H R Khan: Turmoil in global economy - the Indian perspectives
Address by Shri H R Khan, Deputy Governor of the Reserve Bank of India, at the All India
Conference 2012 on "Waves of change: ocean of opportunities", organized by the Institute of
Chartered Accountants of India, Bhubaneswar, 18 August 2012.
* * *
The speaker acknowledges the contributions of Shri Jagan Mohan, Shri Anand Shankar and Shri Surajit Bose of
the Reserve Bank of India.
Shri Rajendra Kumar Das, Host Branch Chairman, Shri. Prashant Panda, Organizing
Committee Chairman and the office bearers of the National & Branch Managing Committees
of the Institute of Chartered Accountants of India (ICAI), Shri. Jugal Kishore Mahapatra,
Principal Secretary, Finance, Government of Odisha, distinguished delegates from across
the country, ladies and gentlemen. I am very happy to be invited to this important conference
being organized by the ICAI in this picturesque temple city of Bhubaneswar which can also
be called as God's Own City. I am thankful to the organizers for choosing such a topical
subject for this session of the conference.
The last few years have been very challenging times for the policymakers, regulators and
participants of the financial system. The crisis of 2007-08, now popularly referred to as the
Global Financial Crisis (GFC), emanated from developed countries and considerably slowed
down their growth and raised the unemployment to all-time highs. Due to various
interlinkages with the affected Advanced Economies (AEs), Emerging and Developing
Economies (EDEs), including India, experienced the consequential impact by way of
slowdown in trade, increase in risk perception and reversal of capital flows. The recent
European sovereign debt crisis, fears of Chinese slowdown and the "Fiscal Cliff" of the US
are having an adverse impact on the already fragile global economy. In short, the world and
Indian economies are faced with new challenges to growth and stability which have emerged
while some of the old impediments to sustainable growth persist. In my presentation today, I
would attempt to delve into some of the issues related to the current global turmoil and
provide the Indian perspectives on those issues using a "7 C" framework. For the sake of
completeness, I would also like to touch upon the macroeconomic environment as the
occasion demands and very briefly refer to the accounting and auditing issues since the
gathering is predominantly of the accountants.
Challenges facing global economy
The recent slowdown of the AEs is both a cause and an effect of the sovereign debt crises in
the Eurozone and the associated fiscal problems. The sovereign debt crisis in the Eurozone
has not only aggravated the macroeconomic conditions of the countries of the Eurozone but
also, in turn, has deeply affected the balance sheets of global banks having exposures to
these countries. The political measures and announcements, co-ordinated initiatives of the
Governments, and prolonged easing policies backed by unconventional measures of the
central banks to provide a solution to the problems arising out of this crisis have not been
able to evoke sustainable confidence in the financial markets. The fiscal austerity measures
taken in response are further weakening the prospects of growth and employment in the
affected European countries and, in turn, fiscal adjustment and repair of the national balance
sheet are becoming an onerous task. The US continues to face high levels of unemployment,
the consumer and business confidence remains shaken and the financial sector is still
recuperating from the earlier crisis. The European Union and the US form the two largest
economies in the world and are deeply inter-twined with each other even in such adversities.
There is, thus, a felt need for concerted actions by the policy-makers across the AEs to save
the global economy from falling into a downward spiral, rejuvenate the employment led
recovery and pave the way for structural reforms required for sustainable and balanced
growth not only in these economies but also in other economies including India.
Growth prospects
Economic growth around the world weakened significantly in Q2 2012 after being better than
expected in Q1 2012. AEs and EDEs alike are experiencing moderation in growth. The
numerous problems confronting the highly inter-connected global economy are reinforcing
each other in retarding the pace and prospects of growth. Growth in the US has fallen during
Q2 2012 while UK has been experiencing negative growth rates for three quarters now. GDP
growth in the Euro area and Japan has been negative during Q2 2012. Economic growth
even in the BRICS nations, which serve as an engine of growth in the developing world, has
slowed down considerably. One of the other pressure points in the world economy,
particularly the AEs, is the prevailing high unemployment. Unemployment in the US above
8 per cent has been persistently high. UK is also experiencing high unemployment of about
8 per cent and so is the Eurozone at around 11 per cent. Unemployment in the peripheral
countries of Eurozone range between 15 per cent (Portugal) to 25 per cent (Spain). This
obviously has implications for economic growth and the social fabric. China, a large
contributor to the global GDP in the recent times, is slowing down too, much more than what
was anticipated with growth rate for 2012 expected to below 8 per cent vis-à-vis trend rate of
near double digit growth rate. This would have significant influence on the growth prospects
of both AEs and EDEs.
Inflation prospects
The risk of rising inflation globally is currently not high as demand softens and commodity
prices decline. Bond yields across the maturities in the US, the UK and Germany, which are
relatively stable AEs, remain low and do not portend higher inflation down the line. A key risk
factor to benign inflation expectations is, however, brewing. The US is facing the worst
drought in over half a century. There are fears that corn and soyabean crops could fail
leading to an increase in the price of these crops. Since these crops also serve as animal
feed and bio-fuels, there could be an eventual increase in price of animal products like meat,
milk and milk products and bio-fuels due to fall in supply. The drought could have a bearing
on the production of other crops which could potentially increase global food inflation.
Massive liquidity injections by the central banks of advanced countries also have the
potential, particularly through the financialization of the commodity price channel, leading to
build up of inflationary pressures. In the face of falling growth, rising inflation could pose
tremendous challenge for policy-makers who are fighting against heavy odds to maintain the
growth-inflation equilibrium.
European sovereign debt crisis - new challenges
The European debt crisis, which originated in Greece, spread initially to other "peripheral"
sovereigns and has now moved to the bigger "core" European countries, such as, Spain and
Italy. As is expected, when a sovereign is stressed, its banking system is likely to get
embroiled and this is exactly what happened in this case also. The European banking sector
was tested during the onslaught of the global financial crisis and was found to be seized with
less than optimal assets amidst a stagnating economy and high unemployment level. With
aggravation of the sovereign debt crisis, it was observed that these banks with fragile
balance sheets could not lend to the sovereigns. On the other hand, the affected sovereigns
have been finding it increasingly difficult to borrow to re-capitalise the banking sector as
borrowing costs have increased due to perception of high risk associated with sovereigns. In
fact, the borrowing costs in Spain and Italy are inching towards unsustainable levels of 7 per
cent and 6 per cent respectively (Chart 1).
It is important to note that a large number of banks in the Eurozone stand to suffer significant
losses in the event of further escalation of sovereign debt crisis which may put many banks
on the verge of bankruptcy and trigger a worldwide credit crunch. Another equally important
aspect to reckon is the fund availability of the European Financial Stability Facility (EFSF) is
likely to be over-stretched if bigger economies like Italy and Spain require bail-out funds. The
latest twist to the story is news of regional governments in Spain facing insolvency. Recently,
Catalonia and Valencia regions in Spain sought bail outs from the Spanish central
government. This has made the job of policymakers even more challenging. Business
confidence continues to remain weak and the Keynesian "animal spirits" have long been
absent. Any further escalation of the European problem would possibly lead to a deeper
crisis with a potential recessionary impact not only in those economies under sovereign debt
distress but also on other economies across the globe.
The US "Fiscal Cliff" and the Chinese slowdown
Another potential crisis on the horizon is the "fiscal cliff" in the US. There is a risk that
government spending could fall abruptly in the US by as much as 4 per cent of GDP in 2013.
The political deadlock over the budget could potentially harm the economic growth if it leads
to severe fiscal austerity. With the huge unemployment rate unlikely to fall soon, the already
shaken confidence of the households and businesses could be further depressed and
possibly intensify the stressed housing sector, leading to foreclosures which, in turn, would
put the United States banking sector at risk again. Obviously, this has implications for global
growth and financial stability. It has therefore been suggested that the policy-makers in the
US must take steps to avoid the fiscal cliff and also raise the debt limit while devising plans to
return to long term fiscal prudence - a medicine long prescribed by them to the others.
China, according to the IMF, is the most "central" trading power in the world, based on its
extensive trade links with other economies that are themselves tightly interwoven. It is the
largest trading partner for 78 countries. This makes the IMF to classify China as a member of
the so-called S5, or Systemic Five, a group of economies subject to extra IMF attention.
Given its systemic importance, the recent slowdown in growth of China led by fall in
investment and export demand has dampened the hopes that China could make up for weak
demand from the debt-crippled Europe and the United States. Accordingly, the IMF has
projected very low growth rate of 3.5 per cent in 2012. The World Bank has projected global
GDP to increase modestly by 2.5 per cent, 3.0 per cent and 3.3 per cent in 2012, 2013 and
2014 respectively. This year is, thus, shaping up to become the worst year in terms of global
growth since the GFC of 2008.
Accounting and auditing issues emerging from GFC
Allow me to now turn to some issues related to accounting and auditing as most of the
participants are Chartered Accountants and would be in a better position to appreciate the
issues. The GFC has forced various market participants to re-examine their accounting
standards and auditing practices. Though several detailed analysis has been done to
determine the root causes of the crisis, the role of extant accounting standards and auditing
practices in exacerbating the GFC have also been highlighted, particularly the approach
dealing with illiquid markets and distress sales. As a result, a number of G-20 led initiatives
on global regulatory reform process along with various regulatory/standard setting bodies,
such as, the Financial Stability Board (FSB), the Basel Committee of Banking Supervision
(BCBS), and the International Accounting Standards Board (IASB) have been taken.
Some of the key issues related to accounting which were considered to have contributed to
the crisis were (i) Procylicality: Certain aspects of accounting frameworks and capital
regulation tend to enhance the natural tendency of the financial system to amplify business
cycles, affecting both the degree of credit expansion in normal conditions and the degree of
credit contraction in the downturn phase, (ii) Disclosure: Weaknesses in public disclosures by
financial institutions damaged market confidence during the turmoil. Public disclosures by
financial institutions did not always make clear the type and magnitude of risks associated
with their on- and off-balance sheet exposures, & (iii) Recognition of impairment: Loan loss
provisions were based on an incurred loss approach rather than approaches that consider
expected losses. This resulted in the level of provisions being "Too little Too late" in case of
many banking institutions.
Auditing related issues like role of external auditors in conduct of audit with professional
integrity as per the applicable statutes to impart credibility to the opinion expressed on the
reliability, transparency and usefulness of the financial statements have also been raised in
the context of the GFC and many other accounting controversies relating to financial and
non-financial firms. It is expected that international and national initiatives being taken up to
bring about desired revisions of the accounting standards, their convergence across the
jurisdictions under the IFRS framework and improve the transparency of financial reports
without jeopardising financial stability would yield the desired results sooner than later.
Challenges facing Indian economy
India has benefited from greater integration with the world economy and global financial
markets. There was a belief in some quarters that India in particular and the EDEs in Asia
have "decoupled" from the AEs and could grow indefinitely. The experience gained during
the GFC, however, proved that the decoupling theory was only a myth. It is also been
realized that no doubt there are numerous benefits of globalisation it also entails huge costs.
As has been seen over the years India's globalization indicators have been going up; for
example, the current and capital account receipts and payments as a percentage of GDP
has been around 110 per cent in the last two years. The European debt crisis and global
slowdown are creating serious headwinds for the Indian recovery and posing major
challenges for the economy. On the domestic front, the large twin deficits, viz. current
account deficit (CAD) and fiscal deficit, pose significant risks to macroeconomic stability and
growth sustainability. Financing the huge fiscal deficit from internal domestic savings would
potentially crowd out private investment, thus lowering growth prospects. This, in turn, deter
capital inflows, making it more difficult to finance the increasing CAD which in a sense is a
result of global slowdown.
Decelerating growth and persistence of high inflation
Growth deceleration in India has not been accompanied by lower inflation (Chart 2). This
obviously complicates policy making.
Chart 2: Percentage change in GDP and inflation
Source: Bloomberg
The latest GDP growth number of 6.5 per cent for the year 2011-12 is the lowest in the last
nine years. Further, the growth outlook for 2012-13 has been lowered by almost all
stakeholders including the Reserve Bank with its current projection of growth rate of 6.5 per
cent for 2012-13. Lower private consumption demand in face of a slowing economy is
compounding the slowdown. Reserve Bank's estimates suggest non-inflationary trend growth
rate has fallen to 7.5 per cent from 8 per cent. Further, a weak monsoon is feeding into food
inflation worries. This coupled with sharp currency depreciation could lead to imported
inflation. When compared to our peers, India is an outlier in many respects, particularly with
respect to high fiscal deficit accompanied by persistent high inflation (Chart 3). India, for
instance, now ranks at 151 out of 180 countries in respect of the inflation level as against a
rank below 100 few years back. Such high fiscal deficit and inflation in India limits the policy
maneuverability for providing support and stimulus by the Government and the Reserve
Bank.
Currency depreciation and current account deficit
The high current account deficit (CAD) at 4.2 per cent in 2011-12 is much above the
country's comfort level. India's CAD is also relative higher than its peers and the Indian
currency has depreciated by about 20 per cent, year on year. In fact, currencies of other
countries with CAD have also depreciated in the last one year since the US sovereign rating
downgrade. The depreciation of Indian Rupee has been broadly at the same rate vis-à-vis
the BRICS nations but higher than Asian economies (Chart 4).
Note: Currency depreciation is for the period 1 August 2011 until 13 August 2012, CAD is IMF
estimate for 2012. Source: IMF, Bloomberg
Impact of global developments on India
With recent global developments contributing to a significant rebalancing of portfolios as a
result of rapidly changing risk perceptions and appetites, the Indian macroeconomic
environment has looked turbulent during the past year or so. It has been noted that Indian
growth slowdown during 2008 crisis was more due to global developments while in the
current phase of crisis it is due to a combination of both domestic and global factors. Taking
up the latter, it is almost axiomatic that in a world that is highly globalised, developments in
developed economies are bound to have considerable direct and indirect influence on our
domestic economy and the financial system. Against this background, I intend to highlight the
impact of global developments on the Indian economy by using a 7 C framework under which
I will analyse their influence through the seven channels - Commerce, Commodity price,
Capital flows, Currency rates, Contamination, Confidence and Credit rating channels. I will
also highlight the measures that have been taken as also further measures that need to be
taken to contain the impact of these global headwinds along with the challenges that lie
ahead.
Commerce channel
India, notwithstanding its strong domestic consumption and investment drivers for growth,
has witnessed concomitant integration into the world economy over the last
decade. Whenever one thinks of globalisation, the first things that comes to mind is
integration of trade around the world. Over the years there has been substantial
improvement in India's trade openness. Further, services have come to account for a major
contributor to our export earnings. A number of factors have aided this process. Services that
were considered to be non-tradable increasingly became tradable due to innovations in
Information Technology and led to the export of Information Technology Enabled Services
(ITES) and the business processes. Currently, total trade in goods and services, for example,
accounts for over 55 per cent of the GDP (Table 1).
The GFC and the European sovereign debt crisis has slowed down the global growth and
trade and this would impact our exports both in merchandise and services. The recent
decline of Indian exports (during April - June 2012, merchandise exports have contracted by
1.7 per cent) is a clear indication of this. Given the projections of the IMF that during 2012
world trade would grow only at 3.8 per cent as against 5.9 per cent in 2011, Indian exports
are certainly in for turbulent times.
It may, however, be noted that strong and sustained growth in merchandise exports
witnessed in the recent years has been accompanied by structural shifts in the commodity
composition and product and market diversification. Over the years, technology intensive
engineering goods, such as, machinery, transport equipment, manufacture of metals and iron
and steel, and petroleum products have emerged as the drivers of India's exports in place of
traditionally predominant items, such as, gems and jewellery, textiles and textile products. In
addition, India's exports have witnessed geographical diversification as well. India's major
export markets have shifted from developed regions in the European Union and the US to
diversified markets, such as, Asia, OPEC and African countries. All these developments
have provided space for maneuverability for India's exports. Besides rationalization of many
procedures, various policy measures have also been undertaken to boost exports. Some of
the recent significant policy measures taken by the Government include more coverage
under the Focus Market and the Focus Product Schemes and the interest subvention
scheme. Reserve Bank of India has also taken quite a few steps like allowing elongated
period for realization of export proceeds, increasing export credit refinance limits from 15 to
50 per cent of the banks' outstanding Rupee export credit, increasing spread in respect of
FCNR(B) deposits which would provide source for foreign currency denominated export
credit to Indian exporters and deregulating interest rate on export credit in foreign currency
so as to incentivize the banks to extend more foreign currency export credit.
There are many opportunities for India to sustain its export momentum. India could
encourage and build capacity in the export of the 3Es - Engineering, Electrical and
Electronic goods as India's presence in these goods is rather insignificant and there is a
huge scope for improvement. India could tap into the African market and encourage exports
to other EDEs. Invoicing of trade in local currencies, which has received fillip with the
Reserve Bank of India permitting hedging facility to the non-resident importers in respect of
Rupee invoiced exports, could also help reduce reliance on the US Dollar and the vagaries of
the movement in the US dollar. Bi-lateral and regional trade blocks could be promoted and
used to invoice trade in local currencies. The steps already taken and further steps that could
be taken to explore and establish new markets and augmenting manufacturing base to
increase the export capacities could be leveraged when tides turn and would provide us the
opportunity to balance our trade account.
With trade across the globe closely interlinked with the products and markets of different
countries, developments in the world economy will also influence the Indian economy with
greater intensity. While on the one hand our exports may fall, our imports may not moderate
commensurately, thereby posing problems for India on the trade account front. Besides
slowing global demand, excessive volatility in the exchange rate along with uni-directional
movement bias witnessed during the last one year, persistence of high inflation accompanied
by wage pressure which erodes export competitiveness, and infrastructural bottlenecks have
emerged as major challenges for Indian exporters.
Commodity price channel
Commodity price channel also serve as a major transmission mechanism of global
developments to the domestic economy. India is highly reliant on imports, particularly oil
imports. About 70 per cent of demand for oil is met by imports and almost 100 per cent for
the demand of gold is met via imports. Therefore, any change in price of these commodities
has implications for price of these goods in the Indian markets. Inherently, the demand for
these goods is relatively price inelastic. Increase in price of oil and gold have thus little
impact on the demand of these goods in India. Since they are largely imported, India's
current account balance is adversely affected and could also influence inflation expectations,
putting further pressure on the fisc by way of higher subsidies and on the monetary authority
by way of suppressed inflation. Although slowdown and recession in the AEs and EDEs
should moderate oil price substantially, monetary easing by major central banks and
geopolitical factors have ensured that the prices do not fall much. The other major commodity
price channel which adversely affects the global and domestic prices is that of food. The
current drought in the US is already showing the adverse impact in terms of higher prices for
corns. Further, the impact of financialisation of commodities on their prices needs to be
studied further as current level of demand-supply mismatch does not warrant persistence of
such high prices.
Discouraging gold imports, containing the impact of exchange rate dynamics, moderating the
impact of volatility of global commodity prices on domestic economy and moderating the
increasing trend for financialisation of commodities pose serious challenges for India in the
future. Increasing the domestic exploration of gas and oil, augmenting alternative source of
energy in a planned manner and enhancing domestic agricultural productivity by optimally
exploring 32 agro-climatic zones of the country, however, can mitigate risks arising out of
adverse commodity price movements to some extent.
Capital flow channel
The major source of the transmission of external shocks to the domestic economy is through
the movement of capital flows across borders. India has also benefitted from the flow of
capital into the country and integration of financial markets across the world. The
savingsinvestment gap in India has been met by capital inflows. India is structurally a current
account deficit country; therefore, capital inflows play a very important role in financing the
CAD. In the recent period, however, dwindling capital inflows have been a cause of concern
and financing the CAD has become a major challenge. The general risk-off sentiment and
deleveraging by the European banks against the back drop of the European sovereign debt
crisis is affecting trade credit, infrastructure financing and external commercial borrowings
(ECBs) of the Indian corporates. Capital flows are determined by, inter-alia, global investor
sentiment i.e. risk-on - risk-off sentiment, investment climate in the destination country and
its credit rating. Expectedly capital flows into India have slowed in the recent times; the
figures of Q1 of 2012-13 except for non-resident deposit flows have particularly been very
disappointing. (Table 2)
A number of policy measures have been undertaken to augment the capital flows into India
given the general risk-off sentiment prevailing the global markets. With deregulation of
interest rate on NRE deposit schemes and increase in the spread for FCNR (B) deposits,
greater non-resident Indian (NRI) deposit flows have been facilitated. In 2011-12, NRI
deposit flows witnessed a sharp rise of more than 200 per cent and stood at US$ 11.9 billion
as compared with an inflow of US$ 3.2 billion in 2010-11. In addition, remittances facilities
for Indian expatriates have been streamlined given the fact that India remains the largest
remittance receiving country and such flows have huge beneficial impact for bridging the
CAD. There has been calibrated enhancement in the investment limits for the FIIs in
sovereign and corporate bonds. The limit on investment in G-Secs has been enhanced to
US$ 20 billion from US$ 15 billion. Long term investors like Sovereign Wealth Funds (SWFs),
multi-lateral agencies, endowment funds, insurance funds, pension funds and foreign Central
Banks have now been permitted to invest in Government securities. The limit on investment
in corporate bonds has been enhanced to US$ 45 billion from US$ 40 billion and the holding
period and residual maturity requirements for bonds in the infrastructure sector have been
reduced. A new scheme allowing the Qualified Foreign Investors (QFIs) to invest upto
US$ 1 billion in corporate bonds has been introduced. A number of measures like increasing
the limit for availing of ECB under the automatic route, increasing the limit for refinancing the
Rupee loans out of ECBs, new US$ 10 billion scheme of ECBs for export earners, etc. have
been taken to rationalize the regulatory framework for ECBs. All these measures are
expected to augment capital flows into India.
Given the increasing vulnerability of the external sector reflected in increasing short term
debt to total debt ratio, debt service ratio, fall in the import cover of our reserves and reserves
to external debt ratio, the need is to encourage non-debt creating flows and discourage
excessive debt creating flows. Finding funding sources other than the US and European
banks is also a major challenge. Perhaps one of the most daunting challenges for India is to
attract capital given the risk-off sentiment prevailing in the global markets and low investment
and growth outlook in the country. Improving the investment climate in India has to be the
priority area of focus both to retain the interest of Indian corporates in the country and attract
foreign direct investment flows. This could perhaps be addressed by focusing on what can be
called as deficits of the - Land, Linkages, Labour, Legal, Liquidity, Leadership and
7Ls
Learning deficits. Let me spend sometime to briefly explain these seven deficits.
Land: Due to lack of clarity on land titles, incomplete land records, absence of their
digitalization and weaknesses in the laws relating to land acquisition, investors find it difficult
to acquire the required land. Further, given the population density and the type of land use in
the country, the problem in land acquisition gets further aggravated due to social, cultural
and political reasons. Linkages: The problem of non-availability of land at the right locations
is compounded by the lack of required linkages with quality, infrastructure, backward
integration with coal and power and other input sources. Labour: Despite huge
unemployment, lack of employable people with right type of skills, inflexibility of the labour
laws, growing signs of industrial unrest and rising wage demand have resulted in labour
related deficit. In knowledge intensive sectors, which need people trained in hard subjects
like science and mathematics and quality engineers, also face problems in hiring required
people.
Legal deficit:
Difficulty in enforcing contracts in a timely manner, absence of proper
liquidation laws, absence of reforms and certainty in tax laws and uncertainty about
interpretation of laws, as evident from some recent cases, are legal impediments for
investments. Need for obtaining multiple regulatory approvals, which is reflected in very low
global position of India in "Doing Business Ranking", compounds the problems of the
entrepreneurs. Liquidity: At the system level, crowding out of resources from the banks due
to huge government borrowings because of large fiscal deficit pre-empts resources for
private sector investment. In the current context of declining asset quality and loan-deposit
mismatches, banks are found to be risk averse in lending for private investment. Absence of
a vibrant corporate debt market and the dearth of IPOs as seen recently in the capital market
further compound the problems of funding investments. The Reserve Bank has of course
been conducting the open market operations to ease the liquidity deficit in the system
beyond its comfort level; recently to direct flow of resources to the private sector for
productive purposes, it has reduced the Statutory Liquidity Ratio (SLR). Leadership:
Although India has traditionally taken pride in its entrepreneurial class, the recent decades
have brought to the fore the fact that not many new dynamic entrepreneurs have emerged.
Some studies in fact indicate that India has a large number of well entrenched billionaires in
comparison to the peer group countries. Absence of effective political and executive level
leadership at the local, state and the central levels have also been seen as obstacles to
investment in the recent years. Learning deficit: Learnings in the form of Research &
Development (R&D) inputs form an integral part for laying a strong foundation for industrial
growth. Given the quantum of resources and investments required, corporates tend to
compromise on the R&D or depend on reverse engineering to manufacture cheaper
alternatives. For achieving a greater share in world trade of quality products, corporates need
to create or tap resources which will provide original ideas through R&D. Declining number of
Ph.Ds in the country in a way shows how innovation and creativity deficits could affect quality
investment efforts.
Currency rate channel
Movement in exchange rates both in India and abroad is primarily conditioned by the
movement in the US Dollar due to the "Exorbitant Privilege1" that the currency enjoys. Firstly,
a significant portion of world trade is denominated in the US Dollar. Secondly, during times of
global risk aversion, capital flows back to the US and the US dollar strengthens (Chart 5) - a
phenomena witnessed immediately after the US downgrade