Has India Been Decoupled from the Western World During the Subprime Mortgage Crisis Period.Why Was the Threat Not So Bad in India

MACROECONOMICS PROJECT

ON

"HAS INDIA BEEN DECOUPLED FROM THE WESTERN WORLD DURING THE SUBPRIME MORTGAGE CRISIS PERIOD.WHY WAS THE THREAT NOT SO BAD IN INDIA"

INDEX OF CONTENTS

1. INTRODUCTION

2. NATURE AND DIMENSION OF THE CRISIS

3. IMPACT OF RECESSION ON INDIAN ECONOMY-HAS INDIAN ECONOMY BEEN DECOUPLED?

4. MONETARY AND FISCAL POLICIES IMPLEMENTED DURING THE RECESSION PERIOD.

5. CONCLUSION

6. REFERENCES

1. INTRODUCTION:

THE CAUSES OF GLOBAL ECNOMIC CRISIS THAT EMERGED IN UNITED STATES OF AMERICA DURING EARLY 2008.

There are several underlying causes of the current global economic crisis. Firstly the United States and some other European countries enjoyed a prolonged boom in the property prices since the early 1990's right up to the end of 2006. People began to believe that real estate prices can only go up north bound and not otherwise. This led to the massive amounts of lending by banks for home purchases, often to borrowers who did not have jobs or steady incomes. Many of the borrowers were subprime or more simply not credit worthy.

This housing bubble was a part of the massive borrowing in US and other European countries by households and financial institutions that was fuelled by the "easy money" policies of their central banks and huge inflow of funds from capital surplus such as China, Japan, Germany and oil exporters. These big oil exporting nations sold their products to American and European consumers and then parked their surpluses in American and European government securities. As an indication of huge borrowing, the ratio of gross debt to GDP of US households, businesses and government more than doubled from about 160% in 1982 to 340% in 2007.Most of the massive increase in borrowing was accounted by households and financial firms.

Thirdly,this huge increase in borrowing was encouraged by rapid financial innovation which reduced and transferred the risks (defaults) by borrowers such as subprime home loan borrowers. These financial innovations spread the risk of the underlying weak credits throughout the western financial system. Warren Buffet has termed these financial instruments as "weapons of mass destruction". This explosion of financial innovation fuelled excess growth of the finance industry and built and enormous house of financial cards on a weak base of credit risks.

An important reason why this massive expansion of complex financial products built on a foundation of very shaky housing loans could go on for many years is because of a growing culture of weak regulation of financial institutions and markets that prevailed in the western countries for the past two decades.

This huge increase in unregulated borrowing and excessive lending further increased the asset price bubbles in housing, stock markets and commodity prices.

2. NATURE AND DIMENSION OF THE CRISIS

In winter 2006/2007 the housing prices went for a big toss and it started to fall very steeply for the first time in the past 15 years. Due to this many of the subprime housing loans became bad loans. This meant that hundreds of billions of dollars of financial derivatives which were based on the underlying mortgage loans also lost most of the value. Thus "house of financial cards" began to collapse and many American and European financial institutions incurred huge losses on their mortgage backed securities and investments. This process of financial collapse gathered momentum and came to a boil in September 2008 as major American investment banks like Lehman brothers collapsed. Some banks like Merilynch were saved because they got merged with some of the healthier banks like Bank of America. This resulted in the freeze of credit markets in US and Europe and transmitted the sudden squeeze in liquidity throughout the financial world. Governments in these countries declared massive bail outs of their banks and increased government spending to contain the impact of the rest of the economy.

In spite of the government declaring trillions of dollars of bail outs and fiscal stimulus, bank credit continued to remain