Global Financial Crisis and

its Impact on India

Raghul Aravind
PGPSM 2016-17

Abstract
India could not insulate itself from the adverse developments in the international financial
markets, despite having a banking and financial system that had little to do with investments in
structured financial instruments carved out of subprime mortgages, whose failure had set off the
chain of events culminating in a global crisis. Economic growth decelerated in 2008-09 to 6.7
percent. This represented a decline of 2.1 percent from the average growth rate of 8.8 percent in
the previous five years. To counter the negative fallout of the global slowdown on the Indian
economy, the federal Government responded by providing three focused fiscal stimulus packages
in the form of tax relief to boost demand and increased expenditure on public projects to create
employment and public assets. Indias central Bank, the Reserve Bank of India (RBI) took a
number of monetary easing and liquidity enhancing measures to facilitate flow of funds from the
financial system to meet the needs of productive sectors.
From all accounts, except for the agricultural sector initially as noted above, economic recovery
seems to be well underway. Economic growth stood at 8.6 percent during fiscal year 2010-11.
GDP growth for 2009-10 was placed at 8 percent. When compared to countries across the world,
India stands out as one of the best performing economies. Although there was a clear moderation
in growth from 9 percent levels to 7+ percent soon after the crisis hit, in 2010-11, at 8.6 percent,
GDP growth in nearing the pre-crisis levels and this pace makes India the fastest growing major
economy after China. Be that as it may, the process of fiscal consolidation needs to be
accelerated through more qualitative adjustments to reduce government dissavings and
ameliorate

price

pressures.

The step-up in India's growth rate over much of the last two decades was primarily due to the
structural changes in industrial, trade and financial areas, among others, over the 1990s as the
reforms in these sectors were wide and deep and hence contributed significantly to higher
productivity of the economy. Indeed, there is potential for still higher growth on a sustained basis
of 9+ percent in the years.

Global Financial Crisis and its Impact on India

India could not insulate itself from the adverse developments in the international financial
markets, despite having a banking and financial system that had little to do with investments in
structured financial instruments carved out of subprime mortgages, whose failure had set off the
chain of events culminating in a global crisis. Economic growth decelerated in 2008-09 to 6.7
percent. This represented a decline of 2.1 percent from the average growth rate of 8.8 percent in
the previous five years (2003-04 to 2007-08). Per capita GDP growth grew by an estimated 4.6
percent in 2008-09. Though this represents a substantial slowdown from the average growth of
7.3 percent per annum during the previous five years, it is still significantly higher than the
average 3.3 percent per annum income growth during 1998-99 to 2002-03. The effect of the
crisis on the Indian economy was not significant in the beginning. The initial effect of the
subprime crisis was, in fact, positive, as the country received accelerated Foreign Institutional
Investment (FII) flows during September 2007 to January 2008. There was a general belief at
this time that the emerging economies could remain largely insulated from the crisis and provide
an alternative engine of growth to the world economy. The argument soon proved unfounded as
the global crisis intensified and spread to the emerging economies through capital and current
account of the balance of payments. The net portfolio flows to India soon turned negative as
Foreign Institutional Investors rushed to sell equity stakes in a bid to replenish overseas cash
balances. This had a knock-on effect on the stock market and the exchange rates through creating
the supply demand imbalance in the foreign exchange market. The current account was affected
mainly after September 2008 through slowdown in exports. Despite setbacks, however, the Bop
situation of the country continues to remain resilient. The challenges that confronted the Indian
economy in 2008-09 and continue to do so fall into two categories - the short-term
macroeconomic challenges of monetary and fiscal policy and the medium-term challenge of
attaining and sustaining high rates of economic growth. The former covers issues such as the
trade-off between inflation and growth, the use of monetary policy versus use of fiscal policy,
their relative effectiveness and coordination between the two. The latter includes the tension
between short- and longterm fiscal policy, the immediate longer term imperatives of monetary
policy and the policy and institutional reforms necessary for restoring high growth. Indias

balance of payments in 2008-09 captured the spread of the global crisis to India (see Table 1).
The current account deficit during 2008-09 shot up to 2.6 percent of GDP from 1.5 percent of
GDP in 2007-08 (Table 1). And this is the highest level of current account deficit for India since
1990-91 (Chart 1). The capital account surplus dropped from a record high of 9.3 percent of
GDP in 2007-08 to 0.9 percent of GDP. And this is lowest level of capital account surplus since
1981-82. The year ended with a decline in reserves of US$ 20.1 billion (inclusive of valuation
changes) against a record rise in reserves of US$ 92.2 billion for 2007-08.

The global financial crisis began to affect India from early 2008 through a withdrawal of capital
from Indias financial markets. This is shown in Indias balance of payments as a substantial
decline in net capital inflows in the first half of 2008-09 to US$ 19 billion from US$ 51.4 billion
in the first half of 2007- 08, a 63 percent decline.
This is seen from a large outflow of portfolio investment (as equity disinvestment by foreign
institutional investors and lower external commercial borrowings, short-term trade credit, and
short-term bank borrowings. Inflows under foreign direct investment, external assistance and
NRI deposits, by contrast, surged during the first half of 2008-09. In the second half of 2008-09,
net capital flows turned negative as there were huge outflows of portfolio investment, short-term
trade finance and banking capital. Capital flows under foreign direct investment and external
commercial borrowings recorded sharp declines of 66 percent and 56 percent respectively over
the same period of 2007-08. However, inflows under external assistance and NRI deposits
continued to rise considerably during the second half of 2008-09.
In the second half of 2008-09, net capital flows turned negative as there were huge outflows of
portfolio investment, short-term trade finance and banking capital. Capital flows under foreign
direct investment and external commercial borrowings recorded sharp declines of 66 percent and
56 percent respectively over the same period of 2007-08. However, inflows under external
assistance and NRI deposits continued to rise considerably during the second half of 2008-09.
While capital account suffered right from the beginning of 2008-09, the impact of the global

crisis on the current account was felt only in the second half of 2008-09. In the first half of 200809, merchandise exports in fact grew strongly at 35 percent and invisible receipts by 32 percent.
Merchandise imports grew by 45 percent and invisible payments by 14 percent in the first half of
2008-09. Net invisible earnings grew strongly at the rate of 51 percent in the first half of 200809. Things turned adverse dramatically in the second half of 2008-09 as global crisis took its toll
on external trade. Merchandise exports declined by about 18 percent in the second half of 200809 over the same period of 2007-08, and imports declined by 11 percent. Invisible receipts
declined more sharply at 84 percent and invisible payments by 13 percent. As a result, net
invisible receipts declined by 3 percent in the second half 6 of 2008-09 over the same period of
2007-08 in contrast a steep rise of 51 percent in the first half of 2008-09.
The two major items of invisible receipts for India have been software exports and private
transfers (remittances). Net receipts from software exports rose by 19 percent in 2008-09 to US$
44 billion from US$ 37 billion in 2007-08. Remittances also amounted to US$ 44 billion in
2008-09, a rise of 5 percent from US$ 42 billion in 2007-08. Table 2 brings out the decline in
various categories of invisible receipts in the second half of 2008-09. As can be seen from Table
2, the growth in software exports slumped to 3.6 percent in the second half of 2008-09 over the
same period. Remittances in fact recorded a decline of 19.6 percent in the second half of 200809. These have to be seen in the context of a sharp growth of about 38 percent in software
exports and 40 percent in remittances in the first half of 2008-09 over the same period in 200708.

The above analysis of Indias balance of payments has brought out that the global financial crisis
severely hit the flow of capital into the country right from the beginning of 2008-09 and then
subsequently the current account transactions (both trade and invisibles) in the second half of the
year. This has led to one of the highest current account deficits and one of the lowest capital
account surpluses for the country. The 7 impact of the crisis on both capital flows and current
receipts has been much larger than what we initially thought.
Due to the global crisis the economy experienced extreme volatility in terms of fluctuations in
stock market prices, exchange rates and inflation levels during a short duration necessitating
reversal of policy to deal with the emergent situations. Before the onset of the financial crisis, the
main concern of the policymakers was excessive capital inflows, which increased from 3.1
percent of GDP in 2005-06 to 9.3 percent in 2007- 08. While this led to increase in foreign
exchange reserves from US$ 151.6 billion at end-March 2006 to US$ 309.7 billion at end-March

2008, it also contributed to monetary expansion, which fueled liquidity growth. WPI inflation
reached a trough of 3.1 percent in October 2007, a month before global commodity price
inflation zoomed to double digits from low single digits. The rising oil and commodity prices,
contributed to a significant rise in prices, with annual WPI peaking at 12.8 percent in August
2008. The monetary policy stance during the first half of 2008-09 was therefore directed at
containing the price rise. To counter the negative fallout of the global slowdown on the Indian
economy, the federal Government responded by providing three focused fiscal stimulus packages
in the form of tax relief to boost demand and increased expenditure on public projects to create
employment and public assets. Indias central Bank the Reserve Bank of India (RBI) took a
number of monetary easing and liquidity enhancing measures to facilitate flow of funds from the
financial system to meet the needs of productive sectors
This fiscal accommodation led to an increase in fiscal deficit from 2.7 percent in 2007-08 to 6.2
percent of GDP in 2008-09. The difference between the actual figures of 2007-08 and 2008-09
constituted the total fiscal stimulus. This stimulus at current market prices amounted to 3.5
percent of GDP for 2008-09. These measures were effective in arresting the fall in the growth
rate of GDP in 2008-09 and India achieved a growth rate of 6.7 percent. The policy stance of the
RBI in the first half of the year was oriented towards controlling monetary expansion, in view of
the apparent link between monetary expansion and inflationary expectations partly due to the
perceived liquidity overhang. In the first six months of 2008-09, year-on-year growth of broad
money was lower than the growth of reserve money. The Government also took various fiscal
and administrative measures during the first half of 2008-09 to rein in inflation. The key policy
rates of RBI thus moved to signal a contractionary monetary stance. The repo rate (RR) was
increased by 125 basis points in three tranches from 7.75 percent at the beginning of April 2008
to 9.0 percent with effect from August 30, 2008. The reverse-repo rate (R-RR) was however left
unchanged at 6.0 percent. The cash reserve ratio (CRR) was increased by 150 basis points in six
tranches from 7.50 percent at the beginning of April 2008 to 9.0 percent with effect from August
30, 2008.
After a long spell of growth, the Indian economy were experiencing a downturn. Industrial
growth has been faltering, inflation remains at double-digit levels, the current account deficit is
widening, foreign exchange reserves are depleting and the rupee is depreciating. The last two

features can also be directly related to the current international crisis. 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 were seeking havens of safety in an uncertain environment, have
become major sellers in Indian markets.
In 2007-08, net FII inflows into India amounted to $20.3 billion. As compared with this, they
pulled out $11.1 billion during the first nine-and-a-half months of calendar year 2008, of which
$8.3 billion occurred over the first six-and-a-half months of financial year 2008-09 (April 1 to
October 16). This has had two effects: in the stock market and in the currency market.

Given the importance of FII investment in driving Indian stock markets and the fact that
cumulative investments by FIIs stood at $66.5 billion at the beginning of this calendar year, the
pullout triggered a collapse in stock prices. As a result, the Sensex fell from its closing peak of
20,873 on January 8, 2008, to less than 10,000 by October 17, 2008

Falling rupee:

In addition, this withdrawal by the FIIs led to a sharp depreciation of the rupee. Between January
1 and October 16, 2008, the RBI reference rate for the rupee fell by nearly 25 per cent, even
relative to a weak currency like the dollar, from Rs 39.20 to the dollar to Rs 48.86 (Chart 2). This
was despite the sale of dollars by the RBI, which was reflected in a decline of $25.8 billion in its
foreign currency assets between the end of March 2008 and October 3, 2008.
It could be argued that the $275 billion the RBI still has in its kitty is adequate to stall and
reverse any further depreciation if needed. But given the sudden exit by the FIIs, the RBI is
clearly not keen to deplete its reserves too fast and risk a foreign exchange crisis.
The result has been the observed sharp depreciation of the rupee. While this depreciation may be
good for India's exports that are adversely affected by the slowdown in global markets, it is not
so good for those who have accumulated foreign exchange payment commitments. Nor does it
assist the Government's effort to rein in inflation.

EXPOSURE OF BANKS:
A second route through which the global financial crisis could affect India is through the
exposure of Indian banks or banks operating in India to the impaired assets resulting from the
sub-prime crisis. Unfortunately, there were no clear estimates of the extent of that exposure,
giving room for rumor in determining market trends. Thus, ICICI Bank was found to be the
victim of a run for a short period because of rumors that sub-prime exposure had badly damaged
its balance sheet, although these rumors have been strongly denied by the bank. So far the RBI
has claimed that the exposure of Indian banks to assets impaired by the financial crisis was
small. According to reports, the RBI had estimated that as a result of exposure to collateralized
debt obligations and credit default swaps, the combined mark-to-market losses of Indian banks at
the end of July was around $450 million.
Given the aggressive strategies adopted by the private sector banks, the MTM losses incurred by
public sector banks were estimated at $90 million, while that for private banks was around $360
million. As yet these losses are on paper, but the RBI believes that even if they are to be provided
for, these banks are well capitalized and can easily take the hit.
Such assurances have neither reduced fears of those exposed to these banks or to investors
holding shares in these banks.
These fears were compounded by those of the minority in metropolitan areas dealing with
foreign banks that have expanded their presence in India, whose global exposure to toxic assets
must be substantial.
A third indirect fallout of the global crisis and its ripples in India is in the form of the losses
sustained by non-bank financial institutions (especially mutual funds) and corporate, as a result
of their exposure to domestic stock and currency markets.
Such losses were expected to be large, as signalled by the decision of the RBI to allow banks to
provide loans to mutual funds against certificates of deposit (CDs) or buyback their own CDs
before maturity. These losses are bound to render some institutions fragile, with implications that
would become clear only in the coming months

A fourth effect is that, in this uncertain environment, banks and financial institutions concerned
about their balance sheets, have been cutting back on credit, especially the huge volume of
housing, automobile and retail credit provided to individuals. According to RBI figures, the rate
of growth of auto loans fell from close to 30 per cent over the year ending June 30, 2008, to as
low as 1.2 per cent.
Loans to finance consumer durables purchases fell from around Rs 6,000 crore in the year to
June 2007, to a little over Rs 4,000 crore up to June this year. Direct housing loans, which had
increased by 25 per cent during 2006-07, decelerated to 11 per cent growth in 2007-08 and 12
per cent over the year ending June 2008.
It is only in an area like credit-card receivables, where banks are unable to control the growth of
credit, that expansion was, at 43 per cent, quite high over the year ending June 2008, even
though it was lower than the 50 per cent recorded over the previous year.
It is known that credit-financed housing investment and credit-financed consumption have been
important drivers of growth in recent years, and underpin the 9 per cent growth trajectory India
has been experiencing.
The reticence of lenders to increase their exposure in markets to which they are already
overexposed and the fears of increasing payment commitments in an uncertain economic
environment on the part of potential borrowers are bound to curtail debt-financed consumption
and investment. This could slow growth significantly.
Finally, the recession generated by the financial crisis in the advanced economies as a group and
the US in particular, will adversely affect India's exports, especially its exports of software and
IT-enabled services, more than 60 per cent of which are directed to the US.
International banks and financial institutions in the US and EU are important sources of demand
for such services, and the difficulties they face will result in some curtailment of their demand.
Further, the nationalization of many of these banks is likely to increase the pressure to reduce
outsourcing in order to keep jobs in the developed countries.

And the slowing of growth outside of the financial sector too will have implications for both
merchandise and services exports. The net result would be a smaller export stimulus and a
widening trade deficit.

DOMESTIC POLICY:
While these trends are still in process, their effects were already being felt. They were not the
only causes for the downturn the economy has been experiencing, but they were found to be
important contributory factors. Yet, this does not justify the argument that India's difficulties are
all imported. They have been induced by domestic policy as well.
The extent of imported difficulties would have been far less if the Government had not increased
the vulnerability of the country to external shocks by drastically opening up the real and financial
sectors. It is disconcerting, therefore, that when faced with this crisis the Government is not
rethinking its own liberalization strategy, despite the backlash against neo-liberalism worldwide.
By deciding to relax conditions that apply to FII investments in the vain hope of attracting them
back and by focusing on pumping liquidity into the system rather than using public expenditure
and investment to stall a recession, it is indicating that it hopes that more of what created the
problem would help solve it.

Developments in the exchange rate arena:

The exchange rate policy in recent years has been guided by the broad principles of monitoring
and management of exchange rates with flexibility, without a fixed or a preannounced target or a
band, while allowing the underlying demand and supply conditions to determine the exchange
rate movements of the Indian rupee over a period in an orderly manner. Subject to this
predominant objective, the RBIs intervention in the foreign exchange market has been driven by
the objectives of reducing excess volatility, maintaining adequate level of reserves, and
developing an orderly foreign exchange market. The surge in the supply of foreign currency in
the domestic market led inevitably to a rise in the price of the rupee. The rupee gradually
appreciated from Rs. 46.54 per US dollar in August 2006 to Rs.39.37 in January 2008, a
movement that had begun to affect profitability and competitiveness of the export sector. The

global financial crisis however reversed the rupee appreciation and after the end of positive
shock around January 2008, rupee began a slow decline. A major factor, which affected the
emerging economies almost simultaneously, was the unwinding of stock positions by the FIIs to
replenish cash balances abroad. The decline in rupee became more pronounced after the fall of
Lehman Brothers in September 2008, requiring RBI intervention to reduce volatility. It is
pertinent to note that a substantial part of the movement in the rupee-US dollar rate during this
period has been a reflection of the movement of the dollar against a basket of currencies. The
rupee stabilized after October 2008, with some volatility. With signs of recovery and return of
foreign institutional investment (FII) flows after March 2009, the rupee has again been
strengthening against the US dollar. For the year as a whole, the nominal value of the rupee
declined from Rs. 40.36 per US dollar in March 2008 to Rs. 51.23 per US dollar in March 2009,
reflecting 21 percent depreciation during the fiscal 2008/09. In fiscal 2009/10, however, with the
signs of recovery and return of FII flows after March 2009, the rupee has been strengthening
against the US dollar. The movement of the exchange rate in the year 2009/10 indicated that the
average monthly exchange rate of the rupee against the US dollar appreciated by 9.9 percent
from Rs 51.23 per US dollar in March 2009 to Rs 46.63 per US dollar in December 2009, mainly
on account of weakening of the US dollar in the international market.

Developments in the monetary policy arena:

The outflow of foreign exchange, as a fall out of the crisis, also meant tightening of liquidity
situation in the economy. To deal with the liquidity crunch and the virtual freezing of
international credit, the monetary stance underwent an abrupt change in the second half of
2008/09. The RBI responded to the emergent situation by facilitating monetary expansion
through decreases in the CRR, RR and R-RR rates, and the statutory liquidity ratio (SLR). The
RR was reduced by 400 basis points in five tranches from 9.0 in August 2008 to 5.0 percent
beginning March 5, 2009. The R-RR was lowered by 250 basis points in three tranches from 6.0
(as was prevalent in November 2008) to 3.5 percent from March 5, 2009. The R-RR and RRs
were again reduced by 25 basis points each with effect from April, 2009. SLR was lowered by
100 basis points from 25 percent of net demand and time liabilities (NDTL) to 24 percent with
effect from the fortnight beginning November 2008. 9 The CRR was lowered by 400 basis points
in four tranches from 9.0 to 5.0 percent with effect from January 2009. The credit policy

measures by the RBI broadly aimed at providing adequate liquidity to compensate for the
squeeze emanating from foreign financial markets and improving foreign exchange liquidity. At
the same time, it was necessary to ensure that the financial contagion arising from the global
financial crisis did not permeate the Indian banking system. These measures were therefore
supplemented by sector- specific credit measures for exports, housing, micro and small
enterprises and infrastructure. The monetary measures had a salutatory effect on the liquidity
situation. The weighted average call money market rate, which had crossed the LAF corridor at
several instances during the first half of 2008-09, remained within the LAF corridor after
October 2008. Since mid-2008-09, the growth in reserve money decelerated after September
2008. The deceleration in M0 was largely on account of the decline in net foreign exchange
assets of RBI (a major determinant of reserve money growth) due to reduced capital inflows. On
the other hand, the net domestic credit of the RBI expanded due to an increase in net RBI credit
to the Central Government in the second half of the year.

INDIA CONFRONTING THE GLOBAL FINANCIAL CRISIS:

Recent events in the global financial system have been nothing short of seismic. Hundreds of
billions, if not trillions of dollars in capital value have been lost in stock markets. Inter-bank
credit has almost frozen up.
Actual costs of borrowing have gone up (even with falling central bank interest rates),
unemployment has been rising in the major world economies, and home foreclosures and
bankruptcies are on the rise.
This crisis is sought to be addressed by a variety of policy initiatives, the most important aspects
of which are the injection of vast amounts of public funds into financial institutions and the
provision of sovereign guarantees on bank accounts.
But the ability to do so is limited. The budget deficit for 2008 in the US has trebled as compared
to its forecasted value and the ratio of public plus private debt to GDP is well over 300 percent.
The huge injection of funds to stabilise the financial system will need to be financed. But the US
treasury is already stretched and, with a recession looming, prospects for enhanced tax revenue
in 2009 do not appear bright. Similar comments apply to Europe.

So far the global financial crisis has had three major impacts on the Indian economy: (i) the
quantum of liquidity available during the first half of FY 2008-09 is about a third lower than
during the first half of FY 2007-08; (ii) with slackening external demand, export growth is
expected to slow; and (iii) Foreign Institutional Investors have withdrawn from Indian stock
markets leading to sharp falls in key indices. India's economic growth has been rising and
becoming more stable for the past 25 years, fuelled by higher savings and investment (now over
35 percent and 36 percent of GDP respectively), the demographic dividend of a younger, more
educated labor force and accelerated total factor productivity growth. For the past three years, the
economy has grown at 9 percent giving the Indian economy considerable momentum. Second,
during the current FY trade growth has been impressive, with exports rising 35.1 percent in
dollar terms and imports rising 37.7 percent during the period from April-August 2008.
Investment has been buoyant and FDI during 2008-09 is expected to reach US$35 billion. Indian
banks have strong balance sheets, are well-capitalised and well regulated. The capital adequacy
ratio of every Indian bank is well above Basel norms and those stipulated by the RBI. Not one
Indian bank has had to be rescued in the aftermath of the crisis. India has a long history of
working with public sector banks and in engineering bank rescues.
India's growth rate will slow in 2008-09. Growth during the quarter ending June 2008 was 7.9
percent. The current consensus for the 2008-09 FY is 7.5 percent to 8 percent. Nevertheless, that
will be a significant slowdown compared to recent experience, but it will still be robust growth.
The slower growth will be accompanied by reduced employment growth and slower poverty
reduction. Indian policymakers have responded with measures to enhance liquidity primarily
by reducing the cash reserve ratio and the repo rate and enhancing confidence. Bank
guarantees, beyond those that already exist, have been deemed unnecessary. In 2009-10, if the
world economy recovers, India can grow at 9 percent or more. If the world economy remains in
recession, forecasts of Indian growth rates are harder to make.

INDIA TURNING CRISIS INTO OPPORTUNITY: India's economic managers, and particularly the Reserve Bank of India (RBI) take considerable
pride in having protected India from Asia's financial crisis in 1997-98. Although India did
experience a period of slow growth in the years that followed that crisis, the basic financial
machinery of the country remained relatively robust, providing a solid foundation for the much
more rapid growth that has taken place this decade.
In common with its East Asian neighbours, India is grappling once again with many of the same
challenges that the region faced a decade ago, creating difficult choices for economic and
financial policy. In a recent statement, India's PM Dr. Manmohan Singh said that the broad goal
of India's policy is to try to ensure that any reduction in India's growth is temporary, so that the
economy can return quickly to a nine per cent growth rate.
In charting its course, the Government is juggling multiple considerations: the state of the
domestic business cycle; ensuring financing for the balance of payments deficit; the sharp shift in
the availability of global risk capital for financing Indian investment; and the slowdown in
growth in the world's rich economies.
After three years of buoyant, investment-led growth, the Indian economy started to slow late last
year (2007). This growth slowdown was initially welcomed by the RBI, which had been
gradually tightening monetary policy (since 2004) in a fight against inflation.
Price pressures were further exacerbated by the sharp rise in commodity prices late last year and
early this year. The net effect has been partially to reverse the measured (but inadequate)
progress toward fiscal consolidation, as well as to increase the current account deficit in the
balance of payments.
The political cycle is at an awkward point. Parliamentary elections are due by next summer, and
there is considerable uncertainty as to the government that is to follow. India continues to suffer a
series of terrorist incidents in its larger cities, and the political and economic instability in
Pakistan adds another layer of uncertainty.
Taking economic and political pressures together, it is perhaps not surprising that, for many
Indians the present moment is compared less with 1997 than with 1990-91. That was the year

when India suffered a major external payments crisis and was obliged to apply to the IMF for
assistance. Thanks, however, to inspired political and economic leadership at that time, that
payments crisis was turned into an opportunity for major structural reform from which India
continues to benefit till this day. The interesting question is whether a similar opportunity can be
created again. Policy until late August operated on a business-as-usual basis. Even though the
financial crisis had been underway for almost a year, policy action was based on the assumption
that India could remain largely unscathed. Government attitudes changed sharply in September.
Notwithstanding the generally sound domestic financial position of India's commercial banks,
bank liquidity came under strain as banks' overseas subsidiaries found their sources of wholesale
finance withdrawn. This effect was compounded by the intensified sell-off by foreign investors
in domestic equity markets and the repatriation of funds to meet liquidity calls abroad. Over the
course of October, the RBI has sharply reversed course on the two key instruments at its
disposal: the cash-reserve ratio (that is, reserve requirements) that banks are required to hold in
their accounts with the RBI; and the overnight secured lending rate at which the RBI lends to
banks. India's policymakers have both the experience and the tools to ride out the present storm.
They will be helped by India's lower integration with world trade and finance, and by a variety of
institutional features. Yet by itself this is not enough: the larger challenge will be, as in 1991, to
use this crisis also to resume the momentum of reforms that have largely stalled. Of this there is
as yet little sign.

CONCLUSION
In conclusion, if India does attain and sustain growth rates of 9+ percent that it had achieved
prior to the crisis, this itself is likely to push up its domestic savings in the next few years.

Besides, stronger growth should attract more foreign savings, especially foreign direct
investment, and thus raise the investment rate.