Reserve Bank of India Official Speaks about the Impact of the Financial Crisis at First South Asian Business Forum Conference

Two years ago Rakesh Mohan, the deputy governor of the Reserve Bank of India, gave a speech warning that the increase in complex financial derivatives and a general mispricing of risk could lead to the destabilization of the financial system. At the first Yale SOM South Asian Business Forum (SABF) conference on April 2 of this year, Mohan recalled that two years ago, his outlook was called too conservative. "I suggest you take a look at that speech again," he said.

Now, six months after the failure of Lehman Brothers helped spark a full-blown financial crisis, Mohan said what we’re witnessing in markets around the world could be "epoch changing." A contagion that began in U.S. subprime mortgages quickly went global, as capital that had flowed into many economies at huge rates for much of this decade, was suddenly pulled out. But, as Mohan noted, the origins of the current turmoil goes much deeper than bad mortgages written for a bubble housing market. Going back to the dotcom bust in 2001, he said the United States and other countries kept interest rates too low for too long, which dramatically boosted U.S. consumption rates and led to a boom in a host of asset classes. Coupled with the advent of new investment vehicles, such as mortgage-backed securities and credit default swaps, things quickly got out of hand. A crash was inevitable. "From an Indian point of view, the whole issue is dominated by the large volatility in capital flows," he said. "What’s affecting us now is not the banking crisis, but the reversal of these capital flows."

The student-organized SABF conference was titled India: Seeking Opportunity in Crisis. The topics covered ranged from how India has been hit by the crisis, the impact of the crisis on private equity in India, and what the current economic climate means for Indian companies looking to do business in the United States. Leaders from business, government, and academia from both countries attended.

As the keynote speaker, Mohan set the conference’s tone. His message to the audience was that thanks to the conservative approach of India’s central bank, the country isn’t suffering nearly as badly as European countries and the U.S. While interest rates in the United States were kept very low, the Reserve Bank of India kept credit much tighter. The bank also refused to deregulate the financial sector and discouraged Indian financial institutions from getting involved in new derivatives. All these, Mohan said, combined to spare India a true crash. "The equity markets are down, there have been almost no IPOs in six months, and the overall business sentiment has deteriorated," he said. "But I’m confident Indian growth prospects remain healthy. Indian banks have negligible exposure to toxic assets, partly through prudence, but also because we wouldn’t allow it. They complained very loudly the restrictions were too strict. Now they’re thanking us… Our banks are strong and adequately capitalized. Not a single commercial bank is unprofitable."

This does not mean that people in India aren’t suffering, said Suman Bery, director-general for India’s National Council for Applied Economic Research. Bery, who spoke on a panel with Mohan at the conference, noted how the country has massively under-invested in infrastructure and that the withdrawal of foreign capital means the problem could get even worse. Over the last decade, urban workers benefitted from the boom to a greater degree than those living in rural areas. Bery said this dynamic has quickly reversed since the global crisis began. "Now poverty in urban areas is not very different than in rural areas," he said. "And we’re completely out of ideas."

The end product of the global turmoil is what Mohan calls a "growth recession." The country’s economy will continue to expand, but not significantly again until the rest of the world emerges from the current downturn. He noted that India is still a very poor country, with per capita income of roughly $1,000. At the conclusion of the panel with Bery, he returned to the idea of financial innovation. If the current crisis has exposed one thing, it’s that the growth in developed economies over the last decade was largely an illusion. "How is the real economy benefitting at all from these financial innovations?" he asked.

That question was debated throughout the day. Pramit Mitra ’09, one of the conference’s organizers, said that the variety of expertise and views made for a compelling — and informative — event. "Our goal with the conference was not only to take stock of India’s response to the global financial crisis, but also highlight investment opportunities going forward," he said. "The panelists did a splendid job of not only analyzing the current macroeconomic picture, but also dissecting India’s strengths and weaknesses. We hope this conference becomes an annual Yale event, which will go a long way to promote Yale’s partnership with this vibrant emerging economy."