THE IMPACT OF RECENT GLOBAL ECONOMIC SLUMP ON INDIAN CAPITAL MARKET Global Economic Slump What went wrong?

Beginning in the United States in December 2007 (and with much greater intensity since September 2008, according to the National Bureau of Economic Research), the industrialized world has been undergoing a recession, a pronounced deceleration of economic activity. This global recession has been taking place in an economic environment characterized by various imbalances and was sparked by the outbreak of the financial crisis of 20072009. Although the late-2000s recession has at times been referred to as "the Great Recession," this same phrase has been used to refer to every recession of the several preceding decades. The financial crisis has been linked to reckless and unsustainable lending practices resulting from the deregulation and securitization of real estate mortgages in the United States. The US mortgage-backed securities, which had risks that were hard to assess, were marketed around the world. A more broad based credit boom fed a global speculative bubble in real estate and equities, which served to reinforce the risky lending practices. The precarious financial situation was made more difficult by a sharp increase in oil and food prices. The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans and over-inflated asset prices. With loan losses mounting and the fall of Lehman Brothers on September 15, 2008, a major panic broke out on the inter-bank loan market. As share and housing prices declined many large and well established investment and commercial banks in the United States and Europe suffered huge losses and even faced bankruptcy, resulting in massive public financial assistance. A global recession has resulted in a sharp drop in international trade, rising unemployment and slumping commodity prices. In December 2008, the National Bureau of Economic Research (NBER) declared that the United States had been in recession since December 2007. Several economists have predicted that recovery may not appear until 2011 and that the recession will be the worst since the Great Depression of the 1930s.The conditions leading up to the crisis, characterized by an exorbitant rise in asset prices and associated boom in economic demand, are considered a result of the

extended period of easily available credit, inadequate regulation and oversight, or increasing inequality. The recession has renewed interest in Keynesian economic ideas on how to combat recessionary conditions. Fiscal and monetary policies have been significantly eased to stem the recession and financial risks. Most economists believe that the stimulus should be withdrawn as soon as the economies recover enough to "chart a path to sustainable growth

Pre-recession economic imbalances The onset of the economic crisis took most people by surprise. A 2009 paper identifies twelve economists and commentators who, between 2000 and 2006, predicted a recession based on the collapse of the then booming housing market in the U.S: Dean Baker, Wynne Godley, Fred Harrison, Michael Hudson, Eric Janszen, Steve Keen, Jakob Brchner Madsen & Jens Kjaer Srensen, Kurt Richebcher, Nouriel Roubini, Peter Schiff and Robert Shiller. Among the various imbalances in which the US monetary policy contributed by excessive money creation, leading to negative household savings and a huge US trade deficit, dollar volatility and public deficits, a focus can be made on the following ones: Commodity boom Further information: 2000s energy crisis and 20072008 world food price crisis See also: 2008 Central Asia energy crisis and 2008 Bulgarian energy crisis

Brent barrel petroleum spot prices, May 1987 March 2009. The decade of the 2000s saw a global explosion in prices, focused especially in commodities and housing, marking an end to the commodities recession of 19802000. In 2008, the prices of many commodities, notably oil and food, rose so high as to cause genuine economic damage, threatening stagflation and a reversal of globalization. In January 2008, oil prices surpassed $100 a barrel for the first time, the first of many price milestones to be passed in the course of the year. In July 2008, oil peaked at $147.30 a barrel and a gallon of gasoline was more than $4 across most of the U.S.A. These high prices caused a dramatic drop in demand and prices fell below $35 a barrel at the end of 2008. Some believe that this oil price spike was the product of Oil. There is concern that if the economy was to improve, oil prices might return to pre-recession levels. The food and fuel crises were both discussed at the 34th G8 summit in July 2008. Sulfuric acid (an important chemical commodity used in processes such as steel processing, copper production and bioethanol production) increased in price 3.5-fold in less than 1 year while producers of sodium hydroxide have declared force majeure due to flooding, precipitating similarly steep price increases. In the second half of 2008, the prices of most commodities fell dramatically on expectations of diminished demand in a world recession. Housing bubble

UK house prices between 1975 and 2006. Further information: Real estate bubble

By 2007, real estate bubbles were still under way in many parts of the world, especially in the United States, United Kingdom, United Arab Emirates, Italy, Australia, New Zealand, Ireland, Spain, France, Poland, South Africa, Israel, Greece, Bulgaria, Croatia, Canada, Norway, Singapore, South Korea, Sweden, Finland, Argentina, Baltic, India, Romania, Russia, Ukraine and China. U.S. Federal Reserve Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market) it's hard not to see that there are a lot of local bubbles". The Economist magazine, writing at the same time, went further, saying "the worldwide rise in house prices is the biggest bubble in history". Real estate bubbles are (by definition of the word "bubble") followed by a price decrease (also known as a housing price crash) that can result in many owners holding negative equity (a mortgage debt higher than the current value of the property).

Inflation
In February 2008, Reuters reported that global inflation was at historic levels, and that domestic inflation was at 1020 year highs for many nations. "Excess money supply around the globe, monetary easing by the Fed to tame financial crisis, growth surge supported by easy monetary policy in Asia, speculation in commodities, agricultural failure, rising cost of imports from China and rising demand of food and commodities in the fast growing emerging markets," have been named as possible reasons for the inflation. In mid-2007, IMF data indicated that inflation was highest in the oilexporting countries, largely due to the unsterilized growth of foreign exchange reserves, the term unsterilized referring to a lack of monetary policy operations that could offset such a foreign exchange intervention in order to maintain a country's monetary policy target. However, inflation was also growing in countries classified by the IMF as "non-oil-exporting LDCs" (Least Developed Countries) and "Developing Asia", on account of the rise in oil and food prices. Inflation was also increasing in the developed countries, but remained low compared to the developing world.

Causes

The great asset bubble: 1. Central banks' gold reserves $0.845 tn. 2. M0 (paper money) - $3.9 tn. 3. Traditional (fractional reserve) banking assets $39 tn. 4. Shadow banking assets $62 tn. 5. Other assets $290 tn. 6. Bail-out money (early 2009) $1.9 tn. Financial crisis of 20072009 Debate over origins The central debate about the origin has been focused on the respective parts played by the public monetary policy (in the US notably) and by private financial institutions practices. On October 15, 2008, Anthony Faiola, Ellen Nakashima, and Jill Drew wrote a lengthy article in The Washington Post titled, "What Went Wrong". In their investigation, the authors claim that former Federal Reserve Board Chairman Alan Greenspan, Treasury Secretary Robert Rubin, and SEC Chairman Arthur Levitt vehemently opposed any regulation of financial instruments known as derivatives. They further claim that Greenspan actively sought to undermine the office of the Commodity Futures Trading Commission, specifically under the leadership of Brooksley E. Born, when the Commission sought to initiate regulation of derivatives. Ultimately, it

was the collapse of a specific kind of derivative, the mortgage-backed security, that triggered the economic crisis of 2008. While Greenspan's role as Chairman of the Federal Reserve has been widely discussed (the main point of controversy remains the lowering of Federal funds rate at only 1% for more than a year which, according to the Austrian School of economics, allowed huge amounts of "easy" credit-based money to be injected into the financial system and thus create an unsustainable economic boom), there is also the argument that Greenspan actions in the years 20022004 were actually motivated by the need to take the U.S. economy out of the early 2000s recession caused by the bursting of the dotcom bubble although by doing so he did not help avert the crisis, but only postpone it. Some economists claim that the ultimate point of origin of the great financial crisis of 20072009 can be traced back to an extremely indebted US economy. The collapse of the real estate market in 2006 was the close point of origin of the crisis. The failure rates of subprime mortgages were the first symptom of a credit boom tuned to bust and of a real estate shock. But large default rates on subprime mortgages cannot account for the severity of the crisis. Rather, low-quality mortgages acted as an accelerant to the fire that spread through the entire financial system. The latter had become fragile as a result of several factors that are unique to this crisis: the transfer of assets from the balance sheets of banks to the markets, the creation of complex and opaque assets, the failure of ratings agencies to properly assess the risk of such assets, and the application of fair value accounting. To these novel factors, one must add the now standard failure of regulators and supervisors in spotting and correcting the emerging weaknesses. Subprime lending as a cause Based on the assumption that subprime lending precipitated the crisis, some have argued that the Clinton Administration may be partially to blame, while others have pointed to the passage of the Gramm-Leach-Bliley Act by the 106th Congress, and over-leveraging by banks and investors eager to achieve high returns on capital. Some believe the roots of the crisis can be traced directly to subprime lending by Fannie Mae and Freddie Mac, which are government sponsored entities. The New York Times published an article that reported the Clinton

Administration pushed for subprime lending: "Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people" (NYT, 30 September 1999). In 1995, the administration also tinkered with Carter's Community Reinvestment Act of 1977 by regulating and strengthening the anti-redlining procedures. It is felt by many that this was done to help boost a stagnated home ownership figure that had hovered around 65% for many years. The result was a push by the administration for greater investment, by financial institutions, into riskier loans. In a 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 it was shown that $467 billion of mortgage credit poured out of CRA-covered lenders into low- and mid-level income borrowers and neighborhoods. (See "The Community Reinvestment Act After Financial Modernization," April 2000.) Government activities as a cause In 1992, the 102nd Congress under the George H. W. Bush administration weakened regulation of Fannie Mae and Freddie Mac with the goal of making available more money for the issuance of home loans. The Washington Post wrote: "Congress also wanted to free up money for Fannie Mae and Freddie Mac to buy mortgage loans and specified that the pair would be required to keep a much smaller share of their funds on hand than other financial institutions. Whereas banks that held $100 could spend $90 buying mortgage loans, Fannie Mae and Freddie Mac could spend $97.50 buying loans. Finally, Congress ordered that the companies be required to keep more capital as a cushion against losses if they invested in riskier securities. But the rule was never set during the Clinton administration, which came to office that winter, and was only put in place nine years later." Others have pointed to deregulation efforts as contributing to the collapse. In 1999, the 106th Congress passed the Gramm-Leach-Bliley Act, which repealed part of the Glass-Steagall Act of 1933. This repeal has been criticized by some for having contributed to the proliferation of the complex and opaque financial instruments which are at the heart of the crisis. However, some economists object to singling out the repeal of GlassSteagall for criticism. Brad DeLong, a former advisor to President Clinton and economist at the University of California, Berkeley and Tyler Cowen of

George Mason University have both argued that the Gramm-Leach-Bliley Act softened the impact of the crisis by allowing for mergers and acquisitions of collapsing banks as the crisis unfolded in late 2008. Over-leveraging, credit default obligations as causes swaps and collateralized debt

Another probable cause of the crisisand a factor that unquestionably amplified its magnitudewas widespread miscalculation by banks and investors of the level of risk inherent in the unregulated Collateralized debt obligation and Credit Default Swap markets. Under this theory, banks and investors systematized the risk by taking advantage of low interest rates to borrow tremendous sums of money that they could only pay back if the housing market continued to increase in value. According to an article published in Wired, the risk was further systematized by the use of David X. Li's Gaussian copula model function to rapidly price Collateralized debt obligations based on the price of related Credit Default Swaps. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies.[45] According to one wired.com article: "Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected. The cracks became full-fledged canyons in 2008when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril...Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees." The pricing model for CDOs clearly did not reflect the level of risk they introduced into the system. It has been estimated that the "from late 2005 to the middle of 2007, around $450bn of CDO of ABS were issued, of which about one third were created from risky mortgage-backed bonds... [o]ut of that pile, around $305bn of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi." The average recovery rate for high quality CDOs has been approximately 32 cents on the dollar, while the recovery rate for mezzanine CDO's has been approximately five cents for every dollar. These massive, practically unthinkable, losses have

dramatically impacted the balance sheets of banks across the globe, leaving them with very little capital to continue operations. Credit creation as a cause The Austrian School of Economics proposes that the crisis is an excellent example of the Austrian Business Cycle Theory, in which credit created through the policies of central banking gives rise to an artificial boom, which is inevitably followed by a bust. This perspective argues that the monetary policy of central banks creates excessive quantities of cheap credit by setting interest rates below where they would be set by a free market. This easy availability of credit inspires a bundle of malinvestments, particularly on long term projects such as housing and capital assets, and also spurs a consumption boom as incentives to save are diminished. Thus an unsustainable boom arises, characterized by malinvestments and overconsumption. But the created credit is not backed by any real savings nor is in response to any change in the real economy, hence, there are physically not enough resources to finance either the malinvestments or the consumption rate indefinitely. The bust occurs when investors collectively realize their mistake. This happens usually some time after interest rates rise again. The liquidation of the malinvestments and the consequent reduction in consumption throw the economy into a recession, whose severity mirrors the scale of the boom's excesses. The Austrian School argues that the conditions previous to the crisis of the late 2000s correspond exactly to the scenario described above. The central bank of the United States, led by Federal Reserve Chairman Alan Greenspan, kept interest rates very low for a long period of time to blunt the recession of the early 2000s. The resulting malinvestment and overconsumption of investors and consumers prompted the development of a housing bubble that ultimately burst, precipitating the financial crisis. This crisis, together with sudden and necessary deleveraging and cutbacks by consumers, businesses and banks, led to the recession. Austrian Economists argue further that while they probably affected the nature and severity of the crisis, factors such as a lack of regulation, the Community Reinvestment Act, and entities such as Fannie Mae and Freddie Mac are insufficient by themselves to explain it.

Austrian economists argue that the history of the yield curve from 2000 through 2007 illustrates the role that credit creation by the Federal Reserve may have played in the on-set of the financial crisis in 2007 and 2008. The yield curve (also known as the term structure of interest rates) is the shape formed by a graph showing US Treasury Bill or Bond interest rates on the vertical axis and time to maturity on the horizontal axis. When short-term interest rates are lower than long-term interest rates the yield curve is said to be positively sloped. When short-term interest rates are higher than longterm interest rates the yield curve is said to be inverted. When long term and short term interest rates are equal the yield curve is said to be flat. The yield curve is believed by some to be a strong predictor of recession (when inverted) and inflation (when positively sloped). However, the yield curve is believed to act on the real economy with a lag of 1 to 3 years. A positively sloped yield curve allows Primary Dealers (such as large investment banks) in the Federal Reserve system to fund themselves with cheap short term money while lending out at higher long-term rates. This strategy is profitable so long as the yield curve remains positively sloped. However, it creates a liquidity risk if the yield curve were to become inverted and banks would have to refund themselves at expensive short term rates while losing money on longer term loans. The narrowing of the yield curve from 2004 and the inversion of the yield curve during 2007 resulted (with the expected 1 to 3 year delay) in a bursting of the housing bubble and a wild gyration of commodities prices as moneys flowed out of assets like housing or stocks and sought safe haven in commodities. The price of oil rose to over $140 dollars per barrel in 2008 before plunging as the financial crisis began to take hold in late 2008. Other observers have doubted the role that the yield curve plays in controlling the business cycle. In a May 24, 2006 story CNN Money reported: in recent comments, Fed Chairman Ben Bernanke repeated the view expressed by his predecessor Alan Greenspan that an inverted yield curve is no longer a good indicator of a recession ahead.

Oil prices Economist James D. Hamilton has argued that the increase in oil prices in the period of 2007 through 2008 was a significant cause of the recession. He evaluated several different approaches to estimating the impact of oil price shocks on the economy, including some methods that had previously shown a decline in the relationship between oil price shocks and the overall economy. All of these methods "support a common conclusion; had there been no increase in oil prices between 2007:Q3 and 2008:Q2, the US economy would not have been in a recession over the period 2007:Q4 through 2008:Q3." Hamilton's own model, a time-series econometric forecast based on data up to 2003, showed that the decline in GDP could have been successfully predicted to almost its full extent given knowledge of the price of oil. The results imply that oil prices were entirely responsible for the recession; however, Hamilton himself acknowledged that this was probably not the case but maintained that it showed that oil price increases made a significant contribution to the downturn in economic growth. Other claimed causes Many libertarians, including Congressman and former 2008 Presidential candidate Ron Paul and Peter Schiff in his book Crash Proof, claim to have predicted the crisis prior to its occurrence. Schiff also made a speech in 2006 in which he predicted the failure of Fannie and Freddie . They are critical of theories that the free market caused the crisis and instead argue that the Federal Reserve's expansionary monetary policy and the Community Reinvestment Act are the primary causes of the crisis. Alan Greenspan, former Federal Reserve chairman, has said he was partially wrong to oppose regulation of the markets, and expressed "shocked disbelief" at the failure of self interest, alone, to manage risk in the markets. An empirical study by John B. Taylor concluded that the crisis was: (1) caused by excess monetary expansion; (2) prolonged by an inability to evaluate counter-party risk due to opaque financial statements; and (3) worsened by the unpredictable nature of government's response to the crisis. It has also been debated that the root cause of the crisis is overproduction of goods caused by globalization (and especially vast investments in countries such as China and India by western multinational companies over the past 1520 years, which greatly increased global industrial output at a reduced

cost). Overproduction tends to cause deflation and signs of deflation were evident in October and November 2008, as commodity prices tumbled and the Federal Reserve was lowering its target rate to an all-time-low 0.25%. On the other hand, Professor Herman Daly suggests that it is not actually an economic crisis, but rather a crisis of overgrowth beyond sustainable ecological limits. This reflects a claim made in the 1972 book Limits to Growth, which stated that without major deviation from the policies followed in the 20th century, a permanent end of economic growth could be reached sometime in the first two decades of the 21st century, due to gradual depletion of natural resources. Global Effects Overview The late-2000s recession is shaping up to be the worst post-war contraction on record:

Real gross domestic product (GDP) began contracting in the third quarter of 2008, and by early 2009 was falling at an annualized pace not seen since the 1950s. Capital investment, which was in decline year-on-year since the final quarter of 2006, matched the 195758 post war record in the first quarter of 2009. The pace of collapse in residential investment picked up speed in the first quarter of 2009, dropping 23.2% year-on-year, nearly four percentage points faster than in the previous quarter. Domestic demand, in decline for five straight quarters, is still three months shy of the 197475 record, but the pace down 2.6% per quarter vs. 1.9% in the earlier period is a record-breaker already.

Trade and industrial production In middle-October 2008, the Baltic Dry Index, a measure of shipping volume, fell by 50% in one week, as the credit crunch made it difficult for exporters to obtain letters of credit. In February 2009, The Economist claimed that the financial crisis had produced a "manufacturing crisis", with the strongest declines in industrial production occurring in export-based economies.

In March 2009, Britain's Daily Telegraph reported the following declines in industrial output, from January 2008 to January 2009: Japan 31%, Korea 26%, Russia 16%, Brazil 15%, Italy 14%, Germany 12%. Some analysts even say the world is going through a period of deglobalization and protectionism after years of increasing economic integration. Sovereign funds and private buyers from the Middle East and Asia, including China, are increasingly buying in on stakes of European and U.S. businesses, including industrial enterprises. Due to the global recession they are available at a low price. The Chinese government has concentrated on natural-resource deals across the world, securing supplies of oil and minerals. Pollution According to the International Energy Agency man-made greenhouse gas emissions will decrease by 3% in 2009, mainly as a result of the financial crisis. Previously emissions had been rising by around 3% per year. The drop in emissions is only the 4th to occur in 50 years. Unemployment The International Labour Organization (ILO) predicted that at least 20 million jobs will have been lost by the end of 2009 due to the crisis mostly in "construction, real estate, financial services, and the auto sector" bringing world unemployment above 200 million for the first time. The number of unemployed people worldwide could increase by more than 50 million in 2009 as the global recession intensifies, the ILO has forecast. In December 2007, the U.S. unemployment rate was 4.9%. By October 2009, the unemployment rate had risen to 10.2%. A broader measure of unemployment (taking into account marginally attached workers, those employed part time for economic reasons, and discouraged workers) was 16.3%. Spain's unemployment rate reached 18.7% (37% for youths) in May 2009 the highest in the eurozone. In July 2009, fewer jobs were lost than expected, dipping the unemployment rate from 9.5% to 9.4%. Even fewer jobs were lost in August, 216,000, recorded as the lowest number of jobs since September 2008, but the unemployment rate rose to 9.7%. In October 2009, news reports announced that some employers who cut jobs due to the

recession are beginning to hire them back. More recently, economists have announced the end of the recession last month, and have predicted that job losses will stop in early 2010. The rise of advanced economies in Brazil, India, and China increased the total global labor pool dramatically. Recent improvements in communication and education in these countries has allowed workers in these countries to compete more closely with workers in traditionally strong economies, such as the United States. This huge surge in labor supply has provided downward pressure on wages and contributed to unemployment. Recession Entrepreneurs The term Recession Entrepreneurs was coined by JJ Ink in 2009, after they found that most of their marketing consulting clients were recession made entrepreneurs, those that had been laid off due to the economic downturn and had thus decided to use their savings and unemployment benefits to start their own business. The recession has allowed many Recession Entrepreneurs to completely change course in their careers and pursue their dream jobs. Recessions are historically ripe with opportunity for innovation, allowing a unique opportunity for entrepreneurs. "The recession has also injected life into a slew of small businesses that are thriving either in spite of or because of the economic downturn, giving new relevance to the old adage that one man's misfortune is another's opportunity."

Financial markets
Main article: Financial crisis of 20072009 For a time, major economies of the 21st century were believed to have begun a period of decreased volatility, which was sometimes dubbed The Great Moderation, because many economic variables appeared to have achieved relative stability. The return of commodity, stock market, and currency value volatility are regarded as indications that the concepts behind the Great Moderation were guided by false beliefs. January 2008 was an especially volatile month in world stock markets, with a surge in implied volatility measurements of the US-based S&P 500 index, and a sharp decrease in non-U.S. stock market prices on Monday, January

21, 2008 (continuing to a lesser extent in some markets on January 22). Some headline writers and a general news columnist called January 21 "Black Monday" and referred to a "global shares crash," though the effects were quite different in different markets. The effects of these events were also felt on the Shanghai Composite Index in China which lost 5.14 percent, most of this on financial stocks such as Ping An Insurance and China Life which lost 10 and 8.76 percent respectively. Investors worried about the effect of a recession in the US economy would have on the Chinese economy. Citigroup estimates due to the number of exports from China to America a one percent drop in US economic growth would lead to a 1.3 percent drop in China's growth rate. There were several large Monday declines in stock markets world wide during 2008, including one in January, one in August, one in September, and another in early October. As of October 2008, stocks in North America, Europe, and the Asia-Pacific region had all fallen by about 30% since the beginning of the year. The Dow Jones Industrial Average had fallen about 37% since January 2008. The simultaneous multiple crises affecting the US financial system in midSeptember 2008 caused large falls in markets both in the US and elsewhere. Numerous indicators of risk and of investor fear (the TED spread, Treasury yields, the dollar value of gold) set records. Russian markets, already falling due to declining oil prices and political tensions with the West, fell over 10% in one day, leading to a suspension of trading, while other emerging markets also exhibited losses. On September 18, UK regulators announced a temporary ban on shortselling of financial stocks. On September 19 the U.S. Securities and Exchange Commission (SEC) followed by placing a temporary ban of shortselling stocks of 799 specific financial institutions. In addition, the SEC made it easier for institutions to buy back shares of their institutions. The action is based on the view that short selling in a crisis market undermines confidence in financial institutions and erodes their stability. On September 22, the Australian Securities Exchange (ASX) delayed opening by an hour after a decision was made by the Australian Securities and Investments Commission (ASIC) to ban all short selling on the ASX. This was revised slightly a few days later.

As is often the case in times of financial turmoil and loss of confidence, investors turned to assets which they perceived as tangible or sustainable. The price of gold rose by 30% from middle of 2007 to end of 2008. A further shift in investors preference towards assets like precious metals or land is discussed in the media. In March 2009, Blackstone Group CEO Stephen Schwarzman said that up to 45% of global wealth had been destroyed in little less than a year and a half. Travel According to Zagat's 2009 U.S. Hotels, Resorts & Spas survey, business travel has decreased in the past year as a result of the recession. 30% of travelers surveyed stated they travel less for business today while only 21% of travelers stated that they travel more. Reasons for the decline in business travel include company travel policy changes, personal economics, economic uncertainty and high airline prices. Hotels are responding to the downturn by dropping rates, ramping up promotions and negotiating deals for both business travelers and tourists. Insurance A February 2009 study on the main British insurers showed that most of them do not plan to raise their insurance premiums for the year 2009, in spite of the prediction of a 20% raise made by The Daily Telegraph and The Daily Mirror. However, it is expected that the capital liquidity will become an issue and determine increases, having their capital tied up in investments yielding smaller dividends, corroborated with the 644 million underwriting losses suffered in 2007. Countries most affected The crisis affected all countries in some ways, but certain countries were vastly affected more than others. By measuring currency devaluation, equity market decline, and the rise in sovereign bond spreads, a picture of financial devastation emerges. Since these three indicators show financial weakness, taken together, they capture the impact of the crisis.[108] The Carnegie Endowment for International Peace reports in its International Economics Bulletin that two eastern European countries Hungary, and Ukraine as well as Argentina and Jamaica are the countries most deeply affected by the

crisis. By contrast, China, Japan, India, Peru and Australia are "among the least affected". Political instability related to the economic crisis In December 2008, Greece experienced extensive civil unrest that continued into January and then again in late February many Greeks took part in a massive general strike because of the economic situation and shut down schools, airports, and many other services in Greece. In January 2009, the government leaders of Iceland were forced to call elections two years early after the people of Iceland staged mass protests and clashed with the police due to the government's handling of the economy. Hundreds of thousands protested in France against President Sarkozy's economic policies. Prompted by the financial crisis in Latvia, the opposition and trade unions there organized a rally against the cabinet of premier Ivars Godmanis. The rally gathered some 1020 thousand people. In the evening, the rally turned into a riot. The crowd moved to the building of the parliament and attempted to force their way into it, but were repelled by the state's police. Police and protesters also clashed in Lithuania. In addition to various levels of unrest in Europe, Asian countries have also seen various degrees of protest. Communists and others rallied in Moscow to protest the Russian government's economic plans. Protests have also occurred in China as demands from the West for exports were dramatically reduced and unemployment increased. Beginning February 26, 2009, an Economic Intelligence Briefing was added to the daily intelligence briefings prepared for the President of the United States. This addition reflected the assessment of United States intelligence agencies that the global financial crisis presented a serious threat to international stability. In March 2009, British think tank Economist Intelligence Unit published a special report titled 'Manning the barricades' in which it estimated "who's at risk as deepening economic distress foments social unrest". The Report envisioned the next two years filled with great social upheavals, disrupted economies and toppled governments around the globe. Business Week in March 2009 stated that global political instability is rising fast due to the global financial crisis and is creating new challenges that need managing. The Associated Press reported in March 2009 that: United States "Director of National Intelligence Dennis Blair has said the economic

weakness could lead to political instability in many developing nations." Even some developed countries are seeing political instability. NPR reports that David Gordon, a former intelligence officer who now leads research at the Eurasia Group, said: "Many, if not most, of the big countries out there have room to accommodate economic downturns without having large-scale political instability if we're in a recession of normal length. If you're in a much longer-run downturn, then all bets are off." "The recent wave of popular unrest was not confined to Eastern Europe. Ireland, Iceland, France, the U.K. and Greece also experienced street protests, but many Eastern European governments seem more vulnerable as they have limited policy options to address the crisis and little or no room for fiscal stimulus due to budgetary or financing constrains. Deeply unpopular austerity measures, including slashed public wages, tax hikes and curbs on social spending will keep fanning public discontent in the Baltic states, Hungary and Romania. Dissatisfaction linked to the economic woes will be amplified in the countries where governments have been weakened by high-profile corruption and fraud scandals (Latvia, Lithuania, Hungary, Romania and Bulgaria)." Policy responses Main article: 2008-2009 Keynesian resurgence Main article: National fiscal policy response to the late 2000s recession The financial phase of the crisis led to emergency interventions in many national financial systems. As the crisis developed into genuine recession in many major economies, economic stimulus meant to revive economic growth became the most common policy tool. After having implemented rescue plans for the banking system, major developed and emerging countries announced plans to relieve their economies. In particular, economic stimulus plans were announced in China, the United States, and the European Union. Bailouts of failing or threatened businesses were carried out or discussed in the USA, the EU, and India. In the final quarter of 2008, the financial crisis saw the G-20 group of major economies assume a new significance as a focus of economic and financial crisis management.

United States policy responses

The Federal Reserve, Treasury, and Securities and Exchange Commission took several steps on September 19 to intervene in the crisis. To stop the potential run on money market mutual funds, the Treasury also announced on September 19 a new $50 billion program to insure the investments, similar to the Federal Deposit Insurance Corporation (FDIC) program. Part of the announcements included temporary exceptions to section 23A and 23B (Regulation W), allowing financial groups to more easily share funds within their group. The exceptions would expire on January 30, 2009, unless extended by the Federal Reserve Board. The Securities and Exchange Commission announced termination of short-selling of 799 financial stocks, as well as action against naked short selling, as part of its reaction to the mortgage crisis. Market volatility within US 401(k) and retirement plans The US Pension Protection Act of 2006 included a provision which changed the definition of Qualified Default Investments (QDI) for retirement plans from stable value investments, money market funds, and cash investments to investments which expose an individual to appropriate levels of stock and bond risk based on the years left to retirement. The Act required that Plan Sponsors move the assets of individuals who had never actively elected their investments and had their contributions in the default investment option. This meant that individuals who had defaulted into a cash fund with little fluctuation or growth would soon have their account balances moved to much more aggressive investments. Starting in early 2008, most US employer-sponsored plans sent notices to their employees informing them that the plan default investment was changing from a cash/stable option to something new, such as a retirement date fund which had significant market exposure. Most participants ignored these notices until September and October, when the market crash was on every news station and media outlet. It was then that participants called their 401(k) and retirement plan providers and discovered losses in excess of 30% in some cases. Call centers for 401(k) providers experienced record call volume and wait times, as millions of inexperienced investors struggled to understand how their investments had been changed so fundamentally without their explicit consent, and reacted in a panic by liquidating

everything with any stock or bond exposure, locking in huge losses in their accounts. Due to the speculation and uncertainty in the market, discussion forums filled with questions about whether or not to liquidate assets and financial gurus were swamped with questions about the right steps to take to protect what remained of their retirement accounts. During the third quarter of 2008, over $72 billion left mutual fund investments that invested in stocks or bonds and rushed into Stable Value investments in the month of October. Against the advice of financial experts, and ignoring historical data illustrating that long-term balanced investing has produced positive returns in all types of markets, investors with decades to retirement instead sold their holdings during one of the largest drops in stock market history. Loans to banks for asset-backed commercial paper

During the week ending September 19, 2008, money market mutual funds had begun to experience significant withdrawals of funds by investors. This created a significant risk because money market funds are integral to the ongoing financing of corporations of all types. Individual investors lend money to money market funds, which then provide the funds to corporations in exchange for corporate short-term securities called asset-backed

commercial paper (ABCP). However, a potential bank run had begun on certain money market funds. If this situation had worsened, the ability of major corporations to secure needed short-term financing through ABCP issuance would have been significantly affected. To assist with liquidity throughout the system, the US Treasury and Federal Reserve Bank announced that banks could obtain funds via the Federal Reserve's Discount Window using ABCP as collateral.

Federal Reserve lowers interest rates Federal reserve rates changes ( Just data after January 1, 2008 ) Discount Discount Fed Fed funds Date Discount rate rate rate funds rate Primary Secondary new interest new interest rate new interest rate change rate rate change rate Oct 8, -.50% 1.75% 2.25% -.50% 1.50% 2008* Apr 30, -.25% 2.25% 2.75% -.25% 2.00% 2008 Mar 18, -.75% 2.50% 3.00% -.75% 2.25% 2008 Mar 16, -.25% 3.25% 3.75% 2008 Jan 30, -.50% 3.50% 4.00% -.50% 3.00% 2008 Jan 22, -.75% 4.00% 4.50% -.75% 3.50% 2008 * Part of a coordinated global rate cut of 50 basis point by main central banks.

Legislation Main article: Emergency Economic Stabilization Act of 2008 The Secretary of the United States Treasury, Henry Paulson and President George W. Bush proposed legislation for the government to purchase up to US$700 billion of "troubled mortgage-related assets" from financial firms in hopes of improving confidence in the mortgage-backed securities markets and the financial firms participating in it. Discussion, hearings and meetings among legislative leaders and the administration later made clear that the proposal would undergo significant change before it could be approved by Congress. On October 1, a revised compromise version was approved by the Senate with a 7425 vote. The bill, HR1424 was passed by the House on October 3, 2008 and signed into law. The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. In January 2009, the Obama administration announced a stimulus plan to revive the economy with the intention to create or save more than 3.6 million jobs in two years. The cost of this initial recovery plan was estimated at 825 billion dollars (5.8% of GDP). The plan included 365.5 billion dollars to be spent on major policy and reform of the health system, 275 billion (through tax rebates) to be redistributed to households and firms, notably those investing in renewable energy, 94 billion to be dedicated to social assistance for the unemployed and families, 87 billion of direct assistance to states to help them finance health expenditures of Medicaid, and finally 13 billion spent to improve access to digital technologies. The administration also attributed of 13.4 billion dollars aid to automobile manufacturers General Motors and Chrysler, but this plan is not included in the stimulus plan. These plans are meant to abate further economic contraction, however, with the present economic conditions differing from past recessions, in, that, many tenets of the American economy such as manufacturing, textiles, and technological development have been outsourced to other countries. Public works projects associated with the economic recovery plan outlined by the Obama Administration have been degraded by the lack of road and bridge development projects that were highly abundant in the Great Depression but are now mostly constructed and are mostly in need of maintenance.

Regulations to establish market stability and confidence have been neglected in the Obama plan and have yet to be incorporated. Federal Reserve response In an effort to increase available funds for commercial banks and lower the fed funds rate, on September 29 the U.S. Federal Reserve announced plans to double its Term Auction Facility to $300 billion. Because there appeared to be a shortage of U.S. dollars in Europe at that time, the Federal Reserve also announced it would increase its swap facilities with foreign central banks from $290 billion to $620 billion. As of December 24, 2008, the Federal Reserve had used its independent authority to spend $1.2 trillion on purchasing various financial assets and making emergency loans to address the financial crisis, above and beyond the $700 billion authorized by Congress from the federal budget. This includes emergency loans to banks, credit card companies, and general businesses, temporary swaps of treasury bills for mortgage-backed securities, the sale of Bear Stearns, and the bailouts of American International Group (AIG), Fannie Mae and Freddie Mac, and Citigroup. Asia-Pacific policy responses On September 15, 2008 China cut its interest rate for the first time since 2002. Indonesia reduced its overnight repo rate, at which commercial banks can borrow overnight funds from the central bank, by two percentage points to 10.25 percent. The Reserve Bank of Australia injected nearly $1.5 billion into the banking system, nearly three times as much as the market's estimated requirement. The Reserve Bank of India added almost $1.32 billion, through a refinance operation, its biggest in at least a month. On November 9, 2008 the 2008 Chinese economic stimulus plan is a RMB 4 trillion ($586 billion) stimulus package announced by the central government of the People's Republic of China in its biggest move to stop the global financial crisis from hitting the world's second largest economy. A statement on the government's website said the State Council had approved a plan to invest 4 trillion yuan ($586 billion) in infrastructure and social welfare by the end of 2010. The stimulus package will be invested in key areas such as housing, rural infrastructure, transportation, health and education, environment, industry, disaster rebuilding, income-building, tax cuts, and finance.

China's export driven economy is starting to feel the impact of the economic slowdown in the United States and Europe, and the government has already cut key interest rates three times in less than two months in a bid to spur economic expansion. On November 28, 2008, the Ministry of Finance of the People's Republic of China and the State Administration of Taxation jointly announced a rise in export tax rebate rates on some labor-intensive goods. These additional tax rebates will take place on December 1, 2008. The stimulus package was welcomed by world leaders and analysts as larger than expected and a sign that by boosting its own economy, China is helping to stabilize the global economy. News of the announcement of the stimulus package sent markets up across the world. However, Marc Faber January 16 said that China according to him was in recession. In Taiwan, the central bank on September 16, 2008 said it would cut its required reserve ratios for the first time in eight years. The central bank added $3.59 billion into the foreign-currency interbank market the same day. Bank of Japan pumped $29.3 billion into the financial system on September 17, 2008 and the Reserve Bank of Australia added $3.45 billion the same day. In developing and emerging economies, responses to the global crisis mainly consisted in low-rates monetary policy (Asia and the Middle East mainly) coupled with the depreciation of the currency against the dollar. There were also stimulus plans in some Asian countries, in the Middle East and in Argentina. In Asia, plans generally amounted to 1 to 3% of GDP, with the notable exception of China, which announced a plan accounting for 16% of GDP (6% of GDP per year). European policy responses Until September 2008, European policy measures were limited to a small number of countries (Spain and Italy). In both countries, the measures were dedicated to households (tax rebates) reform of the taxation system to support specific sectors such as housing. From September, as the financial crisis began to seriously affect the economy, many countries announced specific measures: Germany, Spain, Italy, Netherlands, United Kingdom, Sweden. The European Commission proposed a 200 billion stimulus plan to be implemented at the European level by the countries. At the beginning

of 2009, the UK and Spain completed their initial plans, while Germany announced a new plan. The European Central Bank injected $99.8 billion in a one-day moneymarket auction. The Bank of England pumped in $36 billion. Altogether, central banks throughout the world added more than $200 billion from the beginning of the week to September 17. On September 29, 2008 the Belgian, Luxembourg and Dutch authorities partially nationalized Fortis. The German government bailed out Hypo Real Estate. On 8 October 2008 the British Government announced a bank rescue package of around 500 billion ($850 billion at the time). The plan comprises three parts. First, 200 billion will be made available to the banks in the Bank of England's Special Liquidity scheme. Second, the Government will increase the banks' market capitalization, through the Bank Recapitalization Fund, with an initial 25 billion and another 25 billion to be provided if needed. Third, the Government will temporarily underwrite any eligible lending between British banks up to around 250 billion. In February 2009 Sir David Walker was appointed to lead a government inquiry into the corporate governance of banks. In early December German Finance Minister Peer Steinbrck indicated that he does not believe in a "Great Rescue Plan" and indicated reluctance to spend more money addressing the crisis. In March 2009, The European Union Presidency confirms that the EU is strongly resisting the US pressure to increase European budget deficits. Global responses

Responses by the UK and US in proportion to their GDPs

Most political responses to the economic and financial crisis has been taken, as seen above, by individual nations. Some coordination took place at the European level, but the need to cooperate at the global level has led leaders to activate the G-20 major economies entity. A first summit dedicated to the crisis took place, at the Heads of state level in November 2008 (2008 G-20 Washington summit). The G-20 countries met in a summit held on November 2008 in Washington to address the economic crisis. Apart from proposals on international financial regulation, they pledged to take measures to support their economy and to coordinate them, and refused any resort to protectionism. Another G-20 summit was held in London on April 2009. Finance ministers and central banks leaders of the G-20 met in Horsham on March to prepare the summit, and pledged to restore global growth as soon as possible. They decided to coordinate their actions and to stimulate demand and employment. They also pledged to fight against all forms of protectionism and to maintain trade and foreign investments. They also committed to maintain the supply of credit by providing more liquidity and recapitalizing the banking system, and to implement rapidly the stimulus plans. As for central bankers, they pledged to maintain low-rates policies as long as necessary. Finally, the leaders decided to help emerging and developing countries, through a strengthening of the IMF. Countries maintaining growth or technically avoiding recession Poland is the only member of the European Union to have avoided a decline in GDP, meaning that in 2009 Poland has created the most GDP growth in the EU. As of December 2009 the Polish economy had not entered recession nor even contracted, while its IMF 2010 GDP growth forecast of 1.9 per cent is expected to be upgraded. While China and India have experienced slowing growth, they have not entered recession. South Korea narrowly avoided technical recession in the the first quarter of 2009. The International Energy Agency stated in mid September that South Korea could be the only large OECD country to avoid recession for the whole of 2009. However, as of the October, the Australian economy has managed to avoid recession thanks largely to a strong mining sector and major stimulus spending, contracting only in the last quarter of 2008. It was

the only developed economy to expand in the first half of 2009. On October 6th, Australia became the first G20 country to raise its main interest rate, with the Reserve Bank of Australia deciding to move rates up to 3.25% from 3.00%. Australia has avoided a technical recession after experiencing only one quarter of negative growth in the fourth quarter of 2008, with GDP returning to positive in the first quarter of 2009. Countries in economic recession or depression Many countries experienced recession in 2008. The countries/territories currently in a technical recession are Estonia, Latvia, Ireland, New Zealand, Japan, Hong Kong, Singapore, Italy, Russia and Germany. Denmark went into recession in the first quarter of 2008, but came out again in the second quarter. Iceland fell into an economic depression in 2008 following the collapse of its banking system. The following countries went into recession in the second quarter of 2008: Estonia, Latvia, Ireland and New Zealand. The following countries/territories went into recession in the third quarter of 2008: Japan, Sweden, Hong Kong, Singapore, Italy, Turkey and Germany. As a whole the fifteen nations in the European Union that use the euro went into recession in the third quarter, and the United Kingdom. In addition, the European Union, the G7, and the OECD all experienced negative growth in the third quarter The following countries/territories went into technical recession in the fourth quarter of 2008: United States, Switzerland, Spain, and Taiwan. South Korea "miraculously" avoided recession with GDP returning positive at a 0.1% expansion in the first quarter of 2009. Of the seven largest economies in the world by GDP, only China and France avoided a recession in 2008. France experienced a 0.3% contraction in Q2 and 0.1% growth in Q3 of 2008. In the year to the third quarter of 2008 China grew by 9%. This is interesting as China has until recently considered 8% GDP growth to be required simply to create enough jobs for rural people moving to urban centres. This figure may more accurately be considered to

be 57% now that the main growth in working population is receding. Growth of between 5%8% could well have the type of effect in China that a recession has elsewhere. Ukraine went into technical depression in January 2009 with a nominal annualized GDP growth of 20%. The recession in Japan intensified in the fourth quarter of 2008 with a nominal annualized GDP growth of 12.7%, and deepened further in the first quarter of 2009 with a nominal annualized GDP growth of 15.2%. Official forecasts in parts of the world On March 2009, U.S. Fed Chairman Ben Bernanke said in an interview that he felt that if banks began lending more freely, allowing the financial markets to return to normal, the recession could end during 2009. In that same interview, Bernanke said Green shoots of economic revival are already evident. On February 18, 2009, the US Federal Reserve cut their economic forecast of 2009, expecting the US output to shrink between 0.5% and 1.5%, down from its forecast in October 2008 of output between +1.1% (growth) and 0.2% (contraction). The EU commission in Brussels updated their earlier predictions on January 19, 2009, expecting Germany to contract 2.25% and 1.8% on average for the 27 EU countries. According to new forecasts by Deutsche Bank (end of November 2008), the economy of Germany will contract by more than 4% in 2009. On November 3, 2008, according to all newspapers, the European Commission in Brussels predicted for 2009 only an extremely low increase by 0.1% of the GDP, for the countries of the Euro zone (France, Germany, Italy, etc.). They also predicted negative numbers for the UK (1.0%), Ireland, Spain, and other countries of the EU. Three days later, the IMF at Washington, D.C., predicted for 2009 a worldwide decrease, 0.3%, of the same number, on average over the developed economies (0.7% for the US, and 0.8% for Germany). On April 22, 2009, the German ministers of finance and that of economy, in a common press conference, corrected again their numbers for 2009 downwards: this time the "prognosis" for Germany was a decrease of the GDP of at least 5 % in agreement with a recent prediction of the IMF On June 11, 2009, the World Bank Group predicted for 2009 for the first time a global contraction of the economic power, precisely by 3%.

Job losses and unemployment rates The examples and perspective in this article deal primarily with North America and do not represent a worldwide view of the subject. Many jobs have been lost worldwide. In the US, job loss has been going on since December 2007, and it accelerated drastically starting in September 2008 following the bankruptcy of Lehman Brothers Net job losses by month in the United States

September 2008 280,000 jobs lost October 2008 240,000 jobs lost November 2008 333,000 jobs lost December 2008 632,000 jobs lost January 2009 741,000 jobs lost February 2009 681,000 jobs lost March 2009 652,000 jobs lost April 2009 519,000 jobs lost May 2009 303,000 jobs lost June 2009 463,000 jobs lost July 2009 276,000 jobs lost August 2009 201,000 jobs lost September 2009 263,000 jobs lost October 2009 111,000 jobs lost November 2009 - 11,000 jobs lost 2008 (September 2008 December 2008) 2.6 million jobs lost 2009 (January 2009present) 2.921 million net jobs lost Current unemployment rate: 10.0%

Since the start of 2008, 6.7 million jobs have been lost, according to the Bureau of Labor Statistics. Canada net job losses by month Drastic job loss in Canada started later than in the US. Some months in 2008 had job growth, such as September, while others such as July had losses. Due to the collapse of the American car industry at the same time as a strong

CAD achieved parity +10% against a poorly-performing USD, the crossborder manufacturing industry has been disproportionately affected throughout.

September 2008 No net loss October 2008 No net loss November 2008 70,600 jobs lost December 2008 34,000 jobs lost January 2009 129,000 jobs lost February 2009 83,000 jobs lost March 2009 61,300 jobs lost April 2009 No net loss (1) May 2009 36,000 jobs lost October 2009 43,200 jobs lost

(1) 37,000 jobs are gained in the self-employment category May 2009 Canadian unemployment rate: 8.4% November 2009 Canadian unemployment rate: 8.6% Australia net job losses by month

September 2008 2,200 jobs created October 2008 34,300 jobs created November 2008 15,600 jobs lost December 2008 1,200 jobs lost January 2009 1,200 jobs created February 2009 1,800 jobs created March 2009 34,700 jobs lost April 2009 27,300 jobs created May 2009 1,700 jobs lost June 2009 21,400 jobs lost July 2009 32,200 jobs created August 2009 27,100 jobs lost September 2009 40,600 jobs created October 2009 24,500 jobs created 2009 2009 2009 Australian Australian Australian unemployment unemployment unemployment rate: rate: rate: 5.5% 5.8% 5.8%

April July August

September 2009 Australian unemployment October 2009 Australian unemployment rate: 5.8%

rate:

5.7%

The unemployment rate for October rose slightly due to population growth and other factors leading to 35,000 people looking for work, even though 24,500 jobs were created. In general, throughout the subdued economic growth caused by the recession in the rest of the world, Australian employers have elected to cut working hours rather than fire employees, in recognition of the skill shortage caused by the resources boom (which was largely unaffected by the financial crisis) which will soon re-assert itself.

The effects of the global financial crisis have been more severe than initially forecast. By virtue of globalization, the moment of financial crisis hit the real economy and became a global economic crisis; it was rapidly transmitted to many developing countries. The crisis emerged in India at the time when Indian economy was already preoccupied with the adverse effects of inflationary pressures and depreciation of currency. The crisis confronted India with daunting macroeconomic challenges like a contraction in trade, a net outflow of foreign capital, fall in stock market, a large reduction in foreign reserves, slowdown in domestic demand, slowdown in exports, sudden fall in growth rate and rise in unemployment. The government of India has been highly proactive in managing this ongoing crisis with a slew of monetary and fiscal measures to stabilize the financial sector, ensure adequate liquidity and stimulate domestic demand. As a result of this combining with many several structural factors that have come to Indias aid, India's economic slowdown unexpectedly eased in the first quarter of 2009. The present paper makes an attempt to assess the impact of global financial crisis on the Indian economy and discuss the various policy measures taken by government of India to reduce the intensity of impacts. The paper also highlights recovery of Indian economy from crisis and in the end of paper concluding remarks are given towards. The intensification of the global financial crisis, following the bankruptcy of Lehman Brothers in September 2008, has made the current economic and

financial environment a very difficult time for the world economy, the global financial system and for central banks. The fall out of the current global financial crisis could be an epoch changing one for central banks and financial regulatory systems. It is, therefore, very important that we identify the causes of the current crisis accurately so that we can then find, first, appropriate immediate crisis resolution measures and mechanisms; second, understand the differences among countries on how they are being impacted; and, finally, think of the longer term implications for monetary policy and financial regulatory mechanisms. The present financial crisis which has its deep roots in closing year of the 20th century became apparent in July 2007 in the citadel of global neoliberal capital, the United States when a loss of confidence by investors in the value of securitized mortgages resulted in a liquidity crisis. But the crisis came to the forefront of business world and media in September 2008, with the failure and merging of many financial institutions. The crisiss global effects differentiate it from the earlier crisis like Asian 1997-98 crisis2, which spread, only to Russia and Brazil or from the debt crisis of the early 1980s that affected the developing world. It is different from the recession of 1973-75 and 1979-81 because they did not propagate as fast and hardly affected Soviet Union, China and India. Added to this, in previous times of financial turmoil, the pre-crisis period was characterized by surging asset prices that proved unsustainable; a prolonged credit expansion leading to accumulation of debt; the emergence of new types of financial instruments; and the inability of regulators to keep up (ADB, 2008). The immediate cause or trigger of the present crisis was the bursting of United States housing bubble3 (Also known as Subprime). Lending crisis), which peaked in approximately 2006-074. In March 2007, the United States' sub-prime mortgage industry collapsed to higher-thanexpected home foreclosure rates, with more than 25 sub-prime lenders declaring bankruptcy, announcing significant losses, or putting them up for sale. As a result, many large investment firms have seen their stock prices plummet. The stock of the country's largest sub-prime lender, New Century Financial plunged 84%. Liquidity crisis promoted a substantial injection of capital into the financial markets by the US Federal Reserve. In 2008 alone, the US government allocated over $900 billion to special loans and rescues related to the US housing bubble, with over half going to the quasi-government agencies of Fannie Mae, Freddie Mac and the Federal

Housing Administration. Bailout of Wall Street and the financial industry moral hazard also lay at the core of many of the causes. Initially, it was thought that other major world economies would not be significantly affected. But, the crisis of U.S. quickly became a global problem affecting major economies worldwide both directly and indirectly. The sub-prime crisis in the US, following the collapse of the housing sector boom, has sent ripples through the economies of many countries. The crisis has brought about a slump in economic growth in most countries and has been called the most serious financial crisis since the Great Depression, with its global effects characterized by the failure of key businesses, decline in the consumer wealth estimated in the trillion of U.S. dollars, rapid decrease in international trade, slowdown in foreign investments, steep falls in industrial productions, substantial financial commitments incurred by the governments and significant decline in the economic activity. Genesis of global financial crisis The proximate cause of the current financial turbulence is attributed to the sub-prime mortgage sector in the USA. At a fundamental level, however, the crisis could be ascribed to the persistence of large global imbalances, which, in turn, were the outcome of long periods of excessively loose monetary policy in the major advanced economies during the early part of this decade. Global imbalances have been manifested through a substantial increase in the current account deficit of the US mirrored by the substantial surplus in Asia, particularly in China, and in oil exporting countries in the Middle East and Russia. These imbalances in the current account are often seen as the consequence of the relative inflexibility of the currency regimes in China and some other EMEs. According to Portes (2009), global macroeconomic imbalances were the major underlying cause of the crisis. These savinginvestment imbalances and consequent huge cross-border financial flows put great stress on the financial intermediation process. The global imbalances interacted with the flaws in financial markets and instruments to generate the specific features of the crisis. Such a view, however, offers only a partial analysis of the recent global economic environment. The role of monetary policy in the major advanced economies, particularly that in the United States, over the same time period needs to be analyzed for a more balanced analysis. Following the dot com bubble burst in the US around the turn of

the decade, monetary policy in the US and other advanced economies was eased aggressively. Policy rates in the US reached one per cent in June 2003 and were held around these levels for an extended period (up to June 2004) (Chart 1). In the subsequent period, the withdrawal of monetary accommodation was quite gradual. An empirical assessment of the US monetary policy also indicates that the actual policy during the period 2002-06, especially during 2002-04, was substantially looser than what a simple Taylor rule would have required (Chart 2). This was an unusually big deviation from the Taylor Rule. There was no greater or more persistent deviation of actual Fed policy since the turbulent days of the 1970s. So there is clearly evidence that there were monetary excesses during the period leading up to the housing boom (Taylor, op.cit.). Taylor also finds some evidence (though not conclusive) that rate decisions of the European Central Bank (ECB) were also affected by the US Fed monetary policy decisions, though they did not go as far down the policy rate curve as the US Fed did. CHART 1:

Chart 2:

Excessively loose monetary policy in the post dot com period boosted consumption and investment in the US; it was made with purposeful and careful consideration by monetary policy makers. As might be expected, with such low nominal and real interest rates, asset prices also recorded strong gains, particularly in housing and real estate, providing further impetus to consumption and investment through wealth effects. Thus, aggregate demand consistently exceeded domestic output in the US and, given the macroeconomic identity, this was mirrored in large and growing current account deficits in the US over the period (Table 1). The large domestic demand of the US was met by the rest of the world, especially China and other East Asian economies, which provided goods and services at relatively low costs leading to growing surpluses in these countries. Sustained current account surpluses in some of these EMEs also reflected the lessons learnt from the Asian financial crisis. Furthermore, the availability of relatively cheaper goods and services from China and other EMEs also helped to maintain price stability in the US and elsewhere, which might have not been possible otherwise. Thus measured inflation in the advanced economies remained low, contributing to the persistence of accommodative monetary policy.

Table:1

The emergence of dysfunctional global imbalances is essentially a post 2000 phenomenon and which got accentuated from 2004 onwards. The surpluses of East Asian exporters, particularly China, rose significantly from 2004 onwards, as did those of the oil exporters (Table 1). The sharp hike in oil and other commodity prices in early 2008 were indeed related to the very sharp policy rate cut in late 2007 after the sub-prime crisis emerged. It would be interesting to explore the outcome had the exchange rate policies in China and other EMEs been more flexible. The availability of low priced consumer goods and services from EMEs was worldwide. Yet, it can be observed that the Euro area as a whole did not exhibit large current account deficits throughout the current decade. In fact, it exhibited a surplus except for a minor deficit in 2008. Thus it is difficult to argue that the US large

current account deficit was caused by Chinas exchange rate policy. The existence of excess demand for an extended period in the U.S. was more influenced by its own macroeconomic and monetary policies, and may have continued even with more flexible exchange rate policies in China. In the event of a more flexible exchange rate policy in China, the sources of imports for the US would have been some countries other than China. Thus, it is most likely that the US current account deficit would have been as large as it was only the surplus counterpart countries might have been somewhat different. The perceived lack of exchange rate flexibility in the Asian EMEs cannot, therefore, fully explain the large and growing current account deficits in the US. The fact that many continental European countries continue to exhibit surpluses or modest deficits reinforces this point. Apart from creating large global imbalances, accommodative monetary policy and the existence of very low interest rates for an extended period encouraged the search for yield, and relaxation of lending standards. Even as financial imbalances were building up, macroeconomic stability was maintained. Relatively stable growth and low inflation have been witnessed in the major advanced economies since the early 1990s and the period has been dubbed as the Great Moderation. The stable macroeconomic environment encouraged under pricing of risks. Financial innovations, regulatory arbitrage, lending malpractices, excessive use of the originate and distribute model, securitization of sub-prime loans and their bundling into AAA tranches on the back of ratings, all combined to result in the observed excessive leverage of financial market entities. Components of the crisis: Most of the crises over the past few decades have had their roots in developing and emerging countries, often resulting from abrupt reversals in capital flows, and from loose domestic monetary and fiscal policies. In contrast, the current ongoing global financial crisis has had its roots in the US. The sustained rise in asset prices, particularly house prices, on the back of excessively accommodative monetary policy and lax lending standards during 2002-2006 coupled with financial innovations resulted in a large rise in mortgage credit to households, particularly low credit quality households. Most of these loans were with low margin money and with initial low teaser payments. Due to the originate and distribute model, most of these mortgages had been securitized. In combination with strong growth in complex credit derivatives and the use of credit ratings, the mortgages,

inherently sub-prime, were bundled into a variety of tranches, including AAA tranches, and sold to a range of financial investors. As inflation started creeping up beginning 2004, the US Federal Reserve started to withdraw monetary accommodation. With interest rates beginning to edge up, mortgage payments also started rising. Tight monetary policy contained aggregate demand and output, depressing housing prices. With low/negligible margin financing, there were greater incentives to default by the sub-prime borrowers. Defaults by such borrowers led to losses by financial institutions and investors alike. Although the loans were supposedly securitized and sold to the off balance sheet special institutional vehicles (SIVs), the losses were ultimately borne by the banks and the financial institutions wiping off a significant fraction of their capital. The theory and expectation behind the practice of securitization and use of derivatives was the associated dispersal of risk to those who can best bear them. What happened in practice was that risk was parceled out increasingly among banks and financial institutions, and got effectively even more concentrated. It is interesting to note that the various stress tests conducted by the major banks and financial institutions prior to the crisis period had revealed that banks were well-capitalized to deal with any shocks. Such stress tests, as it appears, were based on the very benign data of the period of the Great Moderation and did not properly capture and reflect the reality (Haldane, 2009). The excessive leverage on the part of banks and the financial institutions (among themselves), the opacity of these transactions, the mounting losses and the dwindling net worth of major banks and financial institutions led to a breakdown of trust among banks. Given the growing financial globalization, banks and financial institutions in other major advanced economies, especially Europe, have also been adversely affected by losses and capital write-offs. Inter-bank money markets nearly froze and this was reflected in very high spreads in money markets. There was aggressive search for safety, which has been mirrored in very low yields on Treasury bills and bonds. These developments were significantly accentuated following the failure of Lehman Brothers in September 2008 and there was a complete loss of confidence. The deep and lingering crisis in global financial markets, the extreme level of risk aversion, the mounting losses of banks and financial institutions, the elevated level of commodity prices (until the third quarter of 2008) and their

subsequent collapse, and the sharp correction in a range of asset prices, all combined, have suddenly led to a sharp slowdown in growth momentum in the major advanced economies, especially since the Lehman failure. Global growth for 2009, which was seen at a healthy 3.8 per cent in April 2008, is now projected to contract by 1.3 per cent (IMF, 2009c) (Table 2). Major advanced economies are in recession and the EMEs which in the earlier part of 2008 were widely viewed as being decoupled from the major advanced economies have also been engulfed by the financial crisis-led slowdown. Global trade volume (goods and services) is also expected to contract by 11 per cent during 2009 as against the robust growth of 8.2 per cent during 2006-2007. Private capital inflows (net) to the EMEs fell from the peak of US $ 617 billion in 2007 to US $ 109 billion in 2008 and are projected to record net outflows of US $ 190 billion in 2009. The sharp decline in capital flows in 2009 will be mainly on account of outflows under bank lending and portfolio flows. Thus, both the slowdown in external demand and the lack of external financing have dampened growth prospects for the EMEs much more than that was anticipated a year ago.

Table 2:

The Impact of the crisis on the global economy has been studied here forth and the study is focused on following factors as a whole: Volatility in capital flows Initial impact of sub-prime crisis Impact of Lehman failure Volatility in capital flows Implications for emerging market Economies: Monetary policy developments in the leading economies not only affect them domestically, but also have a profound impact on the rest of the world through changes in risk premia and search for yield leading to significant

switches in capital flows. While the large volatility in the monetary policy in the US, especially since the beginning of this decade, could have been dictated by internal compulsions to maintain employment and price stability, the consequent volatility in capital flows impinges on exchange rate movements and more generally, on the spectrum of asset and commodity prices. The monetary policy dynamics of the advanced economies thus involve sharp adjustment for the EMEs. Private capital flows to EMEs have grown rapidly since the 1980s, but with increased volatility over time. Large capital flows to the EMEs can be attributed to a variety of push and pull factors. The pull factors that have led to higher capital flows include strong growth in the EMEs over the past decade, reduction in inflation, macroeconomic stability, opening up of capital accounts and buoyant growth prospects. The major push factor is the stance of monetary policy in the advanced economies. Periods of loose monetary policy and search for yield in the advanced economies encourages large capital inflows to the EMEs and vice versa in periods of tighter monetary policy. Thus, swings in monetary policy in the advanced economies lead to cycles and volatility in capital flows to the EMEs. Innovations in information technology have also contributed to the twoway movement in capital flows to the EMEs. Overall, in response to these factors, capital flows to the EMEs since the early 1980s have grown over time, but with large volatility (Committee on Global Financial System, 2009). After remaining nearly flat in the second half of the 1980s, private capital flows jumped to an annual average of US $ 124 billion during 1990-96.1 with the onset of the Asian financial crisis, total private capital flows fell to an annual average of US $ 86 billion during 1997-2002. Beginning 2003, a period coinciding with the low interest rate regime in the US and major advanced economies and the concomitant search for yield, such flows rose manifold to an annual average of US $ 285 billion during 2003-2007 reaching a peak of US $ 617 billion in 2007 (Chart 3). As noted earlier, the EMEs, as a group, are now likely to witness outflows of US $ 190 billion in 2009 the first contraction since 1988. Amongst the major components, while direct investment flows have generally seen a steady increase over the period, portfolio flows as well as other private flows

(bank loans etc) have exhibited substantial volatility. While direct investment flows largely reflect the pull factors, portfolio and bank flows reflect both the push and the pull factors. It is also evident that capital account transactions have grown much faster relative to current account transactions, and gross capital flows are a multiple of both net capital flows and current account transactions. Also, large private capital flows have taken place in an environment when major EMEs have been witnessing current account surpluses leading to substantial accumulation of foreign exchange reserves in many of these economies.

As noted earlier, the policy interest rates in the US reached extremely low levels during 2002 one per cent and remained at these levels for an extended period of time, through mid 2004. Low nominal interest rates were also witnessed in other major advanced economies over the same period. The extremely accommodative monetary policy in the advanced economies was mirrored in the strong base money expansion during the period 2001-02 shortly before the beginning of the current episode of strong capital flows to EMEs. As the monetary accommodation was withdrawn in a phased manner, base money growth witnessed correction beginning 2004. However, contrary to the previous episodes, capital flows to the EMEs continued to be strong. The expected reversal of capital flows from the EMEs was somewhat delayed and finally took place in 2008. Similarly, the previous episode (1993-96) of heavy capital inflows was also preceded by a significant expansion of base money during 1990-94, and sharp contraction thereafter. This brief discussion highlights the correlation between monetary policy cycles in the advanced economies on the one hand and pricing/mispricing of risk and volatility in capital flows on the other hand. At present, monetary policies across the advanced economies have again been aggressively eased and policy interest rates have reached levels even lower than those which were witnessed in 2002. Base money in the US more than doubled over a period of just six months between June and December 2008. Given such a large monetary expansion and given the past experiences, large capital inflows to the EMEs could resume in the foreseeable future, if the unwinding of the current monetary expansion is not made in a timely fashion. In rapidly growing economies such as India, high real GDP growth needs concomitant growth in monetary aggregates, which also needs expansion of base money. To this extent, the accretion of unsterilized foreign exchange reserves to the central banks balance sheet is helpful in expanding base money at the required rate. However, net capital flows and accretion to foreign exchange reserves in excess of such requirements necessitate sterilization and more active monetary and macroeconomic management. Thus, large inflows of capital, well in excess of the current financing needs, can lead to high domestic credit and monetary growth, boom in stock market and other asset prices, and general excess domestic demand leading to macroeconomic and financial instability.

Abrupt reversals in capital flows also lead to significant difficulties in monetary and macroeconomic management. While, in principle, capital account liberalization is expected to benefit the host economy and raise its growth rate, this theoretical conjecture is not supported by the accumulated empirical evidence. Despite an abundance of cross-section, panel, and event studies, there is strikingly little convincing documentation of direct positive impacts of financial opening on the economic welfare levels or growth rates of developing countries. There is also little systematic evidence that financial opening raises welfare indirectly by promoting collateral reforms of economic institutions or policies. At the same time, opening the financial account does appear to raise the frequency and severity of economic crises (Obstfeld, 2009). The evidence appears to favor a hierarchy of capital flows. While the liberalization of equity flows seems to enhance growth prospects, the evidence that the liberalization of debt flows is beneficial to the EMEs is ambiguous (Henry, 2007; Committee on Global Financial System (2009)). Reversals of capital flows from the EMEs, as again shown by the current financial crisis, are quick, necessitating a painful adjustment in bank credit, and collapse of stock prices. Such reversals also result in the contraction of the central banks balance sheet, which may be difficult to compensate with accretion of domestic assets as fast as the reserves depletion. These developments can then lead to banking and currency crises, large employment and output losses and huge fiscal costs. Thus, the boom and bust pattern of capital inflows can, unless managed proactively, result in macroeconomic and financial instability. Hence, the authorities in the EMEs need to watch closely and continuously financial and economic developments in the advanced economies on the one hand and actively manage their capital account. To summarize, excessively accommodative monetary policy for an extended period in the major advanced economies in the post dot com crash period sowed the seeds of the current global financial and economic crisis. Too low policy interest rates, especially the US, during the period 2002-04 boosted consumption and asset prices, and resulted in aggregate demand exceeding output, which was manifested in growing global imbalances. Too low shortterm rates also encouraged aggressive search for yield, both domestically and globally, encouraged by financial engineering, heavy recourse to securitization and lax regulation and supervision. The global search for yield was reflected in record high volume of capital flows to the EMEs; since such flows were well in excess of their financing requirements, the excess was

recycled back to the advanced economies, leading to depressed long-term interest rates. The Great Moderation over the preceding two decades led to under-pricing of risks and the new financial and economic regime was considered as sustainable. The combined effect of these developments was excessive indebtedness of households, credit booms, asset price booms and excessive leverage in the major advanced economies, but also in emerging market economies. While forces of globalization were able to keep goods and services inflation contained for some time, the aggregate demand pressures of the accommodative monetary started getting reflected initially in oil and other commodity prices and finally onto headline inflation. The consequent tightening of monetary policy led to correction in housing prices, encouraged defaults on sub-prime loans, large losses for banks and financial institutions, sharp increase in risk aversion, complete lack of confidence and trust amongst market participants, substantial deleveraging, and large capital outflows from the EMEs. Financial excesses of the 2002-06 were, thus, reversed in a disruptive manner and have now led to the severest post-war recession. In brief, the large volatility in monetary policy in the major reserve currency countries contributed to the initial excesses and their subsequent painful correction. Initial impact of the sub-prime crisis: The initial impact of the sub-prime crisis on the Indian economy was rather muted. Indeed, following the cuts in the US Fed Funds rate in August 2007, there was a massive jump in net capital inflows into the country. The Reserve Bank had to sterilize the liquidity impact of large foreign exchange purchases through a series of increases in the cash reserve ratio and issuances under the Market Stabilization Scheme (MSS).2 with persistent inflationary pressures emanating both from strong domestic demand and elevated global commodity prices, policy rates were also raised. Monetary policy continued with pre-emptive tightening measures up to August 2008. The direct effect of the sub-prime crisis on Indian banks/financial sector was almost negligible because of limited exposure to complex derivatives and other prudential policies put in place by the Reserve Bank. The relatively lower presence of foreign banks in the Indian banking sector also minimized the direct impact on the domestic economy (Table 3). The larger

presence of foreign banks can increase the vulnerability of the domestic economy to foreign shocks, as happened in Eastern European and Baltic countries. In view of significant liquidity and capital shocks to the parent foreign bank, it can be forced to scale down its operations in the domestic economy, even as the fundamentals of the domestic economy remain robust. Thus, domestic bank credit supply can shrink during crisis episodes. For instance, in response to the stock and real estate market collapse of early 1990s, Japanese banks pulled back from foreign markets including the United States in order to reduce liabilities on their balance sheets and thereby meet capital adequacy ratio requirements. Econometric evidence shows a statistically significant relationship between international bank lending to developing countries and changes in global liquidity conditions, as measured by spreads of interbank interest rates over overnight index swap (OIS) rates and U.S. Treasury bill rates. A 10 basis-point increase in the spread between the London Interbank Offered Rate (LIBOR) and the OIS sustained for a quarter, for example, is predicted to lead to a decline of up to 3 percent in international bank lending to developing countries (World Bank, 2008).

Table 3

Impact of Lehman failure: Balance of payments: capital outflows There was also no direct impact of the Lehman failure on the domestic financial sector in view of the limited exposure of the Indian banks. However, following the Lehman failure, there was a sudden change in the external environment. As in the case of other major EMEs, there was a selloff in domestic equity markets by portfolio investors reflecting deleveraging.

Consequently, there were large capital outflows by portfolio investors during September-October 2008, with concomitant pressures in the foreign exchange market. While foreign direct investment flows exhibited resilience, access to external commercial borrowings and trade credits was rendered somewhat difficult. On the whole, net capital inflows during 2008-09 were substantially lower than in 2007-08 and there was a depletion of reserves (Table 4). However, a large part of the reserve loss (US $ 33 billion out of US $ 54 billion) during April-December 2008 reflected valuation losses. The contraction of capital flows and the sell-off in the domestic market adversely affected both external and domestic financing for the corporate sector. The sharp slowdown in demand in the major advanced economies is also having an adverse impact on our exports and industrial performance. On the positive side, the significant correction in international oil and other commodity prices has alleviated inflationary pressures as measured by wholesale price index. However, various measures of consumer prices remain at elevated levels on the back of continuing high inflation in food prices. Impact on India Economy: The turmoil in the international financial markets of advanced economies that started around mid-2007 has exacerbated substantially since August 2008. The financial market crisis has led to the collapse of major financial institutions and is now beginning to impact the real economy in the advanced economies. As this crisis is unfolding, credit markets appear to be drying up in the developed world. With the substantive increase in financial globalization, how much will these developments affect India and other Asian emerging market economies (EMEs)? India, like most other emerging market economies, has so far, not been seriously affected by the recent financial turmoil in developed economies. In my remarks today, I will, first, briefly set out reasons for the relative resilience shown by the Indian economy to the ongoing international financial markets crisis. This will be followed by some discussion of the impact till date on the Indian economy and the likely implications in the near future. I then outline our approach to the management of the exposures of the Indian financial sector entities to the collapse of major financial institutions in the US. Orderly conditions have been maintained in the

domestic financial markets, which is attributable to a range of instruments available with the monetary authority to manage a variety of situations. Finally, I would briefly set out my thinking on the extent of vulnerability of the Asian economies, in general, to the global financial market crisis. The impact of crisis is studies under following aspects: Financial globalization: the Indian approach Impact on Indian economy Financial Globalization: The Indian Approach:

The Indian economy is now a relatively open economy, despite the capital account not being fully open. The current account, as measured by the sum of current receipts and current payments, amounted to about 53 per cent of GDP in 2007-08, up from about 19 per cent of GDP in 1991. Similarly, on the capital account, the sum of gross capital inflows and outflows increased from 12 per cent of GDP in 1990-91 to around 64 per cent in 2007-081. With this degree of openness, developments in international markets are bound to affect the Indian economy and policy makers have to be vigilant in order to minimize the impact of adverse international developments on the domestic economy. The relatively limited impact of the ongoing turmoil in financial markets of the advanced economies in the Indian financial markets, and more generally the Indian economy, needs to be assessed in this context. Whereas the Indian current account has been opened fully, though gradually, over the 1990s, a more calibrated approach has been followed to the opening of the capital account and to opening up of the financial sector. This approach is consistent with the weight of the available empirical evidence with regard to the benefits that may be gained from capital account liberalization for acceleration of economic growth, particularly in emerging market economies. The evidence suggests that the greatest gains are obtained from. The opening to foreign direct investment, followed by portfolio equity investment until greater domes benefits emanating from external debt flows have been found to be more questionable.

Accordingly, in India, while encouraging foreign investment flows, especially direct investment inflows, a more cautious, nuanced approach has been adopted in regard to debt flows. Debt flows in the form of external commercial borrowings are subject to ceilings and some end-use restrictions, which are modulated from time to time taking into account evolving macroeconomic and monetary conditions. Similarly, portfolio investment in government securities and corporate bonds are also subject to macro ceilings, which are also modulated from time to time. Thus, prudential policies have attempted to prevent excessive recourse to foreign borrowings and dollarization of the economy. In regard to capital outflows, the policy framework has been progressively liberalized to enable the non-financial corporate sector to invest abroad and to acquire companies in the overseas market. Companies in the overseas market. Resident individuals are also permitted outflows subject to reasonable limits.

The financial sector, especially banks, is subject to prudential regulations, both in regard to capital and liquidity (Mohan, 2007b). As the current global financial crisis has shown, liquidity risks can rise manifold during a crisis and can pose serious downside shown, liquidity risks can rise manifold during a crisis and can pose serious downside shown, liquidity risks can rise manifold during a crisis and can pose serious downside well. Some of the important measures by the Reserve Bank in this regard include, first, restricting the overnight unsecured market for funds to banks and primary dealers (PD) as well as limits on the borrowing and lending operations of these entities in the overnight inter-bank call money market. Second, large reliance by banks on borrowed funds can exacerbate vulnerability to external shocks. This has been brought out quite strikingly in the ongoing financial crisis in the global financial markets. Accordingly, in order to encourage greater reliance on stable sources of funding, the Reserve Bank has imposed prudential limits on banks on their purchased inter-bank liabilities and these limits are linked to their net worth. Furthermore, the incremental credit deposit ratio of banks is also monitored by the Reserve Bank since this ratio indicates the extent to which banks are funding credit with borrowings from wholesale markets (now known as purchased funds). Third, asset liability management guidelines for dealing with overall asset-liability mismatches take into account both on and off balance sheet items. Finally, guidelines on securitization of standard assets have laid down

a detailed policy on provision of liquidity support to Special Purpose Vehicles (SPVs). In order to further strengthen capital requirements, the credit conversion factors, risk weights and provisioning requirements for specific off-balance sheet items including derivatives have been reviewed. Furthermore, in India, complex structures like synthetic securitization have not been permitted so far. Introduction of such products, when found appropriate, would be guided by the risk management capabilities of the system.

The Reserve Bank has also issued detailed guidelines on implementation of the Basel II framework covering all the three pillars with the guidelines on Pillar II being issued as recently as on March 27, 2008. In tune with RBIs objective to have consistency and harmony with international standards, the Standardized Approach for credit risk and Basic Indicator Approach for operational risk have been prescribed. Minimum capital-to-risk-weighted asset ratio (CRAR) would be 9 per cent, but higher levels under Pillar II could be prescribed on the basis of risk profile and risk management systems. The banks have been asked to bring Tier I CRAR to at least 6 per cent before March 31, 2010. After analyzing the global schedule for implementation, it was decided that all foreign banks operating in India and Indian banks having a presence outside India should migrate to Basel II by March 31, 2008 and all other scheduled commercial banks encouraged to migrate to Basel II in alignment with them but not later than March 31, 2009. In addition to the exercise of normal prudential requirements on banks, the Reserve Bank has also successively imposed additional prudential measures in respect of exposures to particular sectors, akin to a policy of dynamic provisioning. For example, in view of the accelerated exposure observed to the real estate sector, banks were advised to put in place a proper risk management system to contain the risks involved. Banks were advised to formulate specific policies covering exposure limits, collaterals to be considered, margins to be kept, sanctioning authority/level and sector to be financed. In view of the rapid increase in loans to the real estate sector raising concerns about asset quality and the potential systemic risks posed by such exposure, the risk weight on banks' exposure to commercial real estate was increased from 100 per cent to 125 per cent in July 2005 and further to 150 per cent in April 2006. The risk weight on housing loans extended by banks to individuals against mortgage of housing properties and

investments in mortgage backed securities (MBS) of housing finance companies (HFCs) was increased from 50 per cent to 75 per cent in December 2004, though this was later Reduced to 50 per cent for lower value loans. Similarly, in light of the strong growth of consumer credit and the volatility in the capital markets, it was felt that the quality of lending could suffer during the phase of rapid expansion. Hence, as a counter cyclical measure, the Reserve Bank increased the risk weight for consumer credit and capital market exposures from 100 per cent to 125 per cent.2 An additional feature of recent prudential actions by the Reserve Bank relate to the tightening of regulation and supervision of Non-banking Financial Companies (NBFCs), so that regulatory arbitrage between these companies and the banking system is minimized. The overarching principle is that banks should not use an NBFC as a delivery vehicle for seeking regulatory arbitrage opportunities or to circumvent bank regulation(s) and that the activities of NBFCs do not undermine banking regulations. Thus, capital adequacy ratios and prudential limits to single/group exposures in the case of NBFCs have been progressively brought nearer to those applicable to banks. The regulatory interventions are graded: higher in deposit-taking NBFCs and lower in non-deposit-taking NBFCs. Thus, excessive leverage in this sector has been contained. Various segments of the domestic financial market have been developed over a period of time to facilitate efficient channeling of resources form savers to investors and enable the continuation of domestic growth momentum (Mohan, 2007a). Investment has been predominantly financed domestically in India the current account deficit has averaged between one and two per cent of GDP since the early 1990s. The Governments fiscal deficit has been high by international standards but is also largely internally financed through a vibrant and well developed government securities market, and thus, despite large fiscal deficits, macroeconomic and financial stability has been maintained. Derivative instruments have been introduced cautiously in a phased manner, both for product diversity and, more importantly, as a risk management tool. All these developments have facilitated the process of price discovery in various financial market segments. The rate of increase in foreign exchange market turnover in India between April 2004 and April 2007 was the highest amongst the 54 countries covered in the latest Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by the Bank for International Settlements

(BIS). According to the survey, daily average turnover in India jumped almost 5-fold from US $ 7 billion in April 2004 to US $ 34 billion in April 2007; the share of India in global foreign exchange market turnover trebled from 0.3 per cent in April 2004 to 0.9 per cent in April 2007. There has been consistent development of wellfunctioning, relatively deep and liquid markets for government securities, currency and derivatives in India, though much further development needs to be done. However, as large segments of economic agents in India may not have adequate resilience to withstand volatility in currency and money markets, our approach has been to be increasingly vigilant and proactive to any incipient signs of volatility in financial markets. In brief, the Indian approach has focused on gradual, phased and calibrated opening of the domestic financial and external sectors, taking into cognizance reforms in the other sectors of the economy. Financial markets are contributing to efficient channeling of domestic savings into productive uses and, by financing the overwhelming part of domestic investment, are supporting domestic growth. These characteristics of India's external and financial sector management coupled with ample forex reserves coverage and the growing underlying strength of the Indian economy reduce the susceptibility of the Indian economy to global turbulence. Impact of the Crisis on India: While the overall policy approach has been able to mitigate the potential impact of the turmoil on domestic financial markets and the economy, with the increasing integration of the Indian economy and its financial markets with rest of the world, there is recognition that the country does face some downside risks from these international developments. The risks arise mainly from the potential reversal of capital flows on a sustained mediumterm basis from the projected slow down of the global economy, particularly in advanced economies, and from some elements of potential financial Contagion. In India, the adverse effects have so far been mainly in the equity markets because of reversal of portfolio equity flows, and the concomitant effects on the domestic forex market and liquidity conditions. The macro effects have so far been muted due to the overall strength of domestic demand, the healthy balance sheets of The Indian corporate sector and the predominant

domestic financing of investment. As might be expected, the main impact of the global financial turmoil in India has emanated from the significant change experienced in the capital account in 2008-09 so Far, relative to the previous year (Table 1). Total net capital flows fell from US$17.3 billion in April-June 2007 to US$13.2 billion in April-June 2008. Nonetheless, capital flows are expected to be more than sufficient to cover the current account deficit this year as well. While Foreign Direct Investment (FDI) inflows have continued to exhibit accelerated growth (US$ 16.7 billion during AprilAugust 2008 as compared with US$ 8.5 billion in the corresponding period of 2007), portfolio investments by foreign institutional investors (FIIs) witnessed a net outflow of about US$ 6.4 billion in April-September 2008 as compared with a net inflow of US$ 15.5 billion in the corresponding period last year. Similarly, external commercial borrowings of the corporate sector declined from US$ 7.0 billion in April-June 2007 to US$ 1.6 billion in April-June 2008, partially in response to policy measures in the face of excess flows in 2007-08, but also due to the current turmoil in advanced economies. With the existence of a merchandise trade deficit of 7.7 per cent of GDP in 2007-08, and a current account deficit of 1.5 per cent, and change in perceptions with respect to capital flows, there has been significant pressure on the Indian exchange rate in recent months. Whereas the real exchange rate appreciated from an index of 104.9 (base 1993-94=100) (US$1 = Rs. 46.12) in September 2006 to 115.0 (US$ 1 = Rs. 40.34) in September 2007, it has now depreciated to a level of 101.5 (US $ 1 = Rs. 48.74) as on October 8, 2008. With the volatility in portfolio flows having been large during 2007 and 2008, the impact of global financial turmoil has been felt particularly in the equity market. The BSE Sensex (1978-79=100) increased significantly from a level of 13,072 as at end-March 2007 to its peak of 20,873 on January 8, 2008 in the presence of heavy portfolio flows responding to the high growth performance of the Indian corporate sector. With portfolio flows reversing in 2008, partly because of the international market turmoil, the Sensex has now dropped to a level of 11,328 on October 8, 2008, in line with similar large declines in other major stock markets. As noted earlier, domestic investment is largely financed by domestic savings. However, the corporate sector has, in recent years, mobilized significant resources from global financial markets for funding, both debt and non-debt, their ambitious investment Plans. The current risk aversion in the international financial markets to EMEs could, therefore, have some

impact on the Indian corporate sectors ability to raise funds from international sources and thereby impede some investment growth. Such corporate would, therefore, have to rely relatively more on domestic sources of financing, including bank credit. This could, in turn, put some upward pressure on domestic interest rates. Moreover, domestic primary capital market issuances have suffered in the current fiscal year so far in view of the sluggish stock market conditions. Thus, one can expect more demand for bank credit, and non-food credit growth has indeed accelerated in the current year (26.2 per cent on a year-on-year basis as on September 12, 2008 as compared with 23.3 per cent a year ago).The financial crisis in the advanced economies and the likely slowdown in these economies could have some impact on the IT sector. According to the latest assessment by the NASSCOM, the software trade association, the current developments with respect to the US financial markets are very eventful, and may have a direct impact on the IT industry and likely to create a downstream impact on other sectors of the US economy and worldwide markets. About 15 per cent to 18 per cent of the business coming to Indian outsourcers includes projects from banking, insurance, and the financial services sector which is now uncertain. In summary, the combined impact of the reversal of portfolio equity flows, the reduced availability of international capital both debt and equity, the perceived increase in the price of equity with lower equity valuations, and pressure on the exchange rate, growth in the Indian corporate sector is likely to feel some impact of the global financial turmoil. On the other hand, on a macro basis, with external savings utilization having been low traditionally, between one to two percent of GDP, and the sustained high domestic savings rate, this impact can be expected to be at the margin. Moreover, the continued buoyancy of foreign direct investment suggests that confidence in Indian growth prospects remains healthy. Impact on the Indian Banking System: One of the key features of the current financial turmoil has been the lack of perceived contagion being felt by banking systems in EMEs, particularly in Asia. The Indian banking system also has not experienced any contagion, similar to its peers in the rest of Asia. A detailed study undertaken by the RBI in September 2007 on the impact of the subprime episode on the Indian banks had revealed that none of the Indian banks or the foreign banks, with

whom the discussions had been held, had any direct exposure to the subprime markets in the USA or other markets. However, a few Indian banks had invested in the collateralized debt obligations (CDOs) / bonds which had a few underlying entities with subprime exposures. Thus, no direct impact on account of direct exposure to the sub-prime market was in evidence. However, a few of these banks did suffer some losses on account of the mark-to-market losses caused by the widening of the credit spreads arising from the sub-prime episode on term liquidity in the market, even though the overnight markets remained stable. Consequent upon filling of bankruptcy under Chapter 11 by Lehman Brothers, all banks were advised to report the details of their exposures to Lehman Brothers and related entities both in India and abroad. Out of 77 reporting banks, 14 reported exposures to Lehman Brothers and its related entities either in India or abroad. An analysis of the information reported by these banks revealed that majority of the exposures reported by the banks pertained to subsidiaries of Lehman Bros Holdings Inc. which are not covered by the bankruptcy proceedings. Overall, these banks exposure especially to Lehman Brothers Holding Inc. which has filed for bankruptcy is not significant and banks are reported to have made adequate provisions. In the aftermath of the turmoil caused by bankruptcy, the Reserve Bank has announced a series of measures to facilitate orderly operation of financial markets and to ensure financial stability which predominantly includes extension of additional liquidity support to banks. RBI Response to the Crisis:

The financial crisis in advanced economies on the back of subprime turmoil has been accompanied by near drying up of trust amongst major financial market and sector players, in view of mounting losses and elevated uncertainty about further possible Losses and erosion of capital. The lack of trust amongst the major players has led to near freezing of the uncollateralized inter-bank money market, reflected in large spreads over policy rates. In response to these developments, central banks in major advanced economies have taken a number of coordinated steps to increase short-term liquidity. Central banks in some cases have substantially loosened the collateral requirements to provide the necessary short-term liquidity. In contrast to the extreme volatility leading to freezing of money markets in major advanced economies, money markets in India have

been, by and large, functioning in an orderly fashion, albeit with some pressures.

Large swings in capital flows as has been experienced between 2007-08 and 2008-09 so far in response to the global financial market turmoil have made the conduct of monetary policy and liquidity management more complicated in the recent months. However, the Reserve Bank has been effectively able to manage domestic liquidity and monetary conditions consistent with its monetary policy stance. This has been enabled by the appropriate use of a range of instruments available for liquidity management with the Reserve Bank such as the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)stipulations and open market operations (OMO) including the Market Stabilization Scheme (MSS)4 and the Liquidity Adjustment Facility (LAF). Furthermore, money market liquidity is also impacted by our operations in the foreign exchange market, which, in turn, reflect the evolving capital flows.

While in 2007 and the previous years, large capital flows and their absorption by the Reserve Bank led to excessive liquidity, which was absorbed through sterilization operations involving LAF, MSS and CRR. During 2008, in view of some reversal in capital flows, market sale of foreign exchange by the Reserve Bank has led to withdrawal of liquidity from the banking system. The daily LAF repo operations have emerged as the primary tool for meeting the liquidity gap in the market. In view of the reversal of capital flows, fresh MSS issuances have been scaled down and there has also been some unwinding of the outstanding MSS balances. The MSS operates symmetrically and has the flexibility to smoothen liquidity in the banking system both during episodes of capital inflows and outflows. The existing set of monetary instruments has, thus, provided adequate flexibility to manage the evolving situation. In view of this flexibility, unlike central banks in major advanced economies, the Reserve Bank did not have to invent new instruments or to dilute the collateral requirements to inject liquidity. LAF repo operations are, however, limited by the excess SLR securities held by banks. While LAF and MSS have been able to bear a large part of the burden, some modulations in CRR and SLR have also been resorted, purely as temporary measures, to meet the liquidity mismatches.

For instance, on September 16, 2008, in regard to SLR, the Reserve Bank permitted banks to use up to an additional 1 percent of their

NDTL, for a temporary period, for drawing liquidity support under LAF from RBI. This has imparted a sense of confidence in the market in terms of availability of short-term liquidity. The CRR which had been gradually increased from 4.5 per cent in 2004 to 9 per cent by August 2008 was cut by 50 basis points on October 65 (to be effective October 11, 2008) the first cut after a gap of over five years - on a review of the liquidity situation in the context of global and domestic developments. Thus, as the very recent experience shows, temporary changes in the prudential ratios such as CRR and SLR combined with flexible use of the MSS, could be considered as a vast pool of backup liquidity that is available for liquidity management as the situation may warrant for relieving market pressure at any given time. The recent innovation with respect to SLR for combating temporary systemic illiquidity is particularly noteworthy.

The relative stability in domestic financial markets, despite extreme turmoil in the global financial markets, is reflective of prudent practices, strengthened reserves and the strong growth performance in recent years in an environment of flexibility in the conduct of policies. Active liquidity management is a key element of the current monetary policy stance. Liquidity modulation through a flexible use of a combination of instruments has, to a significant extent, cushioned the impact of the international financial turbulence on domestic financial markets by absorbing excessive market pressures and ensuring orderly conditions. In view of the evolving environment of heightened uncertainty, volatility in global markets and the dangers of potential spillovers to domestic equity and currency markets, liquidity management will continue to receive priority in the hierarchy of policy objectives over the period ahead. The Reserve Bank will continue with its policy of active demand management of liquidity through appropriate use of the CRR stipulations and open market operations (OMO) including the MSS and the LAF, using all the policy instruments at its disposal flexibly, as and when the situation warrants.

RBI studied the impact of the crisis in various other factors which affected the Indian economy as a whole: Reversals of Capital Flows, Depreciation of Rupee and Fall of Stock Market| Fall in Growth Rate, Industrial Output and Rise in Inflation Fall in Exports, Outsourcing Services and Service Sector Other Implications Reversals of Capital Flows, Depreciation of Rupee and Fall of Stock Market: The most immediate effect of that crisis on India has been an outflow of foreign institutional investment from the equity market. Foreign institutional investors, who need to retrench assets in order to cover losses in their home countries and are seeking havens Of safety in an uncertain environment, have become major sellers in Indian markets. FIIs have pulled out an estimated US$ 13 billion from Indian stock market in 2008. Almost immediately after the crisis surfaced FII registered a steel fall between October and November 2007, from $ 5.7 billion to minus 1.6 billion. Since Then the downward trend of FII has remained unabated.FDI investment during 2008-09 was volatile but overall remained stable. Foreign investment received in 2008-09 was US$ 35.1 billion, slightly higher than the FDI received in 2007-08 (US$ 34.3 billion). A significant difference in the total investments of 2008-09 and 2007-08 has been on due to the inflow and outflow of foreign investment observed in 2007-08 and 2008-09 respectively. he financial crisis has also created a shortage of money supply and India is also facing a credit crunch especially in terms of foreign exchange and the Indian Banking sector and forex markets are facing tight liquidity situations each passing day for the past quite some time. This liquidity crisis along with FII sell off has forced the Indian Rupee to devaluate like never before and in a span of 9 months the Indian Rupee has slipped from around Rs 40/US $ to Rs 47.

Chart:4 As is to be expected, FII outflows might also have had a negative impact on domestic investment. Given the relative thinness of the Indian share market, the sharp fall in FII followed by their withdrawal contributed, albeit with some lag, to the bursting of the Indias stock market bubble (figure 4). However, Indian stock markets are never free from falling big and the market crash in 2008 was an anticipated one, but a fall of this extent was never anticipated by even the big of the bear.

Chart:5

Curiously enough, though IIP growth had started declining since March 2007, the share market boom continued until early 2008; between March and December 2007, the Bombay Stock Exchange (BSE) index, fuelled in part by substantial FII inflows, went up from 12,858 to 19,827. The bullish sentiments prevailed for a short while even after the downward drift in FII began in November 2007. The Indian Stock Markets have crashed8 from a peak of around 21,000 in January 2008 to close to 10000 in December 2008.Stocks like RNRL, I spat, RPL, Essar oil and Nagarjuna fertilizers have lost 50-70% of their value. The crisis in the global markets, a fall in the rupee and poor IIP numbers led to the fall.

Fall in Growth Rate, Industrial Output and Rise in Inflation: Second, the global financial crisis and credit crunch have slowed Indias economic growth. GDP started decelerating in the first quarter of 2007-08, nearly six months before the outbreak of the US financial crisis and considerably ahead of the surge of recessionary tendencies in all developed countries from August-September 2008. That was just the beginning of slowdown impact on Indias GDP growth. GDP growth for 2008-09 was estimated at 6.7% as compared to the growth of 9.0% posted in the previous year. All the three segments of the GDP namely agriculture, forestry and fishing, industry and services sector were seen to post growth of 1.6%, 3.8% and 9.6% respectively in 2008-09 against the growth of 4.9%, 8% and 10.8% respectively in 2007-08. Poor agricultural growth is also attributed to low monsoon in major parts of India (Figure 5). Due to shrinkage in demand in the markets; it is not only manufacturing industry but also the services sector that is getting hit. The government came up with a set of stimulus measures on three occasions to aid the ailing industry compromising on the deficits. These measures have however have led to widening of fiscal deficits. Further, Indias industrial output fell at its fastest annualized rate in 14 years, despite tax cuts and fresh spending programme announced by the government of India in December and January to boost domestic demand. Data released by CSO showed that the factory output shrank by 1.2 per cent in February, on week global and domestic demand. This is against growth rate of 9.5 per cent during the same month a year ago. Industrial output thus grew 2.8 per cent during April-February, against 8.8 per cent in the same period a year ago. Manufacturing, which constitutes 80 per cent IIP (Index of Industrial Production), contracted by 1.4 per cent in February, as production of basis, intermediates and consumer goods shrank compared with a year ago (Figure 6). For a little over a year after the outbreak of financial crisis, the global economy experienced, between September 2007 and October 2008, a pronounced stagflationary phase, with the growth slowdown on the one hand and rising inflation on the other hand. So far as the Indian economy is concerned since prices of practically all petroleum products are administered and trade in agricultural goods is far from free, transmission of global inflation to domestic prices occurred with a time lag, from November 2007

rather than September 2007. Beginning of 2008 has seen a dramatic rise in the price of rice and other basic food stuffs. There has also been a no-less alarming rise in the price of oil and gas (Table 3). When coupled with rises in the price of the majority of commodities, higher inflation was the only likely outcome. Indeed, by July 2008, the key Indian Inflation Rate, the Wholesale Price Index, has risen above 11%, its highest rate in 13 years. Inflation rate stood at 16.3 per cent during April to June 2008. This is more than 6% higher than a year earlier and almost three times the RBIs target of 4.1%. Inflation has climbed steadily during the year, reaching 8.75% at the end of May. There was an alarming increase in June, when the figure jumped to 11%. This was driven in part by a reduction in government fuel subsidies, which have lifted gasoline prices by an average 10% Fall in Exports, Outsourcing Services and Service Sector: Indias exports fell the most in at least 14 years as the worst global recession since the Great Depression slashed demand for the nations jewellery, clothing and other products. It must be noted this growth contraction has come after a robust 25%-plus average export growth since 2003. A low-to-negative growth in exports may continue for sometime until consumption revives in the developed economies. The slowdown in the trade sector post April 2008 is more explicit. Exports have declined continuously since July 2008 except the month of December. They declined from US$ 17,095 million in July 2008 to US$ 11,516 million in March 2009, which accounts for almost 33% decline (Figure 7).India's export of steel fall by a whopping 35 per cent to 3.2 million tones during the current fiscal buoyed by healthy domestic demand, Centre for Monitoring Indian Economy (CMIE). Automotive tyre exports from India also suffered a setback in the first quarter of current financial year, according to latest Tyre Manufacturing Association of India. During the period exports registered a 22 per cent drop against that the in the same period of 2008-09). Further, worldwide slowdown in vehicles sales is likely to drag down Indias components exports between zero and 5 per cent in the current fiscal.

The Automotive Components Manufacturing Association has warned that if the slump in auto sales continues, exports could also be negative this year. Apparel exports from India have fallen sharply by 24 percent since August 2008 due to declining sales in the US and the European Union while those from Bangladesh, Indonesia and Vietnam are on an upswing. The current global meltdown has hit the countrys cashew farmers. Official reports with the Cashew Export Promotional Council of India (CPECI) show that cashew kernel exports have dropped marginally from 11.5 lakh tones in 2006-07 to only 11 lakh tones in 2007-08. Indian seafood export during 2007-08 has also recorded a fall of 11.58 per cent in terms of quantity and 8.9 per cent in terms of rupee. The domestic tea industry, which was showing some signs of recovery in 2008 after a long spell of recession since 1999, has been pushed back into gloom y the ongoing financial crisis. Software services receipts also declined by 12.7 per cent during Q4 of 2008-09.

However, when compared with the performance in the first three quarters of 2008-09, software exports at US$ 11.2 billion during Q4 of 2008-09 was almost in line with an average software exports of US$ 11.9 billion recorded in the first three quarters of 2008-09.Initially, the commerce ministry had set an export target of $200 billion for 2008-09, which was subsequently revised downwards to US$175 billion in January this year. But the latest numbers reveal that India has missed even the revised target. While, imports fell 36.6 percent in April from a year earlier and the trade deficit narrowed to US$5 billion from US$8.7 billion in the same month in 2008, todays report showed. Oil imports slid 58.5 percent to US$3.6 billion, while non-oil purchases dropped 24.6 percent to $12.11 billion. The sharp decline in both exports and imports during Q4 of 2008-09 led to a Lower trade deficit (Table 4). The trade deficit on a Bop (Balance of Payment) basis in Q4 of 2008-09 (US$ 14.6 billion) was less than half of the average trade deficit (US$ 34.9 billion) recorded in the first three quarters of 2008-09. The trade deficit during Q4 of 2008-09 was much lower than that of Q4 of 2007-08 (US$ 22.3 billion). A decelerating export growth has implications for India, even though our economy is far more domestically driven than those of the East Asia. Still, the contribution of merchandise exports to GDP has risen steadily over the past six years- from about 10% of GDP in 2002-03, to nearly 17% by 200708. If one includes service exports, the ratio goes up further. Therefore, any

downturn in the global economy will hurt India. There also seems to be a positive correlation between growth in exports and the countrys GDP. For instance, when between 1996 and 2002 the average growth rate in exports was less than 10%, the GDP growth also averaged below 6%. A slowdown in export growth also has other implications for the economy. Close to 50% of Indias exports-textiles, garments, gems and jewellery, leather and so on-originate from the labour-intensive small- and mediumenterprises. A sharp fall in export growth could mean job losses in this sector. This would necessitate government intervention. A silver lining here, however, is the global slowdown will also lower cost of imports significantly, thereby easing pressures on the balance of payment. The current crisis parallels the 2001-2002 busts especially for Indias outsourcing (BPOs and KPOs) sector. The outsourcing sector is heavily dependent on demand from the US and Europe, which are currently going through a deep recession. This is going to have a strong negative impact on Indian IT groups. Approximately 61% of the Indian IT sectors revenues are from US clients and 20% from UK, the rest comes from other European countries, Australia etc. Just take the top five India players who account for 46% of the IT industrys revenues, the revenue contribution from US clients are approximately 58%. The outsourcing arm of Infosys Technologies, Indias second-biggest software maker, and GATE Global Solutions, both based in Bangalore, lost a major client when Green Point Mortgage was shut down by parent Capital One Financial Corp. About 30% of the industry revenues are estimated to be from financial services. After exports, there seems to be bad news in store for the domestic IT and BPO market in 2009 which is expected to grow only 13.4 per cent being the slowest growth since 2003. This will largely on the back of slower IT consumption in some key verticals including retail and financial services. Large Indian firms such as TCS, Infosys, Wipro, Satyam, Cognizant and HCL Technologies collectively referred as SWITCH vendors are now forced to reconcile to a lower growth rate as their larger banking and auto clients became victims of the financial crisis. The SWITCH vendor account for over half of the countrys software exports. The industry, which grew by 30 per cent on a compound annual basis over the past five years, is likely to see its growth rate halve this year as the economic turmoil intensifies. In fact, the Indian IT and BPO market is slated to see 16.4 per cent CAGR in the coming five years leading to 2013, compared with 24.3 per cent growth Recorded between 2003 and 2008.

In addition, from a qualitative standpoint, the tentacles of the financial sector business are quite well-entrenched and have significant structural impact as well. A recent study by Forrester reveals that 43% of Western companies are cutting back their IT spend and nearly 30 percent are scrutinizing IT projects for better returns. Some of this can lead to offshoring12, but the impact of overall reduction in discretionary IT spends, including offshore work, cannot be denied. The slowing U.S. economy has seen 70 percent of firms negotiating lower rates with suppliers and nearly 60 percent are cutting back on contractors. With budgets squeezed, just over 40 percent of companies plan to increase their use of offshore vendors.

The service sector, which contributes over 55 per cent to India's economy, has started showing a marked deterioration due to the global financial crisis, credit crunch and higher interest rates during recent months, according to a survey carried out by apex business chamber FICCI. During April-November 2008 various services has a negative performance (Table 6). These were air passenger traffic, fixed line telephone subscribers, assets mobilization by mutual funds, asset under management of mutual funds and insurance premium. Segments adversely impacted by the global crisis include financial services, information technology and InfoTech-enabled services, aviation and real estate.

The credit crunch and higher interest rates have impacted these areas. Wireless telephone subscribers grew 50% in April-November 2008 compared with corresponding period of the previous year. In Fiscal 2007-08, the growth was 58 per cent compared to the previous year. Internet subscribers grew by 26 per cent (20 per cent), and Broadband subscribers by 87.7 percent (23.6 per cent). The dipping performance in the services sector comes close on the Heels of the manufacturing sector registering a negative growth and this would result in slowdown in the overall economic growth rate. The government has already admitted that the expected rate of economic growth could not come down to seven per cent.

Other Implications: The major social costs of a recession are those associated with the enforcement of job cuts, lay off and significant upheavals in labour markets. Many companies are laying off their employees or cutting salaries for a few days in month or Cutting production and not doing any further recruitment13. Official sources suggest that there has been already been a sharp fall in employment in the export oriented sectors like textiles and garments, gems and jewellery, automobiles, tyre and metal products. The estimates show that in the year 2008-09, with export growth of 3.4%, the total job loss in India due to lower export growth was of around 1.16 million. The job loss in the IT and BPO sector in the country topped 10,000 in the September-December 2008. While employees of medium-sized companies bore the brunt of job losses in the September-December period, it is going to be their counterparts in the big and small firms, who would increasingly face the axe in the coming six months. According to a recent report, over 50,000 IT professionals in the country may lose their jobs over the next six months as the situation in the sector is expected to worsen due to the impact of global economic meltdown on the export-driven industry, a forecast by a union of IT Enabled Services warned. Indias travel and tourism sector has been hit by global financial crisis. The Indian tourism industry, valued at Rs 333.5 billion, earns most of its forex revenues from the US, UK and European visitors. As per the industry, on account of recent crisis, the sector may lose as much as 40% of annual revenues14. Even as per the estimates of the Tourism Committee of The Associated Chambers of Commerce and Industry of India(ASSOCHAM) on account of the global slowdown, the growth in tourism sector is likely to fall by a minimum of 10% and stay at around 5% for FY09. Of the tourist visiting India, corporate travelers account of the majority chunk. This segment was already getting affected since the start of the year on account of the global credit and subprime crisis. With companies cutting down travel budgets, this segment exercised caution. While the recent terror attacks will affect this segment on a temporary basis, it is more likely to suffer due to the prolonged economic crisis. Hotels in the metros which largely

Cater to corporate tourists have witnessed a sharp dip in occupancy rates in the past few weeks, in some cases as much as 25% to 30%. As per hotel consultants HVS Internationals analysis, almost all the top six-hotel markets-Delhi, Mumbai, Chennai, Hyderabad, Bangalore and Kolkata have been impacted. While the room rates have officially increased hotels are selling corporate travel packages at huge discounts to maintain occupancy levels. Tour operators believe that the real discounts and tariff cuts are as high as 30% to 50%. The recent economic downturn has also been a cause of concern for the Indian hospitality Industry. Taj brand of hotels reported a 73 per cent drop in its net profits at Rs 16 crore for the quarter ended June 2009 against Rs 61 crore in the pervious corresponding quarter. Last but not the least, the prices of food articles has increased by more than one-fifth in this one-year. This, obviously, affects household budgets, especially among the poor for whom food still accounts for more than half of total household expenditure. Meanwhile, on-food primary product prices have hardly changed. The prices of fibres-mainly cotton, jute and silk-have barely increased at all. Oilseed prices have fallen by more than five Percent. This, immediately, affects all the producers of cash crops, who will be getting the same or less for their products even as they pay significantly more for food. They are also paying more for fertilizer and pesticides, prices of which have increased by more Than five percent. Another major item of essential consumption has also increased in price- that of drugs and medicines, up by 4.5 percent. This obviously impacts upon the entire population, but especially the bottom half of the population who may find it extremely difficult if not impossible to meet such expenditures in times of stringency. Policy Responses from India: The global financial crisis has called into question several fundamental assumptions and beliefs governing economic resilience and financial stability. What started off as turmoil in the financial sector of the advanced economies has snowballed into the deepest and most widespread financial and economic crisis of the last 60 years? With all the advanced economies in a synchronized recession, global GDP is projected to contract for the first time since the World War II, anywhere between 0.5 and 1.0 per cent, according to the March 2009 forecast of the International Monetary Fund

(IMF). The emerging market economies are faced with decelerating growth rates. The World Trade Organization (WTO) has forecast that global trade volume will contract by 9.0 per cent in 2009.Governments and central banks around the world have responded to the crisis through both conventional and unconventional fiscal and monetary measures. Indian authorities have also responded with fiscal and monetary policy and regulatory measures. Monetary Policy Measures: On the monetary policy front, the policy responses in India since September 200815 have been designed largely to mitigate the adverse impact of the global financial crisis on the Indian economy. In mid September 2008, severe disruptions of international money Markets, sharp declines in stock markets across the globe and extreme investor aversion brought pressures on the domestic money and forex markets. The RBI responded by selling dollars consistent with its policy objective of marinating conditions in the foreign exchange market. Simultaneously, it started addressing the liquidity pressures through a variety of measures. A second repo auction in the day under the Liquidity Adjustment Facility (LAF16) was also introduced in September 2008. The repo rate was cut in stages from 9 percent in October 2008 to rate of 5 per cent. The policy reverse repo rate under the LAF was reduced by 250 basis points from 6.0 per cent to 3.5 per cent. The CRR (Cash Reserve Ratio) was also reduced from 9 per cent to 5 per cent over the same period, whereas the SLR (Statutory Liquidity Ratio) was brought down by 1 per cent to 24 per cent. To overcome the problem of availability of collateral of government securities for availing of LAF, a special refinance facility was introduced in October 2008 to enable banks to get refinance from the RBI against declaration of having extended bona fide commercial loans, under a preexisting provision of the RBI Act for a maximum period of 90 days. These policy measures of the RBI since mid September resulted in augmentation of liquidity of nearly US $80 billion (4, 22,793 crore). In addition, the permanent reduction in the SLR by 1.0 per cent of NDTL (Net Demand and Time Liability) has made available liquid funds of the order of Rs.40,000 crore for the purpose of credit expansion. The liquidity situation has improved significantly following the measures taken by the Reserve Bank. The overnight money market rates, which generally hovered above the repo rate during September-October 2008, have softened considerably

and have generally been close to or near the lower bound of the LAF corridor since early November 2008.Other money market rates such as discount rates of CDs (Certificates of Deposits), CPs (Commercial Papers) and CBLOs17 (Collateralized Borrowing and Lending Obligations) softened in tandem with the overnight money market rates. The LAF window has been in a net absorption mode since mid-November 2008. The liquidity problem faced by mutual funds has eased considerably. Most commercial banks have reduced their benchmark prime lending rates. The total utilization under the recent refinance/liquidity facilities introduced by the Reserve Bank has been low, as the overall liquidity conditions remain comfortable. However, their availability has provided comfort to the banks/FIs, which can fall back on them in case of need. The Indian financial markets continue to function in an orderly manner. The cumulative amount of primary liquidity potentially available to the financial system through these measures is over US$ 75 billion or 7 per cent of GDP. This sizeable easing has ensured a comfortable liquidity position starting mid-November 2008 as evidenced by a number of Indicators including the weighted-average call money rate, the overnight money market rate and the yield on the 10-year benchmark government security. The Collapse of Lehman Brothers: On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourthlargest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide. Lehman's demise also made it the largest victim, of the U.S. subprime mortgage-induced financial crisis that swept through global financial markets in 2008. Lehman's collapse was a seminal event that greatly intensified the 2008 crisis and contributed to the erosion of close to $10 trillion in market capitalization from global equity markets in October 2008, the biggest monthly decline on record at the time. The History of Lehman Brothers: Lehman Brothers had humble origins, tracing its roots back to a small general store that was founded by German immigrant Henry Lehman

in Montgomery, Alabama, in 1844. In 1850, Henry Lehman and his brothers, Emanuel and Mayer, founded Lehman Brothers. While the firm prospered over the following decades as the U.S. economy grew into an international powerhouse, Lehman had to contend with plenty of challenges over the years. Lehman survived them all the railroad bankruptcies of the 1800s, the Great Depression of the 1930s, two world wars, a capital shortage when it was spun off by American Express in 1994, and the Long Term Capital Management collapse and Russian debt default of 1998. However, despite its ability to survive past disasters, the collapse of the U.S. housing market ultimately brought Lehman Brothers to its knees, as its headlong rush into the subprime mortgage market proved to be a disastrous step The Prime Culprit: In 2003 and 2004, with the U.S. housing boom well under way, Lehman acquired five mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan Services, which specialized in Alt-A loans (made to borrowers without full documentation). Lehman's acquisitions at first seemed prescient; record revenues from Lehman's real estate businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006, a faster rate of growth than other businesses in investment banking or asset management. The firm securitized $146 billion of mortgages in 2006, a 10% increase from 2005. Lehman reported record profits every year from 2005 to 2007. In 2007, the firm reported net income of a record $4.2 billion on revenue of $19.3 billion. Lehman's Colossal Miscalculation: In February 2007, the stock reached a record $86.18, giving Lehman a capitalization of close to $60 billion. However, by the first quarter of 2007, cracks in the U.S. housing market were already becoming apparent as defaults on subprime mortgages rose to a seven-year high. On March 14, 2007, a day after the stock had its biggest one-day drop in five years on concerns that rising defaults would affect Lehman's profitability, the firm reported record revenues and profit for its fiscal first quarter. In the postearnings conference call, Lehman's chief financial officer (CFO) said that the risks posed by rising home delinquencies were well contained and would have little impact on the firm's earnings. He also said that he did not foresee

problems in the subprime market spreading to the rest of the housing market or hurting the U.S. economy. The Beginning of the End: As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds, Lehman's stock fell sharply. During that month, the company eliminated 2,500 mortgage-related jobs and shut down its BNC unit. In addition, it also closed offices of Alt-A lender Aurora in three states. Even as the correction in the U.S. housing market gained momentum, Lehman continued to be a major player in the mortgage market. In 2007, Lehman underwrote more mortgage-backed securities than any other firm, accumulating an $85-billion portfolio, or four times its shareholders' equity. In the fourth quarter of 2007, Lehman's stock rebounded, as global equity markets reached new highs and prices for fixed-income assets staged a temporary rebound. However, the firm did not take the opportunity to trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance. Hurtling Toward Failure: Lehman's high degree of leverage - the ratio of total assets to shareholders equity - was 31 in 2007, and its huge portfolio of mortgage securities made it increasingly vulnerable to deteriorating market conditions. On March 17, 2008, following the near-collapse of Bear Stearns - the second-largest underwriter of mortgage-backed securities - Lehman shares fell as much as 48% on concern it would be the next Wall Street firm to fail. Confidence in the company returned to some extent in April, after it raised $4 billion through an issue of preferred stock that was convertible into Lehman shares at a 32% premium to its price at the time. However, the stock resumed its decline as hedge fund managers began questioning the valuation of Lehman's mortgage portfolio. On June 9, Lehman announced a second-quarter loss of $2.8 billion, its first loss since being spun off by American Express, and reported that it had raised another $6 billion from investors. The firm also said that it had boosted its liquidity pool to an estimated $45 billion, decreased gross assets by $147 billion, reduced its exposure to residential and commercial mortgages by 20%, and cut down leverage from a factor of 32 to about 25.

Too Little, Too Late: However, these measures were perceived as being too little, too late. Over the summer, Lehman's management made unsuccessful overtures to a number of potential partners. The stock plunged 77% in the first week of September 2008, amid plummeting equity markets worldwide, as investors questioned CEO Richard Fuld's plan to keep the firm independent by selling part of its asset management unit and spinning off commercial real estate assets. Hopes that the Korea Development Bank would take a stake in Lehman were dashed on September 9, as the state-owned South Korean bank put talks on hold. The news was a deathblow to Lehman, leading to a 45% plunge in the stock and a 66% spike in credit-default swaps on the company's debt. The company's hedge fund clients began pulling out, while its short-term creditors cut credit lines. On September 10, Lehman pre-announced dismal fiscal third-quarter results that underscored the fragility of its financial position. The firm reported a loss of $3.9 billion, including a write-down of $5.6 billion, and also announced a sweeping strategic restructuring of its businesses. The same day, Moody's Investor Service announced that it was reviewing Lehman's credit ratings, and also said that Lehman would have to sell a majority stake to a strategic partner in order to avoid a rating downgrade. These developments led to a 42% plunge in the stock on September 11. With only $1 billion left in cash by the end of that week, Lehman was quickly running out of time. Last-ditch efforts over the weekend of September 13 between Lehman, Barclays PLC and Bank of America, aimed at facilitating a takeover of Lehman, were unsuccessful. On Monday September 15, Lehman declared bankruptcy, resulting in the stock plunging 93% from its previous close on September 12 Lehman's collapse roiled global financial markets for weeks, given the size of the company and its status as a major player in the U.S. and internationally. Many questioned the U.S. government's decision to let Lehman fail, as compared to its tacit support for Bear Stearns (which was acquired by JPMorgan Chase) in March 2008. Lehman's bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse also

served as the catalyst for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on September 15. Conclusions : The ongoing global financial crisis can be largely attributed to extended periods of excessively loose monetary policy in the US over the period 2002-04. Very low interest rates during this period encouraged an aggressive search for yield and a substantial compression of risk-premier globally. Abundant liquidity in the advanced economies generated by the loose monetary policy found its way in the form of large capital flows to the emerging market economies. All these factors boosted asset and commodity prices, including oil, across the spectrum providing a boost to consumption and investment. Global imbalances were a manifestation of such an accommodative monetary policy and the concomitant boost in aggregate demand in the US outstripping domestic aggregate supply in the US. This period coincided with lax lending standards, inappropriate use of derivatives, credit ratings and financial engineering, and excessive leverage. As inflation began to edge up reaching the highest levels since the 1970s, this necessitated monetary policy tightening. The housing prices started to witness some correction. Lax lending standards, excessive leverage and weaknesses of banks risk models/stress testing were exposed and bank losses mounted wiping off capital of major financial institutions. The ongoing deleveraging in the advanced economies and the plunging consumer and business confidence have led to recession in the major advanced economies and large outflows of capital from the EMEs; both of these channels are now slowing down growth in the EMEs.The present crisis situation is often compared to the Great Depression of the late 1920s and the early 1930s. True, there are some similarities. However, there are also some basic differences. The crisis has affected everyone at this time of globalization. Regardless of their political or economic system, all nations have found themselves in the same boat. Thus, first time world is facing truly global economic crisis. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems.

The cause of the problem was located in the fundamental defect of the free market system regarding its capacity to distinguish between enterprise and speculation and hence, in its tendency to become dominated by speculators, interested not in the long-term yield assets but only in the shortterm appreciation in asset values. Weak and instable financial systems in some countries increased the intensity of crisis. India which was insulted from the first round of the crisis partly owing to sound macroeconomic management policies became vulnerable to the second round effects of global crisis. The immediate effects were plummeting stock prices, loss of forex reserves, deprecation of Indian rupee, outflow of foreign capital and a sharp tightening of domestic liquidity. Later effects emerged from a slowdown in domestic demand and exports. However, Indias banking system has been considerably less affected by the crisis than banking system in US and Europe32. The single most important concern that Indian government needed to be addressed in the crisis situation was the liquidity issue. The RBI had in its arsenal a variety instruments to manage liquidity, viz., CRR, SLR, OMO, LAF, Refinance and MSS. Through the judicious combination of all these instruments, the RBI was able to ensure more than adequate liquidity in the system. At the same time it was also ensured that the growth in primary liquidity was not excessive. The pressure on financial market has been eased, although there is some evidence of an increase in the non performing loans. However, the financial system has been more risk averse. The decline in global fuel prices and other commodity prices has helped the balance of payments and lowered the inflation level. This has created the space for monetary easing as well as providing better scope for fiscal stimuls.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. However, there are many examples of policy failures (structural and macromanagement) that contributed towards the pre-crisis slowdown and magnified the negative impact of the slowdown. For example, the reason behind the slowdown in export growth in the pre-crisis period seems to be largely policy related. Ignoring all economic logic and international experiences, the government went in for large-scale liberalization of FIIs.

This, apart from inflating stock market bubble, let to a significant strengthening of Indian rupee and posed a serious hurdle to the countrys export growth. The Indian economy suffers from an extended period of high interest rates, high prices consequent to supply constraints that are more domestic in origin than global and declining business confidence that was ignored by policy players fixated on inflation and blinded by GDP numbers. But, in nutshell, macro and micro policies adopted by RBI have ensured financial stability and resilience of the banking system. The timely prudential measures instituted during the high growth period especially in regard to securitization, additional risk weights and provisioning for specific sectors measures to curb dependence on borrowed funds, and leveraging by systematically important NBFCs have stood us in good stead. Added to these, at the policy front there is need to focus of creating as much additional fiscal space as possible to prop up the domestic economy while preventing macroeconomic stability. Expenditure priority should be defined rationally. Public spending that creates jobs especially for poor is essential. Ongoing efforts to increase effectiveness and efficiency of the banking system must continue. At organizational level, efforts to raise domestic productivity and competitiveness in international market become critical factors for protecting export market shares. Last but not the least, a close coordination and integration between government of India, financial institutions and organizations is needed to deal with the crisis and restore the growth momentum.