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

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Global Financial Crisis: Causes, Consequences and India’s Prospects By RAKESH MOHAN

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Global financial crisis causes consequences and india s prospects by rakesh mohan

Global Financial Crisis:

Causes, Consequences and

India’s Prospects

By

RAKESH MOHAN

Deputy Governor

Reserve Bank of India


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


Global financial crisis causes consequences and india s prospects by rakesh mohan

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