The Great Recession and Indias trade collapse

India escaped the direct adverse impact of the Great

Recession of 2008-09, since its financial sector, particularly its
banking, is very weakly integrated with global markets and
practically unexposed to mortgage-backed securities.
However, Indias real economy is increasingly integrated
into global trade and capital flows. It thus did suffer second
round effects when the financial meltdown morphed into a
worldwide economic downturn.

As seen in Figure 1, Indian exports fell in line with global

trade flows. This should firmly dismiss the decoupling myth
for the Indian economy. Collapsing foreign trade, capital
flows, and exchange rate movements all transmitted
negative impacts to the Indian economy

FIG-1
Source: IFS

What caused the trade collapse?

A plausible explanation for the severe contraction in global
trade during the Great Recession can be the increased
income elasticity of world trade which has risen from around
2 in the 1960s to around 4 in 2008 (Freund 2009).This
increased elasticity of world trade is due to the emergence of
cross-border production and supply networks. Trade finance
is the other major factor that has been proposed. Some
estimates say that trade finance contributes to 80% of trade
flows and hence it has contributed to around 10% to 15% fall
in world trade (Auboin 2009).
Other factors through which exporters were hit hard were
the sharp reduction in the prices of the major traded
commodities. As Figure 2 shows, world commodity prices
crashed between August 2008 to February by an average of
49%.3 Thus, the decline in world trade was a combined effect
of both volume and price decline.

FIG-2

The Indian trade collapse

As Figure 3 demonstrates, Indian exports and imports fell in

line with global trade flows. In terms of year on year growth
rates, the export contraction started from October 2008;
imports started contracting a little later, from December
2008. During the core period of the crisis, the average
contraction in exports and imports has been around 20% in
the first phase (October 2008-September 2009) and 28% in
the second (December 2008-September 2009).

FIG-3: INDIAN TRADE YEARLY GROWTH RATES

Past crises and Indian trade trends

The trade collapse triggered by this global crisis is more
severe than previous major episodes such as the balance of
payment crisis (1991), the Asian crisis (1997), and the dot
com bust (2000-01). This point is illustrated in Figure 4.
The 1991 Balance of Payment crisis, saw a sharp contraction
in imports primarily due to the sudden spike in the value of
petroleum imports with imports plummeting by 38%
(November 1991). This was fortunately not accompanied by a
decline in exports, which benefited from the marked rupee
devaluation of July 1991.

FIG-4

Indias merchandise exports

The traditional export destinations for India have been Asia,

EU and North America. Within Asia, ASEAN is the largest
export destination (52%) followed by the EU27 (21%), and
the US (13%). The USs share, however, has recently fallen to
11% (March 2009), even lower than that of the United Arab
Emirates (13%). This sudden decrease can be considered an
aftermath of the financial crisis.

FIG-5

Imports of goods and services

Crude oil, petroleum and petroleum products constitute the

largest share (32%) of Indias imports. India is structurally
deficit in terms of domestic availability of crude oil, having to
import nearly half of its requirements. Over the years,
however, Indian corporate giants like Reliance, Essar, and the
Indian Oil Corporation have established globally competitive
refining capacities. These are presently in excess of the
countrys requirements so they import crude and export
refined products. The expansion of this processing activity
has contributed to the rather sharp increase in the share of
crude oil and petroleum products in recent years.
Indias oil imports which had been growing robustly at
around 40% (2007-08) saw a decline in growth of about 17%
during 2008-09. Indias merchandise imports started
contracting from November 2008 onwards on a year on year
basis along with oil imports whereas the contraction in nonoil imports started from January 2009. During the period
from October 2008September 2009, imports have
contracted more (22%) than exports (20%).

FIG-6

Trade in services

India is a major services exporting country with about 3% of

the world total service exports. Indias exports of services are
mainly to the EU and the US. The latter alone accounting for
around 11% of Indias total services exports.
Services exports have not been as affected as exports of
merchandise. The sub-sectors within services exports that
have registered some contraction are travel, insurance,
business and communication services. Software services
exports, which are for some reason classified under
miscellaneous receipts for India have been a major
contributor to the growth of services exports, accounting for
as much as 45% of total exports, goods and services
combined (2007-08). However the intensity of the adverse
impact of the global economic downturn on Indias exports is
perhaps best demonstrated by noting that even Indias
software exports recorded a contraction in the fourth quarter
of 2008-09 by more than 15%. While the actual decline was
confined to only a single quarter, the growth of software
exports in 2008-09 has been far from the levels achieved in
the years preceding the global crisis.
During the crisis most businesses cut costs to cope with the
declining revenues. This in turn meant a reduction in IT
spending by advanced economies and a negative impact for
the growth of Indian software exports. The financial crisis
reflected in the slowdown of foreign business visitors and
brought down foreign travel receipts by 4% (2008-09). As a

related incidence, business and communication services also

experienced contraction of 3% and 10% respectively.

FIG-7

How the Federal Reserve Fights Recession

1. Help for Unemployment

In the third week of June, the Fed announced that it would
continue its "Operation Twist" program to reduce long-term
interest rates until year's end. The program is designed to
make borrowing cheaper for businesses and consumers
when the Fed sells short-term U.S. debt and takes the cash
to buy long-term U.S. debt. Fed Chairman, Ben Bernanke,
said that additional Fed action may be required if
unemployment doesn't fall below 8.2%. The labor market
showed signs of modest improvement in the early months
of 2012, but had slowed through the spring and early
summer.

2. Money for Mortgages

Throughout the years of America's recent recession and
subsequent slow recovery, the Fed, under chairman Bernanke,
has been actively attempting to restart the faltering economy.
In recent years, the Fed announced it was to buy a significant
amount of mortgages. The money would be used to buy
mortgage debt and government bonds, a move designed to
stimulate spending, reduce long-term interest rates and fire
up the stock market. This Fed action was known as
quantitative easing, or QE for short.

3. Lending for Banks

In 2008 and 2009, as the nation's economic problems became
severe, the Fed provided lines of credit to financial and lending
institutions. This cash infusion provided funds for consumer
loans and consequent consumer buying - the engine that
drives the economy. A follow-up effort to pull down long-term
interest rates was initiated in 2010, with an additional $267
billion earmarked by the Fed for bond buying.

Besides these actions by the Fed, America's central bank

loaned money to J.P. Morgan Chase to help the banking giant
takeover the failing investment bank, Bear Stearns. The Fed
also established a line of credit and financing for the
government's acquisition of American International Group
(AIG), one of the largest global insurance firms. By mid-June
this year, these loans had been totally repaid, according to the
Federal Reserve Bank of New York.

US RESPONSE TO THE GREAT DEPRESSION

In the United States, the government followed a twopronged strategy to reverse the financial crisis: bail out
distressed financial institutions (lest they transmit their
failure to their creditors) and pump government money into
the economy (to stimulate business activity when private
loans were scarce). What emerged from the bailout was an
extraordinary degree of government involvement inand
sometimes even majority ownership ofthe private sector.
Altogether, the government by late 2009 had provided an
estimated $4 trillion to keep the financial sector afloat. Many
of the biggest bailout beneficiaries quickly paid the
government back, and the ultimate cost of the bailout to
taxpayers was estimated at only $1.2 trillion.
Congress in February handed Pres. Barack Obama the first
legislative triumph of his month-old presidency when it
enacted a $787 billion fiscal stimulus bill that comprised $288
billion in tax cuts and $499 billion in spending, most of it for
public-works programs such as school construction and
highway repair. Although Republicans groused that checks
for much of the $499 billion would be issued too late to do
any good, the nonpartisan Congressional Budget Office said
that thanks to the tax measures, about three-quarters of the
full $787 billion would be spent in 18 months. Obama
claimed that the bill would create or preserve 3.5 million
jobs, a figure that many of his opponents called far too
optimistic.

Congress also played a role in the bailout of failing financial

institutions. At the end of 2008, Congress enacted the
Troubled Asset Relief Program (TARP) authorizing the
Department of the Treasury to invest up to $700 billion by
buying unproductive real-estate investments or even
becoming part owners by purchasing financial company
stock. The Fed, using authority that it already had, played an
even bigger role. Printing more money when not enough was
available, the central bank invested heavily in foundering
institutions and guaranteed the value of their shaky assets.
By the end of 2009, the government owned almost 80% of
American International Group (AIG), the countrys biggest
insurer, at a cost of more than $150 billion. It also owned
60% of GM and had a stake in some 700 banks. It initially
spent $111 billion to prop up Fannie Mae and Freddie Mac,
the companies sponsored by Congress to buy mortgages
from their issuers. The government promised to play no role
in managing these companies and to sell its ownership stakes
as soon as practical. TARP provided the Treasury with only a
fraction of the funds used for the bailout, however. The Fed
was responsible for the lions share, and even the massive
AIG rescue was engineered entirely outside the legislated
Treasury Department program.
Reflecting public views, members of the government
expressed outrage that some of the same executives who
helped precipitate the financial crisis should make millions of
dollars a year in salaries and bonuses. Treasury Secretary
Timothy Geithner appointed a special master for executive
compensation to review the compensation packages of top

financial executives at firms that received bailouts. Many of

the biggest bailout beneficiaries balked at the proposed
salary limits and strove to get out from under them by paying
the government back.

More ominously for the financial institutions, many members

of Congress marched into 2010 with a determination to
regulate them more closely. The House passed a bill in 2009
that for the first time would bring exotic financial
instruments under review by federal regulators. The bill
would also establish a single agency to protect financial
consumers and guarantee shareholders a chance to vote on
the compensation packages of corporate executives. The
Senate planned to take up the issue in 2010.