Invst Bnkin Case

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SHANTI BUSINESS SCHOOL

Investment Banking

Case Analysis–

Global Financial Crisis

Submitted By:- KINNARY THAKKAR (1011012021)

9/20/2011



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1. Is Indian Economy affected according to the report? Which sectors of the

economy were affected by the crisis?

Yes, Indian economy was affected by the Global financial crisis.

Impact of Global Financial Crisis on India:-

Stock market crash

o Following eruption of financial crisis, stock markets of US and other European countries

crashed and its effect spilled over to India and the Indian stock market was also badly hit.

o To meet liquidity requirement of parent companies, Investors (FIIs) started selling shares

of Indian companies held by them.

o In the last few years, FIIs had invested massively in the equity shares of Indiancompanies ranging from consumer goods to infrastructure industries.

o As a result of the buying spree by FIIs, share prices rose, with the Sensex reaching the

peak of around 21,000 in Jan 2008.

o Around this time (Jan 2008), share prices in US and European markets started falling

sharply and the problem of liquidity and credit crunch assumed grave proportions which

led to FIIs selling shares held by them in the Indian stock market.

o The Sensex started tumbling and fell to the 9000 mark in Nov 2008 ie 60% fall since Jan

2008. This caused huge losses to Indian companies and investors.

o FIIs sold more than $13 billion worth of shares of Indian companies in 2008 and

repatriated them to their home countries. This also led to a decline in foreign exchange

reserves held by RBI.

Depreciation of Indian Rupee

o Revenue got by sale of shares by FIIs was converted to dollars in order to facilitate the

repatriation of the money to the home country. This led to an increase in the demand fordollars.

o Rupee-dollar exchange rates being determined by demand for and supply of currencies,

the increase in demand for dollars caused an appreciation of US dollar in rupee terms, ie

rupee depreciated against US dollar.

o Indian importers also demanded dollars to pay for the import of goods.



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o Indian banks doing foreign operations also bought US dollars in India to keep their

foreign exchange operations afloat as due to the credit crunch there was hardly any

lending happening in foreign countries.

o This further raised the demand for dollars causing fast depreciation of the rupee in Sept –

Nov 2008. The value of Indian rupee depreciated from Rs. 39.4 for a dollar in 2007 to Rs.50.6 in Nov 2008. This depreciation did make our exports cheaper and imports more

expensive.

Liquidity crunch in the Banking sector

o Large outflow of dollars led to depreciation of rupee, to prevent depreciation of rupee and

maintain exchange rate stability, Reserve Bank of India intervened and supplied dollars

from its foreign exchange reserves and got rupees in return.

o With this too much depreciation of the rupee was prevented but in the process quantity of

rupees with the banking system declined in turn causing liquidity problem in the Indian

banking system and affecting the credit flow to the industry.

o Affected credit flow impacted the credit availability for working capital and fixed

investment requirements by the industry.

o Risk aversion by Banks in India also restricted credit flow to consumers for

buying cars, houses etc.

Impact on Indian Economic Growth

o With the US economy witnessing a slowdown in economic growth, its effect spilled over

to Europe, Japan and other Asian countries, Britain, Germany, Italy…….

o IMF’s assessment was that the growth rate of the global economy was expected to hit 3%

in 2008 and near zero in 2009.

o In Sept 2008, IMF also predicted lower growth of 7% for India as against over 9%

growth in the previous years.

o Even though India’s economic growth depends more on domestic demand and is drivenlargely by domestic savings and investment, after 18 years of globalization, our exports

constitute 17% and imports 20% of GDP.

o There has been a fall in output of automobile, shipping and aviation industries, also

export oriented units of textiles, leather, gems and jewellery have been hit by the global

meltdown.



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Slowdown in the Manufacturing Sector

o As per FICCI’s survey, the manufacturing sector comprising industries like textiles,

metals and metal products, leather and leather products, jewellery and automobiles has

seen a steep decline in production. Decreased consumer demand affected exports

o Both domestic demand and declining export orders have been the cause of the

slowdown.

o Other important cause was that banks were not willing to give credit and high input costs.

o Various industries were planning to downsize employment

Balance of Payments

o Globalization and adoption of export oriented strategy of growth has increased the

dependence of the Indian economy in the external market.

o In 1990-91, exports were to the tune of 5.8% of GDP while in 2006-07 exports were

approx. 14% of GDP.

o India’s foreign trade balance worsened in 2008-09 and registered a deficit of $60 billion

in first half of 2008-09. Decline of exports was one of the main reasons. Also,

depreciation of the rupee made our imports costlier



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2. Where the crisis started first and what was the reason?

Crisis happened in US in second half of 2007 with the burst of the housing bubble.

IT bubble burst in 2001had already led to recession in the US

To get the economy out of recession, US Federal Reserve cut interest rates to increase the

liquidity or money supply in the economy thereby encouraging consumers to borrow.

Crisis happened due to subprime housing loans given on a large scale by American banks

and widespread mortgage defaults.

Banks that held the subprime mortgage loans sold them to other banks and investors

through a financial innovation called CDO (collateralized debt obligations) securities

which were backed by a host of mortgage assets.

To make them safe for investment and increase their marketability, the CDOs were given

high ratings by credit agencies.

American and European intermediaries such as banks, pension funds, mutual funds

invested heavily in these complex securities (CDO) unaware of the risks involved. Those who bought these securities had in turn borrowed heavily from banks and financial

institutions to make investment in them.

Fall of housing prices in 2007 led to defaults in payment schedules by borrowers, as a

result of which value of subprime housing securities and CDO’s declined.

Banks and investment funds which had invested millions in these securities suffered

heavy losses leading to liquidity crunch.

As a result of huge losses investment institutions like Lehman Brothers became bankrupt.

September 2008 saw the “Top 5” of Wall Street succumbing to subprime losses, Lehman

Bros filed for bankruptcy, Merrill Lynch was merged with Bank of America, Goldman

Sachs and Morgan Stanley converted into commercial banks and Bear Stearns was

acquired by JP Morgan Chase.

Lack of proper regulation of financial institutions, banks and stock markets in a free

market system led to the creation of complex and non transparent securities (CDO).

Problem of liquidity and credit crunch led to the stock market crash in US and Europe.

Share prices and capital value of many companies tumbled.

Investor confidence shrunk and credit markets around the world gradually dried up.

Erosion of capital base of banks and FIs, led to adversely affecting liquidity and flow of

credit to companies and end consumers. Lines of credit to corporate dried up even for

working capital requirements thereby affecting employees and suppliers and stalling of ongoing investment projects.

Banks stopped giving credit to consumers and corporate, negatively impacting

consumption demand and investment leading to a slowdown in economic growth in US

and countries around the world.

Subsequently, Federal Reserve and other banks injected substantial liquidity in the

markets by means of lowering interest rates or bailing out financial institutions.



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Due to globalization with its free flow of capital and goods between US and other

countries, countries closely integrated with the US heavily suffered.

Exports of European and Asian countries to US were affected leading to decline in output

of export goods and subsequent job losses in these countries too.

3. What were the measures taken by RBI?

Measures taken by RBI:-

Expanding rupee liquidity

o Reduction in CRR (400 bps) & SLR (100 bps)

o Special Repo window under LAF for banks on-lending to NBFCs, HFCs & MFS

o Due to the global financial crisis there was liquidity crunch in the money market

which adversely affected the flow of credit to industries. In order to increase the

liquidity, RBI cut the cash reserve ratio three times in Oct – Nov from 9% to

5.5%. With this approx Rs. 1, 40,000 crores were infused in the banking system.

Currently, the CRR is 6%.

o RBI also cut the statutory liquidity ratio from 25% to 24% which enabled banks to

get Rs. 20,000 crores from RBI against Govt securities for lending to mutual

funds.

o Special Refinance to banks without collateral

o Unwinding of MSS – buyback/desequestering

o OMOs – pre-announced calendar

o RBI for several months before the financial crisis had been increasing the cash

reserve ratio and interest rates to curb the upward trend of inflation. However, it

reversed its track from Oct 2008.

o To curb the depreciation of the Indian rupee the RBI sold billions of dollars in theforeign exchange market from its reserves.

o RBI also further sought to lower lending rates of banks in order to decrease the

cost of borrowing. Repo rate was decreased from 9% to 4.75%.



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o Lowering of repo rates was to ensure that banks lower their lending rates so that

cost of borrowing from banks fall and more credit is created for investment by the

companies and there is higher demand for durable consumer goods such as

houses, cars etc. Cut in repo (425 bps) and reverse repo (275 bps) rates.

o Banks had surplus cash with them.

Existing instruments – enough flexibility

o MSS and CRR – good, effective buffers of liquidity – both absorption and

injection

Managing Forex liquidity

o NRE and FCNR(B) deposits: interest rate ceilings raised

o ECB norms relaxed

o Allowing corporate to buy back FCCBs

o Rupee-dollar swap facility for banks with overseas branches

Encouraging Flow of credit

o Exporters:

Extension of period for export credit.

Expansion in refinance

o Dynamic provisioning

Contra cyclical adjustment of prudential norms

o SIDBI and NHB: lendable resources expanded

o Loan restructuring

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