Indian economy and Policy responses in 2008 crisis

Deepak Mohanty, ED of RBI usually gives nice speeches summarising the key ideas whatever the given theme of his speech.

In this recent speech, he summarises the Indian response to the 2008 crisis and developments in Indian economy:

The seminar is topical and timely. It is now 5 years since the collapse of the Lehman Brothers in September 2008, which evoked unprecedented monetary policy activism – both conventional and unconventional – across the advanced and emerging market economies (EMEs). It is for the first time on December 18, 2013 that the US Fed announced concrete measures to exit from unconventional monetary policy in a calibrated manner starting January 2014.

The Indian economy like other EMEs was affected both by the global financial crisis post-Lehman and the announcement of likely exit by the US Fed in May 2013. We also resorted to both conventional and unconventional policies not only in response to the crisis but also to the announcement of exit, though there were qualitative differences in these responses.

Against this backdrop, I will begin by distinguishing unconventional monetary policy from conventional policy, highlight the contours of unconventional policies in major advance economies and review the impact of such policies. I will then turn to the impact on India and our monetary policy response. I will end by drawing a few broad conclusions.

There is a  nice table summarising the unconv policy of the top four central banks.

On Indian economy, here is the table that says it all:

Table 2: Behaviour 3 of Select Macroeconomic Indicators in India

 

2003-04 to 2007-08 (average)

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14 (Latest)

Real GDP Growth (%)

8.7

6.7

8.6

9.3

6.2

5.0

4.8

WPI Inflation Rate (average) (%)

5.5

8.1

3.8

9.6

8.9

7.4

7.5

CPI Inflation Rate (average) (%)

5.0

9.1

12.4

10.4

8.4

10.4

11.2

Non-food Credit Growth (%)

26.7

17.8

17.1

21.3

16.8

14.0

14.7

Centre’s Fiscal Deficit (% of GDP)

3.6

6.0

6.5

4.8

5.7

5.2

Overnight Call Rate (%)

5.6

7.1

3.2

5.8

8.2

8.1

8.6

10-year G-Sec Yield (%)

7.0

7.5

7.2

7.9

8.4

8.2

8.8

Exchange Rate (Rs./$) (end-March)

43.1

50.9

45.1

44.6

51.2

54.4

61.9

Current Account Deficit (% GDP)

-0.3

-2.3

-2.8

-2.8

-4.2

-4.8

-1.2

 

How fortunes have changed in last few years..

RBI also has its unconv policy two times during the crisis. First was as crisis started but was hardly used by anyone. Second was in May-Sep 2013 period due to taper sell-off.

Restoring normalcy in financial markets, ensuring normal flow of credit to productive sectors of the economy as well as limiting the adverse impact on the real sector of the economy assumed policy priority. The Reserve Bank, like most other central banks, took a number of conventional and unconventional measures to limit the adverse impact of the contagion on the Indian financial markets and the economy. These included augmenting domestic and foreign exchange liquidity and a sharp reduction in the policy rate. The Reserve Bank used multiple instruments such as the liquidity adjustment facility (LAF), open market operations (OMO), cash reserve ratio (CRR) and securities under the market stabilisation scheme (MSS) to augment the liquidity in the system.

…As the economic conditions appeared to be stabilising, volatility in the financial market returned following the announcement in May 2013 of the Fed’s intention of likely tapering of QE. This prompted the Reserve Bank to resort to somewhat unconventional monetary policy measures besides drawing down of foreign exchange reserves to meet the immediate shortfall (Chart 8). Let me give you the flavour of key measures.

  • In terms of monetary policy, the upper bound of the policy rate corridor (i.e., MSF rate) was raised by 200 basis points and the quantity of central bank liquidity available through the LAF window was restrained. This had the desired effect of tightening the monetary conditions and raising the effective policy rate sharply to the MSF rate.

  • In order to signal that the above measure is temporary so that the interest rates at the longer end do not harden a form of operation twist was tried by conducting outright OMO purchase of government securities alongside sale of short-term government cash management bills. This inverted the yield curve, though accompanied by some increase in long-term rates.

  • With a view to containing the current account deficit (CAD) on the balance of payments (BoP), gold imports were restricted.

  • The non-resident deposit schemes and banks’ borrowing abroad were further liberalised with incentives for swapping these inflows directly with the Reserve Bank. This substantially augmented foreign exchange reserves despite some outflow on account of directly meeting the foreign exchange requirement of oil imports.

To sum up:

First, the global financial crisis triggered unprecedented policy activism by advance country central banks. They resorted to unconventional monetary policy of the nature and scale unthinkable hitherto.

Second, as we complete over 5 years of unconventional monetary policy of QE and CE, the question is: did it succeed? While it is too early to say, opinion remains divided. Thus far, with unconventional policies, the central banks have been far less successful in stimulating growth8. While it may not have improved general monetary transmission and prompted sustainable recovery, it did have significant impact on the financial market. The counterfactual of what would have happened without QE is not known? In any case, it seems to have prevented a deeper recession.

Third, the spillover effect of QE on commodity markets and emerging market economies (EMEs) has been significant. This has resulted in increased volatility of capital flows and elevated asset prices. The initiation of exit from QE has also created additional macroeconomic challenges for EMEs including India.

Fourth, the Indian economy and financial markets were significantly impacted by the global financial crisis and the recent signalling of exit from QE by the Fed. This prompted the Reserve Bank to resort to both conventional and unconventional monetary policy alongside other regulatory policies to stabilise markets.

Finally, while the exit from QE increases uncertainties in the financial market, it is increasingly felt that continuation of unconventional monetary policy for long could create risks in the global economy it sought to address by preventing deleveraging and appropriate pricing of risks. In addition, the current policy response has increased sovereign risk in a number of countries which circumscribes the ability of policy to cushion further unexpected shocks.

Nice bit..

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.


%d bloggers like this: