10 years after global financial crisis, India’s fiscal deficit still not back to pre-crisis levels

On September 15, 2008, America’s fourth-largest bank Lehman Brothers filed for bankruptcy, setting off a financial firestorm that demolished global stock markets and pushed the world economy into a once-in-a-generation crisis. Here’s a look at what happened then and its impact on India and the world.

India

India, which had been riding an unprecedented boom before the crisis, was also hit badly by the 2008 contagion which originated in Wall Street and swept across the world.

Gross domestic product (GDP) growth had been more than 8% in the five preceding years before the crisis erupted. It fell sharply immediately after the crisis. In 2007-08, India’s GDP was at 9.32% which fell to 6.72% in 2008-09.

The Sensex plunged from 21,000 points to 8,500 in three months. A combination of monetary and fiscal stimulus – basically, cuts in taxes and interest rates, and more government spending - spurred a temporary recovery but widened the fiscal deficit, which was 2.8% in 2007-08 and went up to 6.5% in 2009-10. When these measures were withdrawn, growth fell.

But due to a change in base for GDP from 2004-05 to 2011-12, a straight comparison of GDP performance before and after the crisis is not possible. Recently a report by the National Statistical Commission estimated back-series of the 2011-12 GDP series.

The Indian economy remains on a lower growth trajectory today than it was in the years preceding the crisis. An important impediment to the post-crisis recovery has been the fall in share of capital formation in the economy’s GDP, which is an important multiplier to economic growth.

Economists have attributed this to the twin balance-sheet problem, where companies have not been able to pay their earlier debts and banks have a shortage of fresh capital to lend. The crisis also led to a derailment of the fiscal consolidation process which was underway in the economy.

How sub-prime crisis unfolded

Lehman Brothers’ woes go back to a period of exuberant investment in real estate and mortgage assets and instruments, a trend that also coincided with a housing bubble.

As the bubble burst and house prices began falling in 2006-07, households with fragile finances began defaulting on monthly payments, which climbed with rising interest rates.

Banks such as Lehman Brothers were saddled with instruments with rapidly depleting value, usually bundled high-risk (or sub-prime) mortgages. These came to be known as sub-prime assets.

By September 2008, after nearly 18 months of the sub-prime crisis unravelling, Lehman’s stocks had already taken a beating and its debt had piled up to $619 billion as compared to its assets of $639 billion.

The aftermath

The 2008 economic crisis caused tens of millions of people to lose their homes, led to hundreds of millions losing their jobs and destroyed trillions of dollars in wealth.

Ten years since the sub-prime crisis, India’s fiscal deficit is still not back to the pre-crisis levels.

(Arjun Srinivas is a recipient of the Mint-Hindustan Times-HowIndiaLives Data Fellowship 2018)