Global Subprime Crisis emerged in the US housing mortgage market in the year 2007 and gradually snowballed into a global financial crisis, leading to a global economic recession.
The transmission of shocks of the crisis was mainly in two phases. First, it started with Inflation and then led to global financial crisis. There was a simultaneous increase in food and commodity prices throughout the world causing inflation. This led to global financial crises followed by a global recession.
During the initial phase the Indian financial markets were unaffected as direct exposure of banks to subprime assets was negligible. The domestic growth process was mainly demand driven which remained intact.
There was a rapid growth in India`s international trade in goods as well as services. Further in 2000s information technology facilitated cross-border delivery of services. With increasing global integration, the Indian economy was subjected to greater influence of global business cycles. Global stock prices and global economic developments started having a greater influence on domestic economy.
Global Subprime Crisis Impact on India
- Demand Shocks
- Foreign Institutional Investors started disinvesting
- International Trade also suffered due to lack of demand for exports
Global Subprime Crisis Impact on Financial Markets
- Reversal of Capital flows
- Sell-off in the equity market by Foreign Institutional Investors
- It put pressure on the dollar liquidity in the domestic market
- Adverse Balance of Payment Expectations
- This led to a downward pressure in the value of Indian Rupee
Global Subprime Crisis Impact on Banks
- Indian Banks were not significantly affected and were well capitalised and inherently sound but reduced foreign funding put pressure on non-banking financial companies and asset management companies which translated into liquidity problems for NBFCs and AMCs as mutual funds were an important source of funds for NBFCs and AMCs.
Global Subprime Crisis Impact on Indian Economy
- There was moderation in growth in the Indian economy in the year 2008-09 as compared to previous 5 years.
- Export growth suffered due to external Demand Shocks ; exports dropped from 40% (Q2) to -15% (Q3) to -22% (Q4) in the year 2008-09
- Reduced aggregate demand lead to reduced growth in private consumption
- There was increase in Demand for bank Credit as external sources of credit were unavailable
- There was pressure on banks for funding Liquidity
Measures taken to overcome the effects of Global Subprime Crisis by India
R.B.I adopted various liquidity augmenting measures to augment the domestic and foreign exchange liquidity problems. It sharply reduced its Key rates. From Oct 2008 to April 2009 there was unprecedented policy activism.
- It reduced the CRR Cash Reserve Ratio by cumulative 400 basis points to 5% which helped banks to expand credit facilities. This also raised the value of money multiplier leading to increase in Broad Money. The money multiplier increased to 4.8 (March 2009) from 4.3(March 2008). The increase in money multiplier ensured steady increase in money supply consistent with liquidity requirements of the economy.
- The Repo rate was reduced by 425 points to 4.75%
- The Reverse Repo Rate was reduced by 275 basis points to 3.25%
- The banks continued to expand credit and meet the fund requirements of mutual funds and NBFCs.
The Government took some significant fiscal measures. There was an increase in aggregate public expenditure and taxes were reduced which increased the overall aggregate demand in the country. The fiscal Deficit rose by 3.5% of GDP in 2008-09 and the government final consumption expenditure registered a sharp increase in Q3 and Q4 of 2008-09.
Conclusion
Despite sound economic structure and no direct exposure to the sub-prime assets, India was affected by the global financial crisis reflecting increasing globalisation of the Indian economy. The policy response from the RBI and the government was swift. While the fiscal policy cushioned the falling demand, the monetary policy augmented both domestic and foreign exchange liquidity problems.