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Policy Responses To The Financial Crisis And Recession Economics Essay

CHAPTER 2

The 2008-2009 recession was long and deep, and according to several indicators was the most severe economic contraction since the 1930s (but still much less severe than the Great Depression) . The slowdown of economic activity was moderate through the first half of 2008, but at that point the weakening economy was overtaken by a major financial crisis that would exacerbate the economic weakness and accelerate the decline.

When the fall of economic activity finally bottomed out in the second half of 2009, real gross domestic product (GDP) had contracted by approximately 5.1%, or by about $680 billion. At this point the output gap—the difference between what the economy could produce and what it actually produced—widened to an estimated 8.1%. The decline in economic activity was much sharper than in the nine previous post-war recessions, in which the fall of real GDP averaged about 2.0% and the output gap increased to near 4.0%. However, the recent decline falls well short of the experience during the Great Depression, when real GDP decreased by 30% and the output gap probably exceeded 40%.

As output decreased the unemployment rate increased, rising from 4.6% in 2007 to a peak of 10.1% in October 2009, and remaining only slightly below that high into 2011. The U.S. unemployment rate has not been at this level since 1982, when in the aftermath of the 1981 recession it reached 10.8%, the highest rate of the post-war period. (During the Great epression the unemployment rate reached 25%.) This rise in the unemployment rate translates to about 7 million persons put out of work during the recession. Another 8.5 million workers have been pushed involuntarily into part-time employment.

The recession was intertwined with a major financial crisis that exacerbated the negative effects on the economy. Falling stock and house prices led to a large decline in household wealth (net worth), which plummeted by more than $12 trillion or about 20% during 2008 and 2009. In addition, the financial panic led to an explosion of risk premiums (i.e., compensation to investors for accepting extra risk over relatively risk-free investments such as U.S. Treasury securities) that froze the flow of credit to the economy, crimping credit-supported spending by consumers, such as for automobiles, as well as business spending on new plant and equipment.

The negative shocks the economy received in 2008 and 2009 were, arguably, more severe than what occurred in 1929. However, unlike in 1929, the severe negative impulses did not turn a recession into a depression, arguably because timely and sizable policy responses by the government helped to support aggregate spending and stabilize the financial system.6 That stimulative economic policies would have this beneficial effect on a collapsing economy is consistent with standard macroeconomic theory, but without the counterfactual of the economy’s path in the absence of these policies, it is difficult to establish with precision how effective these policies were [1] .

Policy Responses to the Financial Crisis and Recession

Both monetary and fiscal policies as well as some extraordinary measures were applied to counter the economic decline. This policy response is thought to have forestalled a more severe economic contraction, helping to turn the economy into the incipient economic recovery by mid-2009.

These policies are likely continuing to stimulate economic activity into 2014

Monetary Policy Actions

To bolster the liquidity of the financial system and stimulate the economy, during 2008 and 2009 the Federal Reserve (Fed) aggressively applied conventional monetary stimulus by lowering the federal funds rate to near zero and boldly expanding its “lender of last resort” role, creating new lending programs to better channel needed liquidity to the financial system and induce greater confidence among lenders. Following the worsening of the financial crisis in September 2008, the Fed grew its balance sheet by lending to the financial system. Between September and November 2008, the Fed’s balance sheet more than doubled, increasing from under $1 trillion to more than $2 trillion.

By the beginning of 2009, demand for loans from the Fed was falling as financial conditions normalized. Had the Fed done nothing to offset the fall in lending, the balance sheet would have shrunk by a commensurate amount, and the stimulus that it had added to the economy would have been withdrawn. In the spring of 2009, the Fed judged that the economy, which remained in a recession, still needed stimulus. On March 18, 2009, the Fed announced a commitment to purchase $300 billion of Treasury securities, $200 billion of Agency debt (later revised to $175 billion), and $1.25 trillion of Agency mortgage-backed securities. The Fed’s planned purchases of Treasury securities were completed by the fall of 2009 and planned Agency purchases were completed by the spring of 2010. At this point, the Fed’s balance sheet stood at just above [2] .

Fiscal Policy Actions

Congress and the Bush Administration enacted the Economic Stimulus Act of 2008 (P.L. 110-185). This act was a $120 billion package that provided tax rebates to households and accelerated depreciation rules for business. Congress and the Obama Administration passed the American Recovery and Reinvestment Act of 2009 (ARRA; P.L. 111-5). This was a $787 billion package with $286 billion of tax cuts and $501 billion of spending increases that relative to what would have happened without ARRA is estimated to have raised real GDP between 1.5% and 4.2% in 2010 but will increase real GDP by a smaller amount in 2011 and an even smaller amount in 2012.

In terms of extraordinary measures, Congress and the Bush Administration passed the Emergency Economic Stabilization Act of 2008 (P.L. 110-343), creating the Troubled Asset Relief Program (TARP). TARP authorized the Treasury to use up to $700 billion to directly bolster the capital position of banks or to remove troubled assets from bank balance sheets.

Congress was an active participant in the emergence of these policy responses and has an ongoing interest in macroeconomic conditions. Current macroeconomic concerns include whether the economy is in a sustained recovery, rapidly reducing unemployment, speeding a return to normal output and employment growth, and addressing government’s long-term debt problem [3] .

Is Sustained Economic Recovery Underway?

Evidence indicates that the economy, as measured by real GDP growth, began to recover in mid-2009. However, the pace of growth has been slow and uneven with a pronounced deceleration evident during 2011. During 2009 and 2010, growth had been sustained by transitory factors, such as fiscal stimulus and the rebuilding of inventories by business. Economic growth in 2010 showed signs of being generated by more sustainable forces, but the strength of those forces continues to be uneven, and a slowing of growth during 2011 prompted concern about the recovery’s sustainability.

The economy began to recover in mid-2009. For the remainder of 2009 and through 2010, real GDP (i.e., GDP adjusted for inflation) increased at an annualized rate of 3.0%. However, during 2011 growth slowed to 1.6% and in the first quarter of 2012 that pace improved only slightly to 2.2%. In comparison to previous economic recoveries, growth at 3.0% is relatively weak, but is fast enough to at least make slow progress at reducing the large output gap and at reducing unemployment. However, growth at less than a 2% annual rate may not be fast enough to close the output gap and keep the unemployment rate from rising. Through 2010, much of the economy’s upward momentum was sustained by the transitory factors of inventory increases and fiscal stimulus. Sustainable recovery would depend on more enduring sources of demand, such as consumers spending and businesses reviving, and providing momentum to the recovery. While business investment spending has been relatively brisk during the recovery, consumer spending was relatively tepid in 2011. Weak consumer spending along with the rapidly fading effects of fiscal stimulus and weaker growth in Europe raises concern about the sustainability of U.S. economic recovery in 2012 [4] .

Credit conditions have improved, making getting loans easier for consumers and businesses, loosening a constraint on many types of credit supported expenditures. The Fed’s survey of senior loan officers indicates that, on net, bank lending standards and terms continued to ease during 2011 and that the demand for commercial and industrial loans had increased.

Manufacturing activity is increasing. Through March 2012, output had increased 3.8% over a year earlier and capacity utilization has risen from a low of 65% in mid-2009 to 77.8%. (A capacity utilization rate of 80% - 85% would be typical for a fully recovered economy.)

Since mid-2009, non-farm payroll employment has increased by about 3.1 million jobs. Monthly gains have been consistently positive since late 2010, but often not at a scale characteristic of a strong recovery. Recent months have seen employment gains steadily falling, down from 275,000 workers in January 2012 to 115,000 workers in April 2012.

The stock market has rebounded and interest rate spreads on corporate bonds have narrowed. The Dow Jones stock index had plunged to near 6500 in March 2009 but through April 2012 had regained about 90% of its lost capitalization. Spreads on investment grade corporate bonds, a measure of the lenders’ perception of risk and creditworthiness of borrowers, have fallen from a high of 600 basis points in December 2008 to less than 100 basis points in 2012.

China, Asia’s other emerging economies, and Latin America are growing rapidly, which is transmitting a positive growth impulse to the United States by boosting demand for U.S. exports. Also the dollar is very competitive from a historical perspective, adding support to U.S. exports [5] .

On the other hand, significant economic weakness remains evident.

In the third quarter of 2011, the economy had regained its prerecession level of output. But it took 15 quarters to accomplish this as compared to 5 quarters on average in previous post-war recoveries. However, since potential GDP has also continued to grow, the output gap over this time period has only narrowed from about 8.1% to 6.1%.

Consumer spending, the usual engine of a strong economic recovery, remains tepid, generally slowed by households’ ongoing need to rebuild substantial net worth lost during the housing crisis and the recession, continued high unemployment and underemployment, and a surge in energy prices in the first half of 2012.

Employment conditions remain weak. The unemployment rate, which had peaked at 10.1% in October of 2009, has only fallen to 8.1% in April 2012. However, much of this improvement occurred during 2010, with essentially no net improvement during 2011, because economic growth in 2011 was only just fast enough to keep the unemployment rate from rising. This high rate of unemployment after more than two years of economic recovery is unusual and a source of concern. Also some of the fall of the unemployment rate does not reflect people finding jobs, rather it is caused by discouraged workers leaving the labor force. Another measure of labor market conditions, the employment to population ratio, which is not affected by changes in labor force participation, shows a labor market that is essentially “treading water.” During the recession that ratio fell from 63% to 58%, and it has remained near that low through nearly three years of economic recovery.

The housing market remains depressed. Mortgage loan foreclosures continue to rise, house prices are still falling in many regions, and millions of mortgage holders are “under-water,” with the market value of their house below the amount of their mortgage. Beyond the direct effect on economic activity through lower rates of new construction, housing market weakness has a strong negative indirect effect on the balance sheets of households and banks. The sharp fall in household net worth caused by the fall of house prices has been an important factor dampening current consumer spending and the pace of overall economic recovery.

Growth in the Euro area has been weak and fiscal austerity measures to stem the growth of public debt have likely pushed the region back into recession, slowing growth there further. Slower growth in Europe, a major U.S. export market, will likely transmit a contractionary impulse to the United States, which could slow the pace of the U.S. recovery [6] .

The Shape of Economic Recovery

In the typical post-war business cycle, lower than normal growth of aggregate demand during the recession is quickly followed by a recovery period with above normal growth of spending, perhaps spurred by some degree of monetary and fiscal stimulus. The degree of acceleration of growth in the first two to three years of recovery has varied across post-war business cycles, but has been at an annual pace in a range of 4% to 8%.This above normal growth brings the economy back more quickly to the pre-recession growth path and speeds up the reentry of the unemployed to the workforce.

Once the level of aggregate demand approaches the level of potential GDP (or full employment), the economy returns to its pre-recession growth path, where the growth of aggregate spending is slower because it is constrained by the growth of aggregate supply, which in recent years is estimated to have been at an annual pace of near 3.0%. (A subsequent section of the report looks more closely at aggregate supply.)

There is concern, however, that this time the U.S. economy, without supporting stimulus from policy actions, will either not return to its pre-recession growth path, perhaps remain permanently below it, or return to the pre-crisis path but at a slower than normal pace, or worse, dip into a second recession. Below normal growth would almost certainly translate into below normal recovery of employment, whereas a second round of recession could increase the already high unemployment rate. The next sections of this report discuss problems on the supply side and the demand side of the economy that could lead to a weaker than normal recovery [7] .

CHAPTER3

IMPACT ON INDIAN ECONOMY

Impact of the international crisis on the Indian financial system

It would have been hard, even a few months prior to the collapse of Lehman Brothers, to anticipate the impact that the global financial crisis would have on the Indian economy. This is because the Indian banking system did not have any direct exposure to sub prime mortgage assets or any significant exposure to the failed institutions, and the recent growth had been driven predominantly by domestic consumption and investment. And yet, the extent to which the global crisis impacted India was dismaying, spreading through all channels – the financial channel, the real channel and the confidence channel. The reason why India was hit by the crisis was because of its rapid and growing integration into the global economy.

Under the impact of external demand shock, there was a moderation in growth in the second half of 2008–09 compared to the robust growth of 8.8% per annum in the preceding five years. The deceleration was more noticeable in the negative growth in industrial output in Q4 2008–09 – the first decline since the 1990s. The transmission of external demand shock was severe on export growth, which deteriorated from a peak rate of about 40% in Q2 2008–09 to (–)22 per cent in Q4, ie the first contraction since 2001–02. Simultaneously, domestic aggregate demand also moderated due to a sharp deceleration in the growth of private consumption demand [8] .

With regard to financial markets, India witnessed a reversal of capital inflows following the collapse of Lehman Brothers. Due to a heavy sell-off by foreign institutional investors (FIIs) there was a significant downward movement in the domestic stock markets. The withdrawal by FIIs and the reduced access of Indian entities to external funds exerted significant pressure on dollar liquidity in the domestic foreign exchange (FX) market. This created adverse expectations on the balance of payments (BOP) outlook, leading to downward pressure on the Indian rupee and increased FX market volatility. While the banking system was sound and well capitalised, some segments of the financial system such as mutual funds (MFs) and non-banking financial companies (NBFCs) came under pressure due to reduced foreign funding and a subdued capital market. Moreover, the demand for bank credit increased due to the drying up of external sources. Against this backdrop, the Reserve Bank of India stepped in with liquidity-supplying measures – both in the rupee and in foreign currency – and the government implemented fiscal stimulus measures, a more detailed account of which is given below [9] .

India’s balance of payments in 2008-09 captured the spread of the global crisis to India (see Table 1). The current account deficit during 2008-09 shot up to 2.6 percent of GDP from 1.5 percent of GDP in 2007-08 (Table 1). And this is the highest level of current account deficit for India since 1990-91 (Chart 1). The capital account surplus dropped from a record high of 9.3 percent of GDP in 2007-08 to 0.9 percent of GDP. And this is lowest level of capital account surplus since 1981-82. The year ended with a decline in reserves of US$ 20.1 billion (inclusive of valuation changes) against a record rise in reserves of US$ 92.2 billion for 2007-08.

Impact of the global financial crisis on different markets

1. local money markets,

Although the direct impact of the sub prime crisis both on Indian banks and on the financial sector was almost negligible because of their limited exposure to the troubled assets, the prudential policies put in place by the Reserve Bank and the relatively low presence of foreign banks in the Indian banking sector, there was a sudden change in the external environment following the failure of Lehman Brothers in mid-September 2008. The knock-on effects of the global financial crisis manifested themselves not only as reversals in capital inflows but also in adverse market expectations, causing a sharp correction in asset prices on the back of sell-offs in the equity market by FIIs and exchange rate pressures [10] .

The withdrawal of funds from the Indian equity markets, as in the case of other emerging market economies (EMEs) and the reduced access of Indian entities to international market funds exerted significant pressure on dollar liquidity in the domestic FX market. With a view to maintaining orderly conditions in the FX market which had become very volatile, the Reserve Bank scaled up its intervention operations, particularly in October 2008. However, the FX market remained orderly in 2009–10 with the rupee exhibiting a two-way movement against major currencies. Indian financial markets, particularly banks, have continued to function normally.

However, the cumulative effect of the Reserve Bank’s operations in the FX market as well as transient local factors such as the build-up in government balances following quarterly advance tax payments had an adverse impact on domestic liquidity conditions in September and October

2008. Consequently, in the money market the call money rate breached the upper bound of the informal Liquidity Adjustment Facility (LAF) corridor during mid-September–October 2008. However, as a result of the slew of measures initiated by the Reserve Bank (referred to in detail below) the money market rates declined and have remained below the upper bound of the LAF corridor since November 2008. In the current financial year, the call rate has thus far hovered around the lower bound of the informal LAF corridor.

The indirect impact of the global financial turmoil was also evident in the activity in the certificate of deposit (CD) market. The outstanding amount of CDs issued by scheduled commercial banks (SCBs), after increasing between March and September 2008, declined thereafter until December 2008 as the global financial market turmoil intensified. With the easing of liquidity conditions, the CD volumes picked up in the last quarter of 2008–09.

The weighted average discount rate (WADR) of CDs, which had increased with the tightening of liquidity conditions, started declining from December 2008 onwards. Commercial paper market developments were similar. As explained above, the rates in the unsecured (call) market went above the LAF corridor from mid-September to October 2008 as a consequence of the liquidity pressure in the domestic market. The rates in the collateralised money market – (Collateralised Borrowing and Lending Obligation (CBLO) and repo markets) – moved in tandem but remained below the call rate [11] .

2.Repo Market

The Indian repo markets were broadly unaffected by the global financial crisis. Currently, only government securities are permitted for repo and a select set of participants (regulated entities) is permitted to participate in repos. All repo transactions are novated by the Clearing Corporation of India and settled on a guaranteed basis. The interbank repo markets continued to function, without freezing, during the period of global financial turmoil. During the period June–October 2008, the repo volumes fell marginally but subsequently recovered.

There was no incidence of settlement failure during the global financial crisis.

3.Money Market

The total volume in the money market segments decreased during September and October 2008. In October 2008, the decrease was more pronounced in the collateralised segment compared to the uncollateralised segment. The volume in the call market actually increased in October 2008. Moreover, the average daily amount of liquidity injected into the banking system through the LAF increased substantially during September and October 2008.

The total money market average daily volume increased after December 2008 and was around Indian rupee (INR) 800 billion in March 2009 and around INR 900 billion in October 2009.

4.Security market

The Indian government securities markets have been broadly insulated from the global financial crisis. There has been no incidence of settlement failure or default. The muted impact of the global crisis on the Indian government securities markets can be attributed, nter alia, to the calibrated opening of the markets to foreign players. Internationally, it has been observed that capital flows to EMEs dried up during the crisis period on account of the “flight to safety”, despite the interest rate differentials. In the Indian context, however, the investment limits for FIIs in the Indian government securities markets have been put in place to contain the volatility and are being revised in a calibrated manner, taking into

consideration macroeconomic factors. Currently, the investment limit for FIIs is USD 5 billion and its utilisation is about 62.60% (as of 9 October 2009).The yields began to firm up in March 2008, tracking the policy rates in the wake of inflationary pressures and the benchmark 10-year yield reached a peak of 9.48% in mid-July 2008 (see the chart below). The failure of Lehman Brothers and the subsequent global developments followed by sharp reductions in policy rates (the repo rate was reduced from 9.00% to 4.75% during the period October 2008–April 2009 and the reverse repo rate was reduced from 6.00% to 3.25% during the period December 2008–April 2009) resulted in a softening of government security yields coupled with higher turnover in the secondary market.

However, the increased borrowing requirements by the central and state

governments on account of various countercyclical fiscal measures taken to stimulate the economy resulted in a huge supply of government securities impacting on the interest rates. The benchmark 10-year yield, which had touched a low of 5.27% on 31 December 2008, rose to around 7.41% during early September 2009 on account of concerns over excess

supply and inflationary expectations [12] .

CHAPTER 4

INDIA’S TCTICS FOR FACING THIS CRISIS

The Reserve Bank subsequently employed a combination of measures involving monetary easing and the use of innovative debt management tools such as synchronising the Market Stabilisation Scheme (MSS) buyback auctions and open market purchases with the government’s normal market borrowings and de-sequestering of MSS balances. By appropriately timing the release of liquidity to the financial system to coincide with the auctions of government securities, the Reserve Bank ensured a relatively smooth conduct of the government’s market borrowing programme, resulting in a decline in the cost of borrowings during 2008–09 for the first time in five years [13] .

In 2008–09, the Indian rupee, with significant intra year variation, generally depreciated against major currencies except the pound sterling on account of the widening of trade and current account deficits as well as capital outflows. The rupee exhibited greater two-way movements in 2008–09. For example, it moved between INR 39.89 and INR 52.09 per US dollar.

The FX market remained orderly during 2009–10, with the rupee exhibiting a two-way movement against major currencies. In the current financial year, the rupee appreciated by 9.7% against the US dollar and 2.6% against the Japanese yen, whereas it depreciated by 5.7% against the pound sterling and 3.2% against the euro. In terms of the real exchange

rate, the six-currency trade-based real effective exchange rate (REER) (1993–94 = 100) moved up from 96.3 at end-March 2009 to 104.2 by 23 October 2009 [14] .

Following the intensification of the global financial crisis in September 2008, the Reserve Bank implemented both conventional and unconventional policy measures in order to proactively mitigate the adverse impact of the global financial crisis on the Indian economy [15] .

The thrust of the various policy initiatives by the Reserve Bank since September 2008 has been on providing ample rupee liquidity, ensuring comfortable dollar liquidity and maintaining a market environment conducive to the continued flow of credit to productive sectors. For this purpose, the Reserve Bank used a variety of instruments at its command such as the repo and reverse repo rates, the cash reserve ratio (CRR), the statutory liquidity ratio (SLR), open market operations, including the liquidity adjustment facility (LAF), the MSS, special market operations and sector-specific liquidity facilities. In addition, the Reserve Bank used prudential tools to modulate the flow of credit to certain sectors consistent with financial stability. The availability of multiple instruments and the flexible use of those instruments in the implementation of monetary policy enabled the Reserve Bank to modulate the liquidity and interest rate conditions amid uncertain global macroeconomic conditions.

When the global markets became dysfunctional in September 2008, the macro financial conditions remained exceptionally challenging from the standpoint of the implementation of the Reserve Bank’s policies, as it had to respond to multiple challenges, from containing inflation in the second half of 2008 to containing the deceleration in growth, preserving the soundness of banks and financial institutions, ensuring the normal functioning of the credit market and maintaining orderly conditions in the financial markets in the first half of 2009.

The Reserve Bank was able to restore normalcy in the financial markets over a short period of time through its liquidity operations in both domestic and foreign currency. The evolving policy stance was increasingly conditioned by the need to preserve financial stability while arresting the moderation in the growth momentum. The Reserve Bank acted aggressively and pre-emptively on monetary policy accommodation, both through interest rate cuts and a reduction in reserve requirements in terms of both magnitude and pace [16] .

The policy repo rate under the liquidity adjustment facility (LAF) was reduced from 9.0% to 4.75%.

The policy reverse repo rate under the LAF was reduced from 6.0% to 3.25%.

With receding inflationary pressures and the possibility of the global crisis affecting India’s growth prospects looming on the horizon, the Reserve Bank switched to an accommodative stance in mid-October 2008 when it reduced the CRR by 250 basis points from 9% to 6.5%. Between 11 October 2008 and 5 March 2009, the CRR was reduced by a cumulative 400 basis points to 5.0%.

The statutory liquidity ratio (SLR), a legal obligation on banks to invest a certain proportion of their liabilities in specified financial assets including cash, gold and government securities (under Section 24 of the Banking Regulation Act 1949), was one of the instruments used during the crisis to modulate the liquidity conditions in the economy. Variation of the SLR has an impact on the growth of money and credit in the economy through the government debt market. Accordingly, on 1 November 2008, the SLR was reduced to 24% of net demand and time liabilities (NDTL) with Effect from the fortnight beginning 8 November 2008. The liquidity situation remained comfortable from mid-November 2008 onwards, as reflected in the daily surplus being placed by banks in the LAF window of the Reserve Bank. In view of this, the SLR was restored to 25% of NDTL with effect from the fortnight beginning 7 November 2009 [17] .

The key policy initiatives taken by the Reserve Bank in response to the

Developments after September 2008 to improve the availability of FX liquidity included the selling of US dollars in the market by the Reserve Bank, the opening of a new FX swap facility for banks and the raising of interest rate ceilings on non- resident repatriable deposits to attract larger inflows. A cumulative increase of 175 basis points in the interest rate ceilings on each of the aforesaid term deposits was affected between mid-September and November 2008.

Banks were permitted to borrow funds from their overseas branches and

Correspondent banks to a maximum of 50% of their unimpaired Tier 1 capital or US$ 10 million, whichever was higher. The systemically important non-deposit- taking non-banking financial companies (NBFC-ND-SI) and housing finance companies (HFCs) were permitted to raise short-term foreign currency borrowings.

The ceiling rate on export credit in foreign currency was raised by 250 basis points to Libor+350 basis points on 5 February 2009. Correspondingly, the ceiling interest rate on the lines of credit from overseas banks was also increased by 75 basis points to six-month Libor/euro Libor/Euribor+150 basis points.

The policy on the premature buyback of foreign currency convertible bonds (FCCBs) was liberalised in December 2008, recognising the benefits accruing to Indian companies as well as to the economy on account of the depressed global markets. Under this scheme, the buyback of FCCBs by Indian companies was allowed under both the approval and the automatic routes, provided that the buyback was financed by foreign currency resources held in India or abroad and/or by fresh external

commercial borrowings (ECBs) raised in conformity with the extant ECB norms and by internal accruals.

Considering the continuing tightness of credit spreads in the international markets, the all-in-cost ceilings for different maturities were increased in respect of ECBs (150 to 250 basis points) as well as trade credit (75 to 150 basis points).Furthermore, the all-in-cost ceiling for ECBs under the approval route was dispensed with, initially until 30 June 2009, and later extended until 31 December 2009 [18] .

Measures were also initiated to safeguard the interests of India’s export sector which was affected by the global economic recession. The period of realisation and repatriation to India of the amount representing the full export value of goods or software exported was enhanced from six months to 12 months from the date of export, subject to review after one year. Similarly, as a relief measure to importers, the limit for the direct receipt of import bills/documents from overseas suppliers was enhanced from US$ 100,000 to US$ 300,000 in the case of imports of rough diamonds and rough precious and semi-precious stones by non-status holder exporters, enabling them to reduce transaction costs [19] .

Economic Recovery

From all accounts, except for the agricultural sector initially as noted above, economic recovery seems to be well underway. Economic growth stood at 8.6 percent during fiscal year 2010-11 per the advance estimates of CSO released on February 7, 2011. GDP growth for 2009-10 per quick estimates of January 31, 2011 was placed at 8 percent. The recovery in GDP growth for 2009-10, as indicated in the estimates, was broad based. Seven out of eight sectors/sub-sectors show a growth rate of 6.5 percent or higher. The exception, as anticipated, is agriculture and allied sectors where the growth rate needs to higher and sustainable over time. Sectors including mining and quarrying; manufacturing; and electricity, gas and water supply have significantly improved their growth rates at over 8 percent in comparison with 2008-09.

When compared to countries across the world, India stands out as one of the best performing economies. Although there was a clear moderation in growth from 9 percent levels to 7+ percent soon after the crisis hit, in 2010-11, at 8.6 percent, GDP growth in nearing the pre-crisis levels and this pace makes India the fastest growing major economy after China.

In order for India’s growth to be much more inclusive than what it has been, much higher level of public spending is needed in sectors, such as health and education along with the implementation of sectoral reforms so as to ensure timely and efficient service delivery. Plan allocations for 2010-11 for the social sectors have been stepped up, as can be seen from the figures below, this process however needs to be strengthened and sustained over time.

As expected, the measures undertaken by government of India to counter the effects of the global meltdown on the Indian economy have resulted in shortfall in revenues and substantial increases in government expenditures, leading to deviation from the fiscal consolidation path mandated under the Fiscal Responsibility and Budget Management (FRBM) Act.

The gross tax to GDP ratio which increased to an all time high of 12 percent in 2007-08, thanks to the conomy riding on a high growth trajectory, has steadily declined to 10.9 percent in 2008-09 and 10.3 per cent in 2009-10 due to moderation in growth and reduction in tax/duty rates. At the same time, total expenditure as percentage of GDP has increased from 14.4 percent in 2007-08 to 15.9 percent in 2008-09 and 16.6 percent in 2009-10. The fiscal expansion in the last 2 years has resulted in higher fiscal deficit of 6 percent of GDP in 2008-09 and 6.7 percent in 2009-10. Moreover, the revenue deficit as percentage ofGDP has worsened to 4.5 percent and 5.3 percent in 2008-09 and 2009-10 respectively. The revenue deficit and fiscal deficit in 2009-2010 are higher than the targets set under the FRBM Act and Rules.

the deviation from the mandate under FRBM Act and Rules was resorted to with the objective of keeping the economy on a high growth trajectory amidst global slowdown by creating demand through increased public expenditures in identified sectors.

While the intent of the government, it says is to bring the fiscal deficit under control with institutional reform measures encompassing all aspects of fiscal management such as subsidies, taxes, disinvestment and other expenditures as indicated in the Budget 2009-10, there is unfortunately no movement on any of these fronts, Considering the current inflationary strains, the as yet excessive pre-emption of the community’s savings by the government, the potential for crowding out the requirements of the enterprise sector, and rising interest payments on government debt, it is extremely essential to reduce the fiscal deficit, and more aggressively, mainly by lowering the revenue deficit. Correction of these deficits would, inter alia, require considerable refocusing and reduction of large hidden subsidies associated with under-pricing in crucial areas, such as power, irrigation, and urban transport. Food and fertilizer subsidies are other major areas of expenditure control. Be that as it may, the process of fiscal consolidation needs to be accelerated through more qualitative adjustments to reduce government dissavings and ameliorate price pressures.

The step-up in India's growth rate over much of the last two decades was primarily due to the structural changes in industrial, trade and financial areas, among others, over the 1990s as the reforms in these sectors were wide and deep and hence contributed significantly to higher productivity of the economy. Indeed, there is potential for still higher growth on a sustained basis of 9+ percent in the years ahead, but among other things, this would require the following:

Revival and a vigorous pursuit of economic reforms at the center and in the states;

A major effort at raising the rate of domestic savings, especially by reducing government dissavings at the central and state levels through cuts in, and refocusing of, explicit and implicit subsidies, stricter control over non-developmental expenditures, improvements in the tax ratio through stronger tax enforcement, and strengthening incentives for savings;

Larger investments in, and better performance of, infrastructural services, both in the public and private sectors; and

Greater attention to, and larger resources for, agriculture, social sectors and rural development programs to increase employment, reduce poverty and for creating a mass base in support of economic reforms. In conclusion, if India does attain and sustain growth rates of 9+ percent that it had achieved prior to the crisis, this itself is likely to push up its domestic savings in the next few years. Besides, stronger growth should attract more foreign savings, especially foreign direct investment, and thus rise the foreign investment rate. [20] 

Conclsion

The global financial crisis caused the greatest crisis in the global economy since the Great Depression. Through the coordinated efforts of the G20 countries, the world economy has avoided the worst possible scenario. However, the world economy remains fragile as a result of high unemployment and large excess capacity in the advanced economies, high levels of sovereign debt and the crisis in the Euro-zone. What are some of the key findings and lessons to be learned from the global financial crisis

First, this paper concludes that the global imbalance and the real estate asset bubble in the United States were largely brought about by U.S. domestic policy. The loose monetary policy that started in 2001 after the ―dot-com‖ bubble burst, magnified by the financial deregulation andthe subsequent various financial innovations, resulted in an exuberant boom in the U.S. housing market. The wealth effect from the housing boom and the financial innovation that allowed households to capitalize their gains in housing prices led to U.S. households‘ overconsumption and over indebtedness. The U.S.‘s large current account deficit, made possible by its reserve currency status, was a result of both the households‘ over-consumption and the public debts due to the Afghanistan and Iraq wars.

Second, the analysis shows that whether a policy is successful should not be judged only by its immediate effects but also its longer-term and overall effects. The use of monetary policy to cope with the recession brought out by the burst of the ―dot-com‖ bubble in 2001 could have been justifiable. However, with hindsight the policy was overused and extended for too long. Moreover, when the symptom of a problem appears, it is important to have a good analysis of the real cause of the problem. If in 2003 when the global imbalance, or specifically the U.S. trade deficit, first became an issue the attention was to understand the reasons for the U.S.‘s over- demand instead of pointing the finger to other countries for the U.S.‘s trouble, the exuberant boom in the U.S. housing market could have been restrained and the financial regulation in the U.S. could have been tightened much earlier. The global crisis could have been avoided or at least its adverse effect could have been reduced.

Third, any new policy initiative needs to be evaluated from both its positive effects and potential risk and negative effects. The crisis highlights the risks emanating from uncontrolled financial deregulation. The subprime mortgage crisis, as well as the collapse of the shadow banking system, illustrates the risks of lack of supervision of new financial instruments [21] .

Developing countries need to be vigilant in adopting appropriate levels of banking supervision that will prevent a recurrence of such a crisis. Most fundamentally, financial instruments and their interaction with one another need to be fully understood before they should be adopted.


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