Response of the Reserve Bank of India (RBI) to the

Financial and Economic Crisis

Aleksandar Zaklan



While the Advanced Economies were in Crisis
Already
India enjoyed GDP growth around 9% going into 2008
Main drivers: domestic investment, resulting from savings
rate of about 35% of GDP, and domestic consumption.
However, foreign investment and trade also contributed to
the expansion of the economy
India was integrating into the world economy
Trade share of GDP (exports + imports/GDP) went from 21.2% in
1997 to 34.7% by 2008
Foreign capital had been available and cheap and capital inflows
amounted to 9% of GDP by 2008
So in 2007 and going into 2008 the RBI was fighting
overheating rather than crisis

Ex Ante Measures by the RBI: Interest Rate
Policy
Starting in early 2008 consumer inflation
started rising towards 10% per year
In addition, a boom was under way in real
estate, in particular in commercial real
estate
To maintain price stability the RBI pursued
a relatively tight monetary policy, and the
main policy rate, the repo rate, was raised
to 9% by the summer of 2008
Ex Ante Measures by the RBI: Micro and Macro
Prudential Policy
The RBI is also in charge of banking supervision,
and 70% of Indias banking system is state-
owned, so the RBI has a lot of control over the
system
The RBIs governor, Y.V. Reddy, took strong anti-
expansionary regulatory measures:
Banks were not allowed to speculate with land
Banks were forced to maintain conservative lending
standards for mortgages and consumer loans
The RBI required fairly high capital reserves (12-14%)
Y. V. Reddy, the anti Greenspan
With the Lehman Brothers Default the Crisis
Reached India
The second-round effects of the crisis were transmitted
both through the financial and the real channel
Financial channel:
Liquidity dried up as foreign investors divested and put pressure
on the Rupee exchange rate
Domestic companies were cut off from foreign capital and turned
to a tightening domestic credit market
Real channel:
Demand for Indian exports dropped because of the recession in
advanced economies
Remittances from the Gulf region dropped because falling energy
prices diminished construction activity there
Ex Post Measures: Interest rate policy
Starting in the fall of 2008 the actions of the RBI
bacame highly expansionary
The repo rate (the rate which RBI charges banks
when they borrow from it) fell from 9% in
October 2008 to 4.75% currently
The reverse repo rate (the rate the RBI offers
banks for taking in the banks money) was cut
from 6% in December 2008 to 3.25% currently
Ex Post Measures: Aggregate Liquidity Supply
Operations
Ensuring Liquidity supply both in the foreign
exchange and the domestic markets was the
overarching goal of the RBIs response to the
crisis
However, no particular emergency measures for
specific banks were needed, since no banks were
threatened by failure.
Ex Post Measures: Aggregate Liquidity Supply
Operations
Domestic liquidity:
The cash reserve ratio (CRR) was decreased from 9% at the end of 2008
to 5% currently
The statutory lending requirement (SLR) was lowered from 25% to 24%
of deposits
A number of special financing programs were set up, e.g. guaranteeing
credit to non-banking financial companies (NBFCs) and to micro, small
and medium sized companies (MSMEs)
Foreign exchange liquidity:
The RBI intervened massively in the foreign exchange market by selling
US dollar reserves to support the Rupee exchange rate
A rupee-dollar swap facility provided liquidity to commercial banks
External borrowing restrictions on corporations were relaxed
Repatriation of remittances was made easier for Indians living abroad
Conclusion
While the crisis is certainly having an impact, the impact
on India is muted compared to what is going on in
advanced economies and other emerging economies, e.g.
Eastern Europe
The RBI has taken pretty swift and decisive action against
the liquidity crunch, and is coordinating its actions with
the fiscal stimulus provided by the government
Overall, the fundamentals of the economy seem to be
sound, and given that the drivers of growth in India are
predominantly domestic, there should not be significant
damage to the countrys medium to long term economic
prospects