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Global Financial Crisis:

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Title: Global Financial Crisis:


1
Global Financial Crisis Causes, Consequences
and Indias Prospects By RAKESH MOHAN Deputy
Governor Reserve Bank of India At Annual General
Meeting of Indian Banks Association May 11, 2009
2
Scheme of Presentation
  • Global Financial Crisis
  • Impact on India
  • Difference between US/Europe and India
  • 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
  • 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 (2002-04)

5
Global Financial Crisis (2)Current Account
Balance (per cent to GDP)
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 2002-04
    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 2009 - large volatility - implications for
    monetary management and financial stability

10
Global Financial Crisis (7) Worsening Global
Economic Outlook
11
Scheme of Presentation
  • Global Financial Crisis
  • Impact on India
  • Difference between US/Europe and India
  • Lessons from the Crisis
  • Medium-term Issues and Challenges

12
Impact on India (1)Trends in Capital Flows
13
Impact on India (2)Key Macro Indicators
14
Scheme of Presentation
  • Global Financial Crisis
  • Impact on India
  • Difference between US/Europe
  • and India
  • 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 5.5-6.0
  • Large increase in market borrowings

18
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.

19
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.

20
Scheme of Presentation
  • Global Financial Crisis
  • Impact on India
  • Difference between US/Europe and India
  • Lessons from the Crisis
  • Medium-term Issues and Challenges

21
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

22
Scheme of Presentation
  • Global Financial Crisis
  • Impact on India
  • Difference between US/Europe and India
  • Lessons from the Crisis
  • Medium-term Issues and Challenges

23
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

24
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.

25
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.

26
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.

27
Medium-term Issues and Challenges (5)Monetary
Policy (2)
  • Further development of financial markets
  • Large capital inflows in recent years
  • Reserve Banks 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?

28
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.

29
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

30
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

31
Medium-term Issues and Challenges (9)Conclusion
  • Indias 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

32
  • Thank You
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