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India’s fed chief on the financial crisis

Wednesday 28 September, 2011

Dr. D Subbarao, the governor of Reserve Bank of India, i.e. India’s Ben Bernanke, came to the school where I teach the GITAM Institute of Management to talk about “India & the Global Financial Crisis:  What have we learnt?”  He opened by summarizing India’s recent economic history like so: India embarked on economic reform in 1991 with 3 pillars:
1. (I missed the 1st 1)
2. Open up the Indian economy
3. Downsize the public sector
Then he noted that globalization is a double-edged sword with invisible costs & benefits. The 2008 financial crisis took a deep toll on India’s growth. The cause of the crisis was global imbalances & too much financial leverage. Irrational exuberance led to the crisis. But this most recent crisis differs from prior crises in these ways:
1. Earlier a crisis might hit only 1 country, but now it leads to the rest of the world
2. It hit the wholesale side of banking, not the retail level
3. There is no buffer for recovery
Subbarao took office just days before Lehman Brothers collapsed, so he jumped in when India & the rest of the world were just falling into the crisis. GDP fell. Exports fell. The Indian rupee fell. Capital fell. This was a crisis of confidence in real channels which resulted in a flight to safety. Lines of credit dried up & there was a strong liquidity crunch. Despite it’s current economic strength, India was hit too because it’s closely integrated with the rest of the world economy. Trade (20%->40% of GDP) & finance (44%->112%) integrated much more deeply from 1998-99 to 2008-9.
India’s response was fiscal stimulus with “accommodative” monetary supply. Their priorities were to keep the financial markets functioning, provide liquidity, & prevent insolvencies. They created ample rupee & foreign exchange liquidity, & enabled credit to flow. Generally they had to manage confidence & expectations.
The result is India recovered sooner from the financial crisis than most other countries in the world. However inflation is creeping up. India’s fed has raised interest rates 11 times since March, 2010. Inflation is driven by food & oil prices, & demand as incomes increase. The focus today is on rural India. They need to ensure the mid-term range to balance the trade-off between growth & inflation, & savers & investors.
What are the lessons of the financial crisis?  Was there creative destruction? It’s probably too early to tell.
1. Decoupling doesn’t work-the world is already too well-connected
2. We must address imbalances to enhance stability. 3B workers have been added to the world’s workforce in China in the 1980’s & India in the 1990’s. Investors are seeking higher rates, but that’s riskier for the banks.
3. Global problems require global coordination. Each country couldn’t douse the flames of the crisis in it’s own land. The G20 helped, but is losing its effectiveness because now there appears to be less urgency.
4. Capital controls are advisable & unavoidable because there are no benign solutions. There is a preference for equity over debt, but capital flows are difficult to manage.
5. Economics is not physics. Everything cannot be captured in equations. There are different contexts & economics depends on real-life behavior.
6. Economic history prevents & resolves crises. Over the last 800 years, the causes have always been the same. Has the world changed that much?
Q&A
• In India, derivatives are centrally regulated
• The early warning signals to the financial crisis could have been too much leverage, financial institutions lending to the same sector, & even having too much stability for too long.

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