment:
India’s exports also revived in 2009-10. Exports which slipped into negative territory in Oct. 2008 due to global economic slowdown and a resulting fall in demand came out of the red after 13 months in November 2009. Since then every month the growth of our exports has been positive. Our exports during 2009-10 was around $ 182.2 billion as against exports worth $ 189 billion in the previous fiscal year. But for the recovery of our exports since Nov. 2009, decline in our exports during 2009-10 would have been much higher.
During 2010-11 our exports recorded on an average 29.5 per cent growth (in US $) year-on-year basis which is quite impressive. This growth in our exports in 2010-11 was helped by global recovery real GDP growth rate in 2010.
Besides exports, foreign capital inflows (both portfolio investment and foreign direct investment, FDI) revived during 2009-10. It is because of portfolio capital inflows during 2009-10, that Indian rupee appreciated to around Rs. 44 per US $ and BSE Index shot up to around 20,000 mark in September 2010. Though in May 2010, due to Greek debt crisis FIIs got panicky and started selling their shares in the Indian stock market and repatriating dollars to the US. However, after a few months, Capital inflows by FII again started coming.
Global investors are getting better returns from India. Therefore, foreign direct investment inflows (FDI) into India in the year 2009-10 are estimated to be around $ 25.8 billion against $ 27.3 billion in the previous year 2008-09. In a globalized world, a congenial global economic environment and a sustainable balance of payments position are critical for achieving the policy goal of sustained growth of 9% per annum in India.
The global recession in 2007-09 operated as a dampener on the prospects of a faster growth. Besides the conventional channels of trade and capital flows for transmission of external shocks to India’s real economy, the uncertainty about global recovery continued to affect business confidence and market sentiments, which indirectly affected domestic private consumption and investment demand.
India’s high degree of resilience and capacity to manage a severe external shock was evident from the strength and pace of recovery in GDP growth rate after 2007-08. India’s growth rate fell to 6.7 per cent in 2008-09 but it recovered to 8.6 per cent growth in GDP in 2009-10 and 9.3 per cent in 2010-11. However, due to slow recovery in the US and Eurozone crisis in 2010, 2011 and 2012, India GDP growth rate fell to 6.2 per cent in 2011-12 and to 5 per cent in 2012-13.