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Global financial crisis II: the challenges for India

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We need to take steps to revive our sluggish economy and insulate it from ripple effects of financial troubles in Europe, the US and Japan, writes Dilip Maitra The economic analysts all over the world are almost convinced that the world is now heading for another financial crisis and a possible recession, three years after the one that started in 2008. Though the epicentre of the 2008 crisis was the United States, this time around it is the countries in Europe which are sending shivers. It was the huge subprime crisis in the US that triggered the last recession and engulfed the world. The subprime crisis or the mortgage crisis, was actually the result of a financial adventurism where borrowers with lower creditworthiness were given generous home loans by banks at a rate of interest higher than the prime rates. To expand the market further, these loan portfolios were sold again to other investors like private equity funds, hedge funds and non-banking finance companies through securitisation. But the artificial boom created with easy money went bust as financially weaker borrowers started defaulting and property prices crashed leading to further defaults and price crash. As the mortgage crisis engulfed the entire financial system in the US and a part of Europe, large financial entities like Lehmann Brothers and many banks went bust and banks like American Express, Citi Bank, Morgan Stanley, UBS, Bear Sterns, etc had to write off large loans and needed governments rescue package to survive. Barely had the world economy recovered from the last crisis that trouble started brewing in Europe and to some extent in the US. Euro zone, a conglomeration of 17 European countries using the common currency Euro, is in trouble because some of its member countries like Greece, Spain, Italy, etc are unable to service their huge sovereign debts. Then there are other countries like Portugal, Cyprus and Ireland which are already in trouble. Some of these troubled countries have already seen downgrading of their credit ratings while others are facing the impending threat. Austerity measures With great reluctance and after a lot of debate, though some of the stronger members of the EU, such as Germany and France, have worked out bailout packages, the stringent austerity conditions attached to them are facing stiff oppositions from the borrowers. As the weaker countries are on the verge of defaulting on their debt commitments, there is an

increasingly nagging fear that euro zone may soon collapse. Economists fear that Greece will soon default on its huge debt repayment and will be forced to pull out of Euro leading to further financial crisis in large European banks who have lent huge sums to Greece. Though the government in Italy has recently raised funds by issuing bonds, because of poor credit rating, it had to offer interest rates four times higher than the normal rates. Noticing the turn of events, World Bank President Robert Zoellick, last week, pronounced that the world had entered a new economic danger zone and Europe, Japan and the United States all needed to make hard decisions to avoid dragging down the global economy. His bluntly-worded address, last week, highlighted mounting fears among global policymakers about an escalating sovereign debt crisis in Europe, which has for now overshadowed investor concerns about public finances and reforms in the US and Japan. The time for muddling through is over, Zoellick said. If we do not get ahead of such events; if we do not adapt to change; if we do not rise above short-term political tactics or recognise, then we will drift in dangerous currents. Things have turned so bad that some of the European countries now want China to bail them out by buying their sovereign bonds. The fear of the euro zone breaking up became so real that US Treasury Secretary Timothy Geithner had to rush to Poland to attend a meeting of the EU finance ministers last Friday. His mission, apart from assuring dollar support, was to tell the bickering governments in euro zone to forget their differences and rise above the political agenda to stop a euro zone break-up. Banks downgraded The European financial crisis further aggravated as the credit rating agency Moodys downgraded the long term debt ratings of two large French banks: Societe Generale SA and Credit Agricole SA have put BNP Paribas under review for downgrades. This in turn has seen huge pullout of funds from European banks by the US money market funds. As a result, Euro sharply lost its value against dollar in the last one week. The situation reached such alarming proportions that the European Central was joined by four central banks, namely US Fed Reserve, Bank of England, Bank of Japan and Swiss National Bank, to make dollar available from their resources so that acute dollar shortage does not lead to a landslide fall Euros value. These developments have raised the most disturbing question: Will euro zone survive? While efforts are on to keep it intact, many believe that Greece may soon dropout from the club and, in turn, will trigger the dismantling of euro zone. According to a recent Bank of America Merrill Lynch survey of global fund managers showed that around 38 per cent of the managers are underweight on Europe, a level last seen at the time of 2008 financial crisis. The economic growth in the euro zone is expected to be near zero in 2011. Things are equally gloomy on the other side of the Atlantic. The US economy is growing abysmally slow, unemployment rates are very high, the US Presidents call for a fiscal stimulus package of $450 billion is facing stiff opposition and the debt-ridden governments deficit is ballooning as US has spent around $4 trillion on Iraq and Afghanistan. Impact on India The crisis in the Europe and US is already affecting India in many ways. Firstly, it is affecting us

through the monetary route as euro is losing value, dollar is becoming more expensive. This, in turn, means Indian currency is losing value against dollar. Recently, when rupee touched 48.01 against dollar, it was the lowest level in the last two years. Our large trade deficits, resulting from imports being far greater than exports, have made the things worse as the trade is funded with large buying of dollars. One of the main reasons for the last weeks petrol price hike was the fall in rupee making imports costlier. As expensive imports of petrol, diesel, cooking gas, fertilizer, etc, add to the general inflation, the Reserve Bank of India (RBI), as a counter inflationary measure, keeps raising interest rates. Continuous hike in interest rates, the one last week was the 12th one in the last 18 months, has already jeopardised Indian industry and led to a slowdown in credit off takes from banks. The purpose of taming the rising inflation was not served but it lead to a further slowdown in investments and industrial growth. Even as RBI justifies this rate hike to dampen inflationary expectations, it is difficult to fathom that this will be achieved when a cumulative rate hike of 325 basis points since March 2010 could not achieve this objective, Ficci Secretary General Rajiv Kumar said. Growth in industrial production slipped to a 21-month low of 3.3 per cent in July. The countrys economic growth also moderated to 7.7 per cent during the April-June quarter this fiscal, the slowest growth in six quarters. The industry bodies are also worried that expensive loans will further contract demand for car and home buying. The market has already slowed down. This latest hike will further dampen the auto sector. It will dampen demand during the festive season. The RBI should have given a break, at least this time, GM India VP P Balendran said. When the economic growth slows down, a country also becomes unattractive for investment. No wonder the foreign direct investment (FDI) in the country has dropped significantly in the last few months and the stock markets are seeing flight of foreign capital as the FIIs are selling their holdings in hoards.

http://www.smedirectory.in/Articles/Impact_of_Current_ Financial_Crisis_on_Indian_Service_Sector_SMEs.asp x

Impact of Current Financial Crisis on Indian Service Sector SMEs

by Chandrakant Salunkhe President, Small & Medium Business Development Chamber of India Email: smechamberofindia@vsnl.net

T
the

global economic meltdown of 2008 had thrown world in economic depression, which was

mainly due to the subprime mortgage crisis that affected the US economy. The 2011 crisis in the US was mainly because of possible US default as the country's legal debt limit or ceiling of $14 trillion had reached 97% of its GDP ($14.5 trillion) in May 2011. Though US Congress initially disapproved to extend the ceiling, it agreed on the extension. However, the major economic shock came when Standard & Poors (S&P), global credit rating agency downgrade US ratings from AAA to AA+ which meant that US treasury bonds which were considered to be safest security in the world were rated lower than bonds issued by Britain, Germany, France and Canada. The rating downgrade also raised the cost of borrowing for American Government, companies and consumers which had direct implication on the world economy as the world largest consumer was thrown in the economic crisis. On the other hand, Euro crisis was mainly due to ever increasing public debt; however the roots of the crisis go much deeper primarily, giving up their sovereign ability to manage their own fiscal and monetary policy and leaving it to the Connect To Us

whim

of

the

Union;

and

secondly

loss

of

competitiveness that has been associated with Euro adoption in countries like Greece, Ireland, Italy, Portugal and Spain (GIIPS). The starting point for the Euro Crisis were the Greek politicians and borrowers who played a significant role in both increasing the debt the nation as well as concealing the actual debt numbers. Also the loss of competitiveness amongst the GIIPS countries is attributed to sequence of events:

The adoption of Euro by GIIPS countries which led to large fall in interest rates and a surge in investors' confidence as inflation and interest rates converged to those of Europe's northern core countries.

Increase in domestic demand, thereby raising the prices of non-tradable activities relative to tradable goods and services; and wages relative to productivity.

A rapid acceleration in growth in GIIPS was primarily driven by domestic services,

construction and an expanding government spending. However the exports stagnated as a share of GDP; and imports and current account deficit soared due to economic

growth in GIIPS

All these factors contributed to very high debt both public and private. The Euro crisis threatens economic stability of not only Euro area alone but of the entire world. A weakened Europe implies slower export growth in

emerging

economies

as

well

as

the

financial

volatility. Emerging economies like India have been impacted by the Euro crisis through three key channels: sovereign First debt is the impact for on the cost of financing these emerging

economies; Second is the trade channel which is driven by the effect of reduced growth in some European countries on import demand for goods and services from India and other emerging economies; and Third is the impact of debt crisis on the global financial sector and the consequent effect on the provision credit to regional banking and financial sectors. Impact of the Crisis on Indian Services Sector SMEs Indian SMEs, both manufacturing and services sector SMEs, play a pivotal role in shaping the economy of India and putting it on a high growth rate. The table below summarizes the contribution of Indian SME Sector:
Impact of Euro crisis on Indian Services Sector SMEs can be summarized as follows: Exports: The Euro crisis has stalled the major economies of Europe including those of Germany, France and Britain which has resulted in slowdown of

demand from Europe - a market that consumes 27% of emerging economies exports. Further Euro has got devalued more than 20% against dollar since November 2009 which has reduced the profitability of exporting to the European market. European Union accounts for 20.2% of India's exports and US for another 10.9%. The slowdown in these

two markets that account for almost one third of India's exports has led to the drop in export revenue of India's services SMEs. Capital Flows: The low policy interest rates are being maintained by the

European Central Bank because of Euro crisis. Similarly low rates in Japan and United States combined with low growth in Europe have led to the capital inflows in India and other emerging markets. This has led to inflationary pressures in India.

This has increased the input costs for services SMEs, who in order to maintain their competitiveness, have found it difficult to raise the cost of their services in comparison to their larger counterparts. This has led to erosion of their profitability. Depreciation of Rupee: Slow growth in Europe led to subsequent depreciation of Euro against the US Dollar. Investors, rather than betting on recovery of Euro Zone found safe haven in US dollar which enabled US dollar to appreciate as compared to other currencies of the world. Dropping exports coupled with rising crude prices created upward pressures SMEs on Indian in Rupee which services in to turn their depreciated with respect to US $. Indian services engaged providing overseas clients and who had hedged against the dollar at a lower value, have witnessed reduction in profits. Market Volatility: Euro Crisis has added to the volatility of global financial markets which in turn has impacted the Indian financial markets too. High rates of inflation have led to increase in interest

rates by Reserve Bank of India. RBI has raised interest rates 13 times since last 20 months. Further volatility in the international markets have led to high bouts of risk aversion by the investors and they have responded by investing in relatively safer bullion market thus increasing the price of gold and silver, thereby pushing the inflation rate still higher. This has increased the cost for these small enterprises in turn affecting their profitability. Credit Availability: Rise in key policy rates (Repo and Reverse Repo) by RBI in order to control the inflation has made loans costlier. This has affected the credit available to enterprises for running their operations. Rise in interest rates has also severely impacted Indian SME sector as the loans have become dearer to them by 3.5% in last 20 months, thereby impacting their input costs & profits. Also the Indian banks have been risk averse in forwarding credit to Indian service sector SMEs as banks have found service sector SMEs to be less credible than the manufacturing sector SMEs. Slowdown in the Manufacturing and Services sectors: Due to the contraction in the European and the US markets, the demand of goods and services from the emerging This these markets has has slowed down got down Indian severely considerably. operating in slowed have

manufacturing and services sector. Indian SMEs sectors impacted due to this slowdown, coupled with high inflationary pressures that increased the cost of raw materials and other input costs. The inflationary pressures have forced the manufacturers and service providers to pass on the cost price rise on the end consumers, thereby

increasing the cost of final product. Indian SMEs especially are losing there competitiveness to their larger counterparts due to high price of final products. Further the slowdown in manufacturing activities has further affected the services sector SMEs who depend on manufacturing sector for their business activities. Financial crisis like the ongoing US and Europe debt crisis impacts unevenly on industries, countries, regions and firms. Therefore there is neither just one way that the crisis affects the businesses nor there is any particular best way to adapt to crisis situation that are applicable to all businesses. Under such uncertain circumstances there is no particular strategy that can guarantee survival or success. Much of it depends on factors like business resources and relations with business stakeholders partners, competitors, customers, suppliers, government and others. SME Directory

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