In year 2008, The United States and the world economy faced a severe financial crisis and are still are convincingly out of threat of the imminent double dip recession. India has so far avoided a banking or financial crisis of the proportions witnessed in the United States and some other economies. However, there are definite indications of a slowdown in the Indian economy, especially in its industrial sector. This article examines the extent to which India’s macroeconomy ( and corporate sector in particular ) was hit by the global recession.
Taking cues from Ila patnaik's article in Indianexpress titled "figure of nine
"There was a strong notion among some part of academic community that India is decoupled from developed economy but it was proved wrong , there has been significant work done to show how business cycles of emerging economies are linked with the developed ones through trade link , capital flow link and banking . "
We see that the Indian economy is now a relatively open economy, despite the capital account not being fully open. The current account, as measured by the sum of current receipts and current payments, amounted to about 53 per cent of GDP in 2007-08, up from about 19 per cent of GDP in 1991. Similarly, on the capital account, the sum of gross capital inflows and outflows increased from 12 per cent of GDP in 1990-91 to around 64 per cent in 2007-08. With this degree of openness, developments in international markets are bound to affect the Indian economy.
India can obviously take comfort in the fact that the global financial troubles have not, so far, triggered a major banking crisis in India, as they did in the UK and a number of other countries. However, there are a number of worrying factors. First, there has been an outflow of foreign institutional investments (FIIs) from India starting in February 2008. The withdrawal of FII investments from India has created other problems in its wake. India’s stock markets have witnessed a major collapse. The Rupee’s value fell from Rs.39-40 to the dollar in January – April 2008 to more than Rs.50. India has been accumulating reserves in 2007. With the outflow of FIIs and depreciation of the Rupee, RBI tried to defend the Rupee by selling dollars. This has resulted in a depletion of foreign exchange reserves.
Econometric analysis suggests that financial crises have a greater impact on expenditure and the financing of corporate sectors in emerging markets than in industrial countries. Industrial countries appear to benefit from a pick-up in bond issuance in the wake of banking crises. Although companies in emerging market countries hold more precautionary liquidity, this is evidently not sufficient to prevent greater amplitude of response of expenditure to shocks (E. Philip Davis, Mark R. Stone, Journal of financial stability)
From the Indian corporate sector point of view important impact was the drying up of investment funds. The foreign source of funds for the domestic corporate is going to dry up. Corporate investment is going to decline during the next few quarters and perhaps sometimes for few years depending upon the speed in which global financial sector recovers. This is perhaps the most important way in which the present global financial crisis is going to affect our macro economy.Indian corporate over the last five years is living in an environment where there is easy exposure to sizable foreign funds. The corporate purchase of foreign funds in different forms – ECBs (External Commercial Borrowings), FCCBs, Depository Receipts and Exchangeable Bonds have facilitated the expansion activities of our corporate in organic as well as inorganic mode.
My attempts include analysing the effect on the following 4 points
.
We take the starting point as the macro-economic linkages between developed and emerging economies. Such macroeconomic indicator explains the overall corporate performance of a country y-o-y.
1) First , I examined the following
• How business cycles are synchronized between the developed countries ( US , Japan ,Germany &
UK) & India .We examine this through significant correlation between the GDP growths of these
Countries with respect to India. Reference The impact of the global financial crisis on business cycles
in Asian emerging economies Jarko Fidrmuc, Iikka Korhonen, Journal of Asian Economics.
• How strongly correlated is Indian financial market with respect to US market .For this we
calculate the correlation between US INDICES and BSE SENSEX .
2) Next I examined the impact of global recession on Indian economy (which in turn would explain the effect on corporate sector).
There were three ways of answering this question
• Capital Flow Link : To examine how fund flows to emerging markets and to India will change when interest rates and stock market returns change in the US.
I collected average return y-o-y on S&P Index of US , interest rate ( T-bill-91 days rate averaged over year), and the net fund inflow to India.
• Banking Link : Banking sector’s exposure to toxic assets. We do not study this because Indian banking sector is negligibly exposed to such toxic assets.
• Trade Link : How directly exposed are Indian exports to the US economy?. We find the trend in India’s export as a percentage of its GDP over the last decade .
3) Finally I tested extent to which corporate sector is hit by global financial crisis , by examining IIP growth numbers affected by the following explanatory variables like interest rate , Rs/dollar exchange rate , and net foreign fund flow
4) We also examine the financial ratios of BSE-100 indexed companies ,the companies included in it are market leaders and thus market representative of India’s corporate sector at large.We examine the trend in the movement of financial ratios before and during the global recession .
Results and Analysis
We anlyse data for the following objectives
1) How business cycles are synchronized between the developed countries & India
On examining the GDP data of developed economies vis-à-vis India.
The increasing weight of emerging countries, especially the trade shares of the largest emerging Asian countries (China and India), have led to faster global growth.
It is said that the pattern of business cycles in emerging Asian economies generally displays a low degree of synchronization with the OECD countries, which is consistent with the decoupling hypothesis. However, the current financial crisis has had a significant effect on economic developments in emerging Asian economies(The impact of the global financial crisis on business cycles in Asian emerging economies§Jarko Fidrmuc a,b,c,*, Iikka Korhonen Journal of Asian Economics). Correlation analysis is the most common approach for describing output synchronization between countries. Classical correlation is a standard measure of co-movement between time series.
By applying correlation on a macroeconomics perspective like the GDP we can make some deductions.
Countries No Of Years Correlation
India-Uk 10 0.89616
India-Japan 10 0.66117
India-USA 10 0.49096
These are the values of correlation between India and the OECD countries.
This shows a high correlation between India and UK markets followed by India and Japan and the least between India and the US. Thus it shows that the business cycle is especially linked between UK and India and somewhat between the US and India. Thus an economic turmoil in these countries can have an effect on the Indian economy and consequently the Indian corporate world through the effect trade linkages/capital linkages.
2) Correlation between US Indices & BSE Index.
• Dow Jones and BSE are more strongly correlated than S&P and Nasdaq
Correlation Summary
BSE & NASDAQ
S&P & BSE BSE & Dow Jones
Correlation
0.33 0.34 0.37
Performance Summary
BSE S&P NASDAQ Dow Jones
Average Return 0.037% -0.042% -0.019% -0.034%
Standard Deviation 2.43% 1.91% 2.08% 1.87%
All indices clearly showed that they had bottomed out in the month of February 2009 and then recovery process has already begun.
The study showed that there is always a link between stock prices and corporate finance, firms always attempt to increase their market value.
The financial downturn shrunk corporate India’s mobilisation of resources in the form of equity and debt.( capital raised through new issues grew by 158.5 per cent year-on-year in 2007-08, but fell by 82.5 per cent in 2008-09.) The decline was inevitable given the collapse of the stock market in 2008-09 largely as a result of the exit of foreign institutional investors.
3) Next we examine the impact of global recession on Indian economy ( Understanding the exposure of India to financial crisis )
Examining the links one by one
• Examining the Capital Flow Link :
To examine how fund flows to emerging markets and to India will change when interest rates and stock market returns change in the US.
We collect average return y-o-y on S&P Index of US , interest rate ( T-bill-91 days rate averaged over year), and the net fund inflow to India.
Attempted : To examine the effect of S&P avg return and interest rates on the amount of fund inflow in India.
Funds ( In crores) T Bills rate S&P rate of returns Funds ( In crores)
1999 5181 4.63 21.04 5181
2000 6789 5.81 -9.10 6789
2001 8151 3.38 -11.89 8151
2002 6014 1.61 -22.10 6014
2003 15699 1.01 28.68 15699
2004 15366 1.37 10.88 15366
2005 21453 3.14 4.91 21453
2006 29829 4.72 15.79 29829
2007 62106 4.35 5.49 62106
2008 21325 1.365 -37.00 21325
I found that Foreign Fund flow to Indian financial markets is effected by the rate of return an investor would get in US s&p and cost of borrowing the fund ( interest rate).
An investor would obviously ,invest in foreign market , in hope of higher returns
• Examining the Trade Link :
To what extent are Indian exports to the jitters across Globe?. We find the trend in India’s export as a percentage of its GDP over the last decade
We also analyse the effect of financial crisis on the export sector of india during the crisis.The Indian exports both products and service contribute about 24%(2008) to the GDP of India thus playing a pivotal role in the growth story of India. Huge increases in investment and a clear focus on creating the capacity to drive exports higher have worked in the sense of rising per capita incomes, ballooning trade surpluses and an increase in global economic influence. This could be a very important element in how the Indian economy will perform. export of goods as a percent of GDP has risen rapidly from just above 5 percent to 14 percent in 2006-07. In other words, exports have grown much faster than GDP. Services exports have risen even faster. As a result, when goods and services are considered together, we find that at around 25 percent, India exports are around one-fourth of its GDP. A slowdown in global trade and exports is thus unlikely to leave India unaffected.Consequently affecting the BPO, ITES and textile industries.
The above figure clearly shows that India’s dependence on Exports have risen greatly. Starting from around 12% in 1999 it has doubled to 24% in 2008. It has effected the Indian economy by creating Jobs and wealth. Considering the other people who are indirectly associated with the textile industries, total direct and indirect job losses were expected to reach 6 million.
To rub the salt the rupee appreciation hit back at the profit margins of firms.
4) We test extent to which corporate sector is hit by global financial crisis
attempt : To examine the extent to which industrial growth ( measured by IIP numbers) is affected by the foreign fund inflow , foreign exchange rates, and the interest rates.
We know that , Indian corporate over the last five years has been living in an environment where there is easy exposure to sizable foreign funds. The corporate purchase of foreign funds in different forms – ECBs (External Commercial Borrowings), FCCBs, Depository Receipts and Exchangeable Bonds have facilitated the expansion activities of our corporate in organic as well as inorganic mode.The sudden shock of financial crisis momentarily ebbed the flow of funds
Year YOY Industrial growth Exchange rate Funds Inflow
1995 9.1 34.35 4892
1996 13 35.915 6133
1997 6.1 39.495 5385
1998 4.1 42.43 2401
1999 6.7 43.605 5181
2000 5 46.64 6789
2001 2.7 48.8 8151
2002 5.7 47.505 6014
2003 7 43.445 15699
2004 8.4 43.755 15366
2005 8.2 44.605 21453
2006 11.6 43.595 29829
2007 8.5 39.985 62106
2008 2.8 50.945 21325
Result : We see how Industrial growth is significantly affected by the amount of foreign fund inflow at a given exchange rate
5) Examining the financial ratios of companies included in BSE-100 Index, ( representative set of 84 companies for India’s corporate sector)
Years/Fields 2009 2008 2007 2006 2005
Core EBITDA Growth(%) 19.78 63.6 65.07 40.93 33.39
EBIT Growth(%) 35.25 69.04 77.24 43.11 28.02
PAT Growth(%) 8.11 68.71 69.86 46.81 49.39
Total Debt/Equity(%) 76.64 67.85 68.73 65.6 63.31
EBIT Margin(%) 104.75 106.82 101.55 98.08 97.67
Total No. of Companies 84 84 84 84 84
From the graphs we can clearly see that , the recession had its significant effect on the balance sheets of companies eating away EBIT and PAT growth. However , since Indian firms are less leveraged the effect wasn’t as severe as in west. But , short-term borrowing costs ,did increase significantly.
Conclusions and Policy implications
Conclusions
1) India’s economic cycle is significantly in synchronization with developed economies
2) India’s exposure to the risks of global crisis can be tested through both trade (export-import) link and the capital flow link. We find that India’s share of export as a percentage of GDP has significantly increased over the years making it even more prone to global shocks. Industries such as IT, BPO , Textile are all prone to foreign demand declines and the rupee appreciation that follows in course of such global downturn
With respect to capital inflows link : fund flows to India will change significantly when interest rates and stock market returns change in the US .
3) Infact, even financial markets (India’s and US) are significantly correlated , matching each other’s movement.
4) Recession weighed heavily on the PAT and EBIT margins of Indian companies, due to decrease in global demand ,especially in services sector ( that is not as much fuelled by domestic demand as by foreign demand)
5) Industrial growth is dependent on such short –to-medium term borrowings( foreign fund inflows) ,foreign exchange rates, and the rate of interest .
Policy implications
In open economies, we must equally focus on domestic demand which may help in insulating the economy from adverse external economic shocks.
That is to build up internal demand. China whose export reliance has increased year by year has started to change policies to drive domestic demand. India which has a export value of 24% of GDP needs to drive domestic demand.
• Limitations of the study :
• To analyse the business cycle synchronization between India and developed world , we have used Classical correlation is a standard measure of co-movement between time series. Unfortunately the classical correlation has drawbacks: An alternative measure of synchronization in the case of business cycles is dynamic correlation.
• The study doesn’t include the testing of corporate earnings before and after 2008 , through dummy variable , because of the lack of sufficient data ( within our reach) beyond q1,2009.
References
1) examined the decoupling hypothesis through published research papers .Work of Jayaram, Shruthi, Patnaik, Ila and Shah, Ajay (2009) "Examining the decoupling hypothesis for India" , National Institute of Public Finance and Policy, New Delhi.
2) referred the “The impact of the global financial crisis on business cycles in Asian emerging economies” by Jarko Fidrmuc &, Iikka Korhonen published in Journal of Asian Studies.
acknowledgement
Special thanks to Amartaya Kundu ( MBA-MS batchmate ) for GDP data , and export link ( trade link ) data .
Sources of data
DU e-resources
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