Effect of European Crisis on Indian Economy

Ms. Preeti Agrawal Pursuing Post Graduate Diploma in Management, Indian Business School Bangalore Mailing address: Indian business academy Laxmipura ,Thataguni Post Kanakapura Main Road Bengaluru 560 062, INDIA Fax no. : +91 80 2608 3708 E mail: agrawalpreeti@gmail.com Phone no. : +91 9916298778 MR. Rahul Roy Pursuing Post Graduate Diploma in Management, Indian Business School Bangalore Mailing address: Indian business academy Laxmipura ,Thataguni Post Kanakapura Main Road Bengaluru 560 062, INDIA Fax no. : +91 80 2608 3708 E mail: rroy725@gmail.com Phone no. : +91 9739733440

Abstract:
The period preceding the Global Crisis was a phase of Great Moderation representing the decline in macroeconomic volatility (both output as well as inflation). The period was marked by strong worldwide GDP growth coupled with low or stable inflation. But it did not last long. With increasing pool of money in developing countries and difference in pattern of consumption and saving, a big chunk of money shifted from developing economies to developed economies (U.S.). This increase the liquidity in market thus lowering the return. And people shifted their investment from safe heaven to high return yielding countries (European countries). And with increasing debt level in these countries and effect of subprime crisis on global economy they found themselves on the verge of bankruptcy unable to refinance their debt. As now most of the countries are well integrated to each other through various channels (trade, financial market, bank exposure, confidence). The contagion effect of crisis spread throughout the world resulting in global economic crisis and affect worlds economy negatively slowing down economic growth in terms of GDP to 0.6% in 2009 from 5% during 2004-07. Due to less exposure of India to European market most of the economist predicted that impact of crisis would be less severe. But the result was quite harmful for Indian economy. India got affected more in indirect way rather than direct way. Due to risk aversion global financial market freeze showing significance of global integration. Investors took the money from financial market and invest in the U.S. Treasury bond (regarded as safe heaven). India still maintains the capital flow in form of FDI but it show withdrawal of large amount of FII which lead to many problem. With withdrawal of FII, stock market of India[The BSE Sensex (on closing basis), which had touched a peak of 20873 on January 8, 2008, declined to a low of 8160 on March 9, 2009 ] declined sharply. Also it imbalances the Balance of Payment leading to rupee depreciation which impacted Indian economy in many ways (costly import, tighten monetary policy etc.). With this because of the economy slowdown export also got impacted with growth of to . Introduction: The paper looks at the impact of the European crisis in Indian Economy mainly we are looking at two big industry of India service and manufacturing industry. Before proceeding further I would like to distinguish these two industries from others. India is one of the fast growing economies with the growth rate of 8.5% in 2009-10. In which service industry alone account for 57% with manufacturing industry contributing 28% to the GDP. It was Infosys who first took the name of India to the global market. But now things are not same, Despite of immense effort we are losing our market. Some of the changes are followed:

Output growth, which averaged little less than 9 per cent in the previous five years and 9.5 per cent during the three year period 2005-08, dropped to 6.8 per cent in the crisis year (2008-09) 8.5% in 2009-10. Service industry output have come down by Manufacturing output has come down by 5.1%. Between August 1, 2011 and November 23, 2011, the rupee has depreciated 18.28% (point-to-point basis). Indian Export Growth has fall down from 25% during 2005/08 decelerated to 13.6 per cent in the crisis year (2008-09) and registered a negative growth of 3.5 per cent in 2009-10. Indian stock market have seen heighten volatility.

All this losses to Indian economy are directed or indirectly related to European crisis.

On 1992 countries in Eurozone area decided to form a contingent. And sign Maastricht treaty and adopted euro as the common currency. They finalize Stability and Growth Pact in summer 1997 which established a strict framework for fiscal policies in the member countries of the euro area. The main purpose of the Pact was to reduce risks for the stability of the new European currency that could result from possible inflationary debt-bailouts. Most of the countries being the developed economy plus this restriction made the euro very strong currency. These countries have single monetary policy which is controlled by ECB (European central bank) and different fiscal policy. Along with this Maastricht treaty put some restriction on these countries: Debt cannot exceed 60% of GDP. Fiscal deficit cannot be more than 3% of GDP.

Evolution of Crisis: Crisis rises in late 2009 but it had its root from 2000 only when finance was getting globalized and credit was available easily at lower cost. Crisis mainly rises in Greek, Ireland and Portugal But due to interconnection of these countries to other country via Global finance system and international market, there is a fear of contagion effect of crisis to other economy as well.as France is under market pressure and have borrowed money from Italian bank on October 2011 $366 billion so if France come under significant pressure under market it would affect Italy also. There were different reasons for crisis in Greek Ireland and Portugal. In the 2000s, Greece had abundant access to cheap capital, fueled by flush capital markets and Increased investors confidence after adopting the euro in 2001. The temptation of easily available credit made them circumvent of rules of Maastricht treaty. For electoral benefit government started increasing its expenditure. In 2009 government expenditure only accounted for 50% of total GDP. This tendency appears to have helped politically influential public sector unions consistently negotiate generous wage and pension agreements and to finance these expenditure they issued securities and debt slowly started to rise.

In Ireland , The Irish sovereign debt crisis was not based on government over-spending, but from the state guaranteeing the six main Irish-based banks who had financed a property bubble. On 29 September 2008, Finance Minister Brian Lenihan, Jnr issued a one-year guarantee to the banks' depositors and bondholders. He renewed it for another year in September 2009. But soon loan got defaulted to property and homeowner and Irish bank lose 100 Billion. And with this Irish economy collapsed. Their unemployment rose from 4% in 2006 to 14% in 2010 and federal budget went from surplus in 2007 to 32% of GDP in 2010.

In

Causes for Crisis:

During 2000 Countries were interconnecting through globalization of finance and influx of capital market. Causes of the crisis begins with the significant increase in savings available for investment during the 20002007 period when the global pool of fixed income securities increased from approximately $36 trillion in 2000 to $70 trillion by 2007. This "Giant Pool of Money" increased as savings from high-growth developing nations entered global capital markets. Differences in the consumption and investment patterns among countries (a saving glut in Asia and oil exporting countries and a spending binge in the United States) have resulted in emergence of global imbalances which led to large capital flows from surplus countries into deficit countries which were mostly the advanced countries (U.S.)

This resulted in increase in liquidity in U.S. financial market leading to low interest rate both for long term and short term securities.

This forces the investors to hunt for the high yield market. The temptation of easily available credit makes European country to circumvent the rules of ECB. They raise more money against the policy through the use of complex currency and credit derivative structure. The most proximate cause for the Crisis was the developments in the US subprime market (Raghu ram Rajan). The crisis, when erupted in 2007, started off as a mere sub-prime crisis localized in the US. But soon the crisis spread to other markets cutting across geographical boundaries signifying the extent of the global integration. The subprime crisis became a banking crisis due to the exposures banks had to the subprime assets which were fast turning bad. Counterparty concerns increased, leading to freezing of global interbank markets. The crisis had spread to other jurisdictions through various channels of contagion- trade, finance and most importantly, confidence. Foreign investors started withdrawing investments from emerging markets pushing them also into liquidity crisis. The policy makers, regulators and the sovereigns had to immediately step in and initiate measures to mitigate the impact of crisis. There have been many measures, both conventional and unconventional, that were taken which provided relief to the badly battered global economy. These various measure taken to mitigate the impact of crisis unveiled issues under lied in unclear information of debt level accumulated and risks. In late 2009 fear of default developed among the investors. Most of their debt was in foreigners hands. The investors started asking for high return to compensate the risk associated with its bond. And borrowing cost started jump like anything. Further Rating agency downgraded their credit from AA+ to junk state. This further made the cost of borrowing goes higher. This fear of default and no hope of rescue from this country spread among the investor. They no longer want to invest their money In European country. And this made very difficult for crisis affected countries to refinance their debt give rise to debt crisis. Reason for debt crisis is economical as well as political. They have single monetary policy but different fiscal budget. ECB put some rule on their debt and deficit level but could not implement

them strictly. Now they cant print money to pay back to creditors because it will devalue the value of currency against its trading partner. Methodology: The research was done by secondary data analysis. The source for the data were mainly Newspapers (business line, Hindu) Journal (wall street journal) and different sites (RBI, ECB, IMF etc.) providing Financial and economic performance of countries through various measures. First I began with exploratory analysis to find out different variable which are linking Indian bad performance with European crisis. I started with newspapers and speeches. With that I took help of different sites. The data were being analyzed through content analysis both in terms of quantitative and qualitative measure. Then after I conduct causal research which helped me understand causes and effect. That how different factor in economy are interrelated to each other and in change in one variable turn the face of whole economy. The data were analyzed through inferential statistical tools. Objective: The topic has already been discussed, analyzed so many times it erupted in 2007 and till now also it is matter of discussion for all. No newspaper is complete without directly or indirectly talking about crisis. No important speech from finance minister is complete without a reference to it. But I am still choosing the topic because it started with a localized subprime crisis and transformed into European sovereign debt crisis and continuously spreading to other countries. It offers a wealth of knowledge and better understanding of global integration and its significance.