especially harish sathi sir ... i m requesting u ....
regards
On Sat, Mar 6, 2010 at 12:33 AM, Harish Sati <harish.sati@gmail.com> wrote:
The Financial Crisis and the Financial Sector Reforms in India
Contrary to the `decoupling theory', the impact of the financial crisis has not been confined to the developed countries. Developing countries, including India, are feeling the heat of the crisis. The Government and the RBI have responded to the crisis through aggressive and unconventional measures. While the main plank of the government's response was the fiscal stimulus, RBI's actions comprised monetary accommodation thereby ensuring that the domestic money and credit markets functioned normally and were able to meet the legitimate credit needs of different sections of the society.
As the financial crisis in the US spread to Europe, Asia and other parts of the globe, forcing central banks to take several measures to combat the crisis, it became clear to all countries that global integration is not always bliss. While integration comes with a host of benefits, it may also entail distribution of crisis. Many countries came with their own homemade solutions to protect their financial system, particularly the markets, banks, financial institutions and their currencies. While countries, like Hungary, raised interest rates to protect their currencies, many others provided liquidity, including currency swaps, to help their banks tide over the crisis. While exchange rate was allowed to fall in some countries, central banks in some countries (Brazil, Korea, Mexico and Singapore) provided forex liquidity. A few central banks (Chile and Turkey) opened a spot window to provide forex liquidity to banks on a day-to-day basis. Some central banks relaxed reserve requirements and used repo mechanism to provide domestic liquidity to banks. A few countries introduced deposit insurance while a few enhanced the insurance coverage (Hungary and UAE). Some countries (Russia and Kazakhstan) recapitalized the banks and some (UK, Iceland and Ireland) nationalized the ailing banks. Some developed nations diluted their norms and accepted corporate bonds and even equity shares as security under repo and introduced buyback of mortgaged debt securities from banks to clean up the toxic assets. Short selling was banned in some countries to protect equity prices from falling further. Some countries enhanced the deposit insurance coverage amount and some announced guarantees to boost confidence in the banking sector.Steps Taken by India
Since liquidity is one of the prime requirements for the market and the banking system to run smoothly, Reserve Bank of India (RBI) was determined to provide liquidity to the banking system despite the high inflation rate prevailing in 2008. Cash reserve ratio was reduced in several steps from 9% to 5%, which injected almost Rs. 1,60,000 cr into the system. Securities issued earlier, under the market stabilization scheme to absorb excess liquidity, were bought back to the extent of about Rs. 98,000 cr. Two separate repo windows were opened. The first one was a term repo facility equal to 1.50% of the Net Demand and Time Liabilities (NDTL) of each individual bank. Banks were permitted to borrow upto 14 days under this facility. The second repo was a special refinance facility under which banks were permitted to borrow upto 1% of their NDTL. Export refinance limit was enhanced from 15% of the export finance outstanding to 50% of the outstanding. A special line of credit was extended to financial institutions like NHB, SIDBI and Exim Bank. Since the liquidity crisis also affected the non-banking financial companies, a special facility was made available to them through a special purpose vehicle. In addition to the above, repo rate (rate at which RBI gives money to banks) was reduced in phases from 9% to 5% and reverse repo rate (rate at which RBI absorbs excess liquidity of banks) was brought down from 6% to 3.5%. Over all, an aggregate potential liquidity to the tune of Rs. 4,22,000 cr was made available to the banking system. Since some banks did not have excess government securities over and above the Statutary Liquidity Ratio (SLR) requirement, SLR was relaxed and reduced from 25 to 24% of the NDTL to enable banks to have adequate securities to borrow from the repo window. (Refer Graph 1).--![]()
Further, since banks having branches/subsidiari es abroad found themselves unable to access inter-bank market to meet their day-to-day needs, due to drying up of the markets and an overall lack of confidence on the repaying ability of the banks next door, forex liquidity was made available to these banks to meet their liquidity needs abroad. RBI purchased oil bonds from oil Public Sector Undertakings (PSUs) and made funds available to them in foreign currency. This helped the oil companies to get access to funds without increasing the money supply in the domestic economy.In addition to the above measures which had a direct financial impact, certain other measures were also undertaken which had an indirect but powerful impact on the banking system. First, RBI diagnosed that the real estate sector was overheated and could cause problems for the Indian banking sector, much before the crisis errupted in Europe and the US. Real estate price had more than doubled in some parts of the country and there was a good demand for bank funds for starting new construction activities, quite a large chunk of it was for investment and speculation purposes. Sensing the root of a potential crisis in this area, RBI increased the risk weightage on commercial real estate loans in May 2006 from 125 to 150% and advised banks to monitor their exposures to this sector. Although banks did not appreciate this measure by the central bank at that point of time, retrospectively, all participants in the financial sector lauded this measure of RBI as the master stroke which saved the Indian banking sector from a crisis. The risk weight was later reduced to 100% in November 2008. Secondly, risk weight on all exposures to corporates was uniformly reduced to 100%. Thirdly, prudential norms for Non-Performing Assets (NPAs) were relaxed and restructuring/ multiple restructuring were given regulatory approvals, without classifying the accounts as NPAs.While the above were measures taken by the central bank to help the banking system to tide over the crisis, several other measures were taken by the government by way of fiscal stimulus for pump priming the economy. The unprecedented job loss of non-resident Indians abroad saw a large number of people returning home. The software sector, at home, was also passing through difficult times as orders were drying up. Exports were crumbling and the shipping sector was facing tough times as the global economy was slowing down. The fiscal stimulus given by the government by way of tax breaks, incentives, etc., were aimed at giving relief to the industry and boosting demand. This combined with the debt waiver scheme of the government for the farm sector, increased government expenditure substantially and the borrowing program of the government went up during the year. The gross borrowing of the Central Government during 2008-09 stood at Rs. 3,18,500 cr as against the budgeted Rs. 1,76,000 cr. Consequently, the gross fiscal deficit of the center also rose from 2.3% in 2007-08 to 6% in 2008-09. The net borrowing was higher at Rs. 2,98,000 cr, as against a budget of Rs. 1,13,000 cr.Status of Financial Sector Reforms
The financial sector reforms undertaken by India were most pronounced in the banking sector. The steps taken include:
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In the US, Fannie Mae and Freddie Mac, the two government-sponsore d agencies dealing in the mortgage market, were taken over by the US Government. Lehman brothers filed for bankruptcy and Merrill Lynch was taken over by Bank of America. Additional capital has been pumped into Citibank, Bank of America and a few other banks. Bear Stearns was initially provided with emergency capital and subsequently sold to JP Morgan Chase. Therefore, if it becomes necessary to give a dosage of a high power medicine to keep the system working, it should be given and there may not be anything wrong with it. It may halt the growth process temporarily, but it is a necessary evil. The crisis through which the financial sector has been passing is unprecedented in magnitude. In such a situation, the Indian banking system, though affected by the crisis, looks relatively better off. Extraordinary problems need extraordinary solutions and if the reform process is halted by a few months, we need not be critical of it.
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with warm regards
Harish Sati
Indira Gandhi National Open University (IGNOU)
Maidan Garhi, New Delhi-110068
(M) + 91 - 9990646343 | (E-mail) Harish.sati@gmail.com
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