The Economic and Social Impacts to India and Its Citizens from Inward Foreign Direct Investment


: The global financial crisis and the impact on development and India



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4.4: The global financial crisis and the impact on development and India


This section is divided into two parts. The first discusses the 2008 global financial crisis and its impact on FDI flows, developing countries and development thinking. The second subsection will specifically explore the impact the crisis had on India.

4.4.1: The 2008 financial crisis and the impact on developing countries and development thinking


A major worldwide financial crisis known as the ‘global financial crisis’ or the ‘2008 global financial crisis’ erupted from the financial and housing markets in the United States in 2007 and in September 2008 the fourth largest investment bank in the United States, Lehman Brothers, declared bankruptcy sending financial shockwaves around the world (Priewe, 2010). The global financial crisis is considered by many to be the worst financial crisis the world has experienced since the Great Depression of the 1930s (Townsend, 2009; Wolf, 2013; Priewe, 2010; Dullien et al., 2010; ILO, 2011; ODI, 2010). The crisis jeopardized the collapse of the most powerful financial institutions and banks in the United States and Europe, impelling the recapitalisation and nationalisation of financial institutions as well as the provision of guarantees on bank deposits and other assets, totalling public expenditure of an estimated $18 trillion (UN, 2009; Utting et al, 2012). The global economy has not yet fully recovered (UNCTAD, 2014; ILO, 2014). While there were signs of growth in 2009 and 2010 in regards to real GDP growth, real private consumption, investment and trade levels, employment creation remains stalled with the ILO declaring the recovery a ‘jobless recovery’ (ILO, 2011, p.6; 2014). In their most recent report on global employment trends, the ILO (2014) state the uneven economic recovery and successive descending drops in economic growth since the crisis continue to depress global employment trends.

What the crisis did do was change the pattern of FDI flows. In 2007 FDI inflows had reached a historical high of $1.8 trillion (UNCTAD, 2008), however, the onset of the crisis and the consequent downfall in world trade, stock markets, real estate values, consumer and investor confidence and access to credit caused a worldwide contraction in FDI in 2009 (Poulsen and Hufbauer, 2011). One particular dynamic of the crisis, of relevance here, is the alteration of the “FDI landscape” whereby investors restructured operations and relocated investments to countries that appeared to have weathered the crisis (Poulsen and Hufbauer, 2011). In 2008 developing and transition economies’ share of global FDI surged to 43 per cent and since 2012, investment to developing countries has been stronger than that to developed countries reaching 55 per cent of the global FDI in 2014 (UNCTAD, 2009; UNCTAD, 2015). In the most recent World Investment Report, UNCTAD (2015) estimates that FDI flows could rise to $1.7 trillion in 2017 driven by increased investments to developed countries. The report goes further to state that the higher expected FDI growth to developed countries may shift the FDI distribution back to the ‘traditional pattern’ of a higher share to developed countries, however, flows to developing countries will remain at a high level (UNCTAD, 2014, p.13). FDI flows declined for both developed (by 44 per cent) and developing (by 27 per cent) in 2009, however, the decline was not as significant as an economic downturn between 2000 and 2003 even though the crisis was more severe (UNCTAD, 2010). Although the crisis impacted FDI levels, it did not arrest the growing trend for internationalisation of production (UNCTAD, 2010) and Nathan and Kelkar (2012) surmise the high level of GVC essentially ruled out protectionism as a policy response for most countries.

Developing and emerging countries experienced the brunt of the global financial crisis in the latter half of 2008 largely through the decline of global trade, withdrawal of investment, decrease in investor confidence and a decline in the value of remittances (Townsend, 2009; Dullien et al, 2010; Utting et al, 2012; Nathan and Kelkar, 2012). Although developing countries were not direct instigators or contributors to the crisis, many developing countries suffered extensively from the indirect effects of the crisis (Priewe, 2010; ODI, 2010). The global financial crisis affected developing countries in different ways depending on the nature and extent of economic integration to global financial markets, the size of the economy, the structural conditions within developing countries (ODI, 2010; Sumner and McCulloch, 2009) as well as the policy response from individual governments (Hirway and Prabhu, 2012). In general, the countries with large current account deficits or surpluses prior to the crisis appeared to experience a greater macroeconomic impact from the crisis (Dullien et al, 2010). The countries of the Commonwealth of Independent States and those of Eastern and Central Europe were most affected in regards to a drop in GDP which declined by an average of 15.2 percentage points between 2007 and 2009 (Dullien et al, 2010). In 2009 the global GDP declined 5.8 per cent from the previous year and the GDP downturn in emerging and developing countries was nearly the same as the decline in developed countries (IMF, 2010). However, a decline of that magnitude in low-income countries can cause severe social consequences as low income countries often have minimal social security systems and provisions in place to assist its citizens with the economic shock (ODI, 2010). Despite the austere impact to developing countries, discussions by leading international institutions either largely focused on the OECD countries and the social consequences experienced in developing countries as a result of the crisis were largely ignored (Utting et al, 2012; Dullien, 2010; Hirway and Prabhu, 2012).

As stated, developing countries often have insufficient or ineffective social security and welfare systems in place and the citizens hardest hit by the crisis most often had limited, if any, access to official social assistance or insurance and were left to rely on informal coping strategies at the household level and community level (Utting et al, 2012; Hirway and Prabhu, 2012). The United Nations estimated that between 47 million and 84 million more people remained poor or became impoverished in developing and transition economies in 2009 due to the impact of the crisis (United Nations General Assembly, 2010). For many developing countries, including India, jobless growth, informalisation and lack of decent work was a major obstacle for inclusive growth and the global financial crisis exacerbated these problems (ILO, 2011; Utting et al, 2012). Furthermore, as was the case with previous financial/economic crisis, the nature of women’s work changed within many developing countries (Elson, 2012; Pearson and Sweetman, 2010). First, women’s labour force participation often increases as other members of the household become unemployed or wages decrease and this often entails women taking on more work and often within the informal and unproductive segments of the labour market as a last resort to meet the family’s survival needs (Hirway and Prabhu, 2012). Second, the unpaid work and care activities that are needed to sustain families and communities increases during economic hardships and the majority of this burden becomes the responsibility of women and girls (Pearson and Sweetman, 2010; Elson, 2012). Hirway and Prabhu (2012, p.213) explain that as female household members take up these responsibilities, they become the ‘shock absorbers’ of the crisis.

The economic instability and adverse social consequences that occurred in developing countries as a result of the crisis also brought with it anticipation of change in economic and development planning:

Just as development states and welfare states emerged as part of the solution for the crisis of the 1930’s, the question arose as to whether a different approach to development might gather momentum in these turbulent times (Utting et al, 2012, p.12).

Utting et al (2012, p.2) examine development thinking in the wake of the financial crisis and postulate three possible outcomes that are worth reviewing here: ‘skewed recovery and development’, ‘embedded liberalism’ and ‘transformative restructuring and social change’. The skewed recovery and development trajectory, while advocating some measure of re-regulation of financial markets, continues to prioritise market-led development (Utting et al, 2012). This scenario promotes a return to ‘business as usual’ and entails a distorted recovery as financial institutions and systems receive enormous liquidity injections from the public purse (Utting et al, 2012).

Embedded liberalism was the solution to the economic and social upheaval that occurred in the wake of the Great Depression and World Wars whereby the economic logic of Keynes, the welfare state and state-led regulation were advocated and implemented (Ruggie, 1982). However, as Utting et al (2012) explain, in today’s context embedded liberalism must contend with the realities of economic and political globalisation where universal social policy, state autonomy and regulation are more restricted. Utting et al (2012, p.16) describe this scenario as ‘post-Washington Consensus Plus’. Just as the post-Washington Consensus added good governance and poverty reduction to the basic economic framework of neoliberalism coupled with export-led growth, the post-Washington Consensus Plus adds an emphasis of social policy and increased real wages to the same macroeconomic neoliberal formula (Utting et al, 2012). Here, social policy and increased real wages are advocated not only for social equity but also to stimulate domestic demand in developing countries (Kumhof and Ranciere, 2010). One problem with the embedded liberalism scenario is there is no call to change the problematic features of contemporary capitalism such as financialisation, the imbalances in trade and investment or speculative finance (Utting et al, 2012). Similar to the skewed recovery and development synopsis, attaining rapid economic growth remains the development priority (Utting et al 2012).

In regards to the last trajectory, transformative restructuring and social change, the impact of the global financial crisis, for many, stressed the need for structural change whereby equality, redistribution and empowerment occupy the forefront of economic and development planning (Jessop, 2012; Utting et al, 2012). Proposals for reform under the transformative restructuring and social change scenario focus on the regulation of the financial sector, demand-led growth, redistributive policies and an increased role for the welfare state (Utting et al, 2012). Reform also includes a restructuring of IGOs and the creation of new ones where developing countries play a more dominant and participatory role (Green et al, 2010; Martens, 2010).

Utting et al (2012) conclude, however, that out of the three possible outcomes for post-financial crisis development planning, the political and ideological impetus, at present, appears to lie with the ‘skewed development’ and the ‘embedded liberalism’ synopsis. Fine (2012), however, contends that the direction of policy outcome is not easy to predict and that each policy area is more likely to be shaped by different social, political and economic dynamics, thus, divergent and even contradictory policy approaches and development planning are entirely likely to coexist.

Having broadly examined the global financial crisis and its impact on developing countries and development planning, the following subsection will explore the crisis and its impact on India.

4.4.2: The global financial crisis and the impact on India


Similar to other developing countries, the global financial crisis impacted India in the second half of 2008 (Reddy, 2009; Sen Gupta, 2010; Nassif, 2010). India’s banking system was largely insulated due to India’s policy of slow liberalisation of the financial sector, regulations that do not allow for the originators of securities to sell risk and a high capital-risk reserve ratio (Reddy, 2009; Nathan and Kelkar, 2012). India’s growth prospects, however, were significantly impeded when the crisis arrived in late 2008 (Sen Gupta, 2010; Nassif, 2010). India was already experiencing an economic downturn prior to the crisis (Sen Gupta, 2010; Nassif, 2010; Reddy, 2009; Nathan and Kelkar, 2012). India had previously experienced a sustained period of high growth for four years and between 2003/2004 and 2006/2007 the economy grew at an annual rate of 8.8 per cent (Sen Gupta, 2010; Nassif, 2010; Mehrotra, 2010; Reddy, 2009). However, by 2007, the economy was showing signs of over-heating and the RBI intervened to increase the cost of credit to the private sector to slow down the economy (Reddy, 2009; Sen Gupta, 2010). Thus, India began to experience a decline in its economy prior to the global financial crisis and this increased its vulnerability when the impacts of the crisis reached India (Sen Gupta, 2010; Nassif, 2010).

At a macroeconomic level, India was affected in four main ways. One impact was a sharp decline in exports due to lack of demand from developed countries which are India’s prime recipients for the majority of its export industries (Mehrotra, 2010; Nathan and Kelkar, 2012; Hirway and Prabhu, 2012; Reddy, 2009). Although India’s economy is largely based on the capacity of its domestic markets (Ghosh, 2011), the export sector had been on the increase since 2003 and had increased to 13.58 percent of the GDP in 2007 (Nathan and Kelkar, 2012). Many of the export industries hurt by the crisis were informal sectors, often at the lowest levels of the GVC, with vulnerable workers without access to formal social assistance, insurance or protection which will be discussed further below (Hirway and Prabhu, 2012).

A second major impact on India was a crisis in its financial sector (Sen Gupta, 2010; Poulsen and Hufbauer, 2011; Mehrotra, 2010). The financial crisis was transmitted to India’s financial sector through large withdrawals of investments, specifically portfolio investments (Nassif, 2010; Sen Gupta, 2010). Investment to India fell from $108 billion in 2007-08 to $9.1 billion in 2008-2009 as a result of investor uncertainty (Sen Gupta, 2010, p159). However, inward FDI remained stable in the face of the crisis, and actually increased from $15.4 billion to $17.5 billion in 2008-09 while other components of the capital account witnessed a sharp decline (Sen Gupta, 2010, p159). The capital outflow, decrease in exports and declining reserves of foreign exchange put pressure on India’s currency and subsequently, the rupee depreciated (Hirway and Prabhu, 2012; Sen Gupta, 2010; Reddy, 2009; Mehrotra, 2010). This is a third major impact on India, the depreciation of the rupee. Although currency depreciation does have some advantages in that it can make FDI more affordable for foreign investors (Sen Gupta, 2010). Finally, a fourth impact on India was the decrease in the demand for services in the global market (Hirway and Prabhu, 2012; Mehrotra, 2010). The decline in the global demand for tradable services such as IT/ITES, communications, transport and tourism propelled a further decline in employment and economic growth (Sen Gupta, 2010; Hirway and Prabhu, 2012).

That said, India is accredited for being the second least adversely affected country by the global crisis following China (Nassif, 2010; Mehrotra, 2010). The policy response from the Indian government is accredited for preventing some of the debilitating consequences experienced by other countries (Dullien et al, 2010; Nassif, 2010). Between August 2008 and January 2009 the RBI lowered the cash reserve ratio for banks, injected liquidity into the economy and undertook other policy measures to encourage credit expansion (Sen Gupta, 2010; Reddy, 2009). One fortunate aspect of the timing of the crisis is that a number of policy measures had been taken immediately before the crisis (Sen Gupta, 2010; Nassif, 2010; Nathan and Kelkar, 2012). Measures included a complete loan waiver for existing loans for small and marginal farmers, food and fertilizer subsidies, an increase in salary for civil servant employees and a nation-wide extension for the National Rural Employment Guarantee (Sen Gupta, 2010; Nassif, 2010; Nathan and Kelkar, 2012). After the transmission of the crisis to India in 2008, the government initiated fiscal measures to increase demand such as indirect tax relief and an increase in expenditure for public projects to increase employment (Sen Gupta, 2010; Nathan and Kelkar, 2012). Additional support was provided to exporting firms as well as credit support for micro- and small-enterprises (Sen Gupta, 2010; Nathan and Kelkar, 2012). As a result of the speed and intensity of the policy measures, India began to demonstrate signs of recovery and the economy grew by 7 per cent in the first half of 2009 (Sen Gupta, 2010; Nassif, 2010; Mehrotra, 2010).

Although India was clearly adversely affected, the picture revealed by macroeconomic data depicts a narrative that India weathered the global financial crisis rather well and the following excerpt is a typical recount of India’s experience:

In 2009 most countries that were integrated into the global economy fell into a recessionary cycle. However, some of the few exceptions were China and India which achieved remarkable real GDP growth. India recorded a real GDP growth rate of over 6 per cent in the 2009 calendar year (and an estimated 6.9 per cent in its fiscal year from April 2009 to March 2010) (Nassif, 2010, p.192).

However, Hirway and Prabhu (2012) argue that such data does not tell the whole story and disregards the impact felt by informal workers and small producers. As discussed above, the majority of the Indian labour force is situated in the informal sector and only 14 per cent of all workers are covered by any type of social security benefit (Papola, 2008). Hirway and Prabhu (2012) explain that the informality of India’s labour markets camouflage the adverse impact to workers allowing macroeconomic analysis or by surveys of the Labour Bureau to report a more rosy picture.

In conjunction with the UNDP, Hirway and Prabhu (2012) conducted a survey within six export sectors affected by the crisis to better understand the impact of the crisis on informal workers and small producers (Hirway and Prabhu, 2012). The sectors that were studied were gems and jewellery, engineering, auto parts, textiles (hand embroidery), home based garments, and agriculture. The workers in the study were all non-permanent and contract workers and did not receive any social security benefits (Hirway and Prabhu, 2012). The authors conclude that the workers were affected in three main ways: workers lost their jobs, workers’ hours were cut significantly and workers had to transfer to other types of work which were often less productive and less remunerative (Hirway and Prabhu, 2012). Even though the line of work was informal, workers experienced a deterioration in employment status from ‘regular’ to ‘casual’ to ‘temporary’ and ‘unemployed’ (Hirway and Prabhu, 2012). The researchers found that the majority of workers, over 60 per cent, did not receive any social assistance and those who did receive some assistance with consumption received an extremely inadequate amount (Hirway and Prabhu 2012).



Thus left to manage on their own, the study concluded that the workers used various coping strategies as means of survival. First, a large number of workers could no longer afford to send remittances to families in villages. Remittances are a big source of support for families residing in poor villages and the loss of this income would, no doubt, have hurt the family as well as the local village economy (Hirway and Prabhu, 2012). Second, the study found that workers were forced to use their savings and pawn or sell some of their assets to make ends meet (Hirway and Prabhu, 2012). Over 50 per cent of the workers in gems and jewellery and 55 per cent in auto parts used up their entire savings as a means of survival (Hirway and Prabhu, 2012). A third coping strategy employed was to borrow money whereby the highest percentage of debt increased from 21 to 61 per cent in gems and jewellery, 23 to 86 per cent in auto parts and 1.5 to 47 per cent in engineering (Hirway and Prabhu, 2012). The most important reason for borrowing was for consumption for survival followed by health and sickness (Hirway and Prabhu, 2012). A fourth coping mechanism for most households was to reduce consumption mostly for food but also for education and health (Hirway and Prabhu, 2012). A fifth means of survival employed was the return migration of workers to villages. Hirway and Prabhu (2012) explain that the return migration of large numbers of people, as was the case in their study, will adversely impact the local economy of the village as remittances will have ceased and the surplus labour will drive down wage rates (Hirway and Prabhu, 2012). Thus the findings of this study reveal an entirely different picture to the one often portrayed in macroeconomic studies and disclose the details of severe destitution incurred by informal workers as a result of the global financial crisis.


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