8/18/2019 The Great Recession and India

1/14

The Great Recession and India’s trade collapse

India escaped the direct adverse impact of the GreatRecession of 2008-09, since its financial sector, particularly itsbanking, is very weakly integrated with global markets andpractically unexposed to mortgage-backed securities.However, In dia’s “real economy” is increasingly integratedinto global trade and capital flows. It thus did suffer “second

round” effects when the financial meltdown morphed into aworldwide economic downturn.

As seen in Figure 1, Indian exports fell in line with globaltrade flows. This should firmly dismiss the decoupling mythfor the Indian economy. Collapsing foreign trade, capitalflows, and exchange rate movements all transmittednegative impacts to the Indian economy

FIG-1

Source: IFS

8/18/2019 The Great Recession and India

2/14

What caused the trade collapse?

A plausible explanation for the severe contraction in global

trade during the Great Recession can be the increasedincome elasticity of world trade which has risen from around2 in the 1960’s to a round 4 in 2008 (Freund 2009).Thisincreased elasticity of world trade is due to the emergence ofcross-border production and supply networks. Trade financeis the other major factor that has been proposed. Someestimates say that trade finance contributes to 80% of tradeflows and hence it has contributed to around 10% to 15% fallin world trade (Auboin 2009).

Other factors through which exporters were hit hard werethe sharp reduction in the prices of the major tradedcommodities. As Figure 2 shows, world commodity pricescrashed between August 2008 to February by an average of49%.3 Thus, the decline in world trade was a combined effectof both volume and price decline.

FIG-2

8/18/2019 The Great Recession and India

3/14

The Indian trade collapse

As Figure 3 demonstrates, Indian exports and imports fell inline with global trade flows. In terms of year on year growthrates, the export contraction started from October 2008;imports started contracting a little later, from December2008. During the core period of the crisis, the averagecontraction in exports and imports has been around 20% in

the first phase (October 2008-September 2009) and 28% inthe second (December 2008-September 2009).

FIG-3: INDIAN TRADE YEARLY GROWTH RATES

8/18/2019 The Great Recession and India

4/14

Past crises and Indian trade trends

The trade collapse triggered by this global crisis is moresevere than previous major episodes such as the ‘balance ofpayment’ crisis (1991), the Asian crisis (1997), and the ‘dotcom’ bust (2000 -01). This point is illustrated in Figure 4.

The 1991 Balance of Payment crisis, saw a sharp contractionin imports primarily due to the sudden spike in the value ofpetroleum imports with imports plummeting by 38%

(November 1991). This was fortunately not accompanied by adecline in exports, which benefited from the marked rupeedevaluation of July 1991.

FIG-4

8/18/2019 The Great Recession and India

5/14

India’s merchandise exports

The traditional export destinations for India have been Asia,EU and North America. Within Asia, ASEAN is the largestexport destination (52%) followed by the EU27 (21%), andthe US (13%). The US’s share, however, has recently fallen to11% (March 2009), even lower than that of the United ArabEmirates (13%). This sudden decrease can be considered an

aftermath of the financial crisis.

FIG-5

8/18/2019 The Great Recession and India

6/14

Imports of goods and services

Crude oil, petroleum and petroleum products constitute thelargest share (32%) of India’s impor ts. India is structurallydeficit in terms of domestic availability of crude oil, having toimport nearly half of its requirements. Over the years,however, Indian corporate giants like Reliance, Essar, and theIndian Oil Corporation have established globally competitive

refining capacities. These are presently in excess of thecountry’s requirements so they import crude and exportrefined products. The expansion of this processing activityhas contributed to the rather sharp increase in the share ofcrude oil and petroleum products in recent years.

India’s oil imports which had been growing robustly at

around 40% (2007-08) saw a decline in growth of about 17%during 2008- 09. India’s merchandise imports startedcontracting from November 2008 onwards on a year on yearbasis along with oil imports whereas the contraction in non-oil imports started from January 2009. During the periodfrom October 2008 –September 2009, imports havecontracted more (22%) than exports (20%).

8/18/2019 The Great Recession and India

7/14

8/18/2019 The Great Recession and India

8/14

Trade in services

India is a major services exporting country with about 3% ofthe world total service exports. India’s exports of services aremainly to the EU and the US. The latter alone accounting foraround 11% of India’s total services exports.

Services exports have not been as affected as exports ofmerchandise. The sub-sectors within services exports that

have registered some contraction are travel, insurance,business and communication services. Software servicesexports, which are for some reason classified undermiscellaneous receipts for India have been a majorcontributor to the growth of services exports, accounting foras much as 45% of total exports, goods and services

combined (2007-08). However the intensity of the adverseimpact of the global economic down turn on India’s exports isperhaps best demonstrated by noting that even India’ssoftware exports recorded a contraction in the fourth quarterof 2008-09 by more than 15%. While the actual decline wasconfined to only a single quarter, the growth of softwareexports in 2008-09 has been far from the levels achieved inthe years preceding the global crisis.

During the crisis most businesses cut costs to cope with thedeclining revenues. This in turn meant a reduction in ITspending by advanced economies and a negative impact forthe growth of Indian software exports. The financial crisisreflected in the slowdown of foreign business visitors andbrought down foreign travel receipts by 4% (2008-09). As a

8/18/2019 The Great Recession and India

9/14

related incidence, business and communication services alsoexperienced contraction of 3% and 10% respectively.

FIG-7

8/18/2019 The Great Recession and India

10/14

8/18/2019 The Great Recession and India

11/14

3. Lending for Banks

In 2008 and 2009, as the nation's economic problems becamesevere, the Fed provided lines of credit to financial and lendinginstitutions. This cash infusion provided funds for consumerloans and consequent consumer buying - the engine thatdrives the economy. A follow-up effort to pull down long-terminterest rates was initiated in 2010, with an additional $267billion earmarked by the Fed for bond buying.

Besides these actions by the Fed, America's central bankloaned money to J.P. Morgan Chase to help the banking gianttakeover the failing investment bank, Bear Stearns. The Fedalso established a line of credit and financing for thegovernment's acquisition of American International Group

(AIG), one of the largest global insurance firms. By mid-Junethis year, these loans had been totally repaid, according to theFederal Reserve Bank of New York.

8/18/2019 The Great Recession and India

12/14

US RESPONSE TO THE GREAT DEPRESSION

In the United States, the government followed a two-pronged strategy to reverse the financial crisis: bail outdistressed financial institutions (lest they transmit theirfailure to their creditors) and pump government money intothe economy (to stimulate business activity when privateloans were scarce). What emerged from the bailout was an

extraordinary degree of government involvement in —andsometimes even majority ownership of —the private sector.Altogether, the government by late 2009 had provided anestimated $4 trillion to keep the financial sector afloat. Manyof the biggest bailout beneficiaries quickly paid thegovernment back, and the ultimate cost of the bailout totaxpayers was estimated at “only” $1.2 trillion.

Congress in February handed Pres. Barack Obama the firstlegislative triumph of his month-old presidency when itenacted a $787 billion fiscal stimulus bill that comprised $288billion in tax cuts and $499 billion in spending, most of it forpublic-works programs such as school construction andhighway repair. Although Republicans groused that checksfor much of the $499 billion would be issued too late to doany good, the nonpartisan Congressional Budget Office saidthat thanks to the tax measures, about three-quarters of thefull $787 billion would be spent in 18 months. Obamaclaimed that the bill would create or preserve 3.5 million jobs, a figure that many of his opponents called far too

optimistic.

8/18/2019 The Great Recession and India

13/14

Congress also played a role in the bailout of failing financialinstitutions. At the end of 2008, Congress enacted theTroubled Asset Relief Program (TARP) authorizing theDepartment of the Treasury to invest up to $700 billion bybuying unproductive real-estate investments or evenbecoming part owners by purchasing financial companystock. The Fed, using authority that it already had, played aneven bigger role. Printing more money when not enough wasavailable, the central bank invested heavily in foundering

institutions and guaranteed the value of their shaky assets.By the end of 2009, the government owned almost 80% ofAmerican International Group (AIG), the country’s biggestinsurer, at a cost of more than $150 billion. It also owned60% of GM and had a stake in some 700 banks. It initiallyspent $111 billion to prop up Fannie Mae and Freddie Mac,

the companies sponsored by Congress to buy mortgagesfrom their issuers. The government promised to play no rolein managing these companies and to sell its ownership stakesas soon as practical. TARP provided the Treasury with only afraction of the funds used for the bailout, however. The Fedwas responsible for the lion’s share, and even the massiveAIG rescue was engineered entirely outside the legislatedTreasury Department program.

Reflecting public views, members of the governmentexpressed outrage that some of the same executives whohelped precipitate the financial crisis should make millions ofdollars a year in salaries and bonuses. Treasury SecretaryTimothy Geithner appointed a “special master for executivecompensation” to review the compensation packages of top

8/18/2019 The Great Recession and India

14/14

financial executives at firms that received bailouts. Many ofthe biggest bailout beneficiaries balked at the proposedsalary limits and strove to get out from under them by payingthe government back.

More ominously for the financial institutions, many membersof Congress marched into 2010 with a determination toregulate them more closely. The House passed a bill in 2009

that for the first time would bring exotic financialinstruments under review by federal regulators. The billwould also establish a single agency to protect financialconsumers and guarantee shareholders a chance to vote onthe compensation packages of corporate executives. TheSenate planned to take up the issue in 2010.