Coping with the Global Economic Crisis

India does not exist in isolation from the world economy. This article covers how global economic shocks have tested India’s policy response.

MCQ Questions

Indian Economy

Three different shocks, three different tests of policy response

2008

Global Financial Crisis

US housing/banking collapse spreads worldwide; India responds with fiscal stimulus and RBI rate cuts.

2013

Taper Tantrum

US Fed signals slower bond-buying; sharp capital outflow names India one of the “Fragile Five.”.

2020

COVID-19 Pandemic

A real-economy shock — supply and demand halt simultaneously, unlike a purely financial crisis.

📑 Contents

1Must Know
2Good to Know
3Previous Year Questions
4Test Yourself
5Great to Know

✊ Must Know

1. The 2008 Global Financial Crisis

Origin The 2008 global financial crisis began with a collapse in the US housing and banking sector. It quickly spread worldwide through interconnected financial markets.
Impact India was less directly hit than Western economies. Indian banks held far fewer of the toxic mortgage-backed securities at the center of the crisis.
Effect India still felt real effects. Export demand fell, and foreign capital flows reversed sharply. GDP growth slowed from its pre-crisis pace.

2. India’s Policy Response

Response The government responded with a fiscal stimulus. This meant extra government spending and tax cuts. The RBI also cut interest rates to support growth.

📘 Good to Know

1. Why 2008 Hit India Less Hard

Caution India took a relatively cautious approach to full capital account convertibility. It had not fully opened its capital markets to unrestricted foreign flows. This is often cited as a factor that limited the 2008 crisis’s direct impact.

2. The 2013 Taper Tantrum

Trigger The 2013 “Taper Tantrum” was a separate global shock, triggered when the US Federal Reserve signaled it would slow its bond-buying programme. This caused a sharp, sudden outflow of capital from emerging markets including India.
Fragile Five India was named one of the “Fragile Five” emerging economies during the 2013 episode, along with Brazil, Indonesia, South Africa, and Turkey. These were economies seen as unusually vulnerable to capital outflows at that time.

3. The 2020 COVID-19 Shock

Different Kind The COVID-19 pandemic (2020) triggered a different kind of global economic shock. It was a sudden halt in both supply and demand simultaneously, unlike a purely financial crisis.

📝 Previous Year Questions

UPSC Prelims 2020 — Which Measures Give India Crisis Immunity?

If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immunity to India?

1. Not depending on short-term foreign borrowings
2. Opening up to more foreign banks
3. Maintaining full capital account convertibility

Select the correct answer using the code given below: (a) 1 only (b) 1 and 2 only (c) 3 only (d) 1, 2 and 3

Answer: (a) 1 only

Avoiding short-term foreign borrowings cuts India’s rollover risk if global credit suddenly dries up. Opening up to more foreign banks and maintaining full capital account convertibility both raise India’s exposure instead. They increase vulnerability to volatile cross-border capital flows during a crisis. That is why only statement 1 gives real immunity.

The capital-account-convertibility statement above is covered in full detail here: IndEco0136 — The Tarapore Committee and Capital Account Convertibility.

Test Yourself

🏆 Great to Know

1. Financial Crisis vs. Real-Economy Shock

Distinction Economists distinguish crises by their origin. A financial crisis, like 2008, starts in banking and credit markets. A real economy shock, like COVID-19, starts by disrupting actual production and consumption directly.

2. Building Reserve Buffers

Buffer India built up its foreign exchange reserves substantially in the years after 2008, partly as a buffer against future external shocks. This was a lesson drawn directly from the 1991 crisis, when reserves had fallen dangerously low.

3. Stimulus vs. Fiscal Discipline

Tension Global crises reveal a recurring policy tension. Short-term stimulus spending to protect growth and jobs can conflict with longer-term fiscal discipline goals, like the targets set under the FRBM Act.

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