Global Financial Meltdown And The Indian Economy

The global financial meltdown and consequent economic recession in developed economies have clearly been major factor in Indiaâ€(tm)s economic slowdown. Given the origin and dimension of the crisis in the advanced countries, which some have called the worst since the Great Depression of the 1929, every developing country has suffered to a varying degrees, depending on their exposure to sub-prime and the related assets. No country, including India, remained immune to the global economic shock. The crisis surfaced around August 2007 with the sudden revelation of the risky and illiquid nature of many sub-prime mortgage instruments and with bursting of the bubble in the sub-prime mortgages in the US as reflected in the credit markets. Eventually, the sub-prime crisis had affected financial institutions in the US, Europe and elsewhere including the shadow banking system fostered by investment banks, broker-dealers, hedge funds, private equity groups and structured investment vehicles ( SIVs), money market funds, non-bank mortgage lenders and in the process, had caused, within a few months, a huge financial meltdown, a string bankruptcies and a sharp global imbalances and slowdown in practically all industrialized countries. This enormous shock reflecting the growing integration of financial markets internationally in the chain of payments -- what Trichet, one of the central bankers of Europe called financial psunami â€" with unprecedented virulence reached Europe on 9 August, causing the European financial markets to seize up. The collapse of the Merrill Lynch and Lehman Brothers in Mid-September 2008 further aggravated the situation leading to the crisis of confidence in the financial markets and, as the Reserve Bank of India ( RBI ) Governor D. Subbarao (2009) had rightly pointed out that from three channels: the trade channe l( affecting the capital and current account of balance of payments), the financial channel and the confidence channel, it arose. The resulting uncertainty cascaded into a full-blown financial crisis of global dimensions. India could not insulate itself from the adverse developments in the international financial markets, despite having a banking and financial system that had little to do with investments in structured financial instruments carved out of sub-prime mortgages, whose failure had set off the chain of events culminating in global crisis. The feedback effect of the crisis on the Indian economy was not significant in the beginning. The initial effect of the sub-prime crisis was, in fact, positive, as the country received accelerated Foreign Institutional Investment (FII) flows during September 2007 to January 2008. This contributed to the debate on “decoupling hypothesis,†where it was believed that the emerging Asian economies, especially the larger ones like China and India could remain insulated from the crisis and provide an alternative engine of growth to the world economy in moderating the global downturn and paving the way for a worldwide recovery in a year or so. It was also believed and there were also arguments that the “strong†domestic financial sector of these economies would be capable to be remain immune to shocks from the international financial system. The arguments soon proved unfounded as the global crisis intensified and spread to the emerging economies through different channels-- one such important channel is capital and current account route of the balance of payments (BoP ). It is worth mentioning that with the recent drive of the government towards capital account convertibility through gradual relaxation of the capital account transactions and the more and more close integration of the domestic economy with the global financial markets, the first memorable impact of global crisis was on the countryâ€(tm)s capital inflows, especially on external commercial borrowings (ECB ) and FII .Almost immediately after the crisis surfaced , net ECBs and FIIS registered a sharp decline between October and November 2007, from$3.6 billion and $5.7 billion to $2.2 billion and minus $1.6 billion, respectively. In the above backdrop the present paper expresses some facets of the global crisis, including its impact on some sectors of the Indian economy. In Section II, we discuss the macroeconomic explanation of the crisis along with the severity of the crisis spread over European countries.