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AMITY UNIVERSITY, NOIDA
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AMITY INTERNATIONAL BUSINES SCHOOL

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EURO CRISIS AND ITS IMPACT ON
INDIA
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Submitted to –
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Dr. Harendra Kumar
Submitted by –

bnmqwertyuiopasdfghjklzxcvbnm Rahul Goyal

Mayank Gupta

qwertyuiopasdfghjklzxcvbnmqwerSiddharth Ahuja
Pulkit Nagpal
Vikas Rana

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Achin Agrawal
Astik Chopra
Baquar Tahir

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EURO CRISIS AND ITS IMPACT ON INDIA

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 Introduction

The European debt crisis (Euro Crisis) is the shorthand term for Europe’s struggle to pay the
debts it has built up in recent decades. Five of the region’s countries – Greece, Portugal, Ireland,
Italy, and Spain – have, to varying degrees, failed to generate enough economic growth to make
their ability to pay back bondholders the guarantee it was intended to be. Although these five
were seen as being the countries in immediate danger of a possible default, the crisis has far-
reaching consequences that extend beyond their borders to the world as a whole. In fact, the head
of the Bank of England referred to it as “the most serious financial crisis at least since the 1930s,
if not ever,” in October 2011. This is one of most important problems facing the world economy,
but it is also one of the hardest to understand. Below is a Q&A to help familiarize you with the
basics of this critical issue.

How it started

The global economy has experienced slow growth since the U.S. financial crisis of 2008-2009,
which has exposed the unsustainable fiscal policies of countries in Europe and around the globe.
Greece, which spent heartily for years and failed to undertake fiscal reforms, was one of the first
to feel the pinch of weaker growth. When growth slows, so do tax revenues – making high
budget deficits unsustainable. The result was that the new Prime Minister George Papandreou, in
late 2009, was forced to announce that previous governments had failed to reveal the size of the
nation’s deficits. In truth, Greece’s debts were so large that they actually exceed the size of the
nation’s entire economy, and the country could no longer hide the problem.

Investors responded by demanding higher yields on Greece’s bonds, which raised the cost of the
country’s debt burden and necessitated a series of bailouts by the European Union and European
Central Bank (ECB). The markets also began driving up bond yields in the other heavily
indebted countries in the region, anticipating problems similar to what occurred in Greece.

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The current global economic slowdown has its epicenter in the Euro-region but the contagion
is being witnessed in all major economies of the world. Several countries are seeing a
slowdown in their economic activities and overall pace of investments. Despite the strong
growth delineated by the Indian exports sector in the last few years (CAGR 2005-11 of 20.2%),
India continues to be a domestic economy with the share of exports to its GDP being around
11% on an average for the last 5 years.

Graph 1 shows that the share of the euro zone exports to their GDP was around 40% in 2010 and
has been around 39% on an average since 2005. This was followed by China at 30% and
UK at 29%.

India’s exposure to the global markets through foreign trade was restricted to 10% in 2010.
However, the impact of the rising global uncertainty and volatility in the exchange rate
movement has been seen in the business climate prevailing in India.

What is happening around the world?

Credit Default Swaps (CDS) provides a unique window of viewing the state of uncertainty
in any country. Table 1 provides information on the CDS for a set of countries at two points of
time. Table 1 shows the severity in the crisis which has eroded the creditworthiness of various
countries as the euro crisis spread. The CDS spreads have increased for countries which have

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now come in the forefront of the crisis like Italy, Hungary and Spain. They have increased 4-fold
in case of Greece and remained at higher levels for the others. This reflects that the crisis is still
some way from being resolved.

An important outcome of the developments in this area and the solution being worked out
is that European banks have to improve their capital ratios and would have to either: raise new
equity, use retained profits or shrink the balance sheet. Raising new capital is a challenge
given the rising distrust amongst investors continuously. Increasing profits is difficult as the
outlook deteriorates as illustrated by the CDS spread. Therefore, the banks appear to be left with
little choice but to shrink their balance sheet. This would lead to lowering credit which will
further exacerbate the crisis.

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Concerns in Developing countries

The rather unsatisfactory outlook of the advanced economies on account of:

 Maintenance of interest rates at near-zero levels

 Uncertainties over the euro region sovereign debt crisis
 Raising US fiscal deficit problems and slowing economic growth has had an impact on
the developing countries.

In the recent past, investors were venturing into the emerging markets that offered
attractive returns. This brought about increased flow of funds into the emerging markets and in
turn increased economic activities in these countries. However, in the last couple of months with
the inability of the emerging economies to tame inflation clubbed with rising uncertainties over
the euro-region and the volatility in the exchange rate, investors have been rushing to ‘safe
haven’ assets like the US Treasury, US Dollar or Gold. Purchasing Managers Index (PMI) is an
indicator of the economic health of the manufacturing sector of any country. The PMI index is
based on five major indicators namely, new orders, inventory levels, production, supplier
deliveries and the employment environment in a country. A PMI of more than 50
represents expansion of the manufacturing sector, compared with the previous month. If the
PMI is below 50 then it represents a contraction, while a PMI at 50 indicates no change in the
manufacturing sector.

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The above table reveals that the PMI has been declining since April reflecting the effect
of the slowdown on the developing economies. However, the PMI has remained above
the 50 mark for most of the countries till Jun 2011. In Aug 2011, when the PMI for all
the 5 countries in the table illustrated a contraction in the manufacturing sector, India
continued to be over the 50 mark.

The PMI for the month of Oct 2011 shows an improvement over the previous months and could
be partly attributed to the growth indicators for the US economy that are showing modest
improvement as well as the stable German performance. In core European countries
confidence improved a little in France and Belgium. Among the indebted peripheral
countries confidence improved in Spain and Portugal (from low levels).

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India’s Export Profile

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 India’s exports are fairly well diversified across countries. The share of West Asian and
North African (WANA) is the most followed by the other Asian countries. While UAE
was the most important destination in 2010-11 with a share of 13.7% followed by
US at 10.2%, East Europe has a share of only 0.06%. The 27 EU countries have a
share of 18.6% in India’s exports. The share of EU countries in India’s total exports has
declined from 20.2% in FY10 to 18.6% in FY11 on account of the sovereign debt crisis
in major economies of this region. The 17 nations that comprise of the Euro zone
together contribute around 14.6% to India’s exports. Of which Netherlands (2.1%),
Germany (2.7%), Belgium (2.5%), France (2.0%), Italy (1.8%) and Spain (1.0%)
contribute around 13% of the India’s exports in 2011. The gross domestic product of the
euro region for 2011 was 1.6% and countries like Greece (-7.5%), Italy (0.6%)
and Spain (0.6%) have illustrated a slowdown. However, the share of these countries
in India’s exports is quite low at around 3% and will not directly have an impact on our
growth prospects in exports. It is observed that in 2010-11, India’s exports to the
European region and US moderated. However, our exports to the Asian and the African
region, which have a greater share in India’s exports, grew during this period.

a. Growth in India’s Exports as product of growth in economic activities

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 The above table shows a positive relation between the growth in world economic
activities and India’s exports. It is observed that in majority cases (9) there is a positive
relation between the world economic growth and India’s export growth. Any decrease
(increase) in the world GDP has been reflected in India’s trade with a fall (rise) in the
exports. Two exceptions were 2006 and 2007 where the two variables were moving in
opposite directions, albeit marginally. However, it comes to one’s notice that the
movement of India’s export is directly correlated to the economic growth in the advanced
economies and the euro region. Despite the positive relation between India’s exports
and the world’s economic activities, taking a look at the average elasticity between
the two parameters shows a different picture. The average elasticity between India’s
exports and the word GDP is 0.29 which indicates positive low elasticity. Similarly,
average elasticity between India’s exports and the advanced nations or the euro region’s
GDP is 0.18. Therefore it can be concluded that, with the advanced economies showing a
slowdown on account of the US fiscal problem, Euro region debt crisis, Japanese
unstable economy post the earth quake & tsunami and the rising inflation in the emerging
economies, India’s exports are likely to be affected and the growth rate will slow down.

b. Indian Software Sector

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 India’s earnings from the software sector have been increasing steadily over the years at a
CAGR of 27.7%. In FY09, the world economic growth slowed to -0.7% but
software services continued to increase, albeit at a slower rate. Net software earnings
growth rate declined from 28.8% in 2007-08 to 14.9% in 2008-09 and further to 7.4% in
2009-10. In the first eight months of 2011, the rupee had been stable in the range of Rs.
44-45 per Dollar. A depreciating trend became stark since Aug 2011. The rupee has
depreciated by 18% against the Dollar and by around 9% against the euro since
Aug 2011. This trend is likely to improve the competitiveness of this sector. The
negative impact, if any, will be marginal.

c. Impact on Foreign Direct Investment (FDI)

FDI inflows in India during 2011-12 (Apr-Sept) increased by 74% to $19,136 MN from
$11,005 MN for the same period last year. FDI inflows peaked to $5,656 mn in Jun 2011
and declined thereafter.
Graph: Country-wise FDI inflows from Apr 2000 to Sept 2011

Mauritius has been the top investing country in India through FDI in equity, with a
historical share of around 41%. Considering the share of euro zone in FDI equity
inflows for cumulative period of Apr 2000 to Feb 2011 was 14.7% with share of
Netherlands, Cyprus and Germany has been around 4.4% and 3.7% and 2.9%

10
 respectively. The share of the other euro zone countries has been marginal.
Further, the share of the euro countries in distress namely, Italy (0.7%), Spain
(0.6%) and Greece (0%) together contribute a marginal share of 1.3% to India’s FDI
flows. Hence, it can be drawn that euro zone slowdown would not have a significant
impact on the India economy. The share of India’s FDI in the emerging and developing
markets is low at 5.2% in 2011. Therefore, the FDI flows have been less volatile to the
global slowdown.

d. Impact on Foreign Institutional Investment (FII)

On the other hand, FII have been moderating with the rise in the global uncertainties. The
following table gives a trend in the FII flows in India.

FII inflows increased in 2009-10 to $29,048 MN and the high levels of FII
inflow were sustained in 2010-11 as well with $29,422 MN flowing into the
Indian economy. FII illustrated a net outflow of $15,017 MN in 2008-09, which can be
attributed to the global financial crisis. The share of India’s FII in the emerging and

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 developing markets has declined from 19.2% in 2010 to 3.8% in 2011 as a
consequence of the global slowdown. The current financial year has seen a decline
in the momentum of FII inflows with approximately $1,881 MN flowing into the
economy so far of which $1,390 MN were in Debt and $491 MN in Equity.
Therefore, it can be observed that the FII flows are positively related to the
global investment sentiments. With the global uncertainties warming up the FIIs are
expected to withdraw from the riskier assets like the emerging market assets and drift
towards safe haven assets.

e. Inflationary scenario

Global inflation (CPI) in 2011 so far increased to 4.2% from 3.3% seen for the
same period in 2010. Inflation in the advanced economies rose sharply from 1.6% in
2010 till Jul to 2.6% in 2011. Similarly, inflation in the emerging economies increased to
6.5% in 2011 from 5.8% in 2010. Since May 2011 with an exception in July 2011
international commodity prices and metal prices in particular are moderating.
Compared with Apr 2011 the international metal index showed a decline of 19.7% with
copper declining by 22%, aluminum 18% and zinc 21%. Headline inflation in India
(WPI) has been outside the comfort zone of the Indian Central Bank since late 2010.
Therefore, the RBI has been increasing interest rates in order to curtain the rising
inflation. RBI has increased interest rates 5 times (175 bps) in the current financial year.
The RBI has maintained time and again that the high headline inflation would start to
decline from Dec 2011 and would settle at 7% by the end of the fiscal. Domestic
inflation for the month of Oct 2011 stood at 9.7%, while the international
commodity prices where moderating. This implies that the moderation in the
international commodity prices has not been translated in to the domestic commodity
prices.

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f. Exchange Rate Depreciation could worsen the outlook

Since the global uncertainties aggravated, the Indian exchange rate has depreciated
17.4% against the US Dollar during the current financial year. This has been
higher than that observed in other markets like Euro and Pound depreciated by
around 5.3% each against the Dollar during the same period.
The depreciating rupee is likely to add further pressure on domestic inflation and India’s
import bills. The rupee depreciation will particularly hit the industrial sector and
put higher pressure on their costs as items like oil, imported coal, metals and minerals
would get affected. However, it is believed that the IT services sector, textile sector and
other such export-oriented industries in India are likely to benefit from the depreciating
rupee.

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 Conclusion

Assessing the impact of the Euro Crisis on India, we can conclude that with the
continued uncertainties in the global economy as illustrated by the rising CDS spread,
slowdown in economic activities pressure is felt on the FII inflows in India. The
exports and the software services earnings are marginally impacted by the slowdown in
the world GDP. On the other hand, export oriented sectors are likely to benefit if the rupee
continues to depreciate or remains in the current band. FDI flows have been less volatile to
the euro zone crisis.

Key takeaways from the analysis

Global Economy

 Euro zone debt problem is likely to remain a concern in the near future. Further, the
European banks withdrawing credit in order to shrink their balance sheet would deepen
impact of the debt crisis on the other economies.
 Near zero level interest rates are to continue in the advanced countries in the
immediate future.

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 Rising fiscal deficit in US and uncertainties over the economic conditions in most
developed countries is adding to the worries.

Impact on India

 Though India is primarily a domestic economy, India’s exports are positively

linked to the global economic growth. This is likely to adversely impact India’s
export growth in the coming months. However, growth will be only marginally
affected by the slowdown in the euro region debt stricken countries as our exposure
is low.
 Software services and other export oriented sectors would benefit from the rupee
depreciation.
 FDI has not been significantly affected by the crisis while the FIIs are showing outflow in
the last couple of months.
 International commodity price moderation is not being translated in domestic prices.
Further, exchange rate depreciation would worsen the inflationary conditions in the
economy. Therefore, the RBI would have to continue with its anti-inflationary
stance in the near term if domestic conditions do not improve.

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