Growth, fiscal consolidation yet to return to pre-financial meltdown levels

A look at how the global financial crisis of 2008 affected the Indian economy

How did the global financial crisis of September 2008 affect the Indian economy? Looking back at how the events unfolded 10 years ago, it becomes quite clear that no other single economic event in several past decades has had as huge an impact on India’s macroeconomic fundamentals as the global financial meltdown.

Consider the following numbers. 

The Centre’s fiscal deficit had been brought down to a very respectable level of 2.54 per cent of gross domestic product (GDP) by 2006-07. This was a healthy outcome of fiscal consolidation efforts made in several years previously to bring the deficit down to less than three per cent of GDP.

But in 2008-09, fiscal consolidation took a major hit with the deficit surging to 5.99 per cent. This was the biggest single-year deterioration in the Centre’s fiscal health. Worse, by 2009-10, the Union government’s fiscal deficit had further widened to 6.46 per cent of GDP, the highest level since 1993-94. 

Clearly, the impact of higher expenditure and foregone revenues through tax concessions could be seen on the government’s finances. The government’s revenue expenditure went up from about 12 per cent of GDP in 2007-08 to over 14 per cent in 2008-09 and stayed at that elevated level even in 2009-10. Overall expenditure also went up from about 14 per cent to 16 per cent of GDP during this period. 

However, gross tax revenues declined from about 12 per cent of GDP in 2007-08 to 11 per cent in 2008-09 and further down to 10 per cent in the following year. This was largely due to a cut in central excise by four percentage points on all non-petroleum products in December 2008 and again by two percentage points in the mean Cenvat rate in February 2009. 

Economic growth fared no better in the year immediately after the global financial crisis of 2008. GDP at factor cost was growing at over 9 per cent annually for three consecutive years from 2005-06. But in 2008-09, growth experienced a steep decline to 6.7 per cent, thanks once again to the global financial meltdown. 

Worse, the decline in GDP growth was triggered by a sharp drop in the manufacturing sector’s performance. After maintaining double-digit growth in the three previous years, the manufacturing sector grew by only 4.3 per cent in 2008-09. 

If overall growth revived to 8.6 per cent in the following year, that was also due to the manufacturing sector bouncing back with an 11.3 per cent rise. The government’s decision on a fiscal stimulus and higher expenditure did play a role in reviving growth so soon after the financial crisis, but the impact did not last too long. 

On the balance of payments front, India’s current account deficit almost doubled to 2.3 per cent of GDP in 2008-09, compared with 1.3 per cent in the previous year. The deterioration continued for another five years, before the deficit could be contained and brought down to a sustainable level. 

The current account deficit rose to 2.8 per cent in each of the following two years – 2009-10 and 2010-11 – and then rose to the dangerously high levels of 4.2 per cent and 4.8 per cent of GDP in 2011-12 and 2012-13, respectively. It was finally brought down to 1.7 per cent by 2013-14, thanks largely to tight controls imposed on imports of gold and a relative softening of international crude oil prices. But the adverse impact of the global financial crisis on India’s balance of payments was too obvious to be missed. 

India's exports too suffered a setback though after a lag. Exports in 2008-09 were valued at about 15.4 per cent of GDP in 2008-09, but they fell to about 13.4 per cent in 2009-10. There was some relief in imports, as with declining international crude oil prices, India's imports too fell from 25.2 per cent of GDP in 2008-09 to 22 per cent in 2009-10. 

The impact on inflows of foreign direct investments (FDI) was similarly delayed. In 2008-09, the year of the crisis, total FDI flows actually increased by 20 per cent to $42 billion. But they fell during each of the two following years – by 10 per cent to $38 billion in 2009-10 and by 8 per cent to $35 billion in 2010-11. The recovery happened only in the years after that. 

The impact on inflows from foreign institutional investors (FII), however, was immediate. India saw its biggest FII outflows during 2008-09, estimated at $15 billion, compared to a net inflow of over $20 billion in 2007-08. The silver lining on this front was that FII inflows bounced back, surging to $29 billion in each of the following two years i.e. 2009-10 and 2010-11.  

Even retail inflation rose in the aftermath of the 2008 crisis. Retail inflation based on the consumer price index for industrial workers rose from 6.2 per cent in 2007-08 to 9.1 per cent in 2008-09 and further to 12.4 per cent in 2009-10. 

To be sure, the Indian government was fully aware of the likely consequences of the global financial crisis and the policy options it would have to exercise. 

On February 16, 2009, about five months after the global financial crisis had led to the collapse of several international financial institutions, the Indian government presented to Parliament its interim Budget for 2009-10. It was an interim Budget as the country was heading for general elections in May. But the Budget speech, presented by Finance Minister Pranab Mukherjee, will be remembered for long as it was perhaps the first comprehensive statement from the government on how the global financial meltdown had hit the Indian economy and what the course of action would be in the coming months. 

Mukherjee noted how there was a “severe choking” of credit as the financial crisis had led to a crash in stock markets across the globe. He also noted how the economic slowdown had intensified with the US, Europe and Japan sliding into a recession. He made no secret of the government’s assessment that the world economy could in 2009 fare worse than in 2008 and that, obviously, included India.

Indeed, soon after the financial crisis hit the world, the newly appointed governor of the Reserve Bank of India (RBI), Duvvuri Subbarao, took a series of steps aimed at easing the monetary policy and releasing liquidity into the economy. Thus, he cut the key policy rates that would help banks reduce interest rates. In six instalments, he cut the repo rate (the rate at which the RBI lends money to banks) from 9 per cent prevailing till October 2008 to 4.75 per cent by April 2009. He also reduced the cash reserve ratio and the statutory liquidity ratio for banks, so that they were left with more resources for lending. 

For its part, the government had also announced a series of measures to boost demand by cutting excise rates in two instalments on all commodities except petroleum products. Measures were taken to help India’s exports withstand the adverse impact of a global slowdown, and these included the extension of export credit for labour-intensive exports, enhancement of pre- and post-shipment credit, additional allocation for refund of excise duty and export incentive schemes and removal of export duty as well as export ban on certain items. A committee of secretaries had been set up so that the procedural problems faced by the Indian industry could be addressed without any delay. 

The government’s response was evident in another crucial area. It decided to relax the targets of fiscal deficit reduction set under the Fiscal Responsibility and Budget Management (FRBM) Act. The objective was to use the fiscal room, secured through a relaxed fiscal consolidation time-table, to increase spending and create demand to meet the challenges posed by the global financial meltdown. 

Traditionally, interim Budgets do not dwell much on the government’s policy imperatives and actions. But the interim Budget of 2009 was different, coming as it did after the global financial crisis. Thus, the finance minister announced some immediate measures in the interim Budget to address the economy’s concerns. He extended the interest subvention of 2 per cent on pre- and post-shipment credit for a few employment-oriented export sectors like textiles, carpets, leather, gems & jewellery, marine products and small & medium enterprises till September 2009. 

Mukherjee’s interim Budget also cautioned that additional fiscal measures might have to be announced when a regular Budget would be presented after the elections and the pace of policy reforms, particularly in the financial sector, needed to be accelerated to make the regulatory and oversight systems more efficient and effective. The interim Budget also announced that additional expenditure to boost demand would be needed and that stimulus could cost the government anything between 0.5 per cent and 1 per cent of GDP. Such was the enormity of the crisis. 

In his interim Budget speech, Mukherjee had tried to justify the slippage in the fiscal deficit targets set under the FRBM Act. “Our government decided to relax the FRBM targets, in order to provide much-needed demand boost to counter the situation created by the global financial meltdown… However, the medium-term objective must be to revert to the path of fiscal consolidation at the earliest… We will return to the FRBM targets once the economy is restored to its recent trend growth path.”

But in spite of efforts by Mukherjee and two finance ministers who succeeded him, neither of the two goals has been achieved even after 10 years. The Centre’s fiscal deficit is yet to return to less than 3 per cent of GDP even for a year since 2007-08, when it was 2.54 per cent. And annual GDP growth is yet to cross the 9 per cent mark since it last touched that level in 2007-08. Such has been the impact of the global financial crisis of 2008!