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For India, Crisis Brings Some Pain with Long-Term Opportunities

Author: Adam Segal, Maurice R. Greenberg Senior Fellow for China Studies
November 13, 2008

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India has been hurt by the global financial crisis, but it may be better positioned for a quick recovery and for future growth than many of the other developing economies. The Indian financial sector is relatively insulated; the rupee is not fully convertible; and Indian banks did not have significant exposure to subprime loans in the United States. The stock market, however, has been badly hit as foreign institutional investors (FIIs) have sold almost $10 billion of their investments in Indian companies to cover losses accrued in their home markets. From January 2008 to late October 2008, the Bombay Stock Exchange fell almost 50 percent, from above 20,000 to around 10,500. There has also been an intense liquidity crisis in the Indian economy, created by the tightening of global credit markets and the withdrawal of FIIs, as well as earlier government efforts to fight inflation and shore up the declining rupee.

Long-term growth prospects remain uncertain. While trade makes up a little less than one-third of Indian gross domestic product (GDP), the Indian economy will be unable to avoid the fallout of a recession in the United States and Europe. Some industries are more vulnerable than others; IT, financial services, and real estate are likely to be hit the hardest, although textile and garment sectors will also be affected by slowing exports and the rising costs of capital. India's auto industry faces bleak prospects, with rising costs, reduced consumer credit, and falling demand. Rising unemployment is a concern, and there have been some high-profile job cuts affecting the middle class, including the firing and subsequent rehiring, under government pressure, of two thousand employees at Jet Airways, a private Indian airline. The GDP growth forecasts for 2008-2009 have been revised down to the 7 percent to 7.5 percent range, although some are more pessimistic, with the International Monetary Fund (IMF) predicting 6.3 percent.

"There is a sense that the international institutions will be remade to reflect the current balance of power, and that India may be able to turn this crisis into a "permanent place at a new high table."

There are reasons, though, for optimism about how quickly India could turn the corner. Domestic demand could remain a strong driver of growth; farm income and rural employment are both up and consumers received large tax breaks in this year's budget. India imports 80 percent of its oil, so it will benefit from prices hovering around $70 a barrel as well as from the declining prices of other commodities. The Centre for Monitoring Indian Economy, a Mumbai-based economic think tank, argues that continued battles over land acquisition for large-scale industrial projects-the protests, for example, that have delayed the Korean steel company Posco's projects  in Orissa and forced Tata to relocate the plant for its small Nano car from Singur to Gujarat-will  have a larger impact on the economy than the financial meltdown. And CLSA Asia-Pacific Markets, a Hong Kong-based financial firm, predicts that India will be the first Asian economy to emerge from the crisis.

So far, the dominant political question has focused on whether Indian leaders responded rapidly and aggressively enough to the financial crisis. For the last year, the primary concern in India has been inflation and so the government has been actively tightening monetary policy. The focus changed as the crisis unfurled in October. Some economists have complained that the government was slow to shift gears; efforts like promoting advance taxes and government bond auctions probably further reduced liquidity. But for the most part, the government has received high marks for moving fairly quickly once the full scope of the global crisis was realized. The Reserve Bank of India has cut the cash reserve ratio (amount of deposits that banks must keep on reserve) and followed through on other measures to increase liquidity.

Still, the true political implications of the crisis will not be known until the voters go to the polls-elections are to be held in five states in November and December and a national election will be held sometime early in 2009. The ruling coalition, the United Progressive Alliance, and the Congress Party in particular, are worried about the possible electoral impact of the downturn, and the fear that it could be punished at the polls clearly lies behind the government's calls for industry to avoid large layoffs during the crisis. Even before the current crisis, the Congress Party had promoted a number of more populist policies, including waiving $15 billion in loans to 30 million small farmers. Market reforms have stalled, especially as the ruling United Progressive Alliance has responded to challenges within its own ranks to the U.S.-India nuclear deal. The left-leaning parties have argued that India has been fairly insulated from the crisis precisely because of their opposition to further liberalization. "If foreign banks had been allowed to take over 74 percent interest in Indian banks, our banks would have collapsed. If pension funds had been privatized, crores [tens of millions] of employees would have been ruined," according to Sitaram Yechury, a member of parliament and politburo member of the Communist Party of India (Marxist).

"While trade makes up a little less than one-third of Indian gross domestic product (GDP), the Indian economy will be unable to avoid the fallout of a recession in the United States and Europe."

As with China, there is a great deal of discussion of what role India will play in the emerging international economic order. There is a sense that the international institutions will be remade to reflect the current balance of power, and that India may be able to turn this crisis into "a permanent place at a new high table," in the words of the columnist Mihir Sharma. Unlike China, India is not sitting on a massive amount of foreign exchange and no one is calling on it to "bail out" Western banks. Instead, India has two broad objectives for the G-20 meeting-ensuring that credit begins to flow again as quickly as possible, and that the World Bank and IMF invest heavily in large infrastructure projects in developing countries. India is also expected to make two concrete proposals: It will support the creation of a "global monitoring authority" to help along "supervision and cooperation" in the global financial system, as well as the creation of a "supervisory mechanism" for the credit rating agencies.

India will be especially concerned about the impact of the crisis on Pakistan's stability. India claims that Pakistan's Inter-Services Intelligence (ISI) has played a role in several terrorist attacks within India as well as the July 2008 car bombing of the Indian embassy in Kabul.  A further deterioration of Pakistan's economy is likely to lead to increased tensions across the border.

Delhi will also be watching Beijing's performance closely, especially at the G-20 meeting. While China may be the more high-profile player, India will not be shy in making sure that the United States and Europe acknowledge that the world has changed. The last round of the Doha trade negotiations collapsed in July because of a disagreement with the United States over safeguard mechanism to protect farmers in developing countries. India can be expected to show a similar willingness to defend its interests at the G-20 and beyond.

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