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2020: A Stroll Down the 2008 Memory Lane?

From the great recession to the great pandemic: a comparative analysis of the prevailing economic scenario to the financial and global chaos of 2008.

The dawn of the new decade is yet to see its brightest sunshine. While many were ready for a fresh start, the year 2020, on the contrary, has been a series of turmoils and tribulations. As governments globally fight the raging battle against COVID-19, we find ourselves amidst a sudden standstill. Volatile markets, fall in investment and consumption, deadstop in the travel and tourism industry amongst others are the banes that 2020 has brought upon us. On similar lines, 2008 saw unsustainable levels of debt, lack of credit quality and liquidity, stock market crashes, etc which led to a global recession. Irrespective of the uncertainty that exists in this sphere, these current convulsions are reminiscent of the aftermath of the 2008 global financial crisis.

Impact on the real estate sector

Lying at the heart of the 2008 financial crisis was the real estate sector and the mammoth amount of loans that were being availed by the people in the USA to purchase houses.The main aim of the financial sector was to maximize profits by granting loans at extremely low interest rates (teaser rates) and entering into mortgage agreements for housing ( knows as mortgage backed securities). Initially, due to the high degree of demand for housing, the real estate prices in the cities almost skyrocketed, also making it one of the best mediums of investment for the common people. However, due to a large degree of deregulation and securitization in the industry clubbed with high degree of defaults by borrowers on their loan obligations (as they were financed by banks in the absence of necessary credentials), the real estate prices immediately crashed. Thus, with respect to mortgage backed securities, the american financial sector suffered enormous losses as they were neither able to recover the requisite loan amounts, nor were they able to sell the houses (collateral) at fair prices.

The tremors of these cracks in the American financial system were severely felt in the Indian real estate market. The RBI put strict restrictions on Indian banks to finance real estate loans and imposed an extremely high rate of interest for borrowers, discouraging them to avail credit. Moreover, investors started pulling out their money from real estate investments. This resulted in an imbalance in demand and supply causing a staggering fall in the Indian housing prices. Catching up to current times, the pandemic has barely had any impact on real estate. With regulatory reforms, steady demand due to rapid urbanization, increasing household income and affordable housing, the Indian housing sector is set to reach $180 billion by the end of 2020.

Impact on the stock markets, banking sector and employment

The subprime mortgage crisis in 2008 caused the american financial bubble to burst. There was a sudden decline in financial assets, sovereign defaults, banking panics which eventually led to a stock market crash (Dow Jones fell by 777.69 points in intra day trading). The impact of the same could be reflected in the form of collapse of investment banks, declaration of bankruptcy by Lehman Brothers and money market funds losing $196 billion (shown in the graph above). The large degree of consumer debt, negative returns on securities and a liquidity crunch in the economy led to a run on the bank, completely eroding customer confidence in the financial system. In response to this, the BSE Sensex also crashed as a large number of companies had investments in the American market and heavily relied on FDI. The Indian stock market experienced sustained capital outflows, frantic and relentless selling, high degree of volatility, and negative interest rates: the market saw the worst fall in its history.

With the 2008 recession substantially curtailing business activities, the unemployment rate jumped to a scary 18.25%, leading to an oversupply of labour. It became increasingly difficult to find jobs, labour productivity slumped to 5.20% and the employment elasticity dropped to 0.01. On the other hand, the Indian banking system was barely impacted: the global exposure of the Indian banks was relatively small, with international assets only 6% of the total assets. This low exposure clubbed with a minimal default ratio (NPA ratio in 2008 stood at 6.20%, Capital Adequacy Ratio was 19.31% and credit-deposit ratio was 77.51%.), absence of complex financial products and proactive liquidity measures enabled the banking sector to show high economic growth.

As the current scenario dictates, Sensex has crashed over 38% since March of this year. Many leading market analysts believe the 2020 stock market crash even worse than that of 2008. With the entire economy coming to a standstill, fall in consumer demand, decline in affordability, many companies find themselves with an impending crisis hovering over their head, struggling to survive. Due to this, the unemployment rate at 23.34% is amongst the highest India has ever seen, the labour productivity slumped to 5.23% and the employment elasticity at 0.2 is almost synonymous to that of 2008. From the banking point of view, the magnificent fall in the indices have led to an increase in NPAs by 8.5% while the capital adequacy ratio stands at 13.3% and the credit-deposit ratio is 73.12%.

Tremors in the oil markets

As the world sputtered to a sudden halt amidst the 2008 crisis, Oil prices dropped from $144.29 in July 2008, to $33.87 in February 2009 and liquid natural gas prices fell from $14 to $4 during the same period. On the contrary, the ramifications of the oil market in the current year are far worse than that of 2008- the oil market in 2020 has been turned on its head due to the price war between Russia and Saudi Arabia, and the sharp global economic downturn spurred by the pandemic. Due to the restrictions on travel, US oil prices turned negative for the first time on record in April 2020 after oil producers ran out of space to store the oversupply of crude. As the stockpiles of crude threatened to overwhelm storage facilities, the price of US crude oil crashed from $18 a barrel to -$38 in a matter of hours. This triggered a drop in crude oil production by ONGC and Oil India by 1.97% and 5.66% respectively.

Policy reforms and measures to control the crises’

With multiple challenges emerging from different fronts, the government and Reserve Bank had to look into containment of inflation, steadiness of growth, soundness of the financial institutions, ensuring normal functioning of the credit market etc. In the first half of 2009, the policy challenge was to deal with high inflation and emerging signs of cyclical slowdowns while the second half had to deal with the adverse effects of the crisis. The stress conditions posed a question on the stance of the Indian monetary policy: any withdrawal of monetary accommodation would weaken recovery, however large borrowing programmes and high fiscal deficits had accentuated inflationary pressure. An inability to control inflation and stabilize growth would lead to a sustained depression in aggregate demand, erode the disposable income of the masses, and lower the demand for credit and commodities in the economy.

In response to the global contagion, the government followed a growth supportive fiscal stance which included deviations from the fiscal consolidation path. Furthermore, the monetary policy stance remained accommodative by ensuring ample liquidity in the system (it involved lowering the cost of credit by dropping interest rates). While the swift and necessary responses of the government and RBI ensured orderly functioning of the financial system, the absence of direct exposure of the Indian economy to the troubles assets and stressed institutions of advanced nations enabled India to largely escape the heat of the crisis.

While the 2008 crisis forced the government and RBI to overhaul and relook into the functioning of the economy, the pandemic invited a greater number of policy measures and regulatory changes. In order to ease the financial stress that the COVID-19 disruptions had created, these initiatives did not only have to be swift, but also robust. The vast changes include extension of time for payment of imports, refinance facility of ₹15,000 crore for Small Industries Development Bank of India to meet the long-term funding requirements of small industries, and temporary tax waivers. To further boost the economy, the government has introduced a Voluntary Retention Route which facilitates long term and stable foreign portfolio investments in debt while offering operational flexibility of instrument choices. Moreover, with a view of promoting the country’s international trade, the government is bestowing export credit by increasing the period of realization and repatriation for export proceeds and providing financial assistance to exporters and importers with the help of EXIM Bank.

Even though the 2008 crisis and the 2020 pandemic seem at crossroads with each other, the two are significantly divergent. While the recession of 2008 was systemic and first took hold of the financial system, the 2020 pandemic is a cyclical crisis that has brought the entire world to a standstill. Furthermore, there is a major difference with respect to the underlying reasons, magnitude of repercussions, sectors impacted etc. This leaves us to see what the rest of the year holds for us and in which direction the pandemic takes the world.