1. Global Financial Crisis: Causes, Consequences and India’s Prospects By
RAKESH MOHAN
Deputy Governor
Reserve Bank of India At
London Business School
April 23, 2009

2. Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and India
RBI’s Policy Response and Impact
Lessons from the Crisis
Medium-term Issues and Challenges

3. Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and India
RBI’s Policy Response and Impact
Lessons from the Crisis
Medium-term Issues and Challenges

4. Global Financial Crisis (1)
Proximate causes
Sub-prime lending
Originate and distribute model
Financial engineering, derivatives
Credit rating agencies
Lax regulation
Large global imbalances
Fundamental cause
Excessively accommodative monetary policy in the US and other advanced economies ( )

5. Global Financial Crisis (2) Current Account Balance (per cent to GDP)
Country
2005
2006
2007
2008
China
1.4
1.9
2.4
7.2
9.5
11.0
10.0
India
-1.3
0.5
-1.1
-1.0
-2.8
Russia
0.9
3.5
11.2
5.9
6.1
Saudi Arabia
-11.7
-2.4
10.6
28.7
27.9
25.1
28.9
United Arab Emirates
8.3
4.6
9.9
18.0
22.6
16.1
15.8
United States
-2.1
-4.5
-5.9
-6.0
-5.3
-4.7
Memo:
Euro area
n.a.
0.4
0.3
0.2
-0.7
Middle East
-5.1
1.0
8.4
19.7
21.0
18.2
18.8
Source: World Economic Outlook Database, April 2009, International Monetary Fund.
Note: (-) indicates deficit.

6. Global Financial Crisis (4) US Monetary Policy (1)
Volatility in monetary policy in advanced economies
Large volatility in capital flows to EMEs
Again very loose MP in US – likely surge in capital flows to EMEs?

7. Global Financial Crisis (5) US Monetary Policy (2)
US Monetary policy too loose during ; aggregate demand exceeded output; large current a/c deficit; mirrored in large surpluses in China and elsewhere.

8. Global Financial Crisis (6) US Monetary Policy (3)
Large Fed cuts in 2007: strong boost to oil, other commodity and asset prices

9. Global Financial Crisis (3) Capital Flows to Emerging Market Economies
Very large capital flows to EMEs –– now outflows in large volatility - implications for monetary management and financial stability

10. Global Financial Crisis (7) Worsening Global Economic Outlook
Growth Forecast of IMF (per cent)
Region
April 2008
July 2008
October 2008
April 2009
2008
2009
Advanced countries
1.3
1.7
1.4
1.5
0.5
0.9
(-)3.8
EMEs
6.7
6.6
6.9
6.1
1.6
World
3.7
3.8
4.1
3.9
3.0
3.2
(-)1.3
Global Trade Volume (Goods and Services)
3.3
-11.0

11. Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and India
RBI’s Policy Response and Impact
Lessons from the Crisis
Medium-term Issues and Challenges

12. Impact on India (1) Trends in Capital Flows
Component
Period
Foreign Direct Investment to India
April-February
27.6
31.7
FIIs (net)
April-March
20.3
-15.0
External Commercial Borrowings (net)
April- December
17.5
6.0
Short-term Trade Credits (net)
10.7
0.5
Total capital flows (net)
82.0
15.3
Memo:
Current Account Balance
-15.5
-36.5
Valuation Gains (+)/Losses (-) on Foreign Exchange Reserves
9.0
-33.4
Foreign Exchange Reserves (variation)
April-December
76.1
-53.8
110.5
-57.7

13. Impact on India (2) Key Macro Indicators
Period
Growth, per cent
Real GDP Growth
April-December
9.0
6.9
Industrial production
April-February
8.8
2.8
Services
10.5
9.7
Exports
April-March
28.4
6.4
Imports
40.2
17.9
GFD/GDP
2.7
6.0
Stock Market
(BSE Sensex)
16,569
12,366
Rs.per US$
40.24
45.92

14. Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe
and India
RBI’s Policy Response and Impact
Lessons from the Crisis
Medium-term Issues and Challenges

15. Differences Between Financial Crisis in US/Europe and India (1)
What has not happened here
No subprime
No toxic derivatives
No bank losses threatening capital
No bank credit crunch
No mistrust between banks

16. Differences Between Financial Crisis in US/Europe and India (2)
Our Problems
Reduction in capital flows
Pressure on BoP
Stock markets
Monetary and liquidity impact
Temporary impact on MFs/NBFCs (Sept-Oct)
Reduction in flow from non-banks
Perceptions of credit crunch

17. Differences Between Financial Crisis in US/Europe and India (3)
Our Problems
Fiscal stress
Oil, Fertiliser, Food subsidies
Pay Commission, Debt waiver, NRE
Stimulus packages
GFD/GDP ratio: %
Large increase in market borrowings
Rs. crore BE RE BE
Gross
1,76,453
3,42,769
3,98,552
Net
1,13,000
3,29,649
3,08,647

18. Differences Between Financial Crisis in US/Europe and India (4)
India’s Approach to Managing Financial Stability (1)
Current account: Full, but gradual opening up
Capital account and financial sector: More calibrated approach towards opening up.
Equity flows encouraged;
debt flows subject to ceilings and some end-use restrictions.
Capital outflows: progressively liberalized.

19. Differences Between Financial Crisis in US/Europe and India (5)
India’s Approach to Managing Financial Stability (2)
Financial sector, especially banks, subject to prudential regulation
both liquidity and capital.
prudential limits on banks’ inter-bank liabilities in relation to their net worth;
asset-liability management guidelines take cognizance of both on and off balance sheet items
Basel II framework: guidelines issued.
Dynamic provisioning
NBFCs: regulation and supervision tightened - to reduce regulatory arbitrage.

20. Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and India
RBI’s Policy Response and Impact
Lessons from the Crisis
Medium-term Issues and Challenges

21. Measures since Mid-September, 2008 (1)
Expanding rupee liquidity
Reduction in CRR (400 bps) & SLR (100 bps)
Special Repo window under LAF for banks on-lending to NBFCs, HFCs & MFS
Special Refinance to banks without collateral
Unwinding of MSS – buyback/desequestering
OMOs – pre-announced calendar
Cut in repo (425 bps) and reverse repo (275 bps) rates.
Existing instruments – enough flexibility
MSS and CRR – good, effective buffers of liquidity – both absorption and injection

22. Measures since Mid-September, 2008 (2)
Managing Forex liquidity
NRE and FCNR(B) deposits: interest rate ceilings raised
ECB norms relaxed
Allowing corporates to buy back FCCBs
Rupee-dollar swap facility for banks with overseas branches

23. Measures since Mid-September, 2008 (3)
Encouraging Flow of credit
Exporters:
extension of period for export credit.
Expansion in refinance
Dynamic provisioning
Contracyclical adjustment of prudential norms
SIDBI and NHB: lendable resources expanded
Loan restructuring

24. Measures since Mid-September, 2008 (4) Impact of Measures (1)
Measures ensuring orderly functioning of Indian financial markets
Cumulative potential primary liquidity impact – over Rs. 4,90,000 crore (9 % of GDP)
Comfortable liquidity position since mid-November, 2008
LAF window in absorption mode.
Call rate within LAF corridor since November 3, 2008 – bottom of the corridor.
Gradual reduction in deposit and lending rates of banks .
Government yields:
upward pressure from large market borrowing programme
Proactive management by RBI
MSS unwinding
Enhanced and pre-announced calendar for OMOs

25. Measures since Mid-September, 2008 (5) Impact of Measures (2)
Item
March 2008
September 2008
October 2008
March 2009
Turnover (Rupees crore, average daily) 1
Call market
11,182
11,690
14,497
11,909 2
All money
63,395
42,891
40,906
81,821
Key Interest Rates (per cent) 3
7.37
10.52
9.90
4.17 4
6.55
9.26
8.66
3.76 5
BSE Sensex
15946
13943
10550
8995 6
Rs. Per US $
40.36
45.56
48.64
51.23 7
10-year G-sec yield
7.69
8.45
7.85
6.56 8
Certificate of Deposits
10.0
11.6
7.0 9
Commercial Paper
10.4
12.3
14.7
8.9 10
Deposit rate (1-3 yrs)# 11
BPLR#
@: Call money, CBLO and market repo; #: Data pertain to PSBs.

26. Total flow of resources (1+2) 7,80,505 6,79,040
Measures since Mid-September, 2008 (6) Total Resource Flow from Banks and Non-banks
Rupees crore
Item 1
Non-food Bank credit
4,44,807
4,14,902 2
Non-banks
3,35,698
2,64,138 3
Total flow of resources (1+2)
7,80,505
6,79,040

27. Measures since Mid-September, 2008 (7) Inflation in India
(per cent)
Item
March 2008
June 2008
September
2008
December 2008
March 2009
Wholesale price inflation
All commodities
7.8
12.0
12.1
5.9
0.3
Of which:
Primary articles
9.7
11.0
11.6
3.5
Fuel
6.8
16.3
16.5
-0.7
-6.1
Manufactured products
7.3
10.9
10.5
6.2
1.4
Consumer price inflation
Agricultural labourers
7.9
8.8
11.4
10.8 (Feb)
Rural labourers
7.6
8.7
Urban non-manual employees
6.0
9.5
9.8
9.9 (Feb)
Industrial workers
7.7
9.6 (Feb)

28. Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and India
RBI’s Policy Response and Impact
Lessons from the Crisis
Medium-term Issues and Challenges

29. Lessons from the Crisis
Avoid high volatility in monetary policy
Appropriate response of monetary policy to asset prices
Manage capital flow volatility
Look for signs of over leveraging
Active dynamic financial regulation
Capital buffers, dynamic provisioning
Look for regulatory arbitrage incentives/ possibilities

30. Scheme of Presentation
Global Financial Crisis
Impact on India
Difference between US/Europe and India
RBI’s Policy Response and Impact
Lessons from the Crisis
Medium-term Issues and Challenges

31. Continuing increase in real GDP growth - Interregnum during the 1970s
Medium-term Issues and Challenges (1) Macroeconomic Indicators at a Glance
(Per cent) to to
1980s
1991/92
1997/98
2002/03
2003/04 To
2007/08 1 2 3 4 5 6 7 8
1. Real GDP Growth
4.1
3.2
5.6
5.3
5.7
5.2
8.7
Agriculture
2.9
2.1
4.4
4.0
3.7
0.9
Industry
6.7
4.2
6.4
7.0
8.4
Manufacturing
6.6
3.9
5.8
4.8
7.5
9.1
Services
4.9
6.3
5.9
7.8
10.3
2. Real GDCF/GDP
13.5
19.2
20.2
24.4
22.5
24.1
31.4
3. ICOR
3.3
6.0
3.6
4.6
4. Nominal GDCF/GDP
11.8
16.7
20.8
26.0
23.9
24.5
33.0
5. GDS/GDP
15.9
19.0
22.8
22.7
32.7
6. Saving-Investment Gap
-1.5
-0.7
-1.8
-3.2
-1.2
-0.4
-0.3
Continuing increase in real GDP growth - Interregnum during the 1970s
Secular uptrend in domestic saving and investment -investment largely financed by domestic savings
Continuation of growth in domestic savings necessary; fiscal prudence

32. Medium-term Issues and Challenges (2) Fiscal Policy (1)
Combined fiscal deficit in India
Even before the recent setback: very high by international standards
contribute to the persistence of an interest rate differential with the rest of the world,
constrains progress towards full capital account convertibility.
self imposed rule based fiscal correction needs to be consolidated and carried forward.

33. Medium-term Issues and Challenges (3) Fiscal Policy (2)
Sustained interest rate differential also connected with the existence of a persistent inflation differential with the rest of the world.
A key challenge is to further reduce inflation expectations toward international levels.

34. Medium-term Issues and Challenges (4) Monetary Policy (1)
A continuous need to adapt monetary management to the emerging needs of a fast growing and increasingly open economy.
Financial deepening and increasing monetisation.
expansion of monetary aggregates departs from their traditional relationship with real GDP growth.
task of monetary management: manage such growth without endangering price or financial stability.

35. Medium-term Issues and Challenges (5) Monetary Policy (2)
Further development of financial markets
Large capital inflows in recent years
Reserve Bank’s ability to manage the impossible trinity
Issues for monetary policy
current account balance as a good guide to evaluation of the appropriate level of an exchange rate?
to what extent should the capital account influence the exchange rate?
implications of large current account deficits for the real economy?

36. Medium-term Issues and Challenges (6) External Sector (1)
Optimal response to the large and volatile capital flows is a combination of (CGFS, 2009)
sound macroeconomic policies
prudent debt management
exchange rate flexibility
effective management of the capital account
accumulation of appropriate levels of reserves as self-insurance and
development of resilient domestic financial markets
combination is country-specific; no “one size fits all”.

37. Medium-term Issues and Challenges (7) External Sector (2)
Indian policy approach to CAL
Distinction between debt and equity flows
Higher inflation and interest rates in India vis-a-vis advanced economies
Liberalisation of debt flows can lead to arbitrage flows
Ceilings on debt flows appropriate

38. Medium-term Issues and Challenges (8) Financial Sector
Commercial banks robust
Committee on Financial Sector Assessment (CFSA)
Stability Assessment and Stress Testing
Concerns about credit risk remain muted at present
Without Stress
Scenario - increase in NPA by:
100 per cent
150 per cent
CRAR (%)
Mar-08
13.0
11.6
11.0
Sept–08
12.5
11.1
10.6
Note: CRAR = credit to risk-weighted assets ratio

39. Medium-term Issues and Challenges (9) Conclusion
India’s fundamentals remain strong
Financial sector robust
Monetary policy – sufficient instruments, flexible
Corporate sector not too leveraged – second round of restructuring going on – productivity gains
Foreign direct investment buoyant
Agriculture improving
Growth domestically financed
Indian economy should be able to recover fast and return to 9%+ growth path

40. Thank You