Tuesday, October 21, 2008

Break the Path Dependent Ideas!!

Eversince sub-prime crisis  initially unearthed during April 2007 in United States, it has been widely written and extensively discussed by the independent scholars, policy makers and so on saying that: the fundamentals of the Indian economy are extremly strong, India has not yet been integrated to the world economy. Hence, the possible impact of the crisis in the western financial system will be very mild on the Indian economy.  By naively subscribing to this view, RBI has maintained the real interest rate as high as 4% (three month rates), SEBI continued to control capital inflow by many ways such as restricting Paricipatory Notes untill early September 2008. Where as the central bank of US (Federal Reserve) kept the credit policy so loose that short term interest rates are in the negative territory during the period.

Almost a year later now after September 2008 which experienced the major collapse of financial system in the western world, we are now feeling pinch and observing the worst part of the effect in our economy.  Our stock markets have fallen steeply by almost 40%, inter bank call rates touched the peak of 23% unearthing the worst ever credit crunch. This resulted in either fully or partially abondened credit lines to the corportes and there by affected the indusrial production. The real estate markets in India have slowed down and the home prices in most of the cities are falling sharply.  In a way high degree of distress has been witnessed in the overall economy. This has disproved the perception of our policy makers over the 'strong fundamentals' and 'decoupled of the economy with the rest of the world', that is based on the position of India 10 years ago. 

 Coordinated effort of RBI, SEBI and Ministry of Finance:

Similar to most of central banks of the developed world, Ministry of Finance and SEBI led by the Indian central bank has now (after realising the true picture) come out with a series of positive steps to correct the system during the last three weeks. a 250 bps cut in CRR, a special window of Rs 20,000 crores to MF to ease the redemption pressure, reliease of Rs 25,000 crores under the loan weaver scheme, a 100 bps cut in the (repo rate) policy rate, a de facto 100 bps cut in SLR, the reversal of the mistakes on PNs of October 2007 and ease of FDI norms. All these measures seems to bringing back the normalcy in to the system as they resulted in bringing down the call rates to around 6% and reduced the panic selling in our stock markets (Indices have taken the northward direction!!) In a way RBI and SEBI exhibited the greater maturity in dealing with the present borrowed crisis without resorting to possible politically motivated measure of "banning of short selling".  Hence, it may be highly commendable to break the subscribing to the path dependent thinking process and accept the Indian economy as nascent market economy in arraiving at policy decisions !!

(The author has highly benefitted from the writings of Ajay Shah, Ila Patnaik and Arthur M Okun)

Comments and suggestions are encouraged!!


Pramod Y.S. said...

I have one question, here you say that Banks have come up with measures to curb the recession but then you've also contradicted in the topic "Current Recession: Policy Implications" as
In this situation there is not much can be done by the central banks.
I think that the latter is not supported with much evidence as it is evident that the Government across the globe affected by Sub-Prime Crisis are coming up with measures to curb its impact.

Uttam said...

Dude...To start with let me say, it was a nice blog to read. Hats off to you for the effort.
But I gotto tell you it's not easy as you say. What if our economy was not affected by this "Slowdown" at all. Would you still say that banks should have cut the CRR, SLR and other rates by a huge margin in April 2007 when the sub prime crisis was unearthed? The RBI and SEBI could not and cannot predict the actual effect of the sub prime crisis on our economy in April 2007.
In Fact, Indian economy is boosted more by domestic demand (growth)and partially by foreign markets. The fundamentals are indeed strong. A testimony to this statement is the September results of Indian companies. Around 50% of the 700 companies which came out with their results, have reported a net profit growth of over 25%. Domestic demand is pushing it up.
But somehow or the other due to extreme global financial slowdown and various other reasons, We are faced with the credit crunch and thereby an economic slowdown which no one could have exactly predicted! Given this situation, the central bank and others are reacting by reducing the concerned rates heavily. They are not reversing their earlier decision but are actually reacting to the current scenario. One cannot expect The central bank to be proactive but they ought to be reactive!
Nothing disproves the perception of our policy makers over the 'strong fundamentals' of our economy!

(This is my personal opinion)