Reserve Bank of India Governor explains India's response to economic crisis

Central bankers are in the lecturing mode. Soon after I wrote about the Chinese central bank governor calling for a new reserve currency, I came across this speech by the Governor of the Reserve Bank of India (RBI) on how India is managing the impact of the financial crisis.

Addressing the Confederation of Indian Industry today, Governor Duvvuri Subbarao explained that, although India's banking sector had no direct exposure to sub-prime mortgages, India has been hit by the crisis because of its 'rapid and growing integration into the global economy'. India's trade (merchandise exports plus imports) to GDP ratio increased from 21.2% in 1997-98 (when the Asian financial crisis hit) to 34.7% a decade later. More significantly, India's financial integration with the global economy has accelerated: the ratio of total external transactions (current and capital account flows) to GDP jumped from 46.8% to 117.4% in the same period.

The financial and real economies in India have had to take the blow. Since a large proportion of corporate investments was financed by incoming capital flows, the global credit crisis has badly hit Indian firms. Demand from India's major export markets (US, Europe and Middle East) has slumped simultaneously. The dominant services sector will see slow growth. And remittances have fallen.

India responded with a relaxed monetary policy and a fiscal stimulus. On the monetary policy side, the RBI reduced interest rates, reduced bank reserve ratios, relaxed external commercial borrowing for firms, allowed non-banking financial companies (NBFCs) and housing companies to tap into foreign debt. RBI also established a rupee-dollar swap facility to help banks with their short-term funding requirements. More importantly, it has established exclusive refinance facilities with increased resources for vulnerable sectors: micro, small and medium enterprises, the housing sector, the export sector, and NBFCs (plus a special purpose vehicle for the latter).

On the fiscal side, the government used emergency provisions in the Fiscal Responsibility and Budget Management Act to offer stimulus packages in December 2008 and January 2009 (amounting to 3% of GDP). The stimulus includes funding guarantees for infrastructure, indirect tax cuts and support to exporters. (The government has also offered farm loan waiver package and is hoping social safety nets like the rural employment guarantee programme will insulate the poor, but it is too soon to tell.)

The RBI expects these strategies to succeed. For the moment, although bank lending rates have dropped, bank credit has not grown as fast as in previous years and not fully cushioned the impact of lower NBFC lending. But Governor Subbarao expects that with the refinance facilities, lower interest rates and higher government spending, India will be able to manage its balance of payments. He remains optimistic that 'once the global economy begins to recover, India's turn around will be sharper and swifter, backed by our strong fundamentals and the untapped growth potential.'