Global Financial Crisis: Reflections on Its Impact on India

Abstract

The Indian economy looked to be relatively insulated from the global financial crisis that started in August 2007 when the sub-prime mortgage crisis first surfaced in the United States (US). In fact, the Reserve Bank of India (RBI) was raising interest rates until August 2008 with the explicit objective of cooling the economy and bringing down the gross domestic product (GDP) growth rate, which visibly had moved above the rate of potential output growth and was contributing to the buildup of inflationary pressures in the economy. This paper attempts an analysis of the origin and causes of global financial crisis and the impact of the crisis on the Indian economy.

India, South Asia’s largest economy, has been facing major challenges owing to the global financial crisis. The immediate effects were plummeting stock prices, a net outflow of foreign capital, a large reduction in foreign reserves and a sharp tightening of domestic liquidity. These caused a rapid depreciation of the exchange rate and a surge in short-term interest rates. The second round effects emerged from a slowdown in domestic demand and exports. Demand effects have been particularly severe in housing, construction, consumer durables and the IT sector. As a result, manufacturing production has taken a hit and activities in the organized services sector (housing, construction, IT) are down sharply. Exports declined for two consecutive months in October and November 2008. A recent government study estimates job losses to the tune of five hundred thousand between October and December 2008. GDP growth rate is now estimated at around 7 percent for 2008, down from 9 percent in 2007, and is projected to decline to around 5 percent in 2009. The monetary and fiscal stimulus package is expected to contain the downward slide in demand in 2009 while providing a good basis for recovery in 2010.

Keywords: financial crisis, gross domestic product, domestic liquidity, easy money policies, monetary and fiscal measures, balance of payments, foreign institutional investment

JEL Classification: A11