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Global Financial Crisis: Causes, Consequences and India’s Prospects By RAKESH MOHAN Deputy Governor Reserve Bank of India At London Business School PowerPoint PPT Presentation


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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. Scheme of Presentation. Global Financial Crisis Impact on India Difference between US/Europe and India

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

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Scheme of presentation

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


Scheme of presentation

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


Scheme of presentation1

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


Global financial crisis 1

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 (2002-04)


Global financial crisis 2 current account balance per cent to gdp

Global Financial Crisis (2)Current Account Balance (per cent to GDP)


Global financial crisis 4 us monetary policy 1

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?


Global financial crisis 5 us monetary policy 2

Global Financial Crisis (5)US Monetary Policy (2)

  • US Monetary policy too loose during 2002-04; aggregate demand exceeded output; large current a/c deficit; mirrored in large surpluses in China and elsewhere.


Global financial crisis 6 us monetary policy 3

Global Financial Crisis (6)US Monetary Policy (3)

  • Large Fed cuts in 2007: strong boost to oil, other commodity and asset prices


Global financial crisis 3 capital flows to emerging market economies

Global Financial Crisis (3)Capital Flows to Emerging Market Economies

  • Very large capital flows to EMEs –– now outflows in 2009 - large volatility - implications for monetary management and financial stability


Global financial crisis 7 worsening global economic outlook

Global Financial Crisis (7) Worsening Global Economic Outlook


Scheme of presentation2

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


Impact on india 1 trends in capital flows

Impact on India (1)Trends in Capital Flows


Impact on india 2 key macro indicators

Impact on India (2)Key Macro Indicators


Scheme of presentation3

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


Differences between financial crisis in us europe and india 1

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 2

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


Differences between financial crisis in us europe and india 3

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


Differences between financial crisis in us europe and india 4

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.


Differences between financial crisis in us europe and india 5

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.


Scheme of presentation4

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


Measures since mid september 2008 1

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


Measures since mid september 2008 2

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


Measures since mid september 2008 3

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


Measures since mid september 2008 4 impact of measures 1

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


Measures since mid september 2008 5 impact of measures 2

Measures since Mid-September, 2008 (5)Impact of Measures (2)


Measures since mid september 2008 6 total resource flow from banks and non banks

Measures since Mid-September, 2008 (6)Total Resource Flow from Banks and Non-banks


Measures since mid september 2008 7 inflation in india

Measures since Mid-September, 2008 (7)Inflation in India


Scheme of presentation5

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


Lessons from the crisis

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


Scheme of presentation6

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


Medium term issues and challenges 1 macroeconomic indicators at a glance

Medium-term Issues and Challenges (1)Macroeconomic Indicators at a Glance

  • 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


Medium term issues and challenges 2 fiscal policy 1

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.


Medium term issues and challenges 3 fiscal policy 2

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.


Medium term issues and challenges 4 monetary policy 1

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.


Medium term issues and challenges 5 monetary policy 2

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?


Medium term issues and challenges 6 external sector 1

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”.


Medium term issues and challenges 7 external sector 2

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


Medium term issues and challenges 8 financial sector

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

  • Note: CRAR = credit to risk-weighted assets ratio


Medium term issues and challenges 9 conclusion

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


Scheme of presentation

Thank You


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