Running Head: INDIAN ECONOMY

The Eurozone Crisis and its Impact on India

Benjamin S. Cheeks

International School of Management, Paris

Author Note

This paper was submitted to fulfill the requirements of Indian Economy, INEC 7017.

I would like to thank the faculty and staff at Amity University, Noida, for their support and

dedication to make the first ISM – Amity Seminar a success. I would also like to thank Dr.

Don Mathews from the Coastal College of Georgia for his valuable insight into

macroeconomic theory.

Correspondence concerning this paper should be addressed to Benjamin S. Cheeks.

Email: bencheeks@hotmail.com

INDIAN ECONOMY 2

Abstract

The epicenter of the global financial crisis moved to Europe in 2010 and became the

eurozone crisis. As the crisis drags on, global growth has slowed. Early in the crisis, the

Government of India along with the Reserve Bank of India (RBI) implemented fiscal

stimulus in the form of tax breaks and government spending as well as liquidity measures

such as lowering interest rates and reducing cash reserve ratio to help India manage the crisis.

Additional policy measures to open up financial inflows such as FDI, FII, and NRI Deposits

soon followed. Despite setbacks in financial inflows between 2008 and 2010, the Indian

economy rebounded in the timeframe of 2010-2011, growing at an impressive 9.32%.

However, as the crisis continues, growth in India has slowed to 4.8%; the slowest in a decade.

Years of deficit spending has increased government debt, raised inflation, and depressed the

rupee, a fact that exacerbates the current account deficit. Inflation and the current account

deficit have limited monetary policy tools. Political stalemate, strong regional parties and

government corruption have limited the fiscal policy tools. Business and Consumer

confidence is falling.

The crisis has forced India to look at its trade policy and find other regions to direct

their imports. It has accelerated reforms for FDI, FII, and NRI Deposits further opening the

economy to the outside investor. It has shined a light on the corruption, bureaucracy, and

poor infrastructure and brought them to the forefront of conversation.

Keywords: Indian economy, euro crisis, India Trade, India FDI, India FII, NRI Deposits,

business confidence

INDIAN ECONOMY 3

The Eurozone Crisis and its Impact on India

The eurozone consists of 17 member states, all of whom have adopted the euro (€) as

their common currency. The current members are: Austria, Belgium, Cyprus, Estonia,

Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands,

Portugal, Slovakia, Slovenia, and Spain. Since 2009 the eurozone has been embroiled in a

financial crisis that has made it difficult for certain member states to pay or refinance their

debt without aid from the other member states, the European Central Bank, and the

International Monetary Fund. The crisis is often referred to as the eurozone sovereign-debt

crisis or just the eurozone crisis.

Mody & Sandri (2012) describe how the eurozone crisis evolved. From the

introduction of the euro in January of 1999 until July of 2007, the risk premia on the debt of

eurozone member states moved in tandem, with little difference across the member states. It

was this assumption of homogeneity between the countries that set the stage for the crisis.

Mody & Sandri (2012) explain how the eurozone crisis evolved in three phases. The

first phase of the crisis began in July of 2007 when the United States sub-prime market began

to show signs of weakness. At this time, the risk premia on bonds issued by the eurozone

sovereigns began to rise from historically low levels. At this time, the assumption of

homogeneity prevailed and the yields rose largely in tandem. The second phase of the crisis

began with the rescue of Bear Stearns by the US Federal Reserve in March of 2008. Along

with the rescue, came the realization that governments would have to support their distressed

banks. With this new view, the spreads on sovereign debt began to diverge as investors

considered the stress in each member state’s financial sector and growth prospects. The third

phase of the crisis came with the nationalization of Anglo Irish in 2009. The rescue of this

bank gave investors an insight in the amount of fiscal support that may be required for the

INDIAN ECONOMY 4

financial sector. This third phase accelerated in May 2010 with the Greek bailout and

continues today.

Figure 1. Increase and dispersion of eurozone sovereign spreads (Mody & Sandri, 2012).

The effects of the crisis are not limited to the eurozone. As one of the world’s largest

trading blocks, the impact can be felt globally. This paper will explore the impact of this

crisis on the Indian economy, review key responses by the Government of India (GoI), and

discuss additional responses the GoI should consider.

Framework for the Analysis

Trade channels, financial channels and confidence channels will be analyzed in this

paper.

Trade Channels

In this paper, an analysis of India’s foreign trade has been undertaken to see the

impact of the global financial crisis on international trade. The paper studies India’s foreign

trade by analyzing imports, exports and region-wide trade in detail. The analysis has been

performed by comparing all variables before, during and after the global financial crisis.

INDIAN ECONOMY 5

Financial Channels

The second channel through which the eurozone crisis could impact India is through

financial channels. This paper analyzes the inflow of Foreign Direct Investment (FDI), the

inflow of Foreign Institutional Investors (FII), and finally the deposits and remittances of

Non-Resident Indians (NRI).

Confidence Channels

In addition to the effects of the traditional trade and financial channels, a change in

the confidence channel could not only accelerate the transmission of macroeconomic shocks,

but also amplify their effects. In a 2009 speech by Duvvuri Subbarao (2009), the Governor

of the RBI, when referring to the Global Financial Crisis stated, “The contagion of the crisis

has spread to India through all the channels – the financial channel, the real channel, and

importantly, as happens in all financial crises, the confidence channel.”

To analyze the change in business confidence, the paper reviews survey results from

the NCAER Business Confidence Index, the FICCI Overall Business Confidence Survey, the

Dun & Bradstreet Business Optimism Survey, and the CII Business Confidence Index. For

consumer confidence, the Nielsen Global Survey of Consumer Confidence and Spending

Intentions is reviewed.

Policy Response

In order to mitigate the effect of the eurozone crisis on the Indian economy, the

Government of India as well as the RBI took a number of conventional and unconventional

responses. This paper will explore a number of these actions.

Additional Measures to Consider

INDIAN ECONOMY 6

This paper will also recommend additional actions that the Government of India and

RBI can take as well as discuss current constraints that limit the Government’s effective

implementation of these measures.

Analysis

Trade Channels

Global shocks are traditionally transferred through the trade channels. As the Indian

economy has become more integrated with the world economy, Indian imports and exports

are more synchronized with the rest of the world. Mohanty (2009) explains that from 1970-

1991, Indian imports and exports were not significantly synchronized with a low correlation

of 0.38. However, between 1992 and 2009, the correlation has increased significantly to 0.80

during the period from 1992 to 2009. Europe and the eurozone are significant markets for

India and one would expect the crisis to decrease exports to these regions.

Total trade of goods. India trade weathered the first two years of the global financial

crisis. Total trade of goods increased 32.6% in 2007-2008 from the previous year with

exports growing at 28.9% and imports at 35.1%. In 2008-2009, total trade increased at a

slower pace of 17.4% from the prior year with exports growing at 13.7% and imports

growing at 19.8%. The eurozone crisis was truly felt in 2009-2010. Total trade actually

decreased in US dollar terms by 2.9% with exports shrinking 3.5% and imports 2.6%. While

this seems drastic, according to a press release by the World Trade Organization (2010),

global trade dropped 12.3% in 2009 on a volume basis and a whopping 23% in US dollar

terms.

The decline in 2009-2010 was short lived and India’s total trade rebounded; chalking

up year-over-year gains of 30.8% in 2010-2011 and 28.1% in 2011-2012. However,

INDIAN ECONOMY 7

preliminary data for the 2012-2013 shows that overall trade showed another decline. This

time with total trade falling 4.8%, with exports falling 6.0% and imports falling 4.0%.

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Figure 2. India total trade of goods in US$ billions (Planning Commission, Government of

India, May 2013).

From the perspective of total trade, the eurozone crisis hit India’s total trade in 2009-

2010. Trade rebounded the following two years, but as the crisis continued into 2013, trade

has once again fallen is US dollar terms.

Trade with the European Union and the eurozone. As the eurozone member states

and the European Union as a whole are at the epicenter of the eurozone crisis, it is important

to look at trade between India and these two regions. According to data available from the

European Commission (2013), in 2008, India made up 2.4% of total exports for the European

Union and 1.9% of imports. However, during the same year, The European Union (EU)

accounted for 20.8% of Indian exports and 13.9% of Indian imports (Department of

Commerce GoI , 2013).

INDIAN ECONOMY 8

Since 2007-2008 exports to the eurozone and the EU make up a smaller percentage of

total exports as India looks for new export markets.

2007-2008 2008-2009 2009-2010 2010-2011 2011-2012 2012-2013 (P)

Exports to eurozone 25.48 29.73 27.39 35.66 40.40 38.23

Exports to EU 34.54 39.35 36.03 46.04 52.56 50.36

eurozone as % of total exports 15.6% 16.0% 15.3% 14.2% 13.2% 12.7%

EU as % of total exports 21.2% 21.2% 20.2% 18.3% 17.2% 16.8%

Figure 3. Exports to eurozone and EU in US$ billions (Department of Commerce GoI,

2013).

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Total Trade total Eurozone Trade total EU Trade

Figure 4. EU-India trade and eurozone-India trade (European Commission, 2013, and

Department of Commerce Government of India, 2013).

As with total trade, exports to the EU and the eurozone recovered in 2010-2011 and

2011-2012. However, the growth rate to these regions was below the overall growth in

exports causing the percent of exports to these regions to continue to fall. In the year 2012-

2013, exports to the EU and the eurozone fell by 4.2% and 5.4% respectively. Both numbers

were higher than the overall decline in exports of 1.8% resulting in a further reduction in

INDIAN ECONOMY 9

exports to these regions as a percent of total exports. Since the large decline in exports

during 2009-2010, trade in the EU and eurozone rebounded. However, for the next 2 years,

the growth was below the trend in India, causing exports as a percent of total exports to fall.

As the crisis continues and global growth slows, trade to these regions appears to be faltering.

Composition of exports. It is also important not only to look at the total exports in

terms of US dollars but to also consider the make-up of these exports to determine whether or

not the profile of goods exported to the EU and eurozone has changed. The table below

shows the top categories of items exported from India to both the European Union and the

eurozone for the years 2005-2006, 2009-2010, and 2012-2013. These five categories make-

up approximately 80% of the total exports for each of the years. The data clearly shows that

the profile of items exported from India to the EU and eurozone has remained relatively

stable over the past eight years. Therefore, while the eurozone crisis has impacted overall

trade and specifically trade to the EU and eurozone, it has had little impact on the profile of

goods exported.

2005-06 2009-10 2012-13

RMG Cotton Incl. Accessories Petroleum (Crude & Products) Petroleum (Crude & Products)

Petroleum (Crude & Products) RMG Cotton Incl. Accessories Gems & Jewelry

Gems & Jewelry Transport Equipments RMG Cotton Incl. Accessories

Machinery And Instruments Gems & Jewelry Transport Equipments

Transport Equipments Machinery And Instruments Machinery And Instruments

Figure 5. Top five Indian exports to the EU, 2005-2006, 2009-2010, and 2012-2013

(Department of Commerce GoI, 2013).

Trade in services. The previous analysis looked only at trade in goods. Country-

wide data is not readily available for trade in services, so it must be analyzed broadly. The

RBI refers to trade in services as one of the invisibles on India’s overall balance of payments.

Services consist of Travel, Transportation, Insurance, Software Services, Business Services,

INDIAN ECONOMY 10

Financial Services, Communication Services, and the catch alls Miscellaneous and GNIE

(Government Not Included Elsewhere).

Research by Borchert & Mattoo (2010), shows that trade in services tends to be more

resilient to change than to trade in goods. This is due to several factors. First, services see

less cyclical demand. Secondly, services are less dependent upon external finance. Finally,

few explicitly protectionist measures have been taken so far in the industry.

In India, total trade of services increased 11.4% in 2008-2009 from the previous year

with exports growing at 17.3% and imports at 1.1%. As with trade in goods, the trade in

services began to feel the impact of the eurozone crisis in 2009-2010. In that year, total trade

decreased in US dollars terms by 1.2% with exports shrinking 9.4% with import growth of

15.3%. Total trade in services turned around in 2010-2011 with a total growth of 39%.

Exports grew by 38.4% that year and imports by 40.0%. As the eurozone crisis continued,

trade in services has slowed. Total trade increased by a minuscule 0.6% in 2011-2012 and a

slightly higher, but still disappointing, 2.7% in 2012-2013. It seems that even India’s world-

class service sector cannot escape the impacts of the eurozone crisis.

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Figure 6. India total trade of services in US$ billions (Planning Commission, Government of

India, May 2013).

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Financial Channels

The second channel through which the eurozone crisis could impact India is through

financial channels. Foreign Direct Investments (FDI), Foreign Institutional Investors (FII),

and Non-Resident Indians Deposits (NRI) are reviewed in this section.

Foreign direct investment. FDI is an important source of financing and technology

for developing countries. The OECD Benchmark Definition of Foreign Direct Investment

(2008) explains the importance of FDI:

By the very nature of its motivation, FDI promotes stable and long-lasting economic

links between countries through direct access for direct investors in home economies

to production units (businesses/enterprises) of the host economies (i.e. the countries

in which they are resident). Within a proper policy framework, FDI assists host

countries in developing local enterprises, promotes international trade through

access to markets and contributes to the transfer of technology and know-how. In

addition to its direct effects, FDI has an impact on the development of labour and

financial markets, and influences other aspects of economic performance through its

other spill-over effect. (p. 20)

There are many European countries that have investments in India. The Planning

Commission, Government of India (May 2013), shows that from April 2000 to March 2013,

the eurozone accounted for 15.1% of India’s FDI with the entire European Union accounting

for 25.2% of FDI. When determining the source of FDI into India, it should be pointed out

that due to tax advantages, nearly 40% of FDI inflows to India originate in Mauritius; making

the true source of the investment difficult to identify. The same could be said for much of the

10% that flows in from Singapore. Therefore the eurozone and the European Union as a

whole could account for a larger share than noted above.

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2008 2009 2010 2011 2012

European Union 977.8 386.8 509.2 558.3 418

Total World 1,911.20 1,107.10 1,445.10 1,619.00 1,422.70

% of Total FDI Outflows 51.2% 34.9% 35.2% 34.5% 29.4%

Change In EU FDI Outflows -60.4% 31.6% 9.6% -25.1%

Change in Total FDI Outflows -42.1% 30.5% 12.0% -12.1%

Figure 7. EU and total world FDI outflows in US$ billions (Bertrand, 2013).

Focusing in on FDI Inflow to India from 2008 to March 2013 shows that while FDI

decreased by 9.9% in 2009-2010 and another 7.7% in 2010-2011 before finally rebounding in

2011-2012. The most recent year, 2012-2013 has also been a slow year, seeing FDI fall

20.8% from the year before.

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Annual FDI Flows Cummulative

2008-2009 2009-2010 2010-2011 2011-2012 2012-2013

Annual FDI Inflows 41,873 37,745 34,847 46,556 36,860

Cummulative Total 134,070 171,815 206,662 253,218 290,078

YoY % Change 20.2% -9.9% -7.7% 33.6% -20.8%

Figure 8. Annual and cumulative FDI inflow to India 2001-2013 (Planning Commission,

Government of India, May 2013).

The 20.8% fall in 2012-2013 is slightly higher than the 12.1% decline in FDI globally

(Bertrand, 2013). It likely does not reflect on India as a destination for FDI, but rather the

INDIAN ECONOMY 13

slowdown of FDI flows in general. This is supported from the fact that the United Nations

survey for 2012 (United Nations Conference on Trade and Development, 2012) shows that

India ranked third as the top prospective economies for FDI. In addition, the Ernst & Young

Attractiveness Survey for 2012 shows 73% of business leaders are keen to invest in India in

the near future.

Foreign institutional investment. Foreign Institutional Investment (FII) is an

investment in securities in India made by an institution established or incorporated outside

India. FII flows are critical to help a country to manage its current account deficit. However,

FII flows are fickle and can move quickly into or out of a country. With FII, it is difficult to

pinpoint the origin of the investment. Therefore, FII numbers are reviewed in aggregate

rather than country or region specific.

Looking at data for FII from 2008 to March 2013 shows that FII flows have been very

erratic over the past five years.

Apr-Mar Apr-Mar Apr-Mar Apr-Mar Apr-Mar Apr-Mar

2007-08 2008-09 2009-10 2010-11 2011-12 2012-13

FII Flows US$(millions) 20,328 15,017 29,048 29,422 16,812 27,583

%YoY Change FII Flows -26.1% 93.4% 1.3% -42.9% 64.1%

Figure 9. FII flows to India, April 2007 to March 2013 (Planning Commission, Government

of India, May 2013).

Several studies have shown that FII flows to India are related to stock market return.

Chakrabarti (2001) concluded in his study that FII flows are correlated with contemporaneous

returns in the Indian markets. Mukherjee, et al (2002) found that returns in the Indian equity

market are indeed an important (and perhaps the single most important) factor that influences

FII flows into the country.

INDIAN ECONOMY 14

Apr-Mar Apr-Mar Apr-Mar Apr-Mar Apr-Mar

2008-09 2009-10 2010-11 2011-12 2012-13

%YoY Change FII Flows -26.1% 93.4% 1.3% -42.9% 64.1%

%YoY Change Sensex Flows -37.9% 80.5% 10.9% -10.5% 8.2%

Figure 10. Percent YoY change in Sensex and FII flows (Planning Commission, Government

of India,May 2013).

NRI deposits. NRI Deposits are an important source of financing India’s current

account deficits. The RBI (2010) states that 18% of total remittances come from Europe and

therefore could be directly impacted by the eurozone crises.

Apr-May Apr-May Apr-May Apr-May Apr-May Apr-May Apr-May

2006-2007 2007-2008 2008-2009 2009-2010 2010-2011 2011-2012 2012-2013

NRI Deposits 41,240 43,672 41,554 47,890 51,682 58,608 70,823

% YoY change 13.7% 5.9% -4.8% 15.2% 7.9% 13.4% 20.8%

Figure 11. Annual NRI deposits April 2006 to May 2013 (Reserve Bank of India 2012, and

Reserve Bank of India 2013).

NRI Deposits have remained strong throughout the Global Financial crisis and the

eurozone crisis. They have increased every year with the exception of 2008-2009 when they

fell 4.8%. Mohapatra and Ratha (2009) attribute this limited effect to several factors. First,

falling asset prices in India, rising interest rate differentials, and a depreciation of the local

currency attracted investments from NRIs. Second, many of the migrants that lost jobs are not

leaving but taking lower paying jobs with other employers. Third, the employment prospects

for Indian migrants has remained relatively stable during the crisis due to the fact that many

Indian migrants work in sectors that have not been hit as hard by the crisis. These sectors

include health care, retail, and professional and technical services sectors. Finally, remittance

flows tend to be more resilient when the migration destinations are diverse. The rather large

increase in 2012-2013 may be attributed to weakening of rupee and deregulation of interest

rate on NRI Deposits.

INDIAN ECONOMY 15

Confidence Channels

This channel shows confidence changes in business and consumer sentiment. So even

if an economy’s macroeconomic conditions and outlook look favorable, the decline in

confidence can disrupt the economic conditions. Policy makers around the world understand

the importance on confidence in the market. This is demonstrated by the G20 Leaders

Declaration when they convened in Los Cabos on June 18-19, 2012. In the first 19

declarations, the word confidence was used six times. Most notably in the declaration, “All

G20 members will take the necessary actions to strengthen global growth and restore

confidence” (The White House, 2012).

Business confidence. The following business confidence indicators are obtained

through business surveys with the goal to evaluate and forecast on a short term the status of

the economic activity, by economic sectors and as a whole. These indicators are built on the

company managers’ subjective responses to a series of questions regarding the past and

future status of their own activity. Business confidence surveys are important tools for policy

makers. Gagea (2002) has shown that industrial confidence indicators can provide important

information on the status and evolution of economic activity. These indicators are closely

monitored by the RBI. The discussion relates to the change in the indices over the past year

and with brief commentary on the most recent survey.

INDIAN ECONOMY 16

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NCAER- Business Confidence Index

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Dun & Bradstreet Business Optimism

CII Business Confidence Index

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Dun & Bradstreet Business Optimism

CII Business Confidence Index

Figure 12. Scores for Indian business confidence from April 2009 to April 2013

(FICCI,2013).

NCAER business confidence index. The NCAER MasterCard Worldwide Index of

Business Confidence is based on a survey which measures business confidence on four

indicators. According to this index, Consumer Confidence in India decreased to 114 in the

first quarter of 2013 from 135 in the first quarter of 2012. Historically, from 2009 until 2013,

India Consumer Confidence averaged 135 reaching a high of 162 in October of 2010 and a

low of 80 in April of 2009. In the latest survey, constraining factors were listed as increasing

input costs and the increasing current account deficit (Voyagers World, 2013).

FICCI overall business confidence. FICCI‘s Business Confidence Survey surveys

Indian companies belonging to a varied array of sectors such as textiles, cement, financial

services, chemicals, metal and metal products, automobiles, FMCG, electrical equipment and

INDIAN ECONOMY 17

machinery, paper and paper products. According to this index, Business Confidence in India

increased to 61.2 in the first quarter of 2013 from 57.7 in the first quarter of 2012.

Historically, from 2009 until 2013, India Consumer Confidence averaged 63.8 reaching a

high of 162 in January of 2011 and a low of 51.5 in July of 2012. In the latest survey,

(FICCI, 2013) listed constraining factors such as rising cost of raw materials and labor,

inadequate infrastructure, and the high cost of credit.

Dun & Bradstreet business optimism. The D&B Business Optimism Index is arrived

at on the basis of a quarterly survey of business expectations. The survey is conducted on a

sample of companies that are selected randomly from D&B’s commercial credit file.

According to this index, Business Confidence in India decreased to 141.6 in the first quarter

of 2013 from 150 in the first quarter of 2012. Historically, from 2009 until 2013, India

Consumer Confidence averaged 145.4 reaching a high of 183 in April of 2011 and a low of

90 in April of 2009. An analysis of the latest survey by Dun & Bradstreet (2013) stated that,

“Factors such as high fiscal deficit, dismal investment activity, high current account deficit,

weak consumer spending and inertia in policy reform have led to deterioration in the business

climate.”

CII business confidence index. The Confederation of Indian Industry (CII) Business

Confidence Index is based on responses from 175 members. A majority of the respondents

53% belonged to large-scale companies, 14.8% were from medium-scale ones and 25.2% and

7% each from small-scale and micro firms, respectively. Further, 67.2% of the respondents

were from the manufacturing sector, while 31% and 1.7% were from the services and primary

sectors, respectively. According to this index, Business Confidence in India decreased to

51.3 in the first quarter of 2013 from 52.9 in the first quarter of 2012. Historically, from

2009 to 2013, India Consumer Confidence averaged 59.1 reaching a high of 67.6 in July of

INDIAN ECONOMY 18

2010 and a low of 48.6 in January of 2012. In the most recent CII survey, BS Reporter

(2013) reported that high levels of corruption, persisting inflation, lack of reform, escalated

interest rates, and political uncertainty are major concerns.

All four reports present similar findings. Confidence fell dramatically after the global

financial crisis and then the eurozone crisis. However, much like trade, condition improved

considerably through mid-2011. As the eurozone crisis has dragged on and European leaders

continue to “kick the can down the road”, global growth has slowed having a continued

negative impact on Indian business confidence. Constraining factors such as increasing input

costs, inertia in policy reform, high interest rates, and the large current account deficit were

common themes across the surveys.

Consumer confidence. Similar surveys are given to consumers to evaluate their

current levels of confidence. Carol (1994) shows that that measures of consumer confidence

are correlated with real consumption and therefore may have some short-term forecasting

ability.

Figure 13. Indian consumer confidence scores as measured by the Nielsen global survey of

consumer confidence and spending intentions from September 2009 to March 2013 (Trading

Economics).

The Nielsen global survey of consumer confidence and spending intentions. The

Nielsen Global Survey of Consumer Confidence and Spending Intentions utilizes the Internet

INDIAN ECONOMY 19

to track consumer confidence, job prospects, personal finances and spending intentions.

Consumer confidence levels above 100 indicate optimism and below 100 indicate pessimism.

Consumer Confidence in India decreased to 120 in the first quarter of 2013 from 121 in the

fourth quarter of 2012. Consumer Confidence in India is reported by Nielsen. Historically,

from 2009 to 2013, India Consumer Confidence averaged 119 reaching an all time high of

131 in December of 2010 and a record low of 92 in March of 2010.

Consumer confidence in India has been on a slow decline since the beginning of

2011. However, it should be noted that in the latest survey, India has the second highest

consumer confidence rating in the world at 120 (Trading Economics, 2013).

Policy Response - Trade Channels

Gupta (2010) divides measures to promote exports into two broad categories, price

measures and non-price. Price factors would include things such as devaluation of currency

and various indirect and direct tax benefits. Tax benefits have been the one of the key

measures the Indian Government has used to stimulate exports since the financial crisis.

Since the start of the financial crisis, the Government of India has made several price

responses in order to help the export sector. These include things such as duty refunds, low

interest loans, and tax waivers for exporters. Roy & Kala (2013) report in the Wall Street

Journal that the recent $555 US million export stimulus package offers a 2% financial

incentive on exports to the United States, Europe and Asia. In order to encourage exporters to

seek out alternative markets, it is also expanding the program to include exports to African

and Latin American countries. The stimulus package also extends for the same period a low-

cost loan program for exporters and a waiver of taxes on imported capital goods.

Gupta (2010) lists non-price factors as things such as comprises the upgradation of

quality of product, fast delivery of consignment, and post-sale services. These factors are

INDIAN ECONOMY 20

more long lasting as they are more difficult for competing nations to emulate. On the non-

price side, the government’s response has been muted. It has however relaxed minimum

export requirements in certain industries.

Discussing trade in India would not be complete without mentioning Special

Economic Zones (SEZ). SEZ are geographical regions within India to setup the export of

goods and provide employment. These zones usually benefit from reduced or no tariffs as

well as reduced to no taxes in order to make exports more competitive. SEZs were dealt a

blow recently following an imposition of an Alternative Minimum Tax as well as a Dividend

Distribution Tax. According to the Ministry of Commerce, India (n.d.), there are currently

156 SEZs operating in India with another 588 approved. One of the major difficulties in

setting up additional SEZs is the ability to obtain large tracts of uncultivable land to set up an

SEZ. The government has responded to this limitation by reducing the minimum land

requirement, but land acquisition remains an issue.

Additional Measures and Limitations – Trade Channels

On the price side, the Government of India is restricted on more aggressive measures

than those they have already undertaken due to the high fiscal deficit. Reuters (2013) reported

that 2013 fiscal deficit to be 4.9% of GDP. However, on the non-price side, the GoI has

opportunity in streamlining logistics to reduce transportation and transaction costs. Nordas,

H., Pinali, E., & Grosso, M,. (2006) found that a 10% increase in transport costs reduces trade

volume by 20 and that the tariff equivalent per day in transit is equal to 0.8%. They also

mention studies that show a 5 to 25% reduction in trade value for every 10% increase in time

for exports, depending on sector and export destination.

The Government of India could also negotiate new free trade agreements. They

currently are discussing Free Trade Agreements with a number of countries/regions;

INDIAN ECONOMY 21

including the EU, Thailand, and Australia. However Free Trade Agreements must be

negotiated carefully to ensure domestic production does not suffer or that domestic industries

are overshadowed by their international competitors

Policy Response – Financial Channels

At the onset of the financial crisis, the Government of India initiated a large stimulus

package containing tax breaks and increased government spending to offset the effects of the

slowdown. The RBI took measures to ensure proper liquidity was maintained. These

measures included lowering the repo and reverse-repo rate as well as reducing cash reserve

requirements through 2009. This policy was reversed in 2010 and 2011 as inflationary

concerns weighed on the economy. However, after disappointing growth in 2012, the RBI

has reduced rates three times in 2013.

Figure 14. Indian interest rates and CRR (Kshitij Consultancy Services).

To help keep FDI flowing, the GoI either opened FDI or raised the FDI maximum

investment in areas such as insurance, telecommunications, retail, pensions, commodity

trading, and broadcasting.

INDIAN ECONOMY 22

In order to encourage more FII, the RBI has increased the limit for investment in

long-term government and corporate securities. In addition, they have reduced the lock-in

period for the corporate bonds and infrastructure debt funds.

In order to stimulate additional NRI Deposits, the RBI has increased the interest rate

paid on these deposits.

Additional Measures and Limitations – Financial Channels.

The financial channel is facing many limitations at the moment. These include an

elevated fiscal deficit, a rising current account deficit, inflation above the RBI target, and a

falling rupee. The GoI has made positive steps toward addressing the fiscal deficit. Reuters

(2013) reported the fiscal deficit for 2013 was 4.9% and is narrower than 2012 that came in at

5.8%. On the current account side, in addition to the policy to stimulate capital inflows, the

GoI has raised duties on gold imports. In addition, the RBI has implemented a policy

requiring companies with in the SEZ to repatriate their funds within one year of the date of

sale.

High inflation has kept the RBI from being aggressive in reducing interest rates. In

the most recent quarter, inflation appears to be cooling. However, it is currently the

depressed rupee that is preventing the RBI from reducing interest rates further.

To make India a more attractive destination for foreign investment, the government

must take more steps to make doing business in India easier. Some basic recommendations

are to invest in market-driven infrastructure, crack down on corruption, reduce bureaucratic

hurdles, and loosen rigid labor laws. These recommendations are not original. Most Indians

that you talk to would point out the exact things. However, at the moment, India is wrapped

in political deadlock due to recent allegations of corruption among top governmental officials

INDIAN ECONOMY 23

and the emergence of strong regional parties. These strong regional parties also make

coordination difficult between state and central government.

Policy Response – Confidence Channels

Recently, the Government of India has done little to boost business or consumer

confidence. If anything, it seems to have done the opposite. Dhume, & Milligan (2012) from

reported:

As economic growth slows to below 6% and yet another corruption scandal gridlocks

governance, are Indians losing faith in their politicians? A spate of recent articles

suggests that’s certainly true of Prime Minister Manmohan Singh. Once seen as an

incorruptible champion of economic liberalization, Singh has recently been termed

The Underachiever (Time Magazine), and a “dithering, ineffectual bureaucrat”

(Washington Post) presiding over a corrupt government that “has passed no

substantial laws” (The Economist).

Conclusion

Former president of the European Central Bank, Jean-Claude Trichet (2013) wrote in

the New York Times, “The epicenter of the worst global financial crisis since World War II,

located in the United States since 2007, crossed the Atlantic at the beginning of 2010. As Fed

Chairman Ben Bernanke told me at that time: “Now it is your turn.”

Early in the crisis, the Government and India along with the RBI implemented fiscal

stimulus in the form of tax breaks and government spending as well as liquidity measures

such as lowering interest rates and reducing cash reserve ratio to help India manage the crisis.

Additional policy measures to open up financial inflows such as FDI, FII, and NRI Deposits

soon followed. Despite setbacks in financial inflows between 2008 and 2010, the Indian

economy rebounded in 2010-11 growing at an impressive 9.32%. However, as the crisis

INDIAN ECONOMY 24

continues, growth in India has slowed to 4.8%; the slowest in a decade. Years of deficit

spending has increased government debt, raised inflation, and depressed the rupee, a fact that

exacerbates the current account deficit. Inflation and the current account deficit have limited

monetary policy tools. Political stalemate, strong regional parties and government corruption

have limited the fiscal policy tools. Business and Consumer confidence is falling.

Everything is not all bad though. In 2012-13, the fiscal deficit decreased to 4.9% of

GDP down from 5.9% of GDP the past two years. The latest wholesale inflation reading was

a 42 month low of 4.7%. Indian remains a preferred destination for FDI and there is still

room to further open the Indian economy to investment. NRI Deposits had risen to a record

$70 billion US in 2012-13.

The eurozone crisis has been a drag on the world economy and India has slowed with

it. However, it has had some positive impacts. As trade with the EU and eurozone slows,

India is forced to look to other export markets for their goods. To date this has been

successful as total trade with the EU continues to fall as a percentage of total trade. The

crisis has increased the urgency of reforms for FDI, FII, and NRI Deposits further opening

the economy to the outside investor. It has shined a light on the corruption, bureaucracy, and

poor infrastructure and brought them to the forefront of conversation. The GoI must address

these issues in order to restore confidence in the international community.

Projects to improve infrastructure can stimulate the industrial sector and reduce

transportation costs making Indian exports more competitive. Indian has huge resources at its

disposal to overcome the crisis, let’s just hope it finds the political will to do so.

INDIAN ECONOMY 25

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