How did Monetary Policy in India Respond to the Global Financial Crisis?

In 2008-09, the financial stresses peaked following the failure of the US financial firm Lehman Brothers in September 2008. This triggered a panic in financial markets globally. The world has witnessed one of the worst economic and financial crises during 2008-09 since the great depression of 1929. India too faced a financial crisis beside the whole world and was impacted by the crisis in terms of the severe credit crunch, net negative inflows, the slowdown in exports, job losses, etc. In line with governments and central banks of other countries, the Reserve Bank of India took aggressive countercyclical measures, sharply relaxing monetary policy and introducing a fiscal stimulus to boost domestic demand. As the crisis unfolded, both monetary and fiscal authorities responded quickly containing the price and maintaining the growth momentum.

The global crisis has affected India through three distinct channels: financial markets, trade flows, and exchange rates. RBI handled the situation through its monetary policy, SEBI handled the capital market crisis through its control over the stock market, and the Government through its fiscal policies. RBI has tried to maintain comfortable rupee liquidity, augment forex liquidity, and arrest growth in moderation. During this period Cash Reserve Ratio (CRR) was 17 times, the Repo rate was changed 11 times, and reverse Repo rate was changed 4 times, and the SLR was changed once to contain inflation. The bank rate remains unchanged during this period. It may be noted that the CRR was changed highest time compared to other key policy rates, during the above period. That’s because changing the Cash Reserve Ratio has an immediate and fastest effect on liquidity in the economy, by controlling inflation and increasing the demand in the domestic market.

A dip in industrial and manufacturing growth and the prognosis of an impending crisis prompted the Government to announce three fiscal stimulus packages in quick succession- on 7th December 2008, the 2nd January 2009, and 24th February 2009. A series of fiscal measures both on the tax revenue and expenditure side were undertaken to ease supply-side constraints. These measures were supplemented by monetary initiatives through policy rate changes by the Reserve Bank of India which together with the fiscal measures contributed to the softening of domestic prices. Headline inflation fell below 5 per cent in January 2009 and is now placed at (-) 1.3 per cent in June 2009. However, the fiscal measures undertaken through tax concessions and increased expenditure on food, fertiliser, and petroleum subsidies along with increased salary bills for implementing the Sixth Central Pay Commission recommendations significantly impacted the deficit position of the Government. The moderation in the growth of the economy and the impact of the fiscal measures taken to stimulate growth has been reflected in lower gross tax revenue receipts at Rs.6,09,705 crore as per the provisional accounts of 2008-09 against B.E.2008-09 of Rs.6,87,715 crore. Additional budgetary resources provided as part of the stimulus package including an increase in plan outlay from Rs.2,43,386 crore in B.E. 2008-09  to Rs.2,82,957 crore in R.E.2008-09 and various committed liabilities of Government including rising subsidy requirements, implementation of Sixth Central Pay Commission recommendations and Debt Waiver and  Debt Relief Scheme for Farmers contributed to increasing the fiscal deficit to 6.2 per cent of GDP in 2008-09 (provisional accounts) as compared to 2.5 per cent of GDP in B.E.2008-09.(Source: India Budget).

These fiscal stimulus packages amounting to about 3% of GDP included public spending, capital expenditure, infrastructure spending, cuts in indirect taxes, additional support to exporters, etc. The large domestic demand bolstered by government consumption, provision for forex and rupee liquidity coupled with sharp cuts in policy rates, a sound banking sector, and well-functioning financial markets helped mitigate the impact of the crisis on India.

Lesson from 2008-2009 crises:

Disciplined investors know that diversifying their holdings is the best way to avoid the financial ruin that the risk of a single concentrated position can bring. Banks have learned a lesson to take calculated risks and not play with other’s money. Another lesson from the Great Recession was expense control. This can apply to corporations and individuals alike. Financial leverage is not always a good option. The crisis also raised a need to re-examine the authenticity of the credit agencies and their fee structure.

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