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Term Paper # 1. Introduction to Global Economic Crisis:
When the world economy crumbled in 1930, there was a clear writing on the wall that the market- based capitalistic economic system failed to work in the critical situations like recession and slump.
The over-enthusiastic advocates of market capitalism refused to learn that fundamental lesson and resurrected it again and again, sometimes in the garb of Brettonwoods system, sometimes in the form of the Reagan-Thatcher model that favoured finance over domestic manufacturing, and sometimes through the dispensations of the WTO.
The purpose here is not to debunk the market capitalism but to underline the fact that it is not always self-regulating and self-correcting. This system has certain rules of the game. When those rules do not apply, the system too becomes unworkable. The profit expectations were over-optimistic in 2007 such that the academic community failed largely to anticipate the impending disaster. They ignored the prophetic words of J.M. Keynes, “It is of the nature of the organised investment markets… that, when disillusion falls upon an over-optimistic and over-bought market, it should fall with a sudden and catastrophic force.”
Only Nouriel Roubini of New York University did make forecast about it on Sept. 7, 2006 before an audience of economists at the I.M.F. meet. He unraveled correctly the contours of the financial meltdown in the United States and its global repercussions.
A person laughed at him and dismissed his assertions as devoid of mathematical models and was labelled as Dr. Doom. By the fall of 2007, Roubini stood fully vindicated, when the U.S. economy was faced with sub-prime mortgage crisis, bankruptcies, fall in hedge funds, crash at stock markets, impeding housing bust and increasing unemployment. Both Federal Reserve System and the U.S. administration had started making panicky interventions in the economic system by that time.
Term Paper # 2. United States and Economic Crisis:
The economic recession is generally defined as two consecutive quarters of declining activities. The Business Cycle Dating Committee of the National Bureau of Economic Research in the U.S.A. specified its own criteria for the determination of downturn. It stated, a recession is a significant decline in economic activity spread across the economy lasting more than a few months, normally visible in production, employment, real income and other indicators upto mid-2007.
This problem was not anticipated as the economy grew at a 0.2 percent rate in the fourth quarter of that year followed by the rates of growth of 0.8 percent and 2.8 percent respectively in the first and second quarters of 2008, while in the third quarter of that year, the real GDP growth dropped by 0.5 percent, there was stunning contraction of real GDP at the rate of 0.3 percent in the fourth quarter of 2008. It was then declared officially that the United States had entered into recession in December 2007.
The deepening of economic crisis in world’s largest economy was bound to have widespread repercussions upon the economies of all developed and developing countries of the world.
The most elementary question is what led to the global economic crisis first in the United States and subsequently in other countries of the world.
The causes of the economic meltdown in the U.S. economy were as under:
(i) The U.S. economy was confronted with sub-prime mortgage scandal in 2007-08. The FRS in the United States had kept the interest rates too low and for too long. The financial institutions bundled together goods, housing and other categories of loans. The rating agencies accorded high rating to these loan packages as they were being paid by those who were supposed to be rated by them. The packages of mortgages and other complex financial products were sold by one bank or financial institutions to another.
The house price bubble created by low interest got burst and the prices of housing units started declining. The depreciating values of the packages of mortgages made the banks to demand money back from their borrowers. This resulted in a severe liquidity and banking crisis. The U.S. administration had to offer bail-out packages to such financial giants as Bear Sterns, Freddie Mac and Fannie Mae. Then came the collapse of the three biggest financial players like Lehman Brothers Merrill Lynch and AIC.
The US economy received a stunning blow on June 1, 2009, when century-old giant automaker General Motors filed for bankruptcy. The relief of $ 20 billion provided by the administration to it could not help its revival. The collapse of this mighty firm employing 2, 44, 500 people worldwide and selling 8.35 million cars and trucks in about 140 countries was bound to have further grave effects on the U.S. economy.
The severity of the economic crisis was reflected by the fact that the United States witnessed 25 bank failures in 2008. Over the previous eight years (2000-08), 52 banks had collapsed. The financial meltdown continued unabated as 16 banks collapsed in the first two months of 2009. It was more than half of total bank collapses in 2008. The criticality of financial turmoil was evident because even the bail-out package of over 700 billion dollars adopted by the government had failed to stem the tide of financial collapse.
(ii) Another factor behind the recent crisis in the U.S. economy was the decline in domestic manufacturing. There was the predominance of manufacturing over finance in that country even upto 1960’s. But decline in American manufacturing saddled the economy not only with almost permanent negative balance of trade but also with a business community which was less and less concerned with the productive capacities in that country.
The globalisation of manufacturing left little room for the United States to revert to the levels of manufacturing that it was having in the good old days. The trend of decline in industrial output continued even after the largest economy of the world slid into recession in December 2007. In March 2009, the industrial output fell by 1.5 percent. It was nearly 13 percent below its level in March 2008 and it was the lowest since December 1998.
(iii) The retention of low rates of interest for creating investment stimulus resulted in the low rate of saving in the US economy. It meant that rest of the world came to hold a large part of capital in that country. As a consequence, the economy became more susceptible to the speculative international movements of capital. The keeping of interest rates too low for too long led to the housing bubble with all its consequences.
(iv) The collapse of a series of large financial institutions led to much speculative activity and excessive risk-taking in a frantic search for super profits at the Wall Street. Excessive selling activity in the stock market resulted in a crash and the Wall Street hit the levels below 8000 mark in November, 2008. Such a low level had not been seen since March 2003.
The worsening of the financial crisis in the United States economy during 2008-09 was on account of the following factors:
(i) The growth rate in the U.S. economy continued to plummet. In the third and fourth quarters of 2008, the real GDP in that country dropped 0.5 and 6.3 percent respectively. The staggering contraction in GDP was primarily due to negative contributions from exports, personal consumption expenditures and equipments and softwares among others. According to the Organisation for Economic Co-operation and Development (OECD), the United States economy was projected to shrink as much as 0.9 percent in 2009.
(ii) The financial meltdown was having serious adverse consequences due to the collapse of housing market, escalation of food and energy prices and the decline in industries like automobiles, steel, engineering, chemicals and many more. The ailing economy shed over 2.6 million jobs over the course of 2008, the most since 1945.
The job losses in November and December 2008 were of the order of 5.84 lakh and 5.24 lakh respectively. The rate of unemployment mounted to 7.2 percent in December 2008 which was the highest since January 1993. This jobs hemorrhage was likely to push up the unemployment rate from 9.0 to 9.5 percent in 2009 as the firms on a very wide front were engaged in lowering their cost structures through job reductions.
(iii) The increasing intensity of job losses resulted in cut in consumer spending in the United States at a rate which is, according to the Commerce Department Report, was the steepest in 28 years. Unless the support packages were directed to reverse the steep fall in consumer spending, the economy it was feared would remain sluggish.
(iv) The financial meltdown in the United States had continued despite the relief packages. Upto May 2009, there had been a collapse of 36 banks which was more than total bank collapses (25) in 2008 and was more than half of the total number of bank failures (68) in the previous nine years. This indicated that the severity of financial crisis could not be mitigated even by the close of May 2009.
The US financial companies were too big to fail and these failures would continue to generate tremors not only in the US economy but also in the other countries of world, unless effective regulatory mechanisms were put in place.
(v) The continued drift of the US economy was obvious on account of around fall in the investment activity. Owing to the fall in consumer spending, failure of banks, accumulation of excess capacity in several industrial sectors, decline in exports and failure of the revival of demand for housing units, the business confidence had been badly shattered despite lowest ever rates of interest as everyone was suspect in the eyes of others.
Even the mega relief package amounting to $ 7.8 trillion seemed inadequate to revive the investment demand. Investment worth $ 3 trillion was to be directed to buy stocks, corporate debts and mortgages.
An amount $ 3.1 trillion was meant for guaranteeing the corporate bonds, money market funds and money in specified deposit accounts. The liquidity crunch was still being felt by the investing companies. They were not yet ready to give their investment policies the benefit of doubt.
Although the US Fed had assured that it would print whatever notes would be required, yet the drift in investment continued. Even after the liquidity crunch was over, the companies still required some time to readjust their balance sheets and start improving their profit-loss situation.
It indicated that the downturn would persist through 2009 and further. Four out of every five investors believed that the United States as well as the other developed countries would continue to be gripped by the recession even beyond 2009. The investors remained embedded in a defensive asset allocation mindset. There was impending fear of deflation that perhaps kept them on the sideline.
(vi) The revival of demand in the US economy was not in sight on account of deteriorating conditions related to exports. The contraction of domestic manufacturing sectors, increasing excess capacities in industries, the declining overseas demand and appreciation of dollar had caused a collapse in the US exports. The growing protectionist tendencies in the US economy were likely to reduce demand for imports from abroad and the resultant contraction also in the US exports.
(vii) Another factor leading to worsening of economic crisis had been the strengthening of the US dollar since September 2008 along with other principal currencies. It resulted in a decline in US exports and inflows of capital from abroad which was being employed essentially for restructuring of assets of the weakening financial institutions.
(viii) In the prevailing bleak situation only possible engine of growth seemed to be the increased volumes of federal and local government spending. Once the stimulus packages would get expended, the federal deficits would shrink and even that engine of growth would slow down. Only hope for recovery in that eventuality, according to Christina Romer, would rest on export growth.
The countries of Europe, Japan, China, India and several other countries would also strive to step up their exports. It is impossible for all the big economies to improve their trade balance simultaneously. They are bound to resort to import restraints, dumping of products and manipulation of exchange rates. The world would witness a high degree of volatility in trade and financial flows, uncertainty and speculation.
In view of the conditions existing in the US economy at present, it is too early to congratulate the over-optimistic Fed experts for banishing the crisis through their scholarly prescriptions. The crisis is likely to remain with the US economy even beyond 2010.
Term Paper # 3. Economic Crisis and Other Countries:
The financial meltdown started in the United States in 2007. It soon took Britain into its fold. Thereafter, it engulfed the countries of European Union, Japan and emerging economies in Asia, Africa and Latin America.
The global sweep of the recession was described by Strauss-Kahn, the managing director of the IMF in these words, “Continued deleveraging by world financial institutions combined with a collapse in consumer demand and business confidence is depressing domestic demand across the globe, while world trade is falling at an alarming rate and commodity prices have tumbled.”
The depressing economic conditions in different parts of the globe and policy prescriptions applied by various countries to grapple with that crisis are discussed below:
Like the United States, the financial meltdown started in 2007, was not anticipated even by the British economists. The recession befell the British economy almost as early as the United States got engulfed into it. The meltdown in Britain too was precipitated by weakening of financial institutions, serious instability in equity market and crash of prices of housing units.
The data continued to get worse as the government revenues plunged, exports dwindled down and unemployment continued to mount up. In March 2009, the retail price index saw a negative growth of 0.4 percent. It was evident that Britain had slipped into deflation for the first time in nearly 50 years.
It was estimated by OECD that the British economy would contract by 3.7 percent which would be the worst since 1931. According to a private think tank, the number of jobless workers would exceed 3 million by the end of 2010. In order to grapple with the crisis, Britain announced £ 20 billion fiscal boost including a 2.5 point cut in the value added tax. In order to encourage a large credit flow, the policy of low interest rates was initiated. In February 2009, the Bank of England slashed its base rate to the lowest level of 1.0 percent.
This was the lowest level since the creation of Bank of England in 1694. Evidently, there was the element of desperation in that action. Having realized, like the United States, that initial rescue package did not work, Britain announced in January 2009 a second rescue plan which involved a cost of £ 100 billion or more. It included measures like raising the stake of the government in the Royal Bank of Scotland from 58 percent to 77 percent and provision of government insurance against big losses on toxic assets of the banks. The British Prime
Minister and some academicians held the view that the British economy would not be as badly damaged as the US economy and that its recovery would be faster. It was, in their opinion, on account of two reasons. First, there was depreciation of pound sterling particularly against Euro. It had provided a powerful reflationary effect, as it did back in the early 1990’s. Moreover, British exports were more competitive and there was also a growing evidence of import substitution.
The weakness of pound made some companies to repatriate services and operations which had been off-shored. Second, after the seriousness of the financial crisis and economic downturn was realized, the Treasury and the Bank of England moved much more aggressively than their European counterparts to deal with the situation. The interest rates had been reduced close to zero and there was also an aggressive expansion of money supply through quantitative measures. The IMF was, however, in disagreement with British optimism.
It maintained that the British economy, heavily dependent upon the ravaged financial sector, could be the worst hit in the industrialised world, shrinking by 2.8 percent in 2009.
According to OECD, the soaring deficit of Britain would hamstring the potential for a further boost unless a ‘credible’ framework for restoring public finances was set out. It said, “The room for additional fiscal maneuvers to respond to worse-than-expected development activity is, therefore, limited and new measures would need to be accompanied by detailed and credible fiscal consolidation plans, in order to ensure that confidence is not eroded.”
(ii) Euro-Zone Countries:
The European Union is comprised of a block of 28 nations. Out of them, the economies of 19 countries that share the common currency ‘Euro’ are called the Euro-zone countries. The 19 Euro-zone countries include Germany, Italy, France, the Netherlands, Belgium, Austria, Luxembourg, Portugal, Spain, Greece, Finland, Cyprus, Ireland, Malta, Slovakia and Slovenia etc.
Although the blame for global recession was put upon the USA and Britain, yet despite the claim of relatively greater financial stability in the Euro-zone, that region too slipped into the state of recession. During July-September period in 2008, the region’s economy contracted by 0.2 percent. In the third quarter, the economies of Germany and Italy shrank by 0.5 percent whereas decline was 0.4 percent for both the countries in the second quarter.
The economy of Spain, which was the fourth largest Euro-zone economy contracted by 0.2 percent. In the fourth quarter of 2008, the growth rates were 1.6 percent in the Euro area and -1.5 percent in the European Union. The Euro state said in a statement that the GDP in the 19 nation Euro-zone and the European Union’s shrank by 2.5 percent in the first three months of 2009. Among the Euro-zone countries, the German economy contracted at a staggering pace of 3.8 percent in this quarter on account of a sharp decline in exports.
According to the Organisation for Economic Co-operation and Development, the growth in the European Union Nations was expected to contract in 2009 by 0.4 percent. Out of them, 19 countries would have negative growth. In a report OECD said, “Projections point to a protracted downturn, with GDP likely to decline by a third of a percent in 2009, but the uncertainties are large. That goes not least for the depth and duration of the financial crisis, the prime driver of the downturn.”
It was clear that the European Union and Euro- zone countries were both in deep recession. That brought up the issue of how they planned to get out of this critical situation. The European Central Bank (ECB) applied a cut of 75 basis points on interest rates in December 2008. This move took the ECB’s main refinancing rate to 2.5 percent, its lowest level in nearly 2 and half years.
It was the third cut in barely two months amidst signs that the financial crisis was hitting hard into the real economy. The ECB also cut the rates on its overnight facilities by 75 basis points.
Funds borrowed from its marginal lending facility would now attract an interest rate of 3 percent and over-night deposits would pay 2 percent. Compared with countries like the USA, Britain and Sweden, the move of ECB was much more cautious.
It was because there were significant practical difficulties in following the lead set by the US Federal Reserve- System and the Bank of England. If the ECB were to embark upon a similar programme of asset purchases, it was to be faced with a difficult choice of which government bonds would it buy and in what measure.
If it were to buy the corporate debt, of which country, of which industry and of which companies should they be. Another problem was who would underwrite the credit risk. If the governments were involved, that might be in violation of the ECB’s jealously guarded principle of autonomy. The cautious approach of the ECB in cutting interest rates was also due to its reluctance to expand the supply of money which might result in inflationary conditions.
In order to stimulate the economies of European countries, the European Commission called for “timely, temporary and targeted” action. Apart from a stimulus package of £ 16 billion announced by Britain, the Commission called for a co-ordinated fiscal stimulus package worth E 200 billion (£ 170 billion) which was 1.5 percent of the GDP of Europe, made up of increase in public spending and tax cuts to shore up the confidence among consumers and business enterprises.
However, the fiscal packages subsequently announced by the leading countries of Euro-zone fell far short of the target proposed by the European Commission. The stimulus package announced by Germany was worth only E 12 billion. In case of France, it was E 26 billion.
The stimulus packages announced by Spain and Italy were of the worth of E 40 billion and E 80 billion respectively. The response of the United States, Europe and other regions of the world had been fundamentally on the lines of Keynesian prescriptions for the revival of demand. In that connection Sean O’Grady observed, “Even John Maynard Keynes himself, not an easy man to please, would have been impressed; a global implementation of the policies he prescribed three quarters of a century ago to avoid a slump.”
The second biggest global economy Japan slipped into recession in November 2008, Japan slided into its first recession for seven years in the third quarter of 2008, as financial crisis curbed demand for the Japanese exports. The GDP of the country contracted 0.1 percent in the third quarter. In the earlier quarter, there had been a 0.9 percent fall in the GDP.
With the announcement of recession, Japan’s Nikkei dropped on the average by nearly 7 percent, below the key technical level of 8000 points for the first time in three weeks. It was indeed, true that the Japanese economy didn’t have a severe exposure to the toxic debt that had brought the financial institutions in the USA and Britain to their knees and forced those countries into recession. The recessionary conditions in Japan got precipitated by a high degree of dependence of that country on exports.
As the demand from Japan’s trading partners like China and the USA declined, the economy came under severe strain. The last official experience of recession in Japan was in 2001 after the technology bubble burst in the United States in that year. The Japanese economy went into free fall as the country’s debt and real estate bubble burst. Japan had actually not really got over that situation, when it came under further pressures in 2008.
In the case of Japan it was predicted that there would be at least two more quarters of contraction. The IMF believed that the Japanese economy would fall by 0.2 percent in 2009. The whole situation looked to be pretty grim in Japan. In the words of Kaoru Yosana, the minister of economy of Japan, “We need to bear in mind that our economic conditions could worsen further as the US and European financial crisis deepens, worries of economic downturn heighten and stock and foreign exchange markets make big swings.”
Like the USA and Britain, Japan too opted to cut interest rates to simulate the expansion of credit flow through the system. The Bank of Japan brought down the key interest rate to 0.1 percent during the months of October and November of 2008. On December 2008, the Bank of Japan slashed the un-collaterised overnight call rate by 20 basis points to 0.1 percent from 0.3 percent, its second rate cut in two months.
The Bank of Japan also announced several steps with the aim of ensuring stability in financial markets as well as facilitating corporate financing through the appropriate money market operations.
It also decided to adopt measures for further facilitating corporate financing, including outright purchases of commercial papers in addition to actions related to outright purchases of Japanese government bonds. But low interest rates could do little good to the economy because of the failure of credit markets and banks to pass them in full. For boosting the economic system, the government had to adopt fiscal packages involving tax cuts and public spending.
The funds meant for recapitalising banks were, enhanced from two trillion yen to 12 trillion yen ($ 131.1 billion) and one trillion yen package for securing jobs. By December 2008, Tokyo had already announced a package of economic measures worth 27 trillion yen ($ 295 billion) which included 5 trillion yen in new spending payouts to families, tax breaks on mortgages and relief for small firms. Japan proposed to spend at least $ 100 billion more to help its economy through the global crisis. It was expected that Japan might spend at least 2 percent of its GDP.
No doubt, Japan had adopted a hefty stimulus package, allowing government spending to replace exports but, according to Mallaby, it could not sustain that policy because the magnitude of its national debt was astronomical.
In addition, the Japanese policy of near zero rates of interest and large fiscal packages came a bit late as the confidence had drained from the economy. During 2009, some hopeful signs appeared in the economy, yet the recovery is not likely to occur in a robust manner until there is revival of demand for Japanese exports particularly in the USA and Europe.
China’s economy is the third largest after the United States and Japan. Although China continues to keep a tight lid on the economic and social conditions in the country, yet the available accounts indicated that it too was faced with the worst financial and economic crisis in a century.
The growth rate of GDP of China was high at 11.9 percent in 2007. It slowed down to about 9 percent in 2008 and 8.5 percent in 2009. The IMF forecast was that the GDP growth rate in China would be just 6.7 percent over the next few years. The administration and party sources, however, persisted that 8 percent growth rate was the make-or-break threshold for holding down the rate of unemployment and to stave off the social unrest.
The collapse of overseas demand for textiles, toys, shoes and electronic goods had led to the shut-down of over 6.70 lakh small and medium sized enterprises. According to official estimates, about 20 million migrant workers had already lost jobs owing to the closure of export units, forcing many of them back to their rural homes.
The real estate’s market of China had been sagging. There had been slowing down of tax collections during the latter half of 2008. There had been dampening of investment with a decrease in the inflows of foreign capital. The consumer spending had also been on the decline.
It was evident that the global recession had afflicted very seriously the Chinese economy essentially because of severe slump in Chinese exports to many regions of the world. In order to tackle the crisis, China had adopted both monetary and fiscal measures. The package of policy measures was referred as “active” fiscal and “moderately active” monetary policies.
China announced its biggest interest rate cut in 11 years. The benchmark lending and deposit rates were cut by 108 basis points in November 2008. The People’s Bank of China also reduced reserve requirements by 1 percentage point in the case of big banks and by 2 percentage points in the case of smaller banks.
It was decided that commercial banks’ credit ceiling would be abolished to channel more lending to priority projects, rural areas, small enterprises, technical innovations and industrial rationalisation through mergers and acquisitions. It was specified that credit expansion must be rational and target the spheres that would promote and consolidate the expansion of consumer credit.
On November 10, 2008, China announced a bold stimulus package of 4 trillion Yuan (about $ 570 billion) to be spent over the next two years to finance programmes in 10 major areas including low-income housing, rural infrastructure, water, electricity, transportation, environment, technological innovations and disaster relief programme.
This stimulus package amounted to about one-sixth of China’s annual economic output. The fiscal policy measures included reduction in value added taxes that would cut industry’s costs by 120 billion Yuan and tax rebates for exports apart from several other tax initiatives. China could definitely afford massive fiscal stimulus in view of its huge foreign exchange reserves and large trade surpluses. It was supposed that higher social-welfare spending in public health, infrastructure and rural reform would stimulate private consumption.
The stimulus package announced by China was also intended to demonstrate its capability to contribute to global economic stability. It may yield political dividend to China as it hopes to be recognised as one of the major players in the power structure of international economic organisations like the World Bank and the IMF.
With the bold credit and fiscal initiatives, Chinese economy is expected to turn around by the last quarter of 2009 if, and that is a big if, that country becomes able to drive fast its export engine. Since all the countries like the USA, Britain, Germany, Japan and others will aim at boosting their exports, an intense economic war will be at hand. Since each one of them will try to jockey for advantage, they may start manipulating exchange rates and other measures.
The world, like the depression of 1930, still does not have rules for dealing with disputes that may arise out of such a conflict. It is too early to make any conjecture about the outcome of that struggle for boosting exports by the major trading countries of the world.
Term Paper # 4. Stimulus Packages of Economic Crisis in India:
The leading countries of the world had learnt an important lesson from the Great Depression of 1930’s that the conditions of recession or slump should be effectively dealt with through the demand- raising monetary and fiscal policies.
For tackling the recent global crisis, the rescue or relief packages announced by the governments across the world have crossed 10 trillion dollars which is equivalent to an amount nearly 10 times the total size of the Indian economy. The largest bailout plan of over $ 7 trillion was adopted by the United States. The Indian approach in this connection was of ‘doing too little and too late.’
1. Monetary Action:
By the mid-2008, it had become clear that the global economy, including that of India, had slipped into recession. The countries like the USA, European Union and Japan acted speedily and brought down the rates of interest to near even zero rates for stimulating the consumer spending and investment.
The RBI even then was keeping the interest rates high due to its pre-occupation with the spectre of inflation and for the consideration of foreign capital inflow. The industries and several other sectors even then were crying for low interest loans. In December 2008, the RBI lowered the interest rates with the object of increasing liquidity in the economic system.
The Repo rate, the interest rate charged by the RBI for lending to banks, was reduced from 7.5 percent to 6.5 percent. The reverse Repo rate, the rate at which RBI borrows funds from banks, was lowered from 6 percent to 5 percent. It was hoped that the commercial banks would lower their prime lending rates (PLR) and deposit rates. But the banks were slow in reducing their lending rates. They did not also cut down their deposit rates. The credit off take in the system remained low. It was not likely to make the desired impact on the recessionary conditions in the economy.
On January 2, 2009, RBI announced a further easing of money supply and structure of interest rates. The cash-reserve ratio was lowered by 0.5 percent to 5 percent. The repo and reverse repo rates were reduced by 100 basis points to 5.5 percent and 4 percent respectively. These measures were expected to release Rs. 20,000 crore into the banking system.
In view of the possibility of growing credit risk for banks owing to worsening economic conditions, the RBI observed that banks should “monitor their loan portfolio and take early action, including debt restructuring where warranted, to prevent the rise of bad debts down the road and safeguard the gains of the last several years in improving asset quality.”
It also stressed that banks should price the risk appropriately and sees that the quality enterprises continue to get the required fluids. In view of the system not responding to the earlier monetary steps taken by the RBI, the policy of further easing the rates was announced by it on April 21, 2009. The repo rate was cut by 25 basis points to 4.75 percent. The reverse repo rate was also lowered by 25 basis points to 3.25 percent.
The cash-reserve ratio was held unchanged at 5 percent. The bank rate was kept unchanged at 6 percent. The statutory liquidity ratio too was left unchanged at 24 percent. Despite the rate cutting by the RBI, the commercial banks seemed to be very cautious. They were slow to reduce the lending and deposit rates. It was on account of three reasons. First, banks were afraid that risk of repayment defaults had increased due to the economic slowdown.
Second, the government was expected to undertake massive borrowing programme and whatever additional liquidity was released through rate cuts was likely to be absorbed by the government borrowing programme. Three, banks were disinclined to cut the deposit rates. Industry and realty sector were not satisfied by the extent of rate reduction. They wanted the banking system to be more positive.
The RBI admitted that worst was not yet over. According to the RBI Governor, D. Subbarao, “While there are incipient signs of business confidence and consumer spending trying to gain toehold, rising unemployment, high inventories and financial stress weigh heavily on overall demand conditions.”
2. Fiscal Package:
In order to boost the economic system, the government came out with three stimulus and relief packages in December 2008, January 2009 and in February 2009.
On December 7, 2008, the government announced the fiscal relief and stimulus package for boosting up the sagging demand in sectors like housing, textiles, exports and infrastructure. An across-the-board cut on ad-valorem duty by 4 percent was permitted for encouraging additional spending. The additional relief of Rs. 1400 crore was provided to the textile sector towards the entire backlog of the technology upgradation fund (TUF).
In order to encourage exports, the government decided to provide an interest subvention of 2 percent upto March 2009 for the pre and post-shipment export credit for the labour-intensive exports such as textiles, marine products, leather and small and medium exports sector.
A provision of Rs. 350 crore additional funds was made by way of export incentives. A back up guarantee of Rs. 350 crore was assured to the Export Credit Guarantee Corporation (ECGC) for providing guarantee for exports to difficult markets and products. In some areas, the refund of service tax was permitted.
The government decided to seek authorisation for additional plan expenditure of Rs. 20,000 crores ($ 4 billion) in the year 2008-09. The total spending programme of the government upto March 2009 was expected to be of the order of Rs. 300,000 crore. This fiscal package made the provision that India Infrastructure Finance Company would raise Rs. 10,000 crores through tax free bonds by March 2009.
The government departments were allowed to take up the replacement of the government vehicles to assist the automobile sector. The government decided to lift the import duty on Naptha for use in the power sector. For assisting the export of iron ore, it was decided by the government to eliminate the export duty.
The second stimulus package was announced by the government on January 2, 2009. This package involved an increase in plan expenditure upto Rs. 20,000 crore with the object of strengthening the ongoing programmes in rural, infrastructure and social security schemes. The measures would be taken by the government to ensure easy availability of credit to exporters, industries and infrastructure developers.
The relief was provided to exporters by way of higher rates for tax refunds. The government also made the commitment to extend the reimbursement duty entitlement passbook scheme upto December 2009. It was decided to extend the duty drawbacks at enhanced rates to the specific sectors like knitted fabrics, bicycles, agricultural hand tools and some categories of yarn.
A line of credit of Rs. 5,000 crore was made available from the RBI for providing pre-shipment and post- shipment credit to Indian exporters at the competitive rates. In order to provide a boost to the sagging industrial sector, the government announced an across-the-board 4 percent cut in ad valorem cenvat rate. For refinancing banks lending for infrastructure projects, Rs. 10,000 crore were provided to India Infrastructure Finance Limited.
To give boost to the housing and construction sectors that were under severe pressure, the government decided to allow the development of integrated townships and an access to external commercial borrowings. This stimulus package provided about Rs. 25,000 crore for pending highway and port projects.
As the commercial vehicle manufacturers had been hit hard due to slump in their sales, it was hoped that there would be revival of demand with accelerated depreciation of 50 percent on vehicles purchased in the first quarter of calendar year 2009. The non- banking finance companies, which are often active in financing commercial vehicles, were assured of credit through the public sector banks.
Although certain elements of stimulus package second such as across-the-board cut of 4 percent in ad valorem cenvat rate and removal of ceiling of ECB and extension of DEPB schemes were welcomed by trade and industry, yet the additional plan expenditure of Rs. 20,000 crore on critical rural, infrastructure and social security schemes was found to be quite inadequate.
In view of cold response of government’s interim budget in February 2009 from trade and industry, the third stimulus package was announced by the government on February 24, 2009.
The important highlights of this package were:
a. Across-the-board 4 percent cut in excise duty to continue beyond March 2009;
b. Abolition of 10 percent excise duty slab involving a revenue loss of Rs. 30,000 crore to the government;
c. Reduction in the general rate of central excise duty from 10 percent to 8 percent;
d. Excise duty on bulk cement to be 8 percent or Rs. 230 per metric tonne, which ever higher;
e. No custom duty on naphtha used in power generation; extension of this relaxation beyond March, 2009; and
f. The rate of service tax on taxable services to be reduced from 12 percent to 10 percent.
Term Paper # 5. Recovery of Global Economy:
The world economy which was in the grips of serious recession since 2007-08, started having a turnaround, though weak, in the mid-2009. The Euro-zone Countries like Germany and France, along with Japan were the first to shrug off recession, followed by the United States.
In the third quarter of 2009, the American GDP increased by 3.5 percent compared with its growth in the second quarter of only 1.5 percent.
The third quarter growth was facilitated by the rise in personal consumption expenditure, federal government spending, exports, private inventory investment and residential fixed investment. However, the rate of unemployment was still quite high. The budgetary and monetary supports have to be withdrawn. There was still a great deal of volatility in stock market and currency creating some degree of uncertainty about the future course of the economy.
The EU countries including Britain, Germany and France started showing signs of revival even a little earlier than they appeared in the US economy. In Britain, the equity prices and the prices of housing units started rising in mid-2009 but a large number of people were willing to sell-off their holdings. That might have adverse effect on the level of confidence.
Moreover, the exit from stimulus package was looming large on the horizon. In the second and third quarters of 2009, the economy of Germany, the largest in Europe, expanded 0.4 percent and 0.7 percent respectively. However, zero growth rate of GDP in the last quarter of 2009 indicated that the recovery was weak in that country. In France, the growth rates of GDP in the third and fourth quarters of 2009 rose by 0.2 percent and 0.6 percent respectively. But the recovery was fragile even in that country at the beginning of 2010.
Japan climbed out of recession to join Germany and France in the latter half of 2009, after four straight quarters of recession. In the second largest economy of the world, GDP expanded by 0.9 percent in the second quarter and 1.1 percent in the fourth quarter of 2009. The better-than-expected performance of the Japanese economy was mainly driven by larger exports and stimulus package of over $131 billion.
In this connection, the fear was expressed that export-driven Japanese economy would perhaps see a sluggish growth in the near future.
The economy of China too emerged from the state of recession in the second half of 2009. While Chinese government pointed out that the GDP growth rate in that country would be 8 percent, the IMF estimate was higher at 8.7 percent. In 2010, the GDP growth in that country is likely to be about 9.5 percent.
Thus China has recorded a quicker recovery than other countries on account of huge stimulus package, strong domestic demand, high growth rate of manufacturing, increase in exports, and continued inflow of foreign capital and high growth rate of small and medium enterprises.
About some other Asian countries, the recovery from recession is on the way. South Korean economy is expected to expand by 4.5 percent in 2010 compared with low growth rate of only 0.25 percent in 2009. It is supported by strong export growth, particularly capital export to China and a continued boost from the inventory cycle and a rise in business investment in response to high capacity utilisation and strong business confidence.
The economies of ASEAN region are projected to grow by 5.5 percent in 2010. The prime factors leading to their recovery are private domestic investment coupled with boost in exports. Among the ASEAN-5, the economy of Indonesia has proved to be remarkably resilient with a rapid expansion of private investment.
The uncertain and volatile conditions are looming large in the world economy in the wake of recent debt crisis in the European Union.
Term Paper # 6. India’s Recovery from Recession:
India had to face the conditions of economic recession during 2008 and 2009, when the GDP growth rate slumped down to 6.7 from a high of 9.3 percent in 2007-08 resulting in widespread adverse effects like slump in manufacturing activity, net outflow of capital, increase in unemployment, fall in domestic demand, steep and continued contraction in exports and volatile conditions in stock market etc.
Indian economy, like other economies, is also on its way to recovery. The World Bank has pegged the growth rate of GDP in Indian economy at 7.5 percent and 8 percent in 2010 and 2011. According to the report published in May, 2010 by United Nations Economic and Social Commission for Asia and Pacific (ESCAP), forecast a growth rate of 8.3 percent for the Indian economy in the current fiscal year and stressed upon continued spending by the government on social programmes like food security, infrastructure, education, healthcare and poverty- removal.
The exports which had been falling for 13 straight months grew for the first time in November 2009. In December 2009, the exports grew further by 9.3 percent. There has also been some resurgence and revival of manufacturing sectors in the economy during the recent months. As regards the FDI flows, World Bank expressed the hope that these flows would get enlarged as India continues to improve its FDI policies by simplifying investment procedures and relaxing investment limits in some sectors.
In the first quarter of fiscal year 2009-10, some initial signs of recovery have appeared such as rise in growth rate of manufacturing industries, inflow of capital from FII’s, stability in the capital market etc. In some quarters, there are expectations that economy may turn around by the middle of 2010. But it seems to be over-optimistic as there are still many challenges like sluggish investment and industrial growth, accumulation of inventory stocks, increasing unemployment, under-utilisation of capacity, high proportion of banks NPA’s, low export, growth rate and low credit off-take.
Although India did recover from the recession by 1911, yet the recent developing situation in the Euro zone area and the worldwide fall-out of devaluation of Yuan by China in August 2015 are likely to result in some volatility in the domestic equity, debt and the forex market.