The impact of the Global
Economic slowdown on
This paper was prepared by the Centennial Group as discussion materials
for the "South Asia Forum on the Impact of Global Economic and Financial
Crisis" a regional technical assistance (RETA No. 6508), funded by the Asian
Development Bank (ADB).
The views expressed in this are those of the consultants and do not necessarily
reflect the views and policies of ADB or its Board of Governors or the
governments they represent.
ADB does not guarantee the accuracy of the data included in this publication
and accepts no responsibility for any consequence of their use.
Use of the term “country” does not imply any judgment by the authors or ADB
as to the legal or other status of any territorial entity.
The impact of the
Global Economic slowdown on south Asia
by Manu Bhaskaran
Centennial Asia Advisors PTE LTD
2 Executive Summary
5 Section 1: The Global Outlook and Implications For South Asia
5 Chapter 1: The Global Economy
9 Chapter 2: Transmission Mechanisms to Asia
19 Section 2: Regional Outlook
21 Chapter 3: India
30 Chapter 4: Bangladesh
36 Chapter 5: Sri Lanka
44 Chapter 6: Other economies
54 Section 3: Analysis of Policy Implications
54 Chapter 7: Short Term Macro-Management Policy
59 Chapter 8: Longer Term Policies
The current global slowdown is unprecedented in scale.
The current global economic slowdown is of an unprecedented form, one that has not been experienced
since the establishment of the current world economic order after the end of the Second World War in 1945.
The trajectory of the deceleration in global measures of trade, industrial production and financial flows has
been extraordinarily rapid.
The key difference from previous global slowdowns is in the substantial weakening of the financial sectors
in the United States and Europe, with consequent damaging implications for credit extension in the global
economy. Although there are increasingly vigorous measures being taken in the United States and Europe to
repair the financial institutions and re-start the flow of credit, these have been partial, patchy and incomplete.
Without a swift rehabilitation of the global financial system, other measures such as fiscal stimulus and
interest rate cuts may not succeed in reviving economic growth in key countries which are important markets
for South Asia.
This crisis poses substantial risks to emerging market countries, operating through multiple transmission
No economy that is open to global trade, finance and other international flows such as remittances can
escape the damaging effects of such a slowdown. Emerging market countries are affected in several ways:
Trade: The volume of exports of goods and services is contracting in most open economies as global
Financial flows: Flows of portfolio capital to emerging market countries have fallen precipitately.
Remittances: As major labour-importing economies suffer recession, foreign workers are being retrenched
and repatriated or foreign workers are finding their incomes reduced by reduced work opportunities or
Commodity prices: Emerging market countries are important exporters of primary commodities. As global
recessionary forces took hold, commodity prices have fallen sharply, reducing incomes to households in
emerging countries which export such commodities.
Foreign direct investment: As global companies’ perception of the risks and rewards of investing become
more cautious and as raising funds for investment becomes more difficult, foreign direct investment will
also tend to fall.
A prolonged period of sub-par global growth will unleash other serious risks for emerging markets.
Difficulties in re-financing external debt are creating substantial risks for economies with high external debt
which is maturing soon. This has been a particular concern in eastern and central Europe, for instance.
There are worrying signs that protectionist tendencies are gaining ground. While we do not see the blatantly
anti-trade measures that compounded the Great Depression of the 1930s, the risks to global trade are rising.
In recent months, there have been incremental measures taken which if not arrested can lead to a more
generalised decline in trade. Some countries have imposed higher tariffs to protect local producers. But in the
main, countries have avoided these overt forms of protectionism. Instead, we have seen the use of indirect
protectionist measures such as increased rebates of value-added tax to exporters.
Although global deflation is not in our central scenario, the risks of damaging deflation will increase under
certain, plausible conditions: If credit mechanisms remain impaired and disrupt monetary growth; output in
major economies remains below potential for a prolonged period of time; and asset prices fall across many
asset classes, the risks of global deflation could well rise.
The policy response in South Asia thus becomes crucial.
Policy responses in the region need to address two separate time horizons. Put simply, in the short term, policy
should be directed at mitigating the impact and possible risks of the global crisis while in the longer term,
policy actions should promote faster economic growth and improved resilience of each country’s economy to
the vicissitudes of the global economy.
Short term: a combination of monetary, fiscal and other measures is needed.
Where inflationary risks are contained, not only because of one-off falls in commodity prices but where
monetary conditions have been appropriate, aggressive use of monetary easing in the form of reduced
interest rates and cuts in reserve requirements is appropriate.
Fiscal stimulus should also complement the use of monetary easing. However, caution should be exercised:
where fiscal deficits are already high and the public sector debt to GDP ratio is high. In such cases, expansionary
fiscal policy could provoke concerns in financial markets which then negate the stimulus effect.
Pro-active depreciation of exchange rates should be used only judiciously. The risks of competitive depreciations
are too high. Only where exchange rates are clearly misaligned should a material devaluation of the exchange
rate be considered.
In this context, it is vital that there is substantial dialogue and policy co-ordination at the regional level.
Such dialogues can also be useful in allowing the region’s concerns to be presented by the region’s sole
representative in the G20 group, India.
Long term: structural improvements will enhance regional resilience
We believe that the following policy approaches will enhance resilience to future global economic shocks:
Increased diversification of the economic base
Stepped up infrastructure development
Increased regional cooperation and coordination
After a challenging 2008, the South Asian economies now face a global economy that in 2009 is likely to be
in its worst shape since the post-Second World War global economic order was established. The first half of
2008 saw the economies grappling with high global prices of essential commodities while the second half
was witness to unprecedented financial distress in the major economies which precipitated highly disruptive
capital outflows from emerging markets followed by global slowdown of unusual severity and speed. This
report will study the South Asian economies in detail with a view to determining policy prescriptions to
mitigate the extraordinary downside risks emanating from the global market.
The report is divided into three sections.
The first section characterises and assesses the current state of the global economy, with a focus on the
G7 economies and the larger emerging economies in Asia. We also outline the mechanisms that transmit
global shocks from the global economy to the South Asian economies.
The second section provides an overview of each South Asian economy, characterising where each stands
In the final section, we provide policy suggestions which we believe will both help the economies in the
crisis times as well as build resilience for the future.
The countries which are being studied are Bangladesh, Bhutan, India, Maldives, Nepal and Sri Lanka.
the Global outlook and impliCations For south asia
In this section, we will study the economic and financial architecture in place in South Asia today with
reference to the region’s interaction with the external economies. In the first chapter of this section, we
will assess the outlook for the major developed economies of the Group of 7 (G7) as well as assess the
prospects for other relevant economies in Asia which have close ties with South Asia. The second chapter
identifies the multiple transmission links between the global economy and to emerging countries in South
Asia. The emphasis is on drawing attention to the key points of vulnerability.
Chapter 1: The Global Economy
1.1 The global slowdown
The global economy weakened through 2008, with the final three months of the year being marked by a
fall in global demand of unusual severity. Worse still, all available lead indicators point to the downslide
continuing through most of 2009. The financial crisis that began in the United States in 2007 has now
become a full-scale economic crisis affecting virtually the entire global economy, including countries which
had not been directly exposed to the toxic financial assets which triggered off the crisis in the United States
and Europe. There is little doubt that the geographic spread and depth of this economic crisis will be the
worst since the Second World War.
Current indicators point to a substantial slowdown in global economic activity. Chart 1.1 shows the
JPMorgan Global Purchasing Manager Index, which is based on a survey of respondents in over twenty
countries, which collectively represent 76% of global economic output. This chart shows the sharp fall in
global manufacturing and services output in recent months. The Japanese economy has been reported
to have declined by a 12.7% annualised rate in 4Q08, the sharpest decline in 35 years. Chart 1.2 shows
the lead indicator for major economies produced by the Organisation for Economic Co-operation and
Development (OECD). These indicators give a sense of the economic trajectory for the next 9-12 months.
The OECD lead indicators point to a severe recession in all the major economies – the United States, the
Eurozone and Japan.
Forecasts for the global economy are getting progressively more pessimistic. The International Monetary
Fund (IMF)’s baseline forecasts published in Jan 09 project global GDP in purchasing power parity (PPP)
terms of just 0.5% in 2009 (Table 1.1). Latest forecasts from the United Nations show global GDP to grow at
1.0% in 20091 and did not rule out the possibility of even more pessimistic outcomes. Similarly, the World
Bank projects slow growth with global GDP growth moderating to 2.5% in 2008 and 0.9% in 2009 from
3.7% in 2007. According to projections of the OECD, GDP of the whole group is expected to decline 0.3%
Closer home, the Asian Development Bank (ADB) expects growth in developing Asia to decline to 5.8% in
2009 from 6.9% in 2008 and 9.0% in 20072. The implications of slower growth are especially forbidding for
those parts of the world which still live in parlous economic conditions, including some regions in South Asia.
In another study, the World Bank estimates that each 1.0% drop in growth would increase the number of
people in poverty by 20 million3. South Asia’s efforts to overcome poverty would be a substantial set back in
Table 1.1: Overview of IMF Growth Projections
% y/y 2006 2007 2008 2009 2010
World GDP 5.1 5.2 3.4 0.5 3.0
Advanced economies 3.0 2.7 1.0 -2.0 1.1
United States 2.8 2.0 1.1 -1.6 1.6
Euro area 2.8 2.6 1.0 -2.0 0.2
Germany 3.0 2.5 1.3 -2.5 0.1
France 2.2 2.2 0.8 -1.9 0.7
Italy 1.8 1.5 -0.6 -2.1 -0.1
Spain 3.9 3.7 1.2 -1.7 -0.1
Japan 2.4 2.4 -0.3 -2.6 0.6
United Kingdom 2.8 3.0 0.7 -2.8 0.2
Canada 3.1 2.7 0.6 -1.2 1.6
Other advanced 4.5 4.6 1.9 -2.4 2.2
Newly industrialized Asian economies 5.6 5.6 2.1 -3.9 3.1
Emerging and developing economies 7.9 8.3 6.3 3.3 5.0
Source: IMF World Economic Outlook Update, January 2009
The origins of the crisis can be traced to the unsustainable build-up of complex financial instruments in
United States and Europe, whose risks were under-estimated and mis-priced by the financial institutions
which created them and marketed them as secure investments. In conjunction with relatively easy monetary
policy in most G7 economies, this helped to create substantial amounts of easy credit in G7 economies and
globally. An enormous amount of debt was undertaken by both corporates and households in this process –
not just in the G7 but also in many emerging markets such as those in eastern and central Europe. Eventually,
such overly easy credit conditions produced irrational exuberance in asset markets and so a bubble in asset
prices across the world, especially in the residential housing market.
In the course of 2007, as the decline in the Unites States housing market crystallised losses in some of
these financial assets, financial institutions began to realise that risks associated with these assets had
been under-estimated. This produced an abrupt reversal in risk perceptions and a sharp decline in risk
appetites. Lenders started cleansing their books of toxic loans and began a process of deleveraging which
we expect will continue until all such bad assets are cleared of their balance sheets. New lending is likely
‘World Economic Situation and Prospects 2009’, United Nations New York, 2009
‘The US Financial Crisis, Global Financial Turmoil, and Developing Asia: Is the Era of High Growth at an End?’, ADB, December 2008.
‘Trade Is Key to Overcome Economic Crisis’, World Bank press release dated 1st December 2008.
to only resume once this deleveraging process is consummated, which we estimate could be somewhere
towards the end of 2009.
Policy makers across the G7 countries have responded with increasing vigour to the growing crisis. First,
the monetary authorities have reduced interest rates aggressively and introduced measures to infuse
liquidity into financial institutions. Second, more recently, fiscal stimulus packages involving both tax
reductions and increased government spending have been announced. Initially cautious and small-scale,
these have become some of the largest fiscal stimulus efforts in recent history. Third, efforts are being
made to address the roots of the crisis: the toxic assets on the balance sheets of financial institutions.
Initially ad hoc and incomplete in nature, these efforts have expanded of late but still do not appear to have
won the confidence of the financial markets. Such efforts include buying bad assets from banks, providing
guarantees to depositors to prevent bank runs, re-capitalising financial institutions and the establishment
of new central bank facilities to support specific financial assets such as mortgage backed securities. The
most substantial financial sector rescue plan was the one announced by the United States government in
early February 2009. Financial markets reacted negatively to this announcement because the plan was
deemed to lack detail.
There are several issues here that are pertinent to policy makers in emerging countries:
First, the trajectory of the decline in global growth combined with the dismal lead indicators point to
continued weakness in external demand for emerging country exports, with little sign of any recovery
Second, the process of restoring the financial sectors of the G7 economies to good health will take time.
Not enough is understood yet of the way in which complex new financial products impact the financial
sector when economies and asset markets are weakening. Moreover, there also remain significant
political obstacles to a speedy resolution of the crisis – in some instances; there are ideological
objections to state intervention in the banking system for instance. In short, this means that financial
intermediation and credit creation in the major economies are not likely to return to some semblance
of normality in the next year or so. And that means that flows of portfolio capital to emerging countries
will probably remain weak for some time to come.
Third, this dismal economic backdrop creates conditions that can in turn produce other shocks that
emerging countries need to be prepared for. For example, protectionism and other forms of backlash
against emerging countries are becoming more likely.
1.2 Slowdown extends beyond G7 to other relevant economies
The effects of such a severe slowdown in the G7 are now permeating to emerging market economies. Charts
1.3 and 1.4 show how external demand for the large Asian trading economies has fallen precipitously.
The IMF estimates that emerging markets are likely to grow by 3.3% in 2009, compared to a high of 6.3%
in 2007 (Table 1.2). It is important to take note of PRC China where GDP is projected to slow to 6.7% in
2009 according to the Jan 09 estimates by the IMF. Other forecasters such as the Swiss bank, UBS, have
forecasted Chinese GDP to grow by 6.5% in 2009 while others such as Morgan Stanley project PRC China’s
GDP growth at only 5.5% in 2009. The five main countries of ASEAN will also be impacted with GDP growth
falling to 2.7% in 20094 from the 2007 peak of 6.3%.
These countries are Singapore, Malaysia, Indonesia, Thailand and Philippines
Table 1.2: Overview of IMF Growth Projections for Developing Economies
% y/y 2006 2007 2008 2009 2010
Emerging and developing economies 7.9 8.3 6.3 3.3 5.0
Developing Asia 9.8 10.6 7.8 5.5 6.9
PRC China 11.6 13.0 9.0 6.7 8.0
India 9.8 9.3 7.3 5.1 6.5
ASEAN-5 5.7 6.3 5.4 2.7 4.1
Other relevant countries/regions
Russia 7.4 8.1 6.2 -0.7 1.3
Middle East 5.7 6.4 6.1 3.9 4.7
Brazil 3.8 5.7 5.8 1.8 3.5
Source: IMF World Economic Outlook Update, January 2009
The impact was first felt in the financial markets of emerging countries. The high dependence on foreign
capital in such emerging markets means that developments in G7 financial markets affect emerging
markets almost immediately. Initially, emerging market economic growth was barely affected. However, as
the deleveraging process hurt credit extension across the world, business activity slowed as did consumer
spending in the G7. Emerging country exports have consequently lost momentum, a deceleration which
has been reinforced by sharp falls in the prices of commodities that emerging countries export. Investment
activity in emerging economies has also slowed as business confidence flagged and access to debt and
equity funding for new projects became more difficult.
Emerging economies are now entering the next phase of the crisis transmission as domestic demand
begins to weaken: consumers in trade-exposed emerging countries are becoming fearful of job losses and
are less confident of income growth. Even domestically-oriented companies are downscaling, deferring or
cancelling expansion plans, resulting in reduced job growth and a material slowdown in investment.
South Asian economies have significant links with ASEAN and PRC China as well as the G7. These links are
associated with trade, investments, remittances, tourism and financial aid. Thus there will be direct effects
of the present economic conditions in the G7 as well as indirect effects from other bilateral partners like
the ASEAN and PRC China.
Chapter 2: Transmission Mechanisms to Asia
In this section, we identify the transmission mechanisms from economic developments in the developed
world to the emerging market economies. Graphic 1 is a simplified overview of the various mechanisms
which feed into the emerging markets following the slowdown in the G7 economies.
Graphic 2.1: Transmission mechanism of the slowdown in G7 economies to South Asia
Drop in external Remittances Financial market
demand fall turmoil
prices fall Corporate losses
Contration in Fall in tourism
Fall in rural household Capital outflows -
income Drop in Portfolio Decrease in lending Higher corporate
Fall in trade related Investment defaults/bankruptcies
Increase in subsidies Cut in Restructuring
Corporate profits Asset price for business
to maintain prices investments
shrink deflation; wealth
Cut in wages and
Fall in demand from employment
commodity exporting Negative
Decrease in domestic
Actual output less than Decline in
potential output Consumer prices
Source: Prepared by Centennial Group
We explain these mechanisms in more detail in Table 2.1.
Table 2.1: Main Elements of Transmission Mechanisms Identified in Graphic 1
Transmission Mechanism Remarks
Trade – exports and imports Exports will slow as the overall demand in G7 falls.
Indirectly, emerging market exporters will also find that their pricing power
is reduced as demand falls, thus eroding profit margins.
Indirectly, exports of components to countries assembling them into finished
goods for G7 markets will also weaken.
Portfolio capital flows – debt and Increased risk aversion causes asset allocators in developed countries to
equity securities cut exposure of their funds to emerging markets, causing a large outflow of
funds from debt and equity markets in the emerging universe.
Credit extension As
risk-averse banks focus on reducing risks and cleaning up balance sheets,
they will cut lending, especially to emerging markets where companies find
it difficult to find new funding for their projects.
Foreign direct investment Given uncertainty over risks as well as demand as well as difficulties in raising
capital, foreign investment into emerging market countries will tend to fall.
Remittances - Income transfers Emerging countries have deployed their workers overseas in sectors as
from workers employed in other diverse as construction, shipping, manufacturing and services. Destination
countries back to their households. markets include developed countries such as in Europe and the United States
as well as other developing economies such as those in the Persian Gulf and
Commodity prices Economically-sensitive commodities such as oil/gas, rubber and base metals
have seen sharp price falls which will reduce incomes and job opportunities
in rural sectors in developed economies.
emerging economies which are net importers of such commodities, the
terms of trade improvement will be a positive shock.
consumer decrease spending they prefer to holiday in locations closer to
their country and also spend less on the holidays.
Source: Prepared by Centennial Group
2.1 Financial and credit market linkages: Deleveraging is paramount
The extent of vulnerabilities in private capital flows into emerging market economies has become evident.
Net capital flows are estimated to fall from USD314.8bn in 2007 to only USD96.2bn in 2008 and further to
just USD64.9bn in 2009 (Table 2.2).
Table 2.2: Capital Flows into Emerging Asia
USD bn 2006 2007 2008 2009
External financing 258.9 314.8 96.2 64.9
Private flows, net 122.6 112.9 57.9 85.7
Equity investment, net 122.6 112.9 57.9 85.7
Direct investment 87.2 148.6 112.7 79.3
Portfolio investment 35.5 -35.7 -54.7 6.5
Reserves (Negative implies increase) -337.5 -587.8 -373.1 -448.3
Source: Capital Flows to Emerging Market Economies, Institute of International Finance, 27th January 2009,
Note: Emerging Asia includes PRC China, India, Indonesia, Malaysia, Philippines, Korea, Thailand, Negative flows imply
increase in reserves in the year.
Equity markets are forward looking in nature and the first to suffer the heat during a cyclical downturn. As
expected most stock markets across Asia have undergone record losses since Aug 07 (Table 2.3). The correction
in the regional markets followed a long period of exaggerated optimism germinating from an across the board
boom in regional markets.
Table 2.3: Changes in Stock Market Indices across Asia(1)
% chg from the % chg from % chg from
Country Exchange peak Aug 07 Oct 08
Bangladesh DSE -11.8 13.9 1.7
PRC China SSE -69.4 -65.1 5.3
Hong Kong Hang Seng -55.9 -42.8 6.5
India BSE -52.1 -36.6 -0.7
Indonesia JSE -50.6 -38.2 7.9
Korea Kospi -45.5 -40.0 1.0
Malaysia KLSE -39.3 -31.2 1.5
Singapore SGX -53.7 -48.1 -1.8
Sri Lanka CSE -61.0 -52.8 -19.7
Thailand SET -50.4 -44.7 8.0
Source: Collated by Centennial Group using CEIC.
Notes (1) Aug 07 was when financial markets first began falling sharply in recognition of the unfolding crisis
and Oct 08 was when financial markets fell sharply again as the crisis deepened.
The importance of international capital flows cannot be under-estimated as these not only help propel
domestic growth by providing funding but also boost asset prices which by enhancing household wealth,
helps raise consumer spending. An IMF study published in 20085 found that a 10% increase in stock prices
of emerging markets between 1985 and 2007 led to approximately 1% increase in investment and a 0.15%
increase in short term consumption.
Financial activity in South Asia is still very limited outside the three large economies of India, Bangladesh and Sri
Lanka. The three large equity markets are the Bombay Stock Exchange (BSE), Dhaka Stock Exchange (DSE) and
Colombo Stock Exchange (CSE). Smaller markets, including the Nepal Stock Exchange (NEPSE) and the Maldives
Stock Exchange (MSE), have much lower market capitalisation. The smaller Royal Bhutan Stock Exchange
currently trades only about 13 companies. Chart 2.1 shows the market capitalisation of some South Asian stock
exchanges comparing them to an open economy like Singapore. We find that the market capitalisation of the
Indian and the Bangladeshi stock exchange has grown substantially in the past four years.
5 ‘Global Financial Stability Report: Financial Stress and Deleveraging’, Box 4.1, IMF, October 2008
Credit markets tightening
The JP Morgan Sovereign Bond Index for emerging markets measures the spread of yield on emerging market
government bonds over similar bonds in the United States – in effect - it measures how investors price the
risk of holding emerging market government bonds (Chart 2.2). Coupled with sharp falls in equity valuations,
outflows of credit also lead to severe tightening of financial conditions across the emerging markets.
The bullish period preceding the financial market corrections saw substantial inflows of international portfolio
capital into the region which pressured emerging market currencies to appreciate. However, the sudden
outflow of portfolio capital reversed this upward trend (Table 2.4).
Table 2.4: Asian Currency Movements Vs US Dollar
Country Currency 2004 2005 2006 2007 2008
Bangladesh Taka - - 69.0 68.5 68.9
PRC China Renminbi 8.3 8.1 7.8 7.3 6.8
Hong Kong Dollar 7.8 7.8 7.8 7.8 7.7
India Rupee 43.3 45.0 44.1 39.4 48.6
Indonesia Rupiah 9,290 9,830 9,020 9,419 10,950
Korea Won 1,035 1,010 930 936 1,262
Malaysia Ringgit 3.8 3.8 3.5 3.3 3.5
Singapore Dollar 1.6 1.7 1.5 1.4 1.4
Sri Lanka Rupee 104.4 102.1 107.4 108.7 112.9
New Taipei, China
Taipei, China 31.7 32.8 32.6 32.4 32.8
Thailand Baht 38.8 41.0 36.1 29.5 34.7
Source: Collated by Centennial Group using CEIC
Foreign Direct Investment
Foreign direct investment (FDI) flow is normally more stable than portfolio investments. FDI involves foreign
spending on plants and machinery or ownership stakes in domestic companies. As such these are not short term
investments and cannot be withdrawal as easily as equity market investment. The report by the United Nations
Conference on Trade and Development (UNCTAD) expects FDI inflows into developing economies in general as
well as into South Asia specifically to have increased in 2008 (Table 2.5),despite the overall fall in global flows of
FDI (decreased by 21% in 2008), as it was developed economies which were most severely affected.
Table 2.5: FDI Inflows in Emerging Market Countries
FDI Inflows Cross border M&As
USD Bn / % chg 2007 2008 % chg 2007 2008 % chg
World FDI 1833.3 1449.1 -21.0 1637.1 1183.7 -27.7
Developing economies 499.7 517.7 3.6 152.9 177.0 15.8
Asia 247.8 256.1 3.3 81.5 89.4 9.7
PRC China 83.5 92.4 10.7 15.5 20.3 31.0
India 23.0 36.7 59.6 5.6 11.2 100.0
Malaysia 8.4 12.9 53.6 4.5 5.5 22.2
Thailand 9.6 9.2 -4.2 2.9 0.6 -79.3
Singapore 24.1 10.3 -57.3 8.8 17.0 93.2
Source: UNCTAD Press release on ‘Assessing the impact of the current financial and economic crisis on global FDI’
Note: Asia refers to South, East and South East Asia
FDI has been an engine of growth in the past few years. Lower FDI would therefore lead to slower economic
growth. New investments would be reduced due to financing difficulties and the need by many multinational
companies (MNCs) to focus on preserving cash in their balance sheets. To examine FDI-related vulnerabilities,
we studied the main suppliers of FDI into South Asia. We find two factors associated with the investing
First, the level of development of the investing country: A large portion of FDI flows into India is from
developed economies (Table 2.6, note that the high investment flow from Mauritius is due to tax
minimization purposes and the true share of G7 countries investing in India should be significantly
Second, locational proximity is an important deciding factor. For example, India and PRC China are the main
foreign investors in Nepal. Similarly, Sri Lanka sees heavy FDI inflows from Southeast Asian economies as
well as India. Often it is also the case of a MNCs office located in India or Southeast Asia which is directing
investment into other countries in South Asia.
Table 2.6: Top Five Investors in South Asian economies
Share of top 5 Share of OECD No. of identified
Year Top 5 countries countries (%) countries (%) source countries
2005 and US, UK, Egypt, UAE,
Bangladesh 68.0 51.2 31.0
Bhutan - - - - -
2006 and Mauritius, UK,
India 66.1 27.0 100.0
2007 Singapore, US, NRI
Maldives - - - - -
India, PRC China, Korea,
Nepal 2005-08 67.0 22.0 25.0
Malaysia, S’pore, UK,
Sri Lanka 2002 62.0 NA NA
Source: ‘Regional Economic Integration and FDI in South Asia: Prospects and Problems’, Aradhna Aggarwal, ICRIER, July 2008,
2.2 Trade linkages
According to the IMF, world trade growth is projected to contract by -2.8% in 2009 after a peak of 9.4% in
2006 (Table 2.7). Three issues need to be addressed here - South Asia’s trade links with the G7 economies,
its trade links with other Asian economies such as PRC China, Southeast Asia and the Middle East and the
composition of the goods exported.
Table 2.7: World Trade Projections
% y/y 2006 2007 2008 2009 2010
World trade volume (goods and services) 9.4 7.2 4.1 -2.8 3.2
Advanced economies 7.5 4.5 1.5 -3.1 1.9
Emerging and developing economies 14.9 14.5 10.4 -2.2 5.8
Advanced economies 8.4 5.9 3.1 -3.7 2.1
Emerging and developing economies 11.2 9.6 5.6 -0.8 5.4
Source: IMF World Economic Outlook Update, January 2009
Exports to the G7: domestic economy restructured to target the G7
Over the past decade, many emerging market economies have employed export-oriented growth strategies.
As a result, the domestic economy has become more integrated with and more dependent on international
demand. This is evident in the correlation between the G3 non-oil imports and Asian export growth, which
was only 0.5 in 1996-2000 but has increased to 0.9 in 2001-2008. As Chart 2.3 shows, economies in South Asia
too have become more export dependant for growth.
Source: Collated by Centennial Group from various statistical websites, CEIC and the US Office of Textiles and Apparel
Note: The data for the Maldives in Chart 1 dates back to 2004.
Importance of PRC China
Additionally intra-regional trade in Asia has been expanding rapidly as PRC China has become an assembling
platform where components – mainly from Southeast Asia and East Asia – are assembled into final goods
meant for final consumption elsewhere, mainly in the G7.This has not been entirely true for South Asia.
Beside India (which has also integrated only to a limited extent), other countries in South Asia have been
unable to join the pan-Asian supply chain as South Asian exports (except India) are niche products (Table 2.8).
India exports 6.3% of its exported goods to PRC China which is comparable with other countries in South East
Asia. Malaysia exports about 7% to PRC China, Thailand about 9% and Singapore also exports about 9% of its
total exports to PRC China.
Table 2.8: Exports to the G7, India and PRC China (2006)
% of total exports G7 India PRC China Developing Asia
Bangladesh 71.0 1.6 0.8 5.1
Bhutan 0.1 81.9 0.0 _
India 33.3 - 6.3 20.6
Maldives 30.5 1.8 0.0 48.8
Nepal NA 66.4 NA 69.5
Sri Lanka 54.9 6.7 0.4 14.3
Source: Collated by Centennial Group from various statistical websites, CEIC and ADB Asian Development
Composition of exports
Vulnerability in trade also lies the composition of the exports. Generally speaking, labour intensive
industries like apparel and clothing are likely to be hit earlier in a crisis as these are directly linked to
consumer demand in the G7 economies. But within apparel exports, expensive and branded clothing are
less resilient as compared to inexpensive and non-branded clothing. PRC China is the largest exporter
of textiles and apparel to the United States, and is suffering a pullback in demand for its imports (Chart
This particular factor is applicable to the three large economies of India, Sri Lanka and most importantly
Bangladesh. The fall in demand might be mitigated to some extent where consumers in the G7 and elsewhere
downgrade to cheaper garments and other lower-priced consumer goods that are manufactured in South
Countries like Bangladesh, Sri Lanka and Nepal rely heavily on exports of low-end manufactured goods.
In addition to slowing demand, we see a few other risks that policy makers need to take note of:
Protectionism: It is unlikely that blatantly protectionist policies will be implemented by policy
makers in developed countries. The lessons of policy errors made during the Great Depression have
been learnt. Note also that the new administration of President Obama consists of staunch pro-free
trade policy makers6. Nevertheless, there are indications that many countries in both the developed
as well as developing world are resorting to non-tariff schemes to achieve what is essentially a
protectionist effect. Tariffs have been imposed by some developing countries on products such as
steel. Export subsidies (such as enhanced rebates for value added taxes) are one such example.
Anti-dumping provisions of trade agreements are also being used. There is a real danger that, as
economic conditions worsen across the world, political pressures will lead to more such trade-
Competitive depreciation: The Bangladesh Taka has faced little downward pressure while other
South Asian and East Asian currencies have depreciated significantly against the US Dollar, making
them more competitive in the export market.
In several Asian economies, households rely on remittances for a material portion of their incomes. As
the global economy was performing exceptionally well since 2001, the demand for foreign workers was
correspondingly strong. But as the developed economies, which represent the largest source of remittance
transfers, slow such remittances by foreign workers will also slow.
According to the World Bank, global remittance flows decelerated in 3Q08 and are projected to contract
almost 1% in 2009 (Table 2.9). As a percentage of GDP, remittances to developing countries are estimated
to fall from 2% in 2007 to 1.8% in 2008.
‘Obama’s China Trade Test’, Business Week, 28th January 2009
Table 2.9: Remittances Outlook - World Bank Forecasts
Remittance flows in developing countries
USD Bn % annual growth
2008 2009 2010 2008 2009 2010
Developing countries 283 280 297 6.7 -0.9 6.1
% of GDP 1.8 1.6 1.5 - - -
East Asia and Pacific 62 63 66 7.5 0.4 6.1
Europe and Central Asia 54 53 57 5.4 -0.1 6.4
Latin America and Caribbean 61 61 64 0.0 -0.2 4.4
Middle East and North Africa 35 32 34 7.6 -6.7 5.7
South Asia 51 51 55 16.2 -0.1 8.2
Sub Saharan Africa 20 20 21 6.3 -1.3 5.3
Source: World Bank, Migration and Remittances Team, Development Prospects Group.
Note: The report was released on 11th Nov 08.
But the changes in remittance flows are not uniform across countries. As Western Europe and North
America are at the core of the current economic situation, remittance flows from these countries have
slowed sharply. But the Middle East which is another important destination of foreign workers has not
yet reduced its demand for foreign workers. For South Asian workers employed abroad, 28% are in the
US, 22% are in Western Europe and 21% are in the Middle East according to data from the World Bank.
The concern is that falling oil prices will reduce government revenues and deflate business confidence,
leading to a decline in activities such as construction which are a vital source of demand for foreign
workers. While we expect remittances from the Middle East to be sluggish, we do not expect a sharp
fall. The historical experience has been that remittances from the Middle East have not fluctuated much
with oil prices (Chart 2.5).
Exchange rate movements can, however, mitigate the impact of reduced demand for foreign workers. As
Asian currencies have been depreciating against Middle Eastern currencies, the local currency amount of the
remittance which workers families receives may not fall as much.
According to the United Nations World Tourism Organization Barometer, international tourism is expected to
stagnate at the least if not decline in 2009 (Table 2.10). They estimate the growth to be in the range of -2%
to 0% in 2009 from an average growth of 7% between 2004 and 2007. In the last six months of 2008, tourist
arrivals shrank 3% in Asia but for the entire year the growth recorded was 2%. More specifically, tourist
arrivals in South Asia grew 4% in 2008.
Table 2.10: International tourist arrivals (UNWTO)
% y/y Jan-Jun Jun-Dec Jan-Dec
World 5.4 -1.3 1.8 6.9
Europe 3.4 -2.5 3.4 5.2
Asia and Pacific 6.3 -2.8 1.6 10.5
South Asia 9.2 -1.1 4.3 9.8
Americas 6.8 1.1 3.6 4.9
Source: Collated by Centennial Group using UN World Tourism Organization data
Tourism within Asia is still resilient but as Asian economies are pulled deeper into the recession, we should
expect cut backs in areas such as travel in 2009. There could be some mitigation where Asian consumers
decide to travel within Asia rather than visit more expensive destinations such as North America or Europe.
Thus, we expect the next year to be dominated by regional tourists.
2.5 Commodity prices
There are two contrasting influences of the increase or decrease in commodity prices. First, since, countries
that are rich in minerals are important agricultural producers stand to lose from decreases in prices, with
corresponding losses for the rural population. Second, decreased global prices for key food and energy
commodities translate into falling consumer inflation, effectively raising the real wages of employees.
Governments also employ mechanisms to stabilise prices through a system of subsidies where the government
absorbs some part of the fluctuation in commodity prices.
The boom in commodities in 2007-08 was quite broad-based (Chart 2.6). Crude oil prices came close to
the USD150/barrel mark (Chart 2.7). Prices of other energy-related commodities such as coal, natural gas
and palm oil also increased. Food products like wheat and rice which are the most common grains found in
South Asia also crossed record levels. In most countries, only a portion of the total price rise was fed back to
the farmer as middlemen in agriculture and multinational corporations in mining drank part of the profits.
However, the rural population benefitted from the higher prices and thereby also started consuming more. As
commodity prices fall, incomes in commodity exporting countries will fall, depressing domestic demand. This
is probably in important trading partners of South Asian economies such as Thailand, Indonesia and Malaysia.
South Asian exporters could suffer from a demand slowdown in these regions.
On the other hand, South Asia economies need to import oil for their domestic energy needs. Falling oil prices
thus imply an improvement in the trade balance as well as reduced domestic inflation. Annual consumer
price inflation averaged 7.8% in 2008 across Asia, rising from 4.3% the year before (Table 2.11). In South Asia,
inflation reached almost 12% in 2008.
Table 2.11: Inflation level and projections (ADB)
(% y/y) 2005 2006 2007 2008 2009
Asia 3.4 3.3 4.3 7.8 6.0
South East Asia 6.3 7.1 4.0 9.4 6.9
South Asia 5.3 5.9 5.5 11.8 9.2
Bangladesh 6.5 7.2 7.2 9.9 9.0
Bhutan 4.8 4.9 5.2 10.0 7.0
India 4.4 5.4 4.7 11.5 7.5
Maldives 3.3 3.5 7.4 11.0 6.0
Nepal 4.5 8.0 6.4 7.9 8.5
Sri Lanka 11.0 10.0 15.8 24.0 18.0
Source: Collated by Centennial Group using ADB Asian Development outlook 2008.
To keep prices at reasonable levels governments in the region increased their fiscal spending to subsidise
rising food and oil prices. With the reduced need for subsidies as inflation eases, there should also be some
relief for the fiscal accounts.
seCtion 2: reGional outlook
In this section, we assess the impact of the global crisis on each of the countries in the region, employing the
framework developed in the preceding section.
In Table 3.0, we show recent forecasts made by the ADB. Growth in Bangladesh and the Maldives was expected
to accelerate in 2009 compared to 2008 while Bhutan, India, Nepal and Sri Lanka were forecast to experience
Table 3.0: Latest ADB Forecasts
GDP (% y/y) Inflation (% y/y) Current Account (% of GDP)
2008 2009 2008 2009 2008 2009
Bangladesh 6.2 6.5 9.9 9.0 0.9 0.5
Bhutan 14.4 7.2 10.0 7.0 10.1 2.4
India 7.4 7.0 11.5 7.5 -3.1 -3.6
Maldives 6.5 7.0 11.0 6.0 -50.9 -40.0
Nepal 5.6 5.0 7.9 8.5 1.9 1.5
Sri Lanka 6.0 6.0 24.0 18.0 -8.2 -8.4
Source: ADB ADO Update, Sep 08
Given the surprisingly steep fall in global economic activity since the forecasts were made in September 2008,
we believe that GDP growth is likely to be substantially weaker in economies such as India, Sri Lanka and the
Maldives which are more exposed to the trade, financial and other transmission mechanisms we outlined
Before we analyse the impact of the crisis in more detail, it is worthwhile to also give some thought to the
medium term perspective, especially in trying to understand how the post-crisis landscape might look like.
Medium Term Perspective
The focus of this paper is on the impact of the global crisis, hence the emphasis of this paper on the outlook
for 2009 and 2010. While the prospects beyond 2010 are still unclear, it might be worth outlining some likely
changes in the post-crisis global and regional economic landscape, since that will have some impact on longer
term policy considerations.
Global and regional landscape
1. The drivers of economic growth in Asia are likely to change: Global economic growth is likely to be
dampened for many years even after the global economy recovers because of the need for household
savings rates to rise and for public sector budget deficits to be reduced substantially in the United States
and other major economies. At the same time, East Asian economies have suffered large falls in economic
output as a result of their substantial dependence on external demand. Consequently, they are likely to
aggressively pursue policies to increase the importance of domestic demand in their economies. These
policies will include stepped-up efforts to build social safety nets as well as accelerated spending on
2. There will be greater efforts to promote Asian economic integration: One reason for the over-reliance on
exports to developed economies is the lack of effective economic integration within Asia. Policy makers
are likely to promote more intra-regional trade and financial flows. Another aspect of integration might
be more co-ordination of monetary, fiscal and exchange rate policies among East Asian economies who
now realise that lack of co-operation especially in exchange rate management could be damaging.
3. Asia is mainly suffering a cyclical slowdown because of problems in the developed economies, it is not
suffering a structural economic breakdown. Consequently, there is no reason to think that the growth
engines that have been unleashed in many parts of Asia – especially in the larger economies of PRC China,
India, Indonesia and Vietnam – are likely to weaken. Vibrant Asian economic growth will resume once the
crisis recedes in 2010. Average growth rates in PRC China may be somewhat slower than in the pre-crisis
period as PRC China switches policy emphasis to the quality of growth rather than simply maximising
growth but Chinese growth will remain extraordinarily high, at around 8%-9% for many years ahead.
4. The global financial system will be changed: We see several important changes in the global financial
American and European banks will be forced to sell many of their Asian assets to other banks which
have been less damaged by the crisis.
Liquidity creation will be circumscribed compared to the last ten years as the shadow banking system
is reduced in size.
Innovation in the global financial sector will be reduced as regulation is increased.
There will be more dependence on relatively newer sources of capital such as sovereign wealth funds
and private equity.
The result will probably be lower, steadier and more disciplined flows of portfolio capital to emerging market
5. Global imbalances will therefore be reduced: With savings rates in developed economies rising and
their investment rates likely to remain subdued, current account deficits among developed economies
such as the United States are likely to fall as a percentage of GDP. In Asia, we see investment rates rising
while savings rates fall a bit, reducing the region’s tendency to generate larger and larger current account
surpluses as a ratio of GDP.
In short, growth in developed economies will slow while Asian economic growth is likely to remain robust,
even if PRC China slows a tad. Growth will probably be more balanced than before, reducing the imbalances
in current accounts we have seen in recent years.
Implications for South Asia
This picture of the post-crisis global and regional economic landscape is fairly positive for South Asia. External
demand will remain high even as the composition of this demand shifts more towards Asia rather than the
developed world. There are likely to be fewer episodes of destabilising portfolio flows moving in and out of
emerging markets in the region.
Under this scenario, the region’s growth prospects remain good. There is no reason why average GDP growth
rates in the past few years cannot be maintained once the global economy recovers in 2010.
Chapter 3: India
The Indian economy has been performing exceptionally well since 2003, with growth in the five quarters until
Sep 08 averaging 8.5% (Table 3.1). This period has seen some substantial changes in the challenges that India
faces as the Indian economy transited from the high growth period of 2007 that threatened overheating to
the deceleration period evident in the later part of 2008.
Table 3.1: India GDP breakdown by industry and expenditure
% y/y 3Q07 4Q07 1Q08 2Q08 3Q08
Gross Domestic Product (GDP) 9.2 8.9 8.9 7.9 7.6
Private Consumption Expenditure (PCE) 7.6 9.4 8.3 8.0 5.0
Government Consumption Expenditure (GCE) 10.3 2.3 16.7 7.7 8.6
Gross Fixed Capital Formation (GFCF) 16.7 14.3 11.2 9.0 13.8
Exports -2.8 15.8 10.1 18.1 13.2
Less Imports 0.4 14.2 9.7 23.4 22.6
Agriculture, Forestry and Fishing 4.7 6.0 2.9 3.0 2.7
Mining and Quarrying 5.5 5.7 5.9 4.8 3.9
Manufacturing 9.2 9.6 5.8 5.6 5.0
Electricity, Gas and Water Supply 6.9 4.8 5.6 2.6 3.6
Construction 11.8 7.1 12.6 11.4 9.7
Trade, Hotels, Transport and Communication 11.0 11.5 12.4 11.2 10.8
Financing, Insurance, Real Estate and Business Service 12.4 11.9 10.5 9.3 9.2
Community, Social and Personal Services 7.7 6.2 9.5 8.4 7.6
Source: Collated by Centennial Group using CEIC database
The year 2008 saw the Indian economy being subject to sets of forces. One was the lagged impacts of the
monetary tightening by the Reserve Bank of India (RBI) and the other was the progressively greater impact of
the global financial crisis. Consequently, India experienced a reversal of important trends:
In the early part of 2008, India was plagued by high inflation, which turned around later in the year as the
global slowdown caused commodity prices to fall.
The fiscal consolidation that was evident in recent years suffered a setback as government raised subsidies
to combat the earlier spike in inflation: with more fiscal stimulus packages likely, fiscal deficits are likely
to widen rather than consolidate.
As the global economy weakened, capital inflows which helped to drive the economy in previous years
turned into capital outflows, putting pressure on the currency, causing the Indian Rupee to reverse its
3.1 The impact of the crisis
We summarise the main impact of the crisis on India in Table 3.2 – most of the impact will come through
financial, trade and remittances.
Table 3.2: Summary - Main Channels of Impact
Transmission Mechanism Assessment
Financial Capital outflows diminish financial market liquidity and depress
valuations, raising the cost of capital and reducing the incentive to
Trade India’s relatively low export/GDP ratio means that India is less damaged
by the global slowdown than PRC China or other East Asian economies.
Still, export-oriented industries such as garments and gems/jewellery
will take a hit.
Exports of services will also slow, as financial institutions in the West,
who are major customers for India downsize.
Remittances We see remittances from both major markets – the Middle East as
well as G7 economies (United States, United Kingdom and Canada) –
Foreign Direct Investment Will fall as global companies’ access to capital declines and as their
appetite for expansion and risk weaken.
Tighter financial conditions: key transmission route
According to the Securities and Exchange Board of India (SEBI), FIIs sold a net of INR 43,782 crore in the
Indian equity markets in 2008/097 as compared to a net purchase of INR64,776 crore in the same period of
2007/08 (Chart 3.1). This extraordinary turnaround in capital flows reflected the increased integration of
Indian financial markets into the global capital market. With the increased correlation of Indian equity price
changes with those in the equity markets of the developed world, India no longer provides the same level of
diversification as in the past when India was more insulated from global financial markets. At a time of rising
risks and reduced risk tolerance among the major investment funds of the world, foreign investors cut their
exposure to Indian financial assets, producing this substantial outflow.
This phenomenon of ‘flight to safety’ is putting pressure on the Indian Rupee which has depreciated dramatically
in 2H08/09. RBI’s foreign reserves have fallen to USD123.44bn in Nov 08 from its peak of USD134.40bn two
months earlier. The Rupee started 2008 at INR39.4/USD and now trades around INR48.5/USD.
Difficulties in funding: higher cost of capital
As capital flowed out of the Indian financial system, credit markets experienced a reduction in liquidity,
causing lending rates to rise until the RBI intervened in Oct 08 (Chart 3.2), an intervention followed up in mid-
December by the central government’s insistence that state-owned banks pass on a part of the RBI interest
rate reductions to consumers and firms.
The average size of public issues declined INR540.8 crore in the Apr-Dec 08 period (Table 3.3). The lack of
resource mobilization is well depicted in the mutual funds market which indicates a net outflow of INR30,432
crore in the same period compared to an inflow of INR1,23,993 crore in the same period of 2007/08.
Table 3.3: Resource Mobilisation by Mutual Funds (Apr-Dec 08)
Crore INR Net mobilisation Net assets Net mobilisation Net assets
Private sector 105,868 447,174 -39,942 330,730
Public sector 18,125 102,762 9,510 82,634
Total 123,993 549,936 -30,432 413,364
Source: ‘Macroeconomic and Monetary Developments 3Q08/09’, RBI, January 2009
Despite these difficulties, the Indian economy did not have to endure the banking sector travails evident in
the United States, Europe and some emerging market countries in Europe.
Trade in goods and services
Indian exports contracted in Oct 08 and Nov 08 for the first time since Mar 02 (Chart 3.3). Indian IT firms
which have grown robustly over the past years are now expecting some slowing in their sector. We expect
a contraction in volumes in the coming months. Already some companies are feeling the heat. The National
Association of Software Services Companies said that revenues are expected to grow about 17% from the
previously estimated 21% for 2008/098. The tarnished reputation of the industry after the recent fraud
scandals will also enforce a cautious approach to outsourcing in the short run.
As for merchandise exports, India is already suffering a slowdown. According to India’s Economic Advisory
Council, growth in exports of refined petroleum products (which account for approximately 15% of exports) is
expected to slow to 6% lower than the amount registered last year9. The export of gems and jewellery is also
expected to fall by about 10% in 2008/09. The declines reflect both lower prices as well as reduced volumes.
‘India’s outsourcing growth seen to slow down’, Financial Times, 5th February 2009
In USD terms
Non-oil, non-jewellery exports are expected to grow at a slower pace of 12% but this is unlikely to offset the
contraction in other exports.
Weaker exports could also affect India’s current account – the current account is driven by a number of
Oil prices: The current account deficit ballooned in the first two quarters of 2008 because of a high oil
imports (Chart 3.4). Since then, oil prices have receded, helping to stabilise the trade deficit in the last
quarter (Chart 3.5). With the global recession putting substantial downward pressure on oil prices, the
Indian economy is set to receive substantial relief on the current account balance.
Remittances: Private transfers comprise 60% of total invisibles in the balance of payments. According
to the World Bank, India is the highest recipient of remittances across the world as of 2008 data10.
Broadly speaking, overseas Indian workers are located in two regions: the Middle East and developed
countries such as the United States, United Kingdom and Canada. The workers in the Middle East are
mostly unskilled labour employed in construction and oil-related services while overseas Indians in
the developed countries include skilled labour in the banking and information technology (IT) industry.
Consequently, it is almost inevitable that remittances will decline. Companies in developed economies
will have to retrench workers including foreign ones such as overseas Indian workers as weaker demand
forces them to align their capacity with lower demand. Remittance outflows from the Middle East are
linked to oil prices: as oil revenues fall substantially below expected levels, spending on construction and
related areas where overseas Indians work will fall and reduce the demand for such workers. Remittances
from overseas Indian workers stood at USD25.7bn in 1H08/09, an increase of 53% and 40.1% in 1Q08/09
and 2Q08/09 (Chart 3.6).
Ultimately, the current account balance is driven by movements in the savings rate vis-à-vis the investment
rate. Our view is that the impact of the global slowdown will be a material fall in the investment rate where
the decline is likely to be greater than the decline we also see in India’s savings rate. This means that the
current account deficit/GDP ratio is likely to improve moderately in 2009.
Foreign Direct Investment
According to UNCTAD, FDI inflows to India in 2008 recorded USD36.7bn, an increase of almost 60% from
10 World Bank, Migration and Remittances Team, Development Prospects Group
the previous year. While India’s long term fundamentals remain compelling for foreign investors, greater
uncertainty as well as the difficulty that companies face in raising capital mean that FDI inflows may diminish
for a period of at least one to two years.
3.2 How resilient will India be?
We see several keys to resilience to such a major external shock.
The first is whether the structure of the economy allows for more shock absorbers in the system or whether
structural weaknesses mean that there are shock amplifiers that far from softening the blow of external
shocks actually magnify the initial impact. In many cases, a key absorber or amplifier is the financial
sector. A robust financial sector with relatively strong banks makes for a more resilient economy.
Second, how diversified is the economy? Is it overly dependent on external demand with domestic
demand playing a subsidiary role? Is its export and/or industrial base diverse enough?
Third, how well-placed is the country to make a robust and effective policy response?
We will assess the first two aspects of resilience in this section and address policy in the next section.
Financial sector: well-supervised and largely resilient
The Indian banking industry was mostly not exposed to the derivative financial products that have caused
the financial crisis in the United States. This is because complex financial tools such as securitized securities
were only recently introduced and had not caught on. Table 3.4 provides an overview of the Indian banking
industry with some key ratios. This shows that Indian banks entered the global crisis with a considerable
capital cushion: a Risk Weighted Capital Ratio of 13% is substantially higher than the minimum regulatory
requirement under the Basel norms of 8%. While Indian banks are relatively secure, a sudden capital outflow
especially from United States investors who stand claim to USD8.5bn of assets of Indian banks is a threat that
has always remained and is now being realized.
Table 3.4: Key ratios of banks in India (2007/08)
Metric Average % of GDP
Risk Weighted Capital Ratio 13% -
Net Non Performing Assets (NPA) 1.00% 0.70%
Loans to deposit ratio 75%-80% -
Return on assets 1.16% -
International claims of Indian banks USD 40 Bn 3.30%
Exposure to US USD 8.5 Bn 0.70%
Source: RBI report titled ‘A Profile of Banks: 2007-2008’ released on 24th Sep 08.
The main vulnerability in the system was the amount of financially mobile capital in the system, as
seen in the level of international claims on Indian banks. However, a large part of the damage that this
entailed has already impacted the economy, given the scale of the outflows described above.
Diversified economic base helps
With a low trade/GDP ratio, India is less exposed to external shocks than East Asian economies. Domestic
demand is the key to Indian economic growth and here there are reasons for confidence because of
some favourable factors operating on consumer spending:
Consumption: Domestic consumption is the largest contributor to the GDP (60% of the GDP as of
fiscal year 2007/08). India remains a largely rural country where the bulk of the population remains
in rural areas.
Investment: Private sector investment is about 30% of GDP. While public sector investment will
rise, investment is bound to suffer. With the real estate sector cooling off rapidly, investment in
residential and commercial construction in urban areas is likely to fall. Tighter credit and lending
conditions coupled with a drying up of informal credit will hurt the unorganised sector’s investment
We look at consumer and investment spending prospects in more detail below.
Implications for GDP growth
India economic growth remained reasonably resilient through 2008 as the global financial crisis turned
into a global economic downturn. India’s GDP growth moderated to 7.6% in 3Q08 (Table 3.1), with
deceleration evident in the growth of both goods producing and service producing industries. Investment
remained surprisingly strong in 3Q08, increasing by 13.8% over the same period in 2008.
Consumption moderated in 3Q08 and should moderate further as the impact of the global slowdown
feeds through to domestic households and businesses. A measure of consumer spending - motor
vehicle sales - dipped sharply towards the end of 2008 (Chart 3.7). This deceleration is also visible in the
production number of consumer goods which is reacting to the slowing demand of durable goods (Chart
There are reasons to expect consumer spending to hold up reasonably well. The indications of the impact
of weather on Indian agriculture are fairly positive for at least the first half of 2009, this is important
in what is still largely a rural country. Consumer spending will also be supported by a number of other
factors. First, the Sixth Pay Commission awards will continue contributing to boosting incomes in the
public sector and sectors closely associated with it, given the phased manner of its implementation.
Second, the substantial deceleration in inflation will bolster consumer confidence, providing some
support to consumer spending. Third, the rural sector will benefit from the farmer loan waiver programme
instituted by the government.
As global inflation cools, as slower growth in India introduces more slack in the economy and as oil prices fall,
inflation in India is decelerating rapidly. As of mid January 2009, the inflation as measured by the wholesale
price index has fallen to below 5% from a peak of 12.8% in Aug 08 (Chart 3.10).
The positive factors supporting consumption mentioned above will probably suffice to offset some of the
headwinds emanating from the following:
As the revenues of domestic companies weaken, companies will be forced to consider retrenchments and
other forms of restructuring to reduce costs. Job prospects in the two highly vulnerable industries – exports
and financial services - are already becoming clouded. Recent announcements by the Commerce Ministry
project job losses from a protracted decline in exports could range between 700,000 and 1,000,000.
As argued above, prospects for both outsourcing and remittances appear to be restrained in 2009. When
incomes from outsourcing and remittances fall, household incomes and spending will be bound to be
A weaker exchange rate has two effects. First, a weaker Rupee increases the prices of imported consumer
durables. But, second, it also offsets some of the benefits of lower US Dollar prices of crude oil. However,
since Indian consumers do not rely heavily on imported goods, the damage from currency depreciation is
likely to be mild. Non-oil imports, a measure of domestic demand, have increased in 4Q08 due to higher
currency costs (Chart 3.9).
Industrial production has decelerated through 2008, with all the main components affected. Manufacturing
with an 80% weight in the industrial production index has been particularly hurt, falling 2% y/y in Dec 08 after
falling 1.7% in Nov 08, the worst performance since Mar 93 (Chart 3.11).
3.3 Policy response
The Indian government, in coordination with the RBI, is using a three-pronged approach to alleviate the
impact of the global crisis on India. The government has introduced two fiscal stimuli packages so far, the
most recent one being on 4th January 2009.
Liquidity infusion and rate cuts
The RBI has noted in its last two statements that policy options have shifted from controlling inflation to
Sharp reductions in policy rates: The repo rate has been cut from a peak of 9.0% in Sep 08 to 5.5% in
Jan 09 and the reverse repo from 6.0% in Nov 08 to 4.0% Jan 09 (Chart 3.12). These changes have only
partially been passed on to borrowers.
Improving liquidity: The cash reserve ratio has been decreased from 9% to 6.5% since Oct 08, releasing
liquidity to the banking sector. The RBI has also opened a special repo window under the Liquidity
Adjustment Facility (LAF) for banks for lending to non-banking financial companies (NBFCs), housing
finance companies (HFCs) and mutual funds.
Improve credit flows in trade finance: The RBI has also extended the period of pre-shipment and post-
shipment credit for exporters and offered other counter cyclical adjustments to augment the presently
abysmal situation of trade financing.
To facilitate external financing, the government through its various regulatory bodies settled for certain
regulatory adjustments. For example, all ceilings on External Corporate Borrowing (ECB) were removed in the
most recent measures. In addition, FII in corporate debt was also significantly raised.
Despite having little room for manoeuvre in the fiscal balance given the already large fiscal deficits and the
heavy burden of energy and other subsidies, the government has still managed to introduce important off-
budgeted fiscal changes described below:
Additional spending: Following the first supplementary budget which entailed additional expenditure of
INR2.3tr in Dec08, the government introduced another round of additional fiscal expenditure amounting
to INR556bn. However, because many of the additional expenditure items related to new commitments
made by the government for other reasons (the Sixth Pay Commission pay increases for civil servants and
the farm loan waiver programme are examples), the actual amount of discretionary additional spending
is around 1% of GDP.
Infrastructure development: Taxation incentives for the Indian Infrastructure Finance Company Limited
which will help supply financing for infrastructure projects.
Export encouragement: The stimulus packages paid special attention to exports through refunding
imported raw materials and financing facility as mentioned earlier.
The government fiscal balance sheet was under pressure even prior to the outbreak of the crisis, weighed
down by recent policy decisions such as the farm loan waiver programme, payouts recommended by the
Sixth Pay Commission, the rural employment guarantee scheme and the energy subsidies.
We will study the needs for future policy in the final section of our report.
Chapter 4: Bangladesh
The Bangladesh economy has been growing at a steady pace for the last five years. GDP grew by 6.2% in
2007/08 (Table 2.4). The Policy Analysis Unit (PAU) of the Bangladesh bank estimates growth in 2008/09 to
register 6.0%, slightly slower than the previous years. This comparatively robust performance points to the
country’s resilience to the global economic crisis so far. The resilience is derived from the relatively small
exposure to international financial markets, capital outflows and tourism. One important area of concern
is the export industry which is dominated by low-cost apparel exports to the United States and Europe.
However we do not believe that this is an immediate concern.
Table 4.1: Bangladesh GDP breakdown by industry
% y/y Weightage of GDP 2004/05 2005/06 2006/07 2007/08
GDP 100 5.9 6.6 6.4 6.2
Agriculture 20.9 2.2 4.9 4.6 3.6
Industry 29.7 8.3 9.7 8.4 6.9
Mining - 8.4 9.3 8.3 8.6
Manufacturing - 8.2 10.8 9.7 7.4
Utilities - 8.9 7.7 2.1 4.9
Construction - 8.3 8.3 7.0 5.9
Services 49.5 6.4 6.4 6.9 6.7
Sources: Bangladesh Bureau of Statistics
2008 has been an important year for Bangladesh. Certain important developments have helped shape the
economy and are likely impact the economy in 2009.
Change in political leadership: The Awami League’s (AL) landslide victory in the Dec 08 elections means a
fresh political start for the country after several years of uncertainty and instability. The new democratic
government is likely to enhance Bangladesh’s investment attractiveness to foreign investors and could
also help to improve economic policy decision-making process in the country.
Reversal in inflation trend: The Bangladeshi economy relies heavily on imports of essential commodities.
Thus, the fall in commodity prices in late 2008 will help to alleviate inflationary pressures in the short
term. However, the longer term risk of inflation remains a function of monetary policies.
Growth maintained despite bleak global environment: The ability of the economy to have withstood
the crisis thus far is an encouraging trend as the domestic fundamentals in the economy appear to be
We will now discuss the current and likely impact of the crisis, and then study the primary factors for resilience.
Finally, we will discuss the policy measures adopted thus far.
4.1 The impact of the crisis
Bangladesh has been relatively unscathed from the crisis in the world economy. However, as the downturn
accelerates further and spreads to other markets to which Bangladesh has significant important links, the
indirect effects of the crisis are likely to affect Bangladesh’s economy. Table 4.2 summarizes the main channels
of impact on Bangladesh.
Table 4.2: Summary - Main Channels of Impact
Transmission Mechanism Assessment
Trade Bangladesh’s poorly diversified export base has its main markets in
the G7 economies and consists mostly of apparel and textile goods.
We see a decline in volume of demand rather than a loss of
competitiveness of Bangladeshi exporters.
Remittances Remittances are mostly concentrated from the Middle East and US/
Workers in the Middle East are mainly employed in the construction
industry. As the crisis spreads into the Middle East economies, inward
transfer flows will slow and we should see the return of a lot of
International aid As the country relies heavily of international aid and grants, there
is likely to sluggishness in the promised disbursements from G7
economies in 2009.
Exports: so far so good but risks remain
Exports remain the most vulnerable sector in Bangladesh. The main exports out of Bangladesh are low-
end manufactured goods such as textiles and footwear. Readymade textile products form over 63% of
total exports from Bangladesh. Of the total exports over 70% are exported to the G7 countries. These
figures suggest that even a minor contraction of exports is likely to hurt the economy and in the less
likely case of a severe pullback, the consequences on Bangladesh may be worse.
We believe that there will be a mild slowing of exports given the relatively inelastic demand for the type
of exports Bangladesh concentrates on. Chart 4.1 and Chart 4.2 do suggest some volatility of exports
in the months leading up to Oct 08 but drawing strong conclusions from this would be premature.
Consumers who are already stretched for cash are likely to shift their purchases to cheaper stores like
Wal-Mart and IKEA. Such companies function on supplying competitively priced products produced
using economies of scale in cheap labour conditions like in Bangladesh. Thus they may not see a sudden
slowdown in demand but a contraction is volume is still likely as total consumption of G7 consumers is
likely to fall.
Other exports may not hold up as much as low end manufacturing exports. These form a small portion of
total exports. These include apparel exports for high-end brands, jute, fisheries and leather goods.
Remittances: buoyant now but for how long?
Remittances from overseas Bangladeshi workers form a significant portion of incoming transfer payments in
the current account balance. There are today about 981,000 Bangladeshi workers employed abroad, in a total
population of 140m. The ratio of remittances to GDP has also increased from 3% in 1993 to 9.7% in 2007.
Remittances from Bangladesh are mainly sourced from two locations, the developed market comprising
of the United States and United Kingdom, and Middle Eastern countries, namely Saudi Arabia, Kuwait and
the United Arab Emirates (Chart 4.3). Workers in the United States and United Kingdom have increased
over the past few years as can be seen by the remittance flows from these countries. In the case of the
Middle East, Bangladeshi labourers are employed in both construction as well as oil production projects.
Remittances are key drivers of household consumption. In Bangladesh, about 66% of remittances is used for
family maintenance; 12% to purchase land and 14% to repay loans. Only 5% is used for business investment
and just 3% is saved11.
Since Bangladesh’s dependence on remittances is highly dependent on the growth of Middle Eastern
economies, this indirect effect of the slowdown in the G7 countries has not entirely been felt in Bangladesh.
Remittances have grown at an average of 25% in the last three months of 2008 (Chart 4.4). Since the
Middle East is only now beginning to be damaged by the global financial crisis, we expect this growth
to slow in coming months. Moreover, Middle Eastern economies are dependant on oil exports, and if oil
prices continue to fall, a vital determinant of construction spending in that region will have weakened
Reduced flows of international aid
With key donor countries in North America and Europe facing recession, Bangladesh could well see a lower
disbursement of financial aid which has been key to Bangladesh’s poverty alleviation strategy.
4.2 How resilient will Bangladesh be?
The main points of resilience in Bangladesh are in its financial sector which is less vulnerable to external
markets and its domestic economy which is currently benefitting rather than suffering.
‘Migrant Worker Remittances and Microfinance in Bangladesh’, Tasneem Siddiqui, 2003
The Dhaka Stock Exchange (DSE) with a current market capitalization of BDT 963,547 Bn (USD14bn) or
120% of GDP, has grown rapidly. Only a year ago, the market capitalization was just 65.3% of GDP. The DSE
has risen 13.1% since Jan 07 but peaked at 3,168 points in May 08 before falling to 2,196 points in Jan 09
The equities market has been driven down by both capital outflows and negative market sentiments flowing
in from India and the developed markets. However, the small size of the outflows suggests a lesser need for
concern in comparison with much greater outflows from other emerging markets in East Asia and Eastern
Europe. Total outflow of foreign portfolio investors for the two quarters preceding Sep 08 was USD17m which
is minor compared to the concerns of capital outflow as in the case of India (Chart 4.6). Another encouraging
statistic is that a total of 55 companies and mutual funds had declared cash dividends in the first seven
months of the year compared to 61 in the entire of 200712.
But the worry over asset quality remains
Even with deleveraging gaining further momentum in international markets, there has been little impact
on domestic credit markets, with nationwide loan disbursements growing by 43% in the quarter ending
Sep 08 (Chart 4.7). In its latest review, the Bangladesh Central Bank noted that heavy credit flow needs to
be directed in the correct direction. There has been some bubble-like pressures in the real estate market
and high asset growth in non-essential and wasteful lifestyle loans such as wedding festivals, holidays
abroad and other forms of conspicuous consumption. These are creating some erosion of asset quality.
This is a reason for longer term regulatory concern and the need for the central bank to watch for bubble
Domestic factors: consumption remains robust
Personal consumption forms about 75% of the GDP and is thus the most significant part of GDP. This supports
economic resilience. There are some important factors which we think will help keep domestic consumption
resilient in the face of further external pressures.
Bangladesh Bank, Monetary Policy Review Vol IV, No. 1, October 2008
Inflation easing and monetary growth to decelerate: Inflation has now moderated, with a high base
effect and decreased energy prices being factored in (Chart 4.8). Monetary growth which peaked at 23.5%
in Sep 08 has eased to 21.0% in Dec 08 and is projected to fall to 17.5% by Jun 09.
Cheaper imports: This will be an important factor in increasing spending among households. As Bangladesh
imports some essential goods, the easing of commodity prices will benefit consumers.
Good harvest in 2008: Agricultural prospects appear to be good in the coming year. The year 2008 had
benign weather conditions and agricultural growth is expected to expand in 2008/09. Bumper harvests
for boro rice, maize, wheat and potato have been reported for the year and outlook on other rice crops
are looking favourable.
Services industry remain healthy: Domestically-oriented services activity sector is also expected to
sustain growth. Wholesale trade, retail trade and transport and telecommunications performed well in
1Q08/09. There has also been noticeable growth in mobile phone and healthcare.
Risks to the benign scenario above
Hold back: If the labour market slows, especially as remittance inflows begin to slow and overseas
unemployed workers return, consumers could apply a ‘wait and see’ strategy before making large
expenditures on durable goods. The slowdown in commodity prices will also erode some of the income
gains of rural households which had supported consumption. Since GDP is heavily dependant on
consumption, this will have rippling effects through the economy.
Natural disasters: Bangladesh is vulnerable to the wrath of nature through cyclones, earthquakes, floods
2.3 Policy response
There has been little in the way of policy changes made by the Bangladesh government and regulatory bodies.
The need for a stimulus package has not arisen yet but businessmen, economists and consumer groups are
pushing for more anticipatory and preventive action from the government.
Remittances: some incentives
The government has been active in the remittance front by signing agreements with other countries on
manpower exports. An agreement with Libya has already been signed while deals with Jordan and Bahrain
are under discussion13. Certain tax exemption schemes on interest income earned by the non-resident
Bangladeshis have also been introduced.
Incentives for exports
Under pressure from various groups, the Finance Minister announced the creation of a high-level political
committee to take remedial actions to counter effects of the crisis14. The committee is expected to examine
proposals which demand increasing cash incentives for apparel exporters. The Ministry of textile and Jute will
be coordinating with the Finance Ministry to form a plan to protect and safeguard exporters.
‘Bangladesh, Libya to sign manpower export agreement’, New Age, 31st October 2008
‘Addressing fallouts of global recession in Bangladesh’, The Financial Express, 1st February 2009
Chapter 5: Sri Lanka
The Sri Lankan economy has experienced stable economic growth in the past five years, averaging about 6.3%
annually (Table 5.1). We shall first discuss in detail the effects of the current external environment on the Sri
Lankan economy and then study the problems in the domestic economy which have been evident since early
2008. We shall also focus on government measures to alleviate the economic pressures and finally study
possible upcoming challenges for policy makers.
Table 5.1: Sri Lankan GDP Breakdown by Industry
% y/y 2006 2007 Dec-07 Mar-08 Jun-08 Sep-08
GDP 7.7 6.8 7.6 6.3 7.0 6.3
Agriculture, Forestry & Fishing 6.3 3.3 6.7 5.9 7.4 12.4
Mining & Quarrying 24.2 19.2 30.7 13.8 19.6 15.6
Manufacturing 5.6 6.5 6.7 4.6 4.9 5.0
Utilities 14.8 4.6 3.6 3.3 6.2 -0.6
Construction 9.2 9.0 8.7 8.6 9.7 6.9
Services 7.7 7.1 7.4 6.4 6.9 5.5
Source: Collated by Centennial Group using CEIC database
The year 2008 has been a remarkably critical year for Sri Lankan. The country has been faced with two crises
in the same year.
Inflationary pressures: Inflationary pressures dominated economic policy in the first half of 2008, with
inflation accelerating to 28% in the year. While inflation began to ease in 2H08, inflationary expectations
Acute shortage of foreign reserves: The Central Bank of Sri Lanka (CBSL) was been active in the foreign
exchange market during Mar-Nov 08 to prevent the Sri Lankan Rupee from depreciating. Coupled with a
widening trade balance due to the high oil import bill in the beginning of the year, gross official reserves
have been falling. Total official US Dollar reserves have declined from USD3.5bn in Jul 08 to USD2.0bn in
Nov 08. The figure is only a little over 1.5 months of import financing.
External borrowing requirement: Raising external funds in the environment may prove to be difficult
and there is a possibility of the country seeking IMF help in this regard although such a situation has not
Conflict in north Sri Lanka: The conflict in northern Sri Lanka has also escalated as the military intensified
its campaign against the Liberation Tigers of Tamil Eelam (LTTE).
5.1 The impact of the crisis
The main transmission mechanisms of the effects of the crisis to the Sri Lankan economy are summarized in
Table 5.2: Summary - Main Channels of Impact
Transmission Mechanism Assessment
Trade Tea and apparel form the bulk of Sri Lankan exports and latest data
suggests that an external demand slowdown in these commodities is
A poorly diversified export destination base increases the risk of the
impact on exports.
The external demand shrinkage of apparel importers in the G7 is more
likely to impact Sri Lanka than its neighbours.
Remittances A slowing of economic activity in the Middle East which is the main
market for overseas workers will likely slow the demand for overseas
Sri Lankan workers and transfers back to Sri Lankan households.
Tourism A decline in consumption in the G7 and adverse socio-political
conditions in the country will substantially hurt tourist inflows.
External borrowing Deteriorating foreign reserves and unfriendly external market
conditions will both create difficulties for the government to finance
its fiscal balance which has become reliant on external financing.
Exports: marked slowdown
Key exports from Sri Lanka include textiles, tea and other minor agricultural products like rubber and coconut.
Textiles constitute 45% of total exports and tea constitutes about 17% of the total. Latest data from Nov 08
show exports growing at 11.1%. However, the underlying trend as measured by the three month moving
average of export growth shows that exports have been performing poorly (Chart 5.1).
The textile export industry of Sri Lanka has so far withstood the demand slowdown in the G7 markets as has
been the case in Bangladesh and India (Chart 5.2). On the other hand tea, exports appear to have a more
elastic demand in the export markets. Interestingly, tea exports have been volatile and the three month
average shows a sharp fall in the second half of 2008 while textile exports have been holding up. In terms
of export destinations, about 41% of textiles and garments exports reached the United States, 27% were
exported to the United Kingdom and 23% to the other European countries. These together formed 91% of
the exports. Beside textiles and tea, other sectors such as rubber and minor agricultural commodities also
showed a decline in Nov 08 on the back of lower commodity prices and lower orders. The data for the coming
months will be a better indicator of the total impact of the global downturn on Sri Lankan exports. However,
we believe that Sri Lankan exporters are at a greater risk that its counterparts in other countries, for reasons
Tougher times ahead for exporters
The risk of textile exporters’ orders being cut is more probable for Sri Lanka than India and Bangladesh because
the Sri Lankan garment exports industry faces increased challenges. There is a serious shortage of skilled
labour which is driving labour costs up. Labour costs of unskilled labour are also becoming impractically
high for exporters operating in a highly competitive market. Higher labour costs have already forced some
garment factories in the country to shut down or downscale. According to the chairman of the Joint Apparel
Association Forum, the industry is facing a brain drain with the loss of middle level management staff going
to other countries to work15. Sinotex, which is among the oldest apparel manufacturers in the country shut
down its operations in Jan 0816. As more operations shut down, we should also see consolidation within the
industry as smaller manufacturers are driven out or bought over by larger exporters.
Remittances: impact not yet transmitted
The ratio of remittances to GDP for Sri Lanka is over 7.8% which is more than India’s (2.3%) but less than
Bangladesh’s (9.7%). Hence, a sharp weakening in remittances would significantly affect domestic demand
and the current account balance. As of 2007, more than 50% of the country’s remittances originated from
the Middle East and about 22% from North America and Europe (Chart 5.3). Sri Lanka, like Bangladesh, offers
cheap unskilled labour for work in oil rigs and construction sites in these countries. Sri Lankan workers are
also popular in South Asia and Southeast Asia as household help but this forms only a small part of the total
remittance flow. As mentioned earlier, the need for employment is directly linked to oil prices which have been
weakening in the past few months and could limit employment needs in the Middle Eastern corporations.
So far, though, remittance flows have held up, amounting to USD2.7bn in Jan-Nov 08 and growing by 17.4%
y/y compared to 15.0% in the same period in 2007. To encourage workers to send more money home, the Sri
Lankan government has offered higher interest rates of overseas worker accounts17.
‘Job Losses’, Lanka Business Online, 21st January 2009
‘Sinotex closes down operations’, The Daily Mirror, 16th January 2009
‘Sri Lanka to give incentives for foreign remittances’, Official Government News Portal of Sri Lanka, 3rd January 2009, retrieved
Tourism: poor growth through 2009
Sri Lanka has been an attractive destination for tourism for many years. Tourism receipts form 1.5% of the
country’s GDP compared to 0.1% for Bangladesh and 1.1% for India as of 2006. But with restrained luxury
spending in the G7 market and the conflict in the north attracting more news coverage in tourism markets,
there are considerable risks to tourism prospects in the country.
As Chart 5.4 suggests, there has been a steady decline in tourist inflows into the country since the beginning
of 2008. Total room occupancy rates have also declined since Jan 08 (Chart 5.5). Marketing the country’s
tourism industry abroad could be a useful policy option to attract newer markets within Asia.
External borrowing: approaching unsustainability
Sri Lanka’s external borrowing to GDP ratio is at 38%. This would imply that the government needs about
USD500m of external financing each year18. This short term borrowing has been built up through the Treasury
Bills and Treasury Bonds market which was partially opened to foreign investment in 2007. However, funding
conditions have deteriorated in recent months:
Syndicated loan failed: Sri Lanka failed to attract foreign investors for a syndicated loan which was
announced in Oct 08. Earlier the central bank had sold a USD500m debut sovereign bond in Oct 07 and
raised about USD300m from a syndicated loan in Mar 08.
Withdrawal by foreign investors: As a part of the global deleveraging process foreigners have been
withdrawing their investments in the T-Bills and T-Bonds19.
Poor foreign exchange reserve management: The Sri Lankan Rupee is a soft peg currency, requiring periodic
government intervention. To prevent the depreciation of the Rupee (Chart 5.6), the Sri Lankan Central
Banka intervened in the foreign exchange market by selling its US Dollars to purchase the Rupee, resulting
in a decline in foreign exchange reserves (Chart 5.7). Later the CBSL noted that it will be more flexible on
exchange rate policy and has allowed the currency to depreciate to 114.04 LKR/USD as of Jan 09.
Currency downgrade: Recently, S&P has downgraded Sri Lanka’s foreign currency risk from B+ to B20.
‘Sri Lanka Economics’, Citi-group, 5th January 2009
‘Foreign bills: Sri Lanka opens T-Bills to foreigners’, Lanka Business Online, 6th May-08
‘Downgraded’, Lanka Business Online, 15th December 2008
5.2 How resilient will Sri Lanka be?
Despite the unpleasant economic and political conditions prevalent in Sri Lanka, there are some areas which
are performing relatively better and could support the negatives from the global slowdown.
Financial sector: somewhat resilient despite capital outflows
The Sri Lankan economy has been mainly indirectly affected by the global downturn. The Sri Lankan Central
Bank imposes capital controls on the inflow of short term volatile capital and this has resulted in a relatively
low stock of foreign-owned portfolio capital in Sri Lanka’s equity market. The banking industry is also negligibly
exposed to international banks and sub-prime assets.
Capital controls have been eased in the last two years with total Net Portfolio Investment in 2007 amounting
to USD101m, almost double the USD51m in 2006. In 2008, portfolio investors exited their positions in the
equity market (Charts 5.8 and 5.9). We believe that the worst of the capital outflows has now passed and
expect a better outlook for the stock market, especially if military progress in the northern conflict produces
a sustainable resolution of that conflict.
External Account improvement despite slowing exports and transfers
A high import bill in 2008 due to high oil prices in the beginning of the year is likely to widen the Current
Account Deficit in 2008 (Chart 5.10). But as oil prices have now receded, the burden on the trade deficit is
also likely to ease allowing for a narrowing of the current account deficit in 2009.
Some concerns regarding possible sluggishness in remittance flows and falling tourism income pose further
threats to the current account deficit. But unless there is a sudden and unexpected slowdown in tourism or
remittances, the net effect on the current account should be positive.
Domestic economy: panic has abated
The painful period of high inflation is now in the past and the domestic economy is more suited to tackle a
slowing external environment. The main areas of growth in the domestic economy are in:
Agriculture: A bumper harvest in 2008 will allow for surplus which could be exported in 2009 for
potatoes, onions and chillies. Also lands in the North which have been out of bounds will now be open
for agricultural use.
Fisheries: Fishing is currently limited in Sri Lanka but as the government is becoming more interested in
fisheries as a revenue earner the prospects for the industry are growing. In the government news portal
it says that the government will allow fisherman from any part of the country to fish in the Northern
and Eastern coasts. The government has also said that it will take action in creating the infrastructural
requirements like harbours and ferries to support the industry.
Inflation: still uncomfortably high
While inflation has eased, inflationary risks remain. The inflation rate has been rising since 2005 when the
government eased monetary and fiscal policies. Average reserve money growth for 2007 was 16.1%, which
raised inflationary pressures considerably. Sri Lanka began 2008 with uncontrollably high inflation at 21.9%
in Jan 08 and this went on to cross 28% later in the year (Chart 5.11). The deceleration in inflation since then
has been mainly due to the fall in oil prices.
Nevertheless, inflationary risks remain given current loose monetary conditions that prevailed until recently.
M2 has been growing by over 16% per year since 2004. The latest monetary aggregate data however shows a
drastic fall in M2 from 15.8% in Jab 08 to 7.3% in Dec 09. Policy makers should perhaps focus greater attention
on the impact of current monetary conditions on future inflation.
5.3 Policy response
Government policy has focused on a pro-active response to the risk that slowing external demand will hurt
the economy rather than on the risks of future inflation.
The CBSL has signalled a period of monetary easing in 2009 after monetary tightening was used to address
high inflation in 2008. The penal rate charged on reverse repurchase transactions was cut by 200 basis points
on 12th Jan 08 and 50 basis points on 11th Feb 08. The repo and the reverse repo rates have also been lowered
by 25 basis points each to 10.25% and 11.75% on 11th Feb 08. These are the first such reductions since Oct 03
reflecting the CBSL’s switched focus on growth.
The government introduced a stimulus package directly targeting supply side dynamics to improve market
conditions. The package includes:
Easing fuel prices: The government is pro-actively passing on falling global oil prices to consumers. This
will help bring inflation down to single digits in 2009. The reduced subsidy burden will alleviate the fiscal
balance and ease government financing ability.
Export incentives: Aware of the brewing problems among exporters, the government included a 15%
reduction on surcharge in certain industries like leather, rubber and tourism.
Tea industry: The government has introduced special incentives for the tea industry which range from
better loan access, minimum price purchases and exemptions on loans for modernizing factories.
More flexibility on the currency: The government has also promised that it will be more flexible on the
currency and this is noticeable in the gradual depreciation in the last few months.
Augmenting remittances to support external financing
As foreign investors are pulling out their monies, the government is now looking toward overseas Sri Lankans
to assist with the external financing. The CBSL is hoping to raise USD 500m through remittances.
The central bank will maintain a sinking fund for Diasporas’ investments in T-Bills and T-Bonds to
boost the confidence of investors and said it will facilitate the withdrawal of investments when
The investors will have the option to invest in any currency and withdraw in the same currency.
The CBSL has also assured prospective investors that the interest on these securities will be higher
than in most advanced economies even if the Rupee depreciates further.
The outcome of the Diasporas bonds will only be known in the coming months. However we believe that
there is some weakness in this plan.
Remittances may fall short of target: Since the Diaspora bonds project the current levels of
remittances to continue, there is a worry of the remittances failing their target as the slowdown hits
Middle Eastern economies.
Need for remittances to fund household consumption: During tougher times overseas workers are less
likely to lock their earnings into bonds but more liable to transfer their income to their family which may
be in the pressing need for cash
The success of using Diaspora bonds to finance the external debt will only be known in the coming months
and if the reaction is positive, this could be a viable tool for the future.
Chapter 6: Other economies
6.1 The Maldives
The Maldives is the smallest among the South Asian economies in terms of land area and population in South
Asia and thus heavily dependant on external demand. In 2005, the economy was faced with the challenge of
rehabilitation from the Dec 04 tsunami. GDP grew 7.6% in 2007 and 18.0% in 2006 after a 4.6% contraction
in 2005 (Table 6.1).
Table 6.1: Maldives GDP breakdown by industry
% y/y Weightage in 2005 2006 2007 2008
GDP 100 -4.6 18 7.2 5.7
Primary sector 6.7 11.8 -.3 -14.9 -1.4
Fisheries 4.2 17.6 -.9 -21.8 -2.6
Secondary sector 17.7 2.9 15.8 10.0 6.9
Manufacturing 6.8 -10.1 14.6 3.3 2.4
Construction 6.4 15.2 20.5 19.6 13.2
Tertiary sector 79.6 -8.2 21.3 9.1 6.0
Tourism 27.2 -33.1 42.3 9.4 2.9
Transport and communication 19.0 15.4 18.5 8.3 7.5
Government administration 17.0 14.2 13.8 15.7 13.1
Source: Ministry of Planning and National Development. Note: 2008 numbers are estimates
The main transmission mechanisms of the external crisis are summarized in Table 6.2. There are two main
channels of transmission.
Table 6.2: Summary - Main Channels of Impact
Transmission Mechanism Assessment
Trade With high export/GDP ratio, Maldives is highly vulnerable to external
The export market is largely Thailand and Sri Lanka which could
provide a buffer but as both these economies are themselves facing
tough situations, there will be an indirect effect of the G7 slowdown.
Tourism Tourism is the main revenue earner in Maldives and is already seeing
sharp decrease in tourist volumes.
Tourists in the Europe/US will cut back on non-essential spending,
preferring locations closer to their homes for holidays.
6.1.1 Impact of the crisis
Exports: highly susceptible to an external demand withdrawal
As shown earlier in Chart 1.3, the export to GDP ratio for the Maldives is the highest in South Asia at
90% of the GDP. The Maldives has major export links with economies in Asia especially Thailand and Sri
Lanka (Table 6.3). Only 31% of Maldivian exports go to the G7 economies. But trade links with other South
Asian economies except Sri Lanka are low. Of its total exports, 15% are destined to Sri Lanka and 41% to
Table 6.3: Maldives exports by destination
%age of total exports 2003 2004 2005 2006 2007
Europe 15.7 19.5 26.4 24.6 29.3
US 32.3 26.5 0.8 0.8 1.2
Sri Lanka 13.6 12.3 15.5 12.8 14.9
Thailand 16.4 23.5 21.8 26 40.9
India 1.8 0.6 0.8 0.7 0.6
Source: Maldives Customs Department
About 43% of total exports are domestic and 57% are re-exports. Jet fuel comprises of 90% of the re-exports.
The largest domestic exports are fish-related commodities. These are generally quite inelastic but are faced
with competition from markets like Vietnam. As of 3Q08, fish exports (excluding live fish) grew 3% over the
year and earning from fish production grew 46% over the previous year. Tuna prices in the international
market have been favourable and supported Maldivian fisheries. Earnings from tuna increased 75% over the
same quarter in 2007.
A sharp slowdown in fish exports seems unlikely but a moderation in demand is quite possible. The fish
industry largely depends on consumption in Thailand which has remained robust. However the inability to
store fish for a longer period implies that farmers may have dispose off their fishes periodically.
Tourism is the most important foreign exchange earner for Maldives. The United Nations World Tourism
Organization warns of stagnant or contraction in worldwide tourism in 2009. Maldives is vulnerable to pull
backs in tourist and a scenario as painted by the UNWTO would create difficulties in Maldives. The ratio of
tourism to the GDP was 50% in 2007. Tourism receipts as a percentage of total exports amounted to 63% in
the same year.
Latest data shows that the tourism industry has been slowing in 2H08 (Chart 6.1). Europe which is the leading
market generator showed a contraction compared to 2007. Arrivals from the United Kingdom, with the
largest market share of 17.1%, contracted by 6.7% in 2008 (Chart 6.2). A similar trend was seen from Italy and
Germany. Arrivals from Asia grew 0.8% in 2008. The Chinese market, which has a small share, grew 15.4% in
2008. Consequently, hotel occupancy rates in resorts and hotels fell to 75% in Sep-Dec 08 compared to 92.6%
in Jan-Apr 08. The bed nights in resorts and hotels which were growing at 7.1% annually in Jan-Apr 08, grew
0.1% in the 4Q08.
To overcome these difficult times, resorts are increasingly defaulting on their bank loans or taking on overdraft
facilities. Expansion plans are being put on hold. The Tourism ministry also noted that the number of bids for
constructing new resorts have declined, reflecting reduced investor interest.
An inflexible Rufiyaa creating a USD shortage
Being a small island, the Maldives is highly dependant on imports for both intermediate goods and final goods.
Also since Maldives imports foreign workers, there is an outflow of remittances to the workers’ respective
countries. Thus, there is a constant need for US Dollars in the economy. On the other hand, US Dollars are
earned mainly through tourism, fish and jet fuel exports and FDI.
Recently there has been an increase in the number of foreign workers in Maldives. Expansion of economic
activities in the last few years has increased the demand for foreign workers especially in construction. The
average number of expatriate workers rose 22% annually in 3Q08. These workers send their incomes back to
their respective home countries and in the process demand large amounts of US Dollar. While the demand
for the dollar has been rising there is a declining supply through slowing tourism exports and FDI. FDI growth
has already moderated in 2008 and is expected to slow further in 2009 (Chart 6.4).
This has created a shortage of US Dollars in Maldives and a parallel black market for the Dollar. In addition,
the need for imports especially by construction companies who need to pay their suppliers is putting pressure
on the currency. Since the Rufiyaa is pegged to the US Dollar, it is unable to balance the demand/supply
mechanism leading to a shortage of rufiyaa in the economy. Many companies and individuals planning to go
abroad are facing the need to revert to the black market to find Dollars. The country’s foreign reserves now
stand at USD116m.
In the coming months, there is likely to be a slowdown in tourism and exports as well as a slowdown in
current construction projects. The narrowing of the current account due to shrinking value of oil imports will
help balance the currency demand/supply in the economy. The current account ballooned in 2008 due to a
large import bill (Chart 6.3).
The net effect of this cannot be concluded as yet but the sustainability of the current regime does raise
several questions. We shall suggest some alternatives to the current regime.
6.1.2 Policy response
The Maldives government has reacted to the pleas of the various industries facing dampened demand
conditions. The most prominent and discussed response of the state has been the lease extension of resorts.
The government is amending laws to extend resort leases from 35 years currently to 50 years; this would
postpone timelines for payment of rents which will help the resort operators to smoothen their cash flows.
The government has also promised to find foreign funding to develop resorts. This bill is still waiting to be
passed. The delay in land rentals will also put pressure on the government budget deficit which had ballooned
post tsunami as unconstrained relief measures were needed. Debt financing will continue to post a serious
problem in Maldives.
Nepal is a small economy and has relatively low exposure to the global economy. These exposures are limited
to remittances, tourism and exports. The financial sector has been relatively insulated but negative sentiments
have floated in. A contagion effect from India’s slowing demand could also be a reason for concern. GDP
growth rebounded in 2007/08 after dismal output growth in 2006/07 (Table 6.3).
Table 6.3: Nepal GDP breakdown by industry
% y/y 2004/05 2005/06 2006/07 2007/08
GDP 2.9 4.1 2.6 5.6
Agriculture 3.5 1.7 0.9 5.7
Mining 6.8 8.3 1.5 2.8
Manufacturing 2.6 2.0 2.6 0.2
Utilities 4.0 4.0 13.0 3.4
Construction 2.9 7.7 2.5 3.1
Wholesale and retail trade -6.2 3.7 -4.5 6.4
Hotels and restaurants -5.4 6.0 3.5 7.6
Transport and communication 2.0 7.0 4.5 6.6
Financial service 24.3 24.4 11.4 13.8
Source: Collated by Centennial Group using report from the Nepal Ministry of Finance
The main transmission mechanisms of the sluggish external environment on Nepal are highlighted in
Table 6.4: Summary - Main Channels of Impact
Transmission Mechanism Assessment
Trade As Nepal is the least dependant on exports among the economies
studied in the paper but with most exports directed to India, the
export oriented sectors could face a demand slowdown from India.
Tourism Tourism is an important growth driver in Nepal.
Due to expensive accessibility for G7 economies there will be a
moderation in tourism revenues.
FDI Nepal depends of FDI to finance its large scale hydro electricity
Disbursements in 2009 may slow due to difficult financing positions
which will likely delay the completion of these projects.
Foreign aids and grants A large part of the government budget is financed through international
aid and grants. A slowdown in these pay-outs of these grants, the
already tight fiscal situation will face fresh nervousness.
6.2.1 Impact of the crisis
Export: slowing demand from India
Amongst the South Asian economies, Nepal is the least dependant on exports (Chart 2.3). The exports to GDP
ratio is only 9% as of 2007, less than the 2000 figure of 13%.
Of the total value of exports in 2006/07, 63% are destined to India while only 37% find their way to other
markets. This is in stark contrast to the ratio in 1992/93 when more than 72% were exported to other countries
(Chart 6.5). The main reason for this is trade liberalization policy following by India since 1991 and bilateral
agreements between the two countries to enhance trade.
The exports to other countries are readymade garments, pashmina and woollen carpets. Such products will
find little demand in such testing times. To India exports are quite diversified and consist of Jute products,
polyester yarn, vegetable ghee or oil, thread, textiles, Zinc sheets and juices (Chart 6.6). We do not expect a
significant pullback in demand as products like polyester and vegetable ghee which are an inelastic part of
Indian households. Indian consumers have not been cornered far enough for the substitution effect to play
in for these commodities. However, a mild moderation in demand is expected. Latest data shows exports
growing by 39.9% in the first four months of 2008/09. Exports to other countries rose 70.8% while exports to
India went up 24.4% in 1Q08/09.
Tourism earning contributes 1.8% to GDP. These tourists are well distributed. About 57.8% come from Asia
and 33.8% from Western Europe and North America. The two largest markets are the United Kingdom with
6.1% of the tourists and the United States with 5.7%. The government has set a target of two million tourists
by 2011, on the assumption that improving political stability will boost tourism.
According to latest data from Tribhuvan airport, total tourist arrivals by air in Jan 09 contracted 15.8% over
the year. Tourist arrivals from India also contracted (17.6% over the year). Most of the European market
registered contractions. The only bright spot was tourists from other parts of Asia. But as the spread of the
crisis intensifies, tourists will be reluctant to travel as far as Nepal for holidays and even though political
worries may be allaying, tourist inflow is expected to slow.
Foreign direct investment: delay in completion of large projects
Nepal is reliant on foreign transfers in the form of FDI and loans/grants for large scale development ventures
like hydroelectricity projects. Nepal has an estimated potential of 83,000 MW of hydroelectricity of which it
is currently harvesting a mere 561 MW21.
In 2007/08, Nepal received FDI commitment of NPR9.81bn (NPR2.9bn in 2006/07). These were distributed
over energy, tourism and agriculture. A South Korean hydropower company committed to invest Rs 1.98
billion to develop a hydro-electricity project in Benighat. Chinese investors have also shown interest in Hydro
power in Nepal. The three largest investors are India, Korea and PRC China.
As the crisis unfolds in the above mentioned countries, the actual disbursement of the investments may be
stalled temporarily or cancelled. However due to the nature of FDI flows, a sharp fall is not very probable
Foreign aid disbursements could slow
Approximately 55%-60% of the government budget is financed by foreign assistance. In the latest budget,
foreign assistance is projected at NPR65.79bn, of which NPR47.9bn comprises foreign grants and NPR18.7bn
The UNDP recently provided NPR238m (USD3m) to Nepal to increase the use of formal financial services in
the remote areas of the country. Also, USAID provided USD42m to support Nepal’s development priorities
in health, economic growth, democracy and governance. This funding is part of a total US development
assistance package for Nepal of USD67m in 2008/09. In another instance of international support, the World
Bank approved a USD36m assistance package under the World Food Programme.
Given difficult economic conditions in donor countries, we expect development assistance from individual
countries in 2009 and 2010 to disappoint.
6.2.2 How resilient will Nepal be?
Room for manoeuvre in fiscal policy
Cautious budgetary policies over the past few years provide the fiscal space for more aggressive fiscal
measures should they be required: the fiscal deficit was a manageable 2% of GDP.
Inflation under control: oil prices fall pass through to consumers
The government has been pro-active in passing on the fall in crude oil prices to the consumers. The government
has reduced fuel prices on four successive occasions in the last few months. These decisions come as per new
government assurances to assess fuel prices every 15 days. The price of petrol and diesel are now at NPR 77
and NPR 57 from the peak price of NPR 100 and NPR 80 respectively22. These in turn will assuage any sudden
consumer spending fallouts.
Abundant foreign exchange
Reserves currently stand at Rs 212.62Bn in 2007/08 and are sufficient to cover 9.1 months of merchandise
‘FDI in Nepal’s Hydropower Sector: A Focus on the Product’, Kundan Pokhrel Majagaiya, Nepal Monitor, 24th January 2009
‘Govt. reduces fuel price marginally’, Nepal Biz News, 2nd February 2009
and services imports. These have been accumulated other years through low imports and high exports and
tourist inflow. In case of the unlikely event of sudden fall in international interest in Nepal, these can be used
to maintain the current stability.
But some weaknesses remain
Low productivity: The manufacturing industry in Nepal is unable to keep pace with other countries in
the region and is becoming uncompetitive. Manufacturing value added in GDP grew a meagre 0.2% in
2007/08. This has raised several questions about the current business climate and the need for more
Power crisis: As of 11th Jan 09, the Nepal government declared a nationwide power crisis23. This increased
the number of hours of no electricity to 16 hours a day for six days a week and 12 hours for one day. This is
becoming a cyclical trend since receding water in the winter constraints hydro-energy production. There
is urgent need for a sustainable development solution on this matter.
Growth in the last few years has been robust and promising. In 2007, GDP growth reached 21.4% (Table 6.5).
The Bhutanese economy is closely linked to the Indian economy and the slowdown in the Indian economy
is causing deceleration in Bhutan’s economy. We see three main effects of the slowdown on Bhutan: slow
disbursement of funds from India for hydroelectric projects, fall in demand for the steel industry and other
exports, and a setback to tourism. The successful political transformation from an absolute monarchy to a
democracy will help the country attract new investments.
Table 6.5: Bhutan GDP by industry breakdown
% y/y 2003 2004 2005 2006 2007
GDP 7.2 6.8 7.0 8.5 21.4
Agriculture 2.1 2.1 0.1 1.7 0.4
Mining and Quarrying -1.1 -5.2 17.1 63.0 23.1
Manufacturing 6.4 5.4 3.3 3.0 5.8
Electricity and water 18.3 -1.7 10.2 35.3 120.8
Construction 2.8 8.3 -2.5 -9.7 5.7
Wholesale & retail trade 11.7 18.5 15.0 3.7 7.5
Transport, storage and communication 0.4 21.9 8.7 18.3 11.3
Finance, insurance and real estate 22.1 12.4 26.0 17.0 5.2
Community, social and personal services 7.8 0.6 13.2 6.4 3.2
Source: Bhutan Statistical Yearbook 2007
The main transmission mechanisms of the current global crisis to Bhutan are summarized in Table 6.6.
Table 6.6: Summary - Main Channels of Impact
Transmission Mechanism Assessment
Trade With almost all trade links with India, the poor diversity in exports is
taking its toll on the Bhutanese export sector.
Steel import duty in India has caused a loss of competitiveness of
Bhutanese steel exports to India.
Tourism The main source of tourism revenue is from the US and Europe and
thus most likely to contract in 2009.
FDI and grants Investment inflows and international grants have been pivotal in
financing the large scale hydro electric projects in the country.
A softening of these in 2009 is highly likely.
6.3.1 Impact of the crisis
Trade: main vulnerabilities
The main trading partner of Bhutan is India with 81.6% of exports and 79.4% of the imports being through
India as of 2007. Trade with India is limited to three main commodities: electricity, steel and vegetable oil.
Electricity comprises 44.2% of the total exports to India, while steel and vegetable oil comprise 27.7% and
8.3% respectively. Exports to India increased from USD104.8m in 2002 to USD549.5m in 2007 (Chart 6.7).
Another important subject of trade which has become relevant in the last couple of years is the steel trade. With
the economic boom in India, Bhutanese private companies decided to leverage off the low costs of electricity
and lower tax rates in Bhutan to set up steel factories24. Steel manufacturing is electricity-intensive and this could
minimize costs. The companies imported raw material from India and sold the steel back to Indian companies.
However, the Indian government imposed an ad valorem import duty of 5% on iron and steel products in Nov
08. Bhutanese steel manufacturers exporting to India are now facing temporary closures and bankruptcies.
These companies are requesting the government for financial assistance to overcome the current cash flow
deficit. The government has not approved such aid as yet.
As new power projects have been launched and the steel exports gained ground, the trade balance of Bhutan
with India has gone into positive territory after 2006. This is also evident in the reversal of the current account
balance (Chart 6.8).
Electricity is subsidized in Bhutan and manufacturing companies that began production between jan-03 and Jun-07 were granted
tax holidays for three consecutive years.
Tourism contributes 6.1% of Bhutan GDP. Tourist arrivals increased from 21,097 in 2007 to 27,665 in 2008,
an increase of 30%. Americans have the highest market share, followed by British, Japanese, Germans,
Australians and French.
Since the main markets of Bhutanese tourism are themselves faced with reduced consumption, there will be
trickle down effects on tourist inflow into Bhutan. According to the Bhutanese Tour Operators (ABTO), 1,500
travellers have already cancelled their bookings.
Hydroelectric projects may be postponed
The largest export from Bhutan is energy produced through hydroelectric plants. These electricity projects
are largely financed by loans and grants extended by the Indian government. Most recently the Indian
government announced on 18th Dec 08, a package of INR6bn and a standby facility of INR3bn for Bhutan. The
government had already committed INR45.87bn to Bhutan25. The risk is that ongoing projects would have
to be delayed if deteriorating economic conditions and increased fiscal pressures in India caused a delay in
6.3.2 How resilient will Bhutan be?
Capital market conditions: ample liquidity
Financial markets and banks in Bhutan are relatively stable and isolated from the current slowdown. The
capital to risk-weighted assets ratio is quite high and the NPL ratio has been declining over time (Table 2.10).
However the IMF noted that the bulk of private sector credit was extended for housing and there could be a
potential threat if real estate prices deflated precipitously.
Table 6.7: Key financial sector ratios for Bhutan
% Banks Non Banks
2005 2006 2005 2006
Risk weighted CAR 20.8 17.1 32.3 36.5
Core capital ratio 19.5 15.7 23.1 26.0
Net NPL 2.9 2.4 12.0 9.0
Source: IMF Article IV. 2007
Stable exchange rate peg and international reserves
The stability of the currency which is pegged to the Indian Rupee has been an appropriate policy measure
since most of the country’s external links are with India. The anchored exchange rate has been critical in
keeping inflation (especially non-food) steady while neighbouring countries grappled with high inflationary
pressures. Bhutan’s international reserves as of 2007/08 were USD 599m or equivalent to 13 months of
The Tala project26 has increased the country’s power generation capacity from 460 MW to 1,480 MW when it
25 ‘India grants Bhutan, Maldives Rs 13.7 bn additional aid’, The Times of India, 19th December 2008.
26 The Tala project is the largest hydroelectric project in Bhutan costing about Rs 4,124 crore. It is located on the Wangchu
River and was funded 60% by the Indian Government through a grant and 40% through a loan.
was commissioned in 2006. The Tala project is responsible for the sudden spike in GDP in 2007. But the high
base effect will help moderate the GDP in 2008 and 2009. The direct and indirect benefits of the Tala project
will be felt for many years to come.
6.3.4 Policy response
There has not been much response by the new democratic government in Bhutan yet. One noteworthy
intervention has been in the tourism industry. Proposed tariff revisions to the sum of USD 250 have been
postponed to ease tourist operators. Also there are some discounts on the royalties to be paid in different
months to even the flow of cash through the volatile tourist seasons. The Hotel Association of Bhutan also
agreed to refrain from increasing room tariffs in 200927.
‘Tourism Industry: A year in review’, The Bhutan Observer, 16th January 2008
seCtion 3: analysis oF poliCy impliCations
This section is divided into two chapters. The first focuses on the short term requirement to meet the
immediate challenges of slowing global growth and its impact. The second chapter looks at the longer term
needs – assessing what the regional economies should be doing to enhance resilience to future possible
shocks from the global economy.
Chapter 7: Short Term Macro-Management Policy
The current crisis is far from its final stages and the issues in front of the policy makers are unprecedented. As
this crisis is not restricted to South Asia, policy decisions made in the G7 economies will impact decision making
in other economies. South Asia has been relatively less affected than other economies in the developing
world and policy measures should be scaled to the challenges that exist here.
In this context, we suggest policy measures which would be appropriate given the likely global policy reactions,
particularly in the United States and the rest of the G7. Short term policy measures are required to alleviate
the immediate pain and mitigate concerns which may arise in the near future. These should be focused on
alleviating business concerns and buffering the effect of the crisis on the consumer. It is also vital for policy
makers to remain dynamic as the current scenario may require sudden flexibility and decisiveness.
Table 7.1: Overview of Policy Measures and Recommendations
India Bangladesh Sri Lanka Bhutan Nepal Maldives
Current Stance Loosening Conditional Gentle Loosening Neutral policy Policy remains Neutral policy.
easing: business with concern tight.
lending over inflation.
Recommended Continued Monetary Rapid monetary Continue policy Continue policy Easing policy
Stance aggressive easing easing should be growth raises stance until tightening for tourism
through rate cuts cautious, given risks to inflation inflation eases. until inflation companies could
and reductions some remaining and external pressures ease. be needed.
in reserve inflationary risks. accounts.
Current Stance 2 large fiscal No major fiscal Fiscal package Bailing out steel No major Discussions
packages package. announced manufacturers is announcement. are underway
announced aimed at being considered. to introduce a
aimed at controlling package.
infrastructure, fuel prices and
tax cuts, exporters. Bailout
employment etc. of banks also
Recommended Continue fiscal No major Inflation risks No dire need No need for any Careful fiscal
Stance stimulation in the package needed are widespread for supporting major package planning without
same direction. yet but options and too much the iron yet. accentuating the
should be open fiscal deficit manufacturers deficit.
could create has arisen and
inflationary their recovery is
effects. highly dependant
on the industry in
Current Stance Market Managed Managed float. Pegged to the Pegged to the Pegged to
determined float with No change INR, no change INR, no change the USD, no
exchange restrictions on planned despite planned planned devaluation
rate with RBI convertibility and overvaluation plans.
intervention transferability. claims
Recommended Maintain current Allow greater One time No change No change If USD flow
Stance policy. exchange rate currency required. required yet. during tourist
movement. devaluation season fails,
should be devaluation
considered in should be
case of further considered.
Noteworthy Easing Introduction
changes regulations on of the Credit
external current Information
borrowing. Bureau and
7.1 Monetary measures
In current circumstances, monetary policy should have two aims: increasing the volume of credit available
and decreasing the cost of credit. These can be done through liquidity infusions into the market as well as
interest rate cuts.
Several South Asian economies have room for rate reductions, especially where inflation has fallen significantly
and less easy monetary conditions allow further falls. In the three large economies of Bangladesh, Sri Lanka
and India, where credit markets are most developed, repo rates currently stand at 8.75%, 10.25% and 5.5%
respectively28. Bangladesh has yet to reduce rates but has stalled the process of monetary tightening as
inflation has eased. This is concurrent to a 250 bps cut in the penal rate on reverse repurchase transactions
over the last two months. In India, the RBI has been active with monetary policy. The Repo, Reverse Repo
and Cash Reserve Ratio have been decreased by 2.0%, 3.5% and 4.0% respectively since their peak in Sep 08.
We believe that there is still room for further interest rate cuts in India and expect more cuts prior to general
elections which are scheduled for Apr-May 08.
Sri Lanka has started a brisk easing of monetary policy in Jan 09 as inflation is expected to come in at single
digits by Feb 09. Bangladesh which has been only mildly affected by the crisis, has taken a moderate stance
allowing for policy easing in business lending but discouraging excessive consumer lending. Domestic credit
growth has not tapered as much as other countries and grew 24.0% in Nov 08.
Aside from India and Sri Lanka, we do not feel that other economies need urgent monetary easing. However,
given that the global crisis is the worst in 60 years and is marked by substantial downside risks, policy makers
in the region need to keep policy options open and available.
7.2 Fiscal policy
Large scale fiscal stimulus packages have been introduced in the G7 economies as well as in PRC China and
India. The flexibility of fiscal policy is very limited in South Asia as all the economies carry large fiscal deficits
burdened by fuel and food subsidies (Table 7.2).
The rates used are- Bangladesh= Bank rate, Sri Lanka= Reverse Repo rate, India= Repo rate.
Table 7.2: Fiscal Balance
% of GDP 2003 2004 2005 2006 2007
Bangladesh -3.4 -3.2 -3.3 -3.2 -3.2
Bhutan -10.4 1.9 -6.9 -0.8 -3.4
India -8.5 -7.5 -6.7 -6.4 -5.5
Maldives -3.4 -1.6 -10.9 -6.7 -7.9
Nepal -1.4 -0.9 -0.8 -1.6 -2.0
Sri Lanka -7.8 -8.0 -8.5 -8.1 -7.7
Source: ADB Asian Development Outlook
India has introduced two stimulus packages despite its fiscal tightness. The government is also faced with
some off-budgetary fiscal worries including oil and fertilizer bonds issued earlier in 2008 to help oil marketing
companies cope with the rising crude oil prices at the time. We believe that the previous fiscal stimulus
packages have yet to show results due to a lagged effect. In addition, previously agreed increased payouts to
civil servants emanating from the Sixth Pay Commission will help support aggregate demand.
With general elections approaching, the Indian government is restricted by Election Commission rules
regarding tax cuts and other fiscal policy which may be misused by the ruling government to gain quick
popularity immediately prior to an election. Thus, substantial further fiscal policy changes will only be legally
possible after a new administration settles in, around June 2009.
This report makes the following recommendations for India:
More fiscal space for the states: More fiscal authority should be given to the states, as the states have a
more direct ability to improve demand in their regions. Health care, education and other social necessities
are handled under the state accounts. The recent ministerial meeting of state ministers with the finance
minister was a step in the right direction. The states’ fiscal spending should be in line with the centre’s
policy goal which requires dialogue among the different parties at the state and the centre. Misaligned
objectives could lead to poor use of fiscal space.
Improve implementation: Implementation of the already-announced fiscal packages is key to the
economic outlook in 2009. Delaying disbursements will weaken the stimulus impact at a critical point.
In case of other countries we believe that fiscal policy should be more industry-specific, given that the global
slowdown affects these economies in highly sector-specific ways. In the Maldives, fiscal policy should be
used to help the tourism industry through tax rebates and investment incentives. Similarly for the case of
Bangladesh and Sri Lanka, the incentives should focus on export-oriented industries. In Nepal, labour unrest
has spread and could be mitigated by the introduction of social safety nets.
7.3 Addressing potential slowdown in remittances
Remittances play an important role in all South Asian economies and should therefore be given adequate
policy attention, given the risks to remittances outlined above. We advise that remittance flows be monitored
closely and incentives designed to encourage remittances should be implemented soon.
Incentives for transfers: Governments should consider special savings instruments to encourage non-
residents to repatriate larger amounts back to their home country. This is already in force in some
countries through Diaspora bonds.
Credible exchange rate policy to prevent arbitrage: The fear of exchange rate depreciation could be
holding back remittance flows as that the overseas worker can gain on arbitrage opportunities. To tackle
this, policy makers should address exchange rate uncertainty through credible and decisive measures.
7.4 Exchange rate policy
Exchange rates are a key relative price in any economy with a material exposure to the global economy. In this
context, it is important to have an appropriate exchange rate regime, without which risks to external stability
India has a comparatively flexible exchange rate policy and has seen its currency depreciate significantly.
This has been an appropriate policy response.
The rest of the countries have pegged or quasi-pegged exchange rate systems which are coming under
stress. The two countries which may potentially face stresses in the exchange rate market are Sri Lanka and
Maldives. Both countries are facing urgent demands from several sources to devalue the local currency.
There is also some, albeit more limited pressures on the Bangladeshi Taka.
Since Sri Lanka and the Maldives face similar exchange rate issues, we discuss them in greater detail below.
The CBSL mainly fears inflationary pressures if the currency is depreciated further and argues that there is
little scope for more capital outflow. The CBSL plans to supplement the foreign reserves through currency
swaps with other countries. It is currently in the process of discussions with some friendly countries. So far,
however, no agreement has been announced. The IMF in its Article IV assessment reported that the real
effective exchange rate of the LKR is overvalued and is contributing to external instability29. The suggested
solutions included some additional exchange rate flexibility to enhance the confidence in the currency. We
believe that the currency requires greater flexibility and a possible solution could be a one-off devaluation,
followed by a more flexible exchange rate regime. If the CBSL is successful in procuring a ‘substantial’ currency
swap agreement then the one time devaluation could be avoided. However, medium term exchange rate
policy should take in account some flexibility.
In the case of the Maldives, importers are pressing for rufiyaa devaluation, in a country which depends on
imports for its daily needs. This has created a black market for the US Dollar. The Maldives Monetary Authority
should try to find other means of augmenting the supply of US Dollars. The MMA has said that the inflow of
tourists in the coming reason will open up access to possible US Dollars but this seems less likely in the face
of slowing global tourism. The MMA has also discussed other means of ensuring US Dollar remains within the
economy such as savings schemes for foreign workers in the country to incentivize them to keep their salaries in
Maldives, or currency swap agreements with other countries. One suggestion for the medium term is to switch
the peg to a basket of currencies with the Euro as the dominant currency. However, a peg with a large weight for
both the US Dollar and Euro might be more appropriate given that most trade is denominated in US Dollars.
Exchange rate policies in Nepal, Bhutan and Bangladesh have been broadly sufficient in balancing the external
Public Information Notice (PIN) No. 08/140, IMF Article IV consultation note, 31st October 2008
7.5 Need for regional co-ordination in policies
Greater co-ordination and regular dialogues among the region’s central banks is proposed. In this way,
monetary policy in each country would be informed by what others in the region are practicing. Such co-
ordination and dialogue will allow the views and needs of South Asians to be fed to the G20 meetings by
India, which is the sole South Asian representative in the G20.
A coordinated strategy is as important as individual country responses. The magnitude and objective of the
responses vary across the region but there are some common factors which could be easier done with an
Coordinated exchange rate policy: Self defeating policies such as protectionism and competitive
devaluations will only prolong the downturn as they are likely to be self-defeating. An example of this is the
import tariffs introduced by India on steel products which were harmful to Bhutanese manufacturers.
Financial stabilization co-operation: Possible areas of co-operation in financial stabilisation such
as swap arrangements should be discussed. India has a large US Dollar reserve which could come to
use for countries like Maldives and Sri Lanka which are strapped for Dollars. There already exist some
arrangements but these could be expanded in a mutually beneficial manner.30 Sri Lanka and the Maldives
are already in discussion with undisclosed countries to arrange agreement on dollar swaps.
The State Bank of India sells USD 2m every Sunday to the Maldives- ‘Company Buys USD80,000 From Black Market’, Minivan
News, 27th January 2009
Chapter 8: Longer Term Policies
The crisis will allow South Asian economies to take important steps for longer term progress and stability.
Policy makers should use the opportunity of the current slowdown to introduce reform policies aimed at
achieving longer term growth acceleration in the context of economies that are more efficient as well as being
more resilient to external shocks.
8.1 Fiscal consolidation
A priority for all South Asian economies should be to improve the fiscal balance. The current state of
government finances is limiting government ability to react decisively to an economic downturn. While the
current downturn may not be the worst in South Asia, it has exposed potential areas of vulnerability. We
suggest three crucial areas where fiscal consolidation should occur:
Subsidies: Government subsidies on food and fuel remain large, creating a large segment of the
government budget dependant on volatile movements in international markets on which these economies
have little influence. At a time when oil prices are low, the government can remove subsidies without
hurting consumers. The process of removing these subsidies also needs to be gradual and allow time for
consumers to feed in the information.
Privatization: Privatization allows more efficiency in the enterprise’s operations and the capacity to fund
the fiscal deficit in the year of the transfer of ownership. The governments should look to this option as a
useful mechanism to fund budgeted projects without taking on new loans.
8.2 Regulatory changes
South Asia has been regularly ranked poorly on its business environment. A case in point is the World Bank
Doing Business Rankings which shows poor standards of regulatory practise in South Asia (Table 8.1).
Table 8.1: World Bank Doing Business 2009 Rankings
Ease of Trading
Starting a Employing Getting Protecting Closing a
Economy Doing Across
Business Workers Credit Investors Business
Maldives 69 38 4 145 70 121 123
Sri Lanka 102 29 110 68 70 66 43
Bangladesh 110 90 132 59 18 105 106
Nepal 121 73 150 109 70 157 103
India 122 121 89 28 38 90 140
Bhutan 124 63 13 172 126 151 181
Source: Work Bank, Doing Business Indicators
Recent bad press from India following the scandal surrounding Satyam Computer Services and the business
ban on Wipro by the World Bank would have driven away some potential customers31. Below are some
suggestions about how to improve the regulatory system of the countries:
More transparency in devising and enforcing accounting standards: The Satyam scandal in India highlights
the need for sound enforcement of more rigorous accounting standards. A particular area for close study
is the monitoring of family-run businesses.
‘Scandal reveals tenacity of corruption in India’, International Herald Tribune, 20th January 2009
Corruption: High levels of corruption in South Asia cannot be eradicated immediately. But the movement
to fight corruption needs to gain more momentum. First path of eradication should focus on channelling
corruption and limiting it to only certain areas. Corruption and related malpractice have become
established as a normal state of affairs and can only be expunged through better training and stricter
8.3 Infrastructure development
Infrastructure in South Asia is among the poorest in the world. According to the World Economic Forum’s
Global Competitiveness ranking, India ranks, 67 followed by Sri Lanka at 73 and the other countries are
even further behind. Infrastructure indicators show similar findings regarding daily infrastructure usage like
electricity, water, communications and internet (Table 8.2).
The general approach recommended is to
Increase investment levels both over the longer term as well as for counter-cyclical reasons at this time.
Attract more private participation including from other countries in the region;
Remove subsidies (especially in power) to make utilities financially more viable and thus become more
attractive for public-private partnerships (PPPs); and
Have strong and independent regulators to protect consumer interests.
Electricity is an important worry throughout the region. The frequency of electric outages in the region is far
ahead of other regions. The amount of revenue loss due to electrical outages amounts to 12% of an average
Table 8.2: Infrastructure Indicators 2008
Delay in Firms using
Delay in Number Value lost Number
obtaining the web in
obtaining of due to of water
a mainline interaction
an electrical electrical electrical supply
telephone with clients
connection outages outages (% failures
connection and suppliers
(days) (days) if sales) (days)
East Asia and Pacific 14.2 9.0 2.4 3.1 11.3 25.2
Europe and Central Asia 9.3 14.0 3.1 7.5 13.4 56.7
Latin America and Caribbean 33.0 17.8 3.1 14.5 46.5 41.0
Middle East and North Africa 57.5 46.1 4.7 41.7 64.0 32.8
OECD 9.7 1.5 2.3 0.3 9.0 80.2
South Asia 56.3 121.5 5.6 12.0 66.3 29.2
Source: South Asia Economic Report 2008, ADB
8.4 Strengthening the economic base through diversification
Domestic policies should also encourage diversification of the economic base. Economies like Maldives have
little in the way of diversification as it relies entirely on tourism. The case is similar for other economies in
South Asia each of which have developed some key industries but if an external shock is passed through
which affects these industries, the countries become particularly vulnerable.
Bangladesh’s reliance of low-cost manufacturing exports could backfire if there is a sudden external shock
such as new protectionist policies by trading partners or an increase in competition with other low cost
manufacturing hubs. The setback to the economy would be difficult to handle and could lead to a severe
crisis. The same applies to Sri Lanka.
This rule should stand in the case of balance of payment flows also. The safety of two centres of remittance
inflow to South Asian economies has been helpful in reducing vulnerabilities of such transfers but risks are
still high. Similarly portfolio outflows have been an exacerbating factor in the current downturn and measures
should be taken to minimize this effect.
Diversification of sources: The sources of these flows should be diversified. The governments should
encourage other countries to invest in the domestic market or hire workers from their countries. These
could be strengthened by diversifying to other Asian economies. Leveraging around PRC China’s and
ASEAN’s economic potential could be an option.
Maintaining large foreign exchange reserves: Sri Lankan experience is an example of the failure to maintain
adquate foreign exchange reserves and uncertainties that follow in the aftermath of such actions. The
limitations to the Sri Lankan government policy could have been assuaged if reserves were managed in a
careful and shrewd manner. India seems far able to handle the imbalances from these outflows and lack
of inflows due to the safety provided by its reserves.
8.5 Regional cooperation to foster joint aggregate demand
Resilience to global shocks will be enhanced if the intra-regional trade and financial flows were greater. The
domestic economy of South Asia needs to be developed further by fostering links in investments, trade,
tourism, labour movements and aid extensions. We recognize that the poor integration in the region is a
factor of unsettled political disputes within South Asia and only a resolution in those will allow an unrestricted
dialogue on economic cooperation and a joint aggregate demand. We don’t think that regional integration
will increase noticeably in the coming years but if border disputes and other political rivalries are resolved,
regional integration will then be a possibility.
Table 8.4: Intra-regional FDI flows
India Bangladesh Nepal Sri Lanka
% of country total 2001-03 2006-07 1995-96 2005-06 Up to 2006 2006-07 2005
India 0.62 0.54 40.71 46.60 6.20
Bangladesh - - - - 0.75 - 0.18
Nepal - - - - - - -
Sri Lanka 0.01 0.01 0.23 0.41 0.13 -
Bhutan - - 0.01 0.01
Maldives 0.01 0.01 0.00 0.00 - NA
Share of Asia 0.02 0.02 2.25 2.82 41.80 46.60 7.00
Source: Regional economic integration and FDI in South Asia, Aradhana Aggarwal, ICRIER, July 2008
The only two countries where intra regional trade dominates are the two land locked countries of Nepal and
Bhutan for whom the main trading partner is India. The role of India as the largest economy will be the most
important task even for the other economies. This is visible in case of Nepal in Table 3.4. But the volume of
other bilateral trade in the region is shockingly low. We believe that the process to achieve a higher integrated
scenario would be through two key steps:
Regional trade agreements: Multilateral trade agreements remain the first best policy approach. In this
context, the Doha Round should remain a priority. However, it is recognized that achieving an agreement
at the Doha Round which actually achieves its lofty goals will be difficult for some years to come. Given
this context, the next best policy approach might be a region-wide free trade agreement under an
open regionalism approach. This should be pushed harder despite political difficulties. Bilateral trade
agreements are considerably less desirable but may become useful in practice as long as they are non-
discriminatory to others. A preferred approach would be a free trade agreement involving India, Bhutan,
Nepal, Maldives and Bangladesh along the lines of the India-Sri Lanka free trade agreement.
Transport infrastructure needs to improve to support a ‘region wide supply chain’: Transport will be
the most influential factor in allowing better regional integration. Road, port, rail and air infrastructure
in the region is weak which hinders a larger supply chain operating here as the time consumed would
increase unnecessarily. Often ports are far away from the factories and the road/rail links are slow and
unpredictable. When dealing with one location, the externalities are easier to mitigate, this is a dissuading
factor to developing an Asian wide supply chain when different operating centres are located according to
their comparative advantage at different locations in South Asia.
Appendix I: Priority sectors for FDI in South Asian countries (excl. India)
Country Priority sectors for FDI
Bangladesh Textiles, Electronics, IT, natural gas based industries, frozen foods,
leather, Ceramics, Light engineering and agro based
Bhutan Hydro power, agro processing, tourism, medicinal plants
Maldives Marine based
Nepal Medicinal and aromatic plants, agro based (mushroom., spices, vegetables, fruits),
Dairy, Tea, Sericulture, Hydro power, leather, Poultry and textiles
Sri Lanka Electronics, light engineering, Textiles, Rubber, mineral and processing, Tourism, IT,
Gems and Jewellery, Health care and Pharmaceuticals, ceramics, services
Source: Regional economic integration and FDI in South Asia, Aradhana Aggarwal, ICRIER, July 2008
Appendix II: Presence of foreign affiliates
2003 2004 2005
Bangladesh 930 - -
India 508 518 501
Maldives - - -
Nepal 524 - -
Sri Lanka 1766 1867 1871
Source: UNCTAD World Investment Report 2008
Appendix III: External debt outstanding
USD Million 2004 2005 2006 2007
Bangladesh 17,953 18,416 18,603 19,703
Bhutan 529 608 677 756
India 123,973 138,129 169,629 190,516
Maldives 332 397 574
Nepal 3,069 3,122 3,249 3,218
Sri Lanka 11,345 11,369 12,235 16,130
Source: ADB Asian Development Outlook
Appendix IV: An overview of FDI policies in South Asia
Bangladesh India Nepal Sri Lanka Bhutan Maldives
Sectoral ban on Private ownership 9 broad sectors Positive list of sectors
FDI restricted in 4 sectors
Caps of foreign None Ownership cap on 16 FDI prohibited in A negative list of Max 70% equity allowed. Investment>5 million can be
ownership sectors 23 sectors. sectors wholly owned.
Screening No screening Screening for FDI in Approval from Strict screening by BOI FDI committee which Mandatory Screening if foreign
except in telecom, specified department of meets once in 3 months equity >51% Conditional
power and mineral sectors industries screening if it is <51%
Minimum None None None None Mfg. $1Mn Services: $0.5 None
Employment Restricted No1
Technology None None Sub to approval None Sub to approval No3
Restrictions on None None Sub to approval None Sub to approval No3
Tax incentives Tax incentives Non discriminatory Non discriminatory Non Discriminatory Non Discriminatory Foreign investors have to pay
on expatriate incomes incentives royalty to the government
Source: Regional economic integration and FDI in South Asia, Aradhana Aggarwal, ICRIER, July
1 Rules and conditions under which investors may operate, including the approved business activities; lease terms for land, the royalty payments and fees due to the
government, and investment duration are governed by contracts signed between the government and investors.