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The Great Recession and Developing Countries
then and March 2009. Most of the outflow was in the equity market, and resulted in the BSE falling by more than 50 percent between its January 2008 peak and March 2009. ECBs, which had become a key source of finance for the Indian corporate sector, also fell sharply. To attract more ECBs, the RBI relaxed a number of restrictions on such borrowing that were imposed in 2007. These declines, along with the increasing vulnerability of corporate profits and of the corporate business environment (as well as falling credit ratings), complicated investment decisionmaking. Moreover, with slowing demand, excess capacity emerged in many sectors. The slowdown in investment, resulting from the sudden stop in foreign capital flows, is likely to have shaved another estimated 1 percentage point from overall GDP growth in FY10. Thus, the combined impact of all of these developments reduced the momentum of Indian growth in FY10, slowing it from the 6.5–7.0 percent expected earlier to a now possible 3.0–3.5 percent. Much of this slowdown is due to the global weakening of private capital flows to emerging countries. While all components of net private capital inflows have slowed, the largest drop is in net bank lending, forecast to shift from a net inflow of US$30 billion in 2008 to a net outflow of US$25 billion in 2009 (IIF 2009). In contrast, FDI flows remained relatively buoyant as cumulative inflows of FDI in April 2008–January 2009 rose to US$24 billion, compared to US$15 billion in the same period a year earlier. Financial Markets Financial markets tightened after the collapse of Lehman Brothers, with the call money rate rising to 20 percent (figure 6.15). While some domestic factors—such as advance payment of taxes and withdrawal of bank deposits for festival shopping—tightened liquidity conditions, the rise was largely attributable to the liquidity squeeze associated with the sudden stop in foreign capital flows and the freezing up of the interbank market. The uncertainty about various Indian banks’ exposure to toxic assets resulted in banks being unwilling to lend to one another, even though most banks were in the public sector. Credit default swap spreads for Indian banks rose sharply in October–November 2008 as the risk perception of the stakeholders of these banks rose substantially. A sharp drop in nonbank financing for the corporate sector worsened the downturn. While the flow of funds from domestic sources fell