Impact of Global Economic Crisis on the Indian Economy

Abstract

The sub-prime crisis that started in 2007 and limited to the US economy has created systemic problem throughout the global financial system following the collapse of a big investment bank. The real economic impact of this financial turmoil is expected to be very large. It has been officially stated that developed economies such as the US and the European Union are entering a recessionary phase. Even the world economic growth has been predicted to decline. The impact of this financial crisis on India is also going to be significant, as India is not decoupled with the global macroeconomic behaviour. The service sector, of which two sectors namely ‘trade, hotels group’ and the ‘financing, insurance group’, growth is strongly linked with the global economy. Hence, any decline in the global economic activity is expected to have adverse impact on the domestic services growth. On inflation front, this crisis indeed brought down the inflationary expectations as it led to decline in the world oil prices to around US$ 70 per barrel after reaching a peak of US$ 142 in July. This would have positive impact on the domestic economy through reduction in overall interest rate structure, which could stimulate domestic demand. On the external sector front, we might see a fall in the foreign exchange reserves due to outflow of short-term capital in the short term. Together with this, predicted fall in exports would result in weak rupee. But, given the strong domestic fundamentals, we do expect that this adverse impact is limited only to the short term and there would be resilience in the economy in the medium term once the demand and investments pick-up. On the reforms side, the significant adverse impact would be the possible shelving of much-awaited financial sector reforms that is expected to enhance financial inclusion.