R-squared 0.312 0.311 0.281 0.379 0.318 0.289 Notes: The above table presents regression estimates of equation 4. We include state level fixed effects in the regressions to account for time invariant state characteristics. We estimate the regression using data from 1999–2000 onward for the sample of the large Indian states. All specifications are estimated with heteroskedasticity robust standard errors.

# **3.3 Policy response to the GFC and macroeconomic stability**

The impact of the GFC on different countries and the pace of recovery depended both on the preconditions, such as the pace of GDP growth, and credit and investment growth in the years prior to the crisis, and on the policy response to the crisis. The initial impact of the crisis is considered relatively mute on India (see Acharya 2012), largely due to a prompt and rather large policy response to the crisis, including monetary policy easing, a large fiscal stimulus, and regulatory forbearance on banks (or what some have referred to as the “evergreening of loans”).<sup>29</sup> Mohan and Kapur (2015) and Mundle et. al. (2011) have persuasively argued that in the run-up to the 2009 general election, the fiscal stimulus in fact started prior to the GFC. The excessively stimulative policy response and the subsequent macroeconomic management of the economy however worsened macroeconomic stability and possibly prolonged the slowdown. The slow and delayed recognition and resolution of stressed bank assets subsequently added to the issues with impaired balance sheets.

A fallout of these policies was that some of the macroeconomic indicators reached crisis proportions by 2013, as the general government deficit touched nearly 10 percent of GDP; inflation reached double-digit levels; the current account deficit increased to 5 percent of GDP; and the quality of public expenditure possibly worsened due to a decline in the share of capital expenditure. Hence, it is unsurprising that as the market sentiment turned against emerging markets in summer 2013, during the “tapering talk,” India was one of the most impacted economies.<sup>30</sup> The tapering talk episode started on May 22, 2013, when Federal Reserve Chairman Ben Bernanke first spoke of the possibility of the U.S. central bank reducing the pace of its security purchases. Even though this announcement had a sharp negative impact on many emerging markets, market commentary focused most on five countries, Brazil, Indonesia, India, Turkey, and South Africa, christened as the “Fragile Five.” Within this group, India had the second-largest exchange rate depreciation and the second-largest decline in reserves. With the rupee depreciating by 18 percent at one point, bond spreads increasing, and equity prices falling, some were concerned that the country was heading toward a financial crisis.<sup>31</sup>

> 29 Repo rates dropped from 9% in Sept. 2008 to 3.25% in April 2009 and the center’s fiscal deficit increased by 5 1⁄2 percentage points of GDP.

> 30 The period of the tapering talk is generally referred to that between May 22, 2013, and September 18, 2013.

> 31 - See e.g. “India in crisis mode as rupee hits another record low,” http://money.cnn.com/2013/08/28/investing/india <u>rupee/; “India’s Financial Crisis, Through the Keyhole,” http://www.economist.com/blogs/banyan/2013/08/india-sfinancial-crisis.</u>

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