Today’s India is different from the India of 2008
The events that occurred in March this year took many of us back to the days of the Global Financial Crisis (GFC) of 2007-2008.
The GFC had seen the fall of many an iconic name that included Bear Stearns, Lehman Brother and AIG. The Citigroup survived mainly because of government intervention, and a bluechip name such while Merrill Lynch was forced into a merger with Bank of America.
In the month gone by we witnessed the fall of Silicon Valley Bank, which catered to the tech industry (~US$ 200 bn of assets) and a forced merger of Switzerland’s largest bank UBS with the country’s second largest bank Credit Suisse. Explaining the reason behind this hastily orchestrated weekend merger, The Swiss National Bank said Credit Suisse would not have survived another day given the challenges it was facing. In the US, the Federal Reserve invoked a rarely used exception to guarantee deposits, in excess of the legally permissible cap. Further, it provided a new liquidity facility to banks against securities held by them at par value rather than at their much lower market value. The Central Banks of the US and Switzerland used tactics — they had not resorted to earlier — to prevent a conflagration that reminded them of the grim events of the 2007-2008 crisis.
We in India are no strangers to stressed banks and the need to protect the interests of depositors. In 2020 private sector bank Lakshmi Vilas Bank (LVB) was merged with DBS Bank, wiping out equity holders of LVB while protecting depositors. In the case of Yes Bank Limited, intervention by RBI and the government protected depositors while inflicting costs on certain bond holders and equity holders. Plus, a consortium of leading banks stepped in with equity capital to stabilise the bank.
In theory, there are limits on the quantum of deposits that are insured/guaranteed by statute. In practice, it appears that the political economy across the globe does not favour inflicting such risks on deposit holders. Under this scenario, we are faced with the likelihood of stricter financial limits being placed on banks in the days ahead. This could come in the form of both limits on risk-taking, higher capital adequacy and more high-quality liquid assets or higher insurance costs. It is also a reality that a bank run escalates faster in the digital age than it did in the physical world. This realisation is also likely to feed into the methods that regulators use to stress test liquidity at banks.
It is too early to define what direction regulations will take, but regulators across the world will look to implement rules based on their experience and their understanding of the root causes and fragilities that drove the panic of March 2023.
A comparative study
With that out of the way, let us take a more studied look at how the current macro environment, including economic indicators, flows and valuations, compares to the period of the 2007-2008 GFC.
There were 15 successive quarters of growth of over 8% from 2005 to 2008, with some nearing 10%. In contrast, the growth has been more sporadic since FY19, with sudden steep contractions and growth values in between and a moderate 4-6% growth in other quarters. Another essential factor is that despite the rollercoaster growth we have witnessed since FY19 (due to COVID), the absolute numbers have not moved much. The CAGR since 2019 for real GDP growth is a mere 3.4%. During the GFC, the brakes were slammed hard and abruptly on a fast-moving economy. This time the velocity is slower but also more stable and hence a global slowdown is not expected to drastically affect India’s economy, which has just started to pick up.
Inflation had constantly increased in the lead-up to the GFC and has also increased in the current year, but the reasons are different. The scale is also significantly different with India experiencing double-digit inflation in the run-up to the GFC alongside high growth.
Inflation in 2008 was driven by surging demand, whereas inflation in 2022 was high due to supply- side shocks and rising crude/ commodity prices. During the GFC, inflation had rapidly declined from 11.4% in Oct ‘08 to 7.8% by April ‘09 and later started inching up as growth returned. The path this time will be different because of the difference in scale (with recent prints around the 6% mark) and because of different underlying causes.
Inflation in the US is being driven significantly by labour shortages even as good inflation is tapering, raising concerns over a slowdown. India’s inflation is more goods-centric and hence the global slowdown may favour a gradual tapering in India in line with the RBI forecast that expects inflation to decline to 5.20% in FY24.
Even though repo rates were high heading into FY09 and FY23, the repo rate increases were more spread out before the GFC. The rates started increasing in 2004 from a level of 4.5% and peaked at 9% in Oct 2008. This time, the increase from 4% to 6.5% happened within 11 months. Also, the rates are now merely back to their 2019 levels, while in 2008, those were the highest in the decade. With the current banking segment developments in the US, the rates are expected to peak soon and fall afterwards, in line with Fed projections for CY24 and CY25. This will create issues, as inflation is expected to remain high when rates start falling. This will also restrict the extent of policy rate cuts, which will be smaller than in 2008 in the US when rates had dropped to near zero.
In India, the inflation targeting regime with a target of 4 plus or minus 2% came into existence much after the GFC. This policy regime is likely to limit the scope for rapid rate cuts in India as well.
Heading into the GFC, the overall capex cycle was very strong. The GFC impacted the growth of capex for a year in FY09, but it recovered swiftly as the economy was supported by fiscal and monetary policy along with credit growth. This situation is different now, with the capex cycle showing early signs of strength after a prolonged period of sluggishness.
Source: MOSPI, Bernstein analysis, Government estimates
The declining inflation during GFC can also be attributed to the fact that credit growth declined in a similar fashion, eroding demand. Credit growth, which had been strong heading into both phases, suffered materially during the GFC. Between Oct ‘08 and Oct ‘09, the non-food credit growth slowed from c29.7% to 9.2% but it recovered strongly by 2011. This time, it has risen from very low levels ofc 5.5% in 2019 and is running at a more sustainable low to mid-teens trajectory. While the growth may come down from the current levels of c15.6%, given this sector’s recently gained momentum, it will be protected from a GFC-like fall. The NPA cycle is witnessing a continued improvement trajectory and the risk to bank credit growth appears limited in the near term.
Forex reserves and currency exchange rate
India's currency saw a long period of appreciation before the GFC, helped by strong FDI inflows, which grew over 7.5 times between FY05 and FY08. It also ended up building a strong forex reserves kitty, which swelled from c97 billion in November 2003 to c315 billion by May 2008.
The performance has been weaker this time. While the currency has been consistently depreciating, foreign exchange reserves have declined since reaching a lifetime high in August 2021. RBI sold dollars to arrest the decline in rupee throughout 2022. Fears of a global recession are driving a reduction in commodity prices. The services sector in India is now larger and the improvement in Current Account Deficit (CAD) will help the currency a bit, limiting the room for any wild depreciation.
We often talk about the structural difference between the ownership pattern of the markets today vs the situation in 2007. This is borne out rather starkly by the data below. The aggregate stake of FPIs in the market (S&P BSE 200) at 21.4% is higher by 1% in December 2022 vs December 2007. The stake of Mutual Funds has climbed from 3.8% to 8.3% leading the total ownership of Indian institutions (MFs + Insurance + Banks/FIs) to rise to 14.9% from 10.3%.
Ownership Pattern (%)
- We have prepared above data on S&P BSE 200 Index.
- FPIs include ADR/GDR
- BFIs include banks, financial institutions and insurance companies
- Others include entities such as corporate bodies, HUF, NRI and trusts
Source: Prime Infobase, Kotak Institutional Equities
This difference made by the rising participation of Indian investors in the market is reflected in the data below. In the 12 months ended December 2008, buying of equities by Indian MFs amounted to US$3.2bn, this was overwhelmed by FPI selling to the tune of $12.92bn. However, in the 12 months ended December 2022, net buying of equities by domestic MFs amounted to $23.95bn, with FPI selling of $17.01bn.
Flows (US$ mn)
Source: Bloomberg, Kotak Institutional Equities
This difference is accounted for by the rising appetite for mutual funds from Indian investors. As per AMFI data, flows into MFs amounted to $22.77bn during the 12 months ended December 2022 vs $7.2bn for the 12 months ended December 2007.
No discussion about the market can be complete without valuations. In December 2007, the Nifty 50 was trading at 19.4x 12 months forward consensus earnings before the breakout of the full-blown crisis that was to be the GFC. On February 28, 2023, the Nifty 50 was trading at 17.78x consensus forward earnings.
However, we have to be on guard for further escalation and fragilities that could get exposed in the financial system. The banking panic of 2023 in the US is happening in an environment wherein India finds itself better placed.