THE 2008 SUBPRIME CRISIS AND THE INDIAN ECONOMY*

In 2008, the subprime crisis first hit the United States housing market, and the contagion
spread across world, resulting in a negative world economic growth rate of (−)0.7 per cent in
2009.1 Although the crisis originated in developed nations, it had a devastating impact on the
export sectors of emerging economies as well as their financial markets. India’s GDP growth
dropped from 9.3 per cent in 2007-8 to 6.7 per cent in 2008-9 (see Table 1). The growth rate
of India’s services exports dropped to 12.5 per cent in 2008-9 from 22.4 per cent in 2007-8, 2
and the growth rate of India’s total exports dropped to 13.7 per cent in 2008-9 from 28.9 per
cent in 2007-8.3 India’s benchmark stock index BSE Sensex crashed from its peak of over
20,000 to 8,995 (monthly average) in March 2009 (see Graph 1). The Index of Industrial
Production also remained very volatile between mid-2008 and mid-2009, recording negative
growth rates in some months (see Graph 2).

Table 1: Annual Percentage Change in Key Economic Indicators

Indicator 2007-8 2008-9 2009-10 2010-11

Real GDP growth 9.3 6.7 8.6 9.3
Inflation (CPI based) 6.2 9.1 12.4 10.4
Growth of Imports (in US$) 35.5 20.7 -5 28.2
Growth of Exports (in US$) 29 13.6 -3.5 40.5
Note: All figures are for Financial Year April 1 to March 31.
Sources: 1. Economic Survey 2011-12, http://indiabudget.nic.in/; 2. Database of Indian
Economy, Reserve Bank of India, http://dbie.rbi.org.in/, accessed on April 11, 2014.

Graph 1: Monthly Average of Daily Closing Stock Index (BSE Sensex, Consisting of 30
Companies)

Source: BSE India, http://www.bseindia.com/indices/indexarchivedata.aspx, accessed on

April 11, 2014.

Graph 2: Index of Industrial Production — Monthly Data (2008 To 2010)

*
Prepared by Ganesh Kumar Niduagala, Professor & Rashmi Shukla, FPM Participant, IIM Indore for class
room discussion in IIM Indore.

1
Source: The Database on Indian Economy, Reserve Bank of India, http://dbie.rbi.org.in/,
accessed on April 11, 2014.

Monetary and Fiscal Policy Response

In response to this crisis, the RBI took various conventional and unconventional measures to
manage domestic and foreign exchange liquidity demand. From October 2008 to April 2009,
within a time period of seven months, RBI sharply reduced policy rates (i.e., repo rate — the
rate at which it lends to commercial banks) and the cash reserve ratio (CRR). The repo rate
was reduced from nine per cent to 4.75 per cent, by consecutively reducing it six times
(Graph 3) and the CRR was reduced from nine per cent to five per cent, by consecutively
reducing it four times (Graph 4). The RBI said that it was able to create a potential provision
of primary liquidity of the order of INR 5.6 trillion (10.5 per cent of GDP). 4 The reduction in
the CRR alone was able to inject approximately INR 1.6 billion of primary liquidity into the
system.5

The Central Govt. also implemented expansionary fiscal policy by cutting excise tax and
increasing spending particularly on social sector schemes. This reflected in increased fiscal
deficit (see Graph 5)

Expansionary monetary and fiscal policies resulted in quick recovery with IIP recovering
(Refer to Graph 2) and GDP growth bouncing back to 8.6% (2009-10) and 9.3% (2010-11)
(Refer to Table 1).

2
Graph 3. Changes in Repo Rate from 2007 To 2010

Source: The Database on Indian Economy, Reserve Bank of India, http://dbie.rbi.org.in/,

accessed on April 11, 2014.

Graph 4. Changes in CRR from 2007 to 2010 (With Specific Dates)

Source: The Database on Indian Economy, Reserve Bank of India, http://dbie.rbi.org.in/,

accessed on April 11, 2014.

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Graph 5. India’s Central Govt. Fiscal Deficit (% of GDP)

7
6
5
4
3
2
1
0
2005-6 2006-7 2007-8 2008-9 2009-10 2010-11 2011-12
Source: Economic Survey, Ministry of Finance, Govt. of India

4
1
IMF World Economic Outlook (WEO), September 2011, http://www.imf.org/external/pubs/ft/weo/2011/02/pdf/c1.pdf, accessed on
April11, 2014.
2
Indian Economic Survey 2009-10, Ministry of Finance, Government of India, http://indiabudget.nic.in/es2009-
10/chapt2010/chapter07.pdf, accessed on April 11, 2014.
3
Indian Economic Survey 2009-10, Ministry of Finance, Government of India, http://indiabudget.nic.in/es2009-
10/chapt2010/chapter06.pdf, accessed on April 11, 2014.
4
“Global Financial Crisis and Monetary Policy Response in India,” Speech by Deepak Mohanty, Executive Director, RBI, November
12, 2009, http://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=446, accessed on April 11, 2014.
5
“Global Financial Crisis: Causes, Impact, Policy Responses and Lessons 1,” Speech by Dr. Rakesh Mohan, Deputy Governor,
RBI, April 23, 2009, http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=417, accessed on April 11, 2014.