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Global Banks incur losses as troubles of the American economy deepen. Loans given by them to American home-owners are not repaid. They have to resort to sale of shares in the Indian markets to raise money to meet these losses in the US. The decline in
Indian share markets in the last two weeks started with such a sell off by foreign banks.

The Government of India is concerned that global black money is being invested in Indian share markets. The recent clamp-down on Promissory Notes was made to prevent such inflows. The decline of the dollar has forced global investors to look for another place to invest their capital. The Saudi Royal Family, for example, is earning huge amounts from the sale of oil due to high prices that are prevailing. Till recently, they were investing this income in New York. But this will now flow to Mumbai, and Indian share markets will glow. Remember the Indian share markets have been scaling new heights as the US economy has been sinking in the last two years. Surely, Indian share markets jitter every time bad news comes from America.

Impact of the Crisis on India

While the overall policy approach has been able to mitigate the potential impact of the turmoil on domestic financial markets and the economy, with the increasing integration of the Indian economy and its financial markets with rest of the world, there is recognition that the country does face some downside risks from these international developments. The risks arise mainly from the potential reversal of capital flows on a sustained medium-term basis from the projected slow-down of the global economy, particularly in advanced economies, and from some elements of potential financial contagion. In India, the adverse effects have so far been mainly in the equity markets because of reversal of portfolio equity flows, and the concomitant effects on the domestic forex market and liquidity conditions. The macro effects have so far been muted due to the overall strength of domestic demand, the healthy balance sheets of the Indian corporate sector, and the predominant domestic financing of investment.

As might be expected, the main impact of the global financial turmoil in India has emanated from the significant change experienced in the capital account in 2008-09 so far, relative to the previous year (Table 1). Total net capital flows fell from US $ 17.3 Billion in April-June 2007 to US $ 13.2 Billion in April-June 2008. Nonetheless, capital flows are expected to be more than sufficient to cover the current account deficit this year as well.

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* Contributed by: -
Sunil Kumar Panda,
PGDBM, 1st Semester,
Fortune Institute of International Business, New Delhi.
Article posted on Fenruary 14, 2009.