A PROJECT REPORT IN

Economic Environment and Policy

PROJECT TITLE: Impact of Eurozone crisis on the Global economy and India, How did India respond to the crisis?

SUBMITTED ON: 21ST DECEMBER 2012

UNDER THE AEGIS OF

Submitted To:

Submitted By: Rakesh Ranjan PGDFS - 2011-13 Roll No. : FT-(FS)-11-340

Prof. Rajkishan Nair

PROJECT TITLE: Impact of Eurozone crisis on the Global economy and

India, how did India respond to the crisis?

The Eurozone: A background:

On January 1, 1999 eleven European countries decided to denominate their currencies into a single currency. The European monetary union (EMU) was conceived earlier in 198889 by a committee consisting mainly of central bankers which led to the Maastricht Treaty in 1991. The treaty established budgetary and monetary rules for countries wishing to join the EMU - called the - convergence criterion. The criterion were designed to be a basis for qualifying for the EMU and pertained to the size of budget deficits, national debt, inflation, interest rates, and exchange rates. Denmark, Sweden, and the United Kingdom chose not to join from the inception. The "Euro system" comprised the European Central Bank (ECB), with 11 central banks of participating States assuming the responsibility for monetary policy. A large part of Europe came to have the same currency much like the Roman Empire, but with a crucial difference. The members were sovereign countries with their own tax systems. Greece failed to qualify, but was later admitted on 1 January 2001. The Euros took the form of notes and coins in 2002, and replaced the domestic currencies. From eleven euro zone members in 1999, the number increased to 17 in 2011. The Eurozone Consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. The European sovereign debt crisis has emerged out of a situation that has made it difficult or impossible for some countries in the euro area to re-finance their government debt without the assistance of third parties.

The European sovereign debt crisis has its genesis in a series of policies followed by countries in response to economic challenges. These policies can be traced to the period 2002-2008 when access to easy credit paved the way for high-risk lending and borrowings. Subsequently, the period 2007-2012 saw the emergence of a global financial crisis, starting with the 2007 subprime crisis in the US and soon turning into a global recession and now has become a sovereign debt crisis in Europe. This crisis has not just challenged the European vision of economic unification, but it also has serious implications for its other global dreams and ambitions.

India- Europe Trade a Review:

The European Union is a major trade partner for India. It accounts for close to 20 percent of Indias exports and 13 percent of Indias imports. In 2010-2011, European Union Countries imported roughly USD 46.8 billion worth of agriculture products, fuel and mining products , machinery and transport equipment, chemicals, semi manufactured products, textile and clothing products in 2010 from India. The Europe exports to India amounted to USD 44.5 billion. This largely constituted of machinery chemical products and semi manufactured items which was almost 2.6 percent of Europe Exports. Bilateral trade between the two has been growing on an average of 9.6 percent during 2006-10.

India Europe Trade:

Exports Year 2006-07 2007-08 2008-09 2009-10 2010-2011 2011-2012 (US $ Million) 26,831 34,535 39,351 36,028 46,819 26,421 15.51 28.71 13.95 -8.45 29.95 % Growth Imports (US $ Million) 29,856 38,450 42,733 38,433 44,540 24,473 14.84 28.72 11.41 -10.06 15.89 % Growth

Given The situation, the Eurozone crisis and its impact on world economic scenario is definitely a cause for concern. Even the Indian Prime Minister Dr. Manmohan Singh has said that the situation in Europe is of particular concern as Europe accounts for a significant share of the global economy and is also Indias major trade and investment partner.Continuing problems there will further dampen global markets and adversely impact our own economic growth. It is our hope that European facing them, he said, It is also important therefore, to analyse the impact that this will have on the Indian economy in general and its exports and FDI in particular.

Share of Exports in GDP:

The current global economic slowdown emanates from the Euro zone. However, the contagion is being witnessed in all major economics of the world. Many countries are seeing a slowdown in their economic activities and overall pace investments. This is largely a result of the share of exports in their overall GDP. The table below the shows the share of exports tin GDP of leading countries Indias share of exports to GDP is around 11% on an average for the last 5 years. It is evident that countries like china, Japan and UK, with very significant export-led economies would be impacted in a more serve manner as compared to India. A globalised trading environment means that Indias trade is inextricably linked to the global economic movement patterns and can no longer remain isolated or insulted from these. This is likely to adversely impact Indias export growth in the coming months. It is however to be noted that the presence of a large domestic market and growing demand for goods and services will serve as a cushion to absorb some of these global shocks. It will therefore be expected that growth will be only marginally affected by the slowdown in the euro region debt stricken countries as our exposure is low.

Share of Total Exports in GDP

45% 40% 35% 30% 25% 20% 15% 10% 5% 0% world EuroArea Brazil China India Japan South UK US

The Eurozone experiment of different countries coming together to form a common Monetary Union is under a grave threat of disintegrating in the face of severe debt crisis facing several member countries. The welfare-oriented states in Europe have run up huge deficits that are fast becoming unsustainable. In the absence of readily visible solutions to the crisis, management of the issue is going to test European leadership to the limit. India would also not be unaffected from the global contagion that a European crisis might unleash. Eurozone is an Economic and Monetary Union comprised of seventeen member states of the European Union. Members of the Euro zone have adopted the Euros as their common currency and the monetary policy of the Euro zone is laid out by the European Central Bank . Fiscal Policy, however, is the domain of individual member countries.

The Sovereign Debt Crisis in Eurozone:

The crisis now sweeping Eurozone arises from the basic fact that many countries have accumulated too much debt and do not have highEnough growth to even finance this debt In addition, due to a common monetary union, woes of countries such as Greece, Ireland, Spain etc are now being transferred to fiscally stronger countries such as Germany, thus impacting the economies of these countries as well. The Euro as a common currency of countries with disparate political and fiscal policies has meant the crisis has spread across the Euro zone. If each of these countries would have had a separate currency and monetary policy, the crisis would have been localized instead of having spread across the Eurozone. Europe represents about one-fifth of the world economy and a crisis there is hence going to have a severe impact on overall global economy. Till the time the debt crisis was confined to a few small countries, they could be rescued by other European countries who gave loans to substitute for the credit denied by private lending markets. For example, Greece, Ireland and Portugal were all given loans by the ECB. However, whereas these countries could be extended some support in 2010, larger countries are now facing a crisis, making it difficult to come out with bailout packages. With Spain, Italy and possibly France now under financial assault, the situation changes dramatically. There are more debtor nations and more debt at risk. In 2010, Italy's debt was 1.8 trillion euros; Spain's 639 billion euros; and France's 1.6 trillion euros. With slowing GDP growth, large welfare budgets and popular opposition to measures towards curbing entitlements, the situation is Europe is extremely difficult. At present, Germany is the only large Euro zone country with a sound economy, and it cannot be expected to bail out all of Eurozone on its own. Efforts at confronting the crisis have also been adhoc and short-sighted. Rather than trying to address the fundamental issues that gave rise to such a widespread crisis, leaders have so far tried to muddle through decisions such as devising rescue packages for Greece et al; however, while these steps were partially successful with the smaller economies, there is no hope of similar measures for the larger economies that now face trouble. First of all, there is not enough money to bail out these countries, and secondly, in the absence of fundamental changes to the economy and drastic restructuring of the welfare-oriented European state model, there is little hope of avoiding a full-blown default, particularly in the face of poor GDP growth across the Euro zone.

In addition, adoption of austerity measures through steps such as spending cuts (by governments), tax increases etc., that is a standard practice to deal with high public debt, may work for individual countries or even a few countries at a time. But if most of Europe embraces austerity, it would lead to slowdown of economic growth and possible recession. Lower economic growth translates into lower tax revenues which in turn makes it harder for countries to service their debts. This leads to further worsening of the financial crisis, creating a vicious circle. Countries find it difficult to raise further debt, and have to pay higher interest, again worsening the debt situation. This is the precisely the situation Europe faces at present. Rates on sovereign bonds of the crisis-ridden countries are steadily increasing with stagnant and even decreasing growth. Under the vaunted "European model" European citizens have become accustomed to one of the most generous welfare packages in the world, one that is now threatening the very vitals of European economy. However, as recent events in France, Greece and other European countries show, there is widespread public opposition to any attempt at cutting the welfare entitlements. This makes crisis management even more difficult. With a common currency and monetary policy, the weaker countries have been trying to shift costs to others, and this is straining the very idea of Eurozone to the limits, with many sceptics now

The Eurozone crisis could impact India in a number of ways:

First of all, the Europe (excluding UK) accounts for roughly 30% of the countrys merchandise foreign trade (export and import). A slowdown in Europe would naturally have a negative impact on foreign trade and lead to loss of revenue as well as jobs in export-oriented industries. The impact of a slowdown would be much more severe in the service sector (particularly BPO and software) where trade is skewed in Indias favor. In addition, if the European contagion spreads and leads to a global slowdown, this would impact Indias trade with other countries as well, and thus hit the domestic economy directly as well as indirectly. Lower incomes, jobless etc. would also translate into lower domestic demand, thus leading to slower growth even in the sectors dependent on domestic demand. Secondly, the impact of the crisis would be felt in the financial market. The first portends of this may already be visible, with the Indian markets declining by nearly 4% this last week alone. In addition to decline in security markets, one can expect to see a rise in gold prices (gold being the globally-preferred safe asset, its prices show a sharp spike during any crisis), fall in commodity prices (due to lower demand), and depreciation in currency (due to flight of capital). Another way in which India could be impacted is through a slowdown in remittances and NRI deposits. In the wake of a crisis, remittances from abroad could slow down and a significant number of expatriates might even lose jobs and move back to India, thus straining the local economy. Finally, a slowdown would impact global investor confidence and rather than taking even moderate risk, individuals and corporations might prefer to put their money in safe avenues such as gold and government bonds, thus leading to slowdown in capital investment. As a developing country, such a slowdown would adversely affect India which is in severe need of capital for long term growth. This would be another possible negative impact of the crisis. In addition to the possibilities outlined above, the Indian economy could be affected in thousands of other ways, as it is practically impossible to identify all the interlink ages between India and the global economy in this day and age of increasing integration. Another school of thought says that a slowdown in Europe and the US could benefit emerging economies such as India due to fall in commodity prices and flow of capital from those countries to countries such as India. However, in the absence of policy initiatives to kickstart economic growth and overall climate of crisis of governance, it is difficult to see this coming to fruition. Some bold steps on the reform side might induce flow of capital, but that, at the moment, seems

like a distant dream. In addition, past experience also shows that while India may not have fared as badly as parts of the world in time of a slowdown, growth was negatively and not positively affected by these developments.

Possible solutions to the crisis A number of suggestions have been put forth to tackle the crisis: 1. Common European bond: Creation of a common Euro bond that would allow the
weaker countries to share Germany's credit rating and hence borrow at lower rates. However, for this, Germany would have to guarantee other countries' debts. This is highly unlikely.

2. ECB buys bonds of weak countries: It has been proposed that the ECB buys bonds of
the heavily indebted Eurozone members. The ECB has earlier bought Greek, Irish and Portuguese bonds and is now buying Italian and Spanish bonds. But this is not a bottomless pit and purchases would have to stop at some point. The ECB can theoretically keep on printing new currency and buy bonds, but this would lead to an inflationary flood of money, creating another crisis.

3. IMF rescue: Another suggestion is for the International Monetary Fund to organize a
global rescue package worth trillions of euros. Europe's debtor nations could borrow at low rates with long maturities. Once debt pressures were relieved, Europe could follow more pro-growth economic policies. However, such a large package would need financing from countries with huge foreign exchange reserves the oil producing countries and/or China (which has reserves of $3.2 trillion). Whether China would bailout Europe remains to be seen, and entails complicated issues of geopolitics other than finance.

4. Partial write-off of debts or outright default: It has also been suggested that some
European nations could negotiate write-downs on their debts or default on them. Superficially, this seems a solution. But it would create other problems. Defaults would inflict huge losses on banks, insurance companies and pensions. Many European banks might collapse unless rescued. Who would rescue them? Confidence would plunge. A recession would seem unavoidable. Defaulting countries would also have trouble borrowing in the future. As we have seen, there are no easy solutions to the crisis confronting Eurozone. However, the urgency for solid steps to confront the issue is also increasing by the day, as otherwise, not only could the situation in effected countries worsen, it could also spread to other countries, and lead to a full-blown global economic crisis. It remains to be seen what action the European leadership finally takes to tackle this situation.