India feels the heat

Tuesday, October 14, 2008

Domestic financial markets have been feeling the pain of the global financial crisis for quite some time now but last week they seemed particularly vulnerable to the contagion sweeping developed countries as well as most emerging economies. During the week, the Sensex lost 2,000 points, closing at 10,527 — a level that was less than half the record high it touched on January 10 this year (21,206 points). Foreign institutional investors who, in better times, pumped enormous sums of money into Indian stocks are pulling out in droves to shore up their balance sheets back home. On the positive side, India’s economic growth, though slightly diminished, is still expected to be impressive by global standards; most estimates place the GDP growth for 2008-09 at above 7 per cent. Inflation, currently ruling just below 12 per cent, is expected to drop, thanks to the sharply lower oil and other commodity prices in international markets.
There have been other manifestations of the global financial crisis also in India. As the foreign investors exit, there is considerable pressure on the rupee’s exchange rate. On Friday it plunged to Rs.49.30 to the dollar before recovering to Rs.48.36. Forex reserves have fallen by $11.36 billion since the end of August. More ominously, the markets are facing a severe credit crunch and an unprecedented liquidity crisis. Overnight, money market rates have zoomed and several types of bank borrowers are being denied loans. The RBI has cut the CRR by 1.50 percentage points, a measure that would release about Rs.60,000 crore. India has been spared, at least so far, some of the extreme consequences of the crisis. In the developed countries, there has been a serious erosion of faith in the financial sector. Even the massive rescue packages announced by the United States, the United Kingdom, and several other countries have not helped the banks to regain the confidence of investors. In contrast, the mainline banking system in India, comprising primarily the public sector banks, has withstood the crisis very well. All the banks have adequate capital. Public ownership of banks has proved to be a decisive factor in retaining the confidence of savers. In its extreme form, the financial crisis is also fuelled by psychological factors. The government and the RBI have done well to assuage the genuine concerns. They should continue to keep their communication channels open to the markets and lay investors and react fast to changing concerns and sentiments. On Monday, the markets everywhere responded favourably to bold pledges by leaders but it is not clear whether the recovery would endure.


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