Europe Financial Crisis: Causes, Consequences and Indias Prospects

Global Financial Crisis (1)

Proximate causes

Sub-prime lending Originate and distribute model Financial engineering, derivatives Credit rating agencies Lax regulation Large global imbalances Excessively accommodative monetary policy in the US and other advanced economies (2002-04)

Fundamental cause

Scheme of Presentation

Global Financial Crisis

Impact on India

Economy impacts other economies via three channels: Trade Channel Financial Channel Confidence channel

Trade Channel

The share of exports to EU (excluding UK) and imports from EU has fallen over the years. In 1987-88, exports to EU constituted about 18.6% of total exports. This has declined to 17.5% by 2008-09. The decline of imports is higher from 25% in 1987-88 to 12% in 2008-09. Hence Total trade between India and EMU is about 29.5% and could be impacted due to the crisis.

Unlike trade in goods which declines immediately, we see a decline in services trade with a lag. It declines visibly in Jan-Mar 2009 quarter when the global crisis started in September 2008. Software exports decline marginally from USD 11.2 bn levels to 10.4 levels which is great given the global nature of the crisis. Hence, impact of crisis was more on goods and muted on services.

Foreign Direct Investment:

There are many European companies which have investments in India. So, there could be a possibility of slowdown in FDI in India.
EU

economies have contributed about 12.8% of total FDI since April 2000. But again FDI remained robust throughout this crisis. Given the severity of the crisis it was felt there will be little FDI investment. However, in case of India, FDI inflows remained positive throughout the crisis. The FDI inflows actually helped keep maintain capital account when all other categories showed sharp decline.

Institutional Investment:

oil in global financial markets, FII inflows will decline. arge number of global financial firms which operate across the world and in case of a decline in one ll out from other markets as well.

External Commercial Borrowings: External commercial borrowings could also decline if the European crisis spreads to other economies. ECBs declined in the first stage of the crisis as well.

This channel shows confidence declines in business and households seeing the global uncertainty. Decline in confidence is also one of the reasons for de cline in business investments which led to decline in overall Indian GDP growth. Credit growth also declined because of decline in business investments.

So even if an economys macroeconomic conditions and outlook look favorable, the decline in confidence can disrupt the economic conditio

India is grappling with high inflation and the central bank has raised the key interest rates a dozen times in the past year and a half. Now, the possibility of Greek debt default affecting the European banking and financial sectors is very real. The crisis is expected to spill over to the other European nations that otherwise appear economically stable

The quantum of impact of Euro zone crisis on markets here is yet to be measured. A slump in domestic industrial growth, unaddressed agricultural woes, rising interest rates and escalating fuel costs have compounded the global factors. A series of scandals emerging from under the carpet have diluted the faith of foreign investors MOODYS Downgrading Rating of SBI and other public sector bank

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

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: 5.5-6.0%

Large increase in market borrowings

Rs. crore 2008-09 BE 2008-09 RE 2009-10 BE Gross Net 1,76,453 1,13,000 3,42,769 3,29,649 3,98,552 3,08,647

Differences Between Financial Crisis in US/Europe and India (4) Indias 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.

Differences Between Financial Crisis in US/Europe and India (5)

Indias 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.