Global Financial Crisis And Changes In Capital Flows Of India: Fill & Download for Free

Thank you for A2A.The answer is a bit long. And it has to be, to explain the view point in a crystal clear manner. I ask for your patience, attention and wise judgement while you read it. Thanks again.RBI employees(Officers, workmen and class 4) are planning to go on a mass strike on 19th of November 2015. There are 2 issue points they intend to protest against:1) GoI's recent moves to whittle down RBI's functions including Financial Sector Legislative Reforms Commission (FSLRC) and the proposed Indian Financial Code. Let's look how the changes would adversely impact RBI here :-1. MONETARY POLICYNow: The Reserve Bank of India (RBI), and within the central bank it is the governor who enjoys absolute power in deciding interest rateProposed: The committee approach to decide interest rate where government will appoint four members, while three will be from RBIImpact: RBI loses its power to decide interest rate. If autonomy of RBI is compromised in the eye of investors, it could have serious implications.2. MANAGING GOVERNMENT'S DEBTNow: The central bank - investment banker for the government - manages its debtProposed: An independent debt management agency to manage government's borrowingImpact: Conflict of interest issues are there on either side. But an independent debt management agency, with external professionals from the beginning will turn out to be risky, as they will not have experience of managing government debt3. STABILITY AND SYSTEMIC RISKNow: The Financial Stability & Development Council (FSDC), was set up in December 2010 to strengthen and institutionalise the mechanism for maintaining financial stability, and enhancing inter-regulatory coordination and promoting financial sector development. The chairman of FSDC is the finance minister, with all the sectoral regulators as members. FSDC also focuses on financial literacy and financial inclusionProposed: FSDC to identify and monitor systemic risk. To take all required action to eliminate or mitigate systemic riskImpact: In the US and UK, macro prudential regulation and supervision are a mandate of the central bank. Limiting the universe of systemic risk tools to three could be an area of concern, as more such risks could be evolving. The central bank, being the monetary policy authority and the only lender of last resort, is the natural choice for being the systemic regulator4. REGULATION OF BANKS/NBFCSNow: RBI is the regulator for the banking system, as well as non-banking finance companies and primary dealersProposed: RBI continues to be the banking regulator and for systematically important payment systems but non-bank credit institutions will be regulated by the Financial Authority. The Financial Authority will also regulate all financial productsImpact: Could lead to fragmentation of regulation and give rise to regulatory arbitrage. There is a view that RBI should oversee non-bank financial entities like insurance and mutual fund companies due to their interconnectedness with the banking system5. REGULATION OF ENTITIES IN THE PAYMENT SYSTEMNow: RBI is the regulator of prepaid payment instruments and has laid regulatory norms for payments banksProposed: Only systematically important payments systems will be regulated by RBIImpact: Many new players are emerging with rapid product innovations. The full impact of all these on financial stability and monetary policy are not clear. RBI, which is the regulator of the payment and settlement systems of the country, could lose power to oversee this function6. CAPITAL CONTROLNow: The present law under FEMA vests the power of capital account regulation with RBI. In practice, the government and RBI consult before initiating a policy measure. While the government takes decisions on various issues, like foreign direct investment, the notification is issued by the central bankProposed: The government will "consult" RBI to make rules on capital controls (section 241). This consultation will cover the problem to be addressed, the goal sought to be achieved and the alternatives available to address problems and achieve goals. RBI will work as an administrator to implement rules. The draft code empowers the government to prescribe rules to seek its nod for capital account transactions which affect national securityImpact: The present practice of both the government and RBI being involved in deciding capital control has served the country well, particularly during the global financial crisis and the Asian crisis. The conduct of monetary policy will be weakened if capital control regulation is taken out from the central bank. Interestingly, the code is silent on the issue of financial stability7. REGULATION OF MONEY MARKETSNow: RBI regulates all these marketsProposed: Separating regulation of such markets from RBIImpact: In India, the exchange rate and interest rate are not fully market-determined. Due to the high fiscal deficit of the government, statutory liquidity ratio of banks are not going to come down in the near future. Since volatile capital flows impact such markets, the central bank should have a role in regulating these markets.2) Now this is something the outsiders don't know about. GoI is not granting updation of pension and another opening of pension option for RBI staff though recommended by the central Board of RBI and pursued by the successive Governors of RBI as well. The scenario today is that an Executive Director who retired in 80s draws a lesser pension than a clerk who retired last year!So they are asking for rationalization and normalization in pension.You say why shouldn't they go on strike ? Who would want the Central Bank of the third largest economy of the world which acts as regulator and supervisor of Banking industry, where half of the citizens don't even have a bank account to become yet another toothless tiger?I don't.P.S. - The above mentioned views are personal and don't represent RBI or any other associated body in any form, whatsoever.

Think of the global recession as a whiplash, it first hit the countries which were at the root cause of the crisis, US, followed by Europe. However, just like the curve along the whiplash travels, the effects of the recession have affected India too rather severely. It is a different thing that the effects did not "very visibly" percolate down to the layman on the street at that time, they are doing so now. So did India really survive the crash? Or has "India" suffered but "Indians" have not seen the effects much? Which is the true answer?Yes, India has her own "huge" internal demand which ideally should sustain her growth (but as we see now, it isn't). So we didn't "survive" the crash due to our internal demand alone. Yes, India has an insulated banking system, but the rupee, the currency of India is not insulated, its highly correlated to the international economy. So we didn't survive the crisis due to our banks or our savings either. How did we survive? Did we survive then to suffer now? Let us examine.We all know of the subprime crisis, the Euro banking crisis, the contagion spreading from Greece to Spain, Italy, Portugal, the Irish crisis etc. So what id this do to India?When the crisis first hit in 2007-2008, it was actually hailed as a good thing in India! Foreign investors fleeing the crashing markets of the west, heavily dumped money in India via FIIs. However, when the general panic and the volatility spread across the world, these FIIs fled out India equally fast. A cursory glance at the graph below shows the change in investment in India overall, from 200 to 2008.The GDP also, understandably started taking a hit, as the effects of the crisis began to sink in across the world. The exports declined concomitant with the fall in demand in export markets.Before the crisis hit, the RBI was worried about excessive capital inflows, it took measures to curb inflation which arose as a result of the huge capital inflows. However, once the flight of capital started, the RBI had to step in to increase liquidity and provide a fiscal stimulus to the sagging economy by 2008.Fig: Flight of Capital post 2008.As a result of the fiscal stimulus given, India's fiscal deficit increased from 2.7% in FY '07-08 to 6.2% in FY '08-09. Consequently the fall in GDP was somewhat arrested. The RBI repeatedly moved in to ensure liquidity as well during this time, via lenient CRRs etc. India's GDP seemed back on track in 2010, although inflation remained a double digit worry. Inflation resulting primarily from the increased liquidity, the fiscal stimulus.So what happened suddenly in 2011? Indian rupee became the worst performer among all currencies in the world, India's GDP took a hit, and has remained between 5 and 6% ever since. Most alarmingly, India by the end of 2012, has a fiscal deficit of around 5.6% and a current account deficit of around 5.9% of GDP respectively. This is an alarming situation, reminding one of the twin deficits and balance of payments crisis of 1991 which led to the reforms of 1992.Herein lies to the answer to the question posed. Despite the worsening economic situation abroad which sent shockwaves down home, India did nothing to curb matters, except for RBI following an expansionary monetary policy for a while, encouraging liquidity (which also increased the inflation) and then later on tightening its belt (which continues to this day) to curb that resulting double digit inflation (which also continues to this day).While the world was reeling from the aftermath, Indians at large still enjoyed massive subsidies on everything from fertilizers to oil. India had one of its biggest farm loan waiver scheme in the midst of the crisis. How was the Government paying for this? Through stimuli which increased the burden on the fiscal deficit. However, given the infrastructural weaknesses inherent in our system, supply side is also very volatile due to poor production efficiency, and thus prone to wild price upswings. Therefore, despite stimuli, prices of essential commodities like food etc. still keep rising. Apart from this, it also means India will have a high current account deficit, will import than it exports thanks to our supply side deficiencies.Higher current account deficit means higher demand for foreign currency, which results in depreciation of the domestic currency. It also discourages capital inflow and leads to capital flight from the country. Therefore to limit the deficit, India needs even more inflows to stem the capital flight. Such high dependence on capital flow naturally results in higher appetite for short-term and risky flows.According to the Reserve Bank of India’s Financial Stability Report, December 2012, the ratio of volatile capital flows to foreign exchange reserves was 81.3% at the end of June 2012 compared with 67.3% at the end of March 2011. Rising dependence on short-term flows is risky as any reversal could pose serious challenges in financing the deficit and may lead to a sharp fall in currency.So this is a vicious cycle, on the one hand, a high current account deficit leads to a weak rupee which leads to risky capital inflows (mostly FIIs), which in turn with the slightest change in world economy (like say, price of oil) can further weaken our own currency.The problem is magnified due to the presence of higher government deficit. Higher fiscal deficit, apart from affecting savings and growth, affects business confidence. And add to this mix, the inflationary pressure on the econom.Inflation control is the prime concern for the RBI (which is independent of the Govt. and does not toe the Government's line). So the RBI will introduce measures to curb inflation.On the other hand, the Government seeks (or should seek) to promote growth. So the Government should try to cut subsidies (which it has started doing very very late), encourage FDIs, not FIIs and so on. At the same time, the rupee started underperforming, which led to a vicious cycle of flight of capital, inflow of risky capial etc. Incase the Government without the RBI moves in too quickly on reforms, this also places cost pressure on the Indian rupee (which will appreciate because of foreign investors again flocking back to India betting against the weak investor sentiment in India, thereby weakening our exports and so on).So this a delicate matter, while Indians majorly did not suffer during the crisis, India in the sense of her macroeconomy definitely did, and we are still facing the heat to this day, for what we have done to counter the crisis those days (or not).

Foreign Direct Investment (FDI) rose by 27% in 2015 and 5.43% in 2016.You need to be careful though with how you interpret that data and how much of that growth can be explained by “Make In India” initiative instead of prevailing trend in FDI flow (it was growing before then)I think several more years of data is needed before you can say if the initiative made any persistent difference in foreign direct investment flow in India.Below chart shows FDI in current US Dollar between 1991 and 2016[*]. The red box highlights the period after “Make In India” initiative was launchedLooking at just the Dollar amount isn’t very useful because Indian economy has grown much larger since 1991 and the amount of foreign investments it receives have grown with that.Moreover, the above isn’t inflation adjusted and gives an exaggerated picture — $100 million investment in 1991 had much more purchasing power than $100 million in 2016A better measure is FDI as a percentage of GDP, adjusting for Indian economy’s growing size over the years —In 2015 and 2016, FDI as a percentage of GDP was just above 2% — this is above average for the period (1.22%) but well below the best years between 2006 and 2009.Also consider year-on-year percentage change in FDI since 1991 —It is illuminating because it shows how volatile and cyclical FDI flow is, subject to lot more powerful forces than domestic economic policy —India had practically no FDI flow before 1991’s economic liberalisation. The first five years after 1991 saw very large increase in FDI, more than 100% for 3 years. This initial surge was driven largely by domestic policy.After the 1997 Asian financial crisis, FDI flow fell in 1998 and 1999It fell again from 2002 in the aftermath of the dot com crashThen it fell again from 2009 after the global financial crisis.It fell in 2012 after India’s own currency crisis.Since then, it had been growing modestly (compared to the past)Purpose of my rambling on like that is to make the point that it is difficult to tease out the impact of one domestic economic policy (Make In India) from FDI data, based on just two years’s worth of data.Lastly, outside the remit of this question, but relevant I hope — is to consider total investment in the economy, including FDIIn an economy as large as India’s, foreign investment can only meet a small fraction of total investment need. For example, in 2016, just 7.4% of gross investment made in India came from FDI. Remaining 92.6% came from domestic firms, government and households.Domestic savings and investment will always retain its dominant share and consequently, developing economic policies that encourage domestic investment will remain critically important. Far more important than attracting FDI, I dare say.Below chart plots investment in India (including FDI) between 1991 and 2016**Investment peaked in 2008 and had been falling since 2011. In last few years, decline in investment has accelerated.Given how volatile and small FDI is compared to total investment required in the economy, even above trend FDI growth is unlikely to make much difference.Footnotes[*] Data till 2015 is from World Bank Database, 2016 data is from a livemint report[**] Data from World Bank Database - Gross fixed capital formation (% of GDP)