Personal Finance Lessons from Past Economic Crises

Impact on India and Lessons from History

Indian economy has experienced multiple economic and financial crises in the past impacting the overall economy and individual finances. The consequences of these crises on the various sectors of the economy may vary from one sector to another, but being aware of such crises and their consequences on the economy is crucial. The economies generally recover from these economic shocks at their own pace, but the uncertainties they bring to individual lives are profound and can be long-lasting. 

Each past crisis offers critical lessons for the future. Hence, it is crucial to prepare for potential unidentified crises and understand how to manage finances in times of crisis. Government authorities can enact necessary reforms, measures, and regulations to limit the consequences of potential crises, while individuals can focus on realigning their finances and investment portfolios to withstand such turbulent times. 

Although it is nearly impossible to predict any crises in advance, but having an understanding of the economic cycles beforehand helps to implement appropriate financial strategies well in time. Macroeconomic indicators provide early warning signs in identifying economic challenges. Tracking their trends regularly provides valuable insights to foresee any potential risks. For example, a steady decline in consumption may indicate impending economic downturns and prompt the government to take timely measures to revive the demand side of the economy. On the personal finance front, having a comprehensive financial plan is very important. Tools such as Asset Allocator help to evaluate and adjust your investments based on the current economic phase to mitigate potential risks. 

In this blog, we analyse the impact of some of the major economic crises on various segments of the economy. While past crises may not repeat with similar severity, their wider impact on asset classes may be comparable. Hence we can learn from these crises which offer a roadmap to avoid or lessen the potential financial difficulties in future through well-planned financial and investment techniques. 

Major Economic Crises Since 1991

The 1991 Economic Crisis

In the 1990s, the Indian economy faced many uncertainties, starting from domestic political instability to fiscal imbalances accentuated by the Gulf War leading to a severe sharp increase in oil prices and a balance of payments crisis. Termed as the 1991 BOP crisis, this is one of the worst economic crises India ever experienced in its economic history. The rupee was devalued in two stages and structural reforms were introduced in India’s trade policy. The crisis resulted in a swift turnaround in India’s external sector that opened the country to foreign investment and led to many other major economic and financial sector reforms. It also raised concerns regarding India’s ability to withstand external vulnerabilities. 

This period highlights the importance of noticing the warning signs of an imminent economic crisis and the need to have sound financial planning to cope with such uncertainties.

Triggers and Tremors

• Spike in Crude Oil Prices: Following the Gulf War, triggered by Iraq’s invasion of Kuwait on August 2, 1990, crude oil prices shot up to $41.5 /barrel as of September 27, 1990, from an average of $14.9/barrel in 1988 and $18.23/barrel in 1989. Since India imports around 80% of its oil needs, this sharp rise in oil prices led to a higher trade deficit and associated hurdles, impacting the overall economy.
• Sharp Reduction in Foreign Exchange Reserves: India’s forex reserves reached a low of $3.2 billion by January 1990, which could barely cover around 3 weeks of imports. Depleting foreign reserves necessitated the devaluation of the domestic currency in 1991. India sought emergency assistance from the International Monetary Fund (IMF), securing a loan of $2.2 billion by pledging gold reserves as collateral.
• Devaluation of the Rupee: In FY1990, the Indian rupee depreciated by 15.0% and in 1991 too, there was significant downward pressure on the value of the rupee from the international market, as India was faced with a shortage of forex reserves, which were nearly depleted, and persistent current account deficits. In 1991, India had a fixed exchange rate system, where the rupee was pegged to the value of a basket of currencies of major trading partners. In July 1991 the Indian government devalued the rupee by 18% and 19%. Domestic currency continued to depreciate and after depreciating by 36.4% against the US dollar in a year in March 1992, it depreciated further by 26.4% in a single month during April 1992. 
• Widening Twin Deficits: In addition to a significant increase in international oil prices, the remittance inflows from Indian workers in the Gulf region were also reduced due to the Gulf War. A rise in the value of imports and a reduction of receipts resulted in a sharp increase in the Current Account Deficit (CAD) which crossed 3.0% of GDP by March 1991, the first time in 33 years (or the highest since March 1958), resulting in a balance of payments crisis. The fiscal deficit (central government) too peaked at 7.8% of GDP as of March 1990, as interest payments and imports rose faster. 
• Rising Debt Levels: Growing CAD were increasingly financed by borrowing on commercial terms and remittances of nonresident workers. India’s external debt almost doubled to $69.0 billion by the end of FY1991 from $35.0 billion in FY1985. Short-term debt rose to $ 8.5 billion by March 1991 and debt service to forex reserves ratio worsened to 154.0%.
• Double-Digit Inflation: WPI inflation reached an exceptionally high level of 16.3% in September 1991 (10.1% annual average in FY1991 from 7.4% in FY1990 and 7.6% in FY1989), and continued through FY1992 (average 13.7%). Factors such as an increase in the prices of essential commodities, and the imposition of a Gulf surcharge of 25% on petroleum products which nearly doubled the oil import bill and added to the inflationary pressure, particularly in manufacturing products.
• Slowdown in Economic Growth: All these challenges culminated in a severe economic crisis and the Real GDP growth slipped to 5.9% (YoY) in FY1990 from 9.6% in FY1989 and the agriculture sector grew just by 1.2% (YoY) in FY1990 from 15.6% in FY1989.
• Rating Downgrade: The combination of economic crisis and political instability led to a significant loss of investor confidence. India’s credit rating (long-term) was downgraded to Ba2 non-investment grade speculative by Moody’s credit rating agency in mid-1991.
• Unemployment: The number of unemployed was estimated to have risen to 17 million by FY1992 from 14.5 million in 1988.
• Equity Markets: BSE Sensex fell by 35.1% in four months (from 1,472.4 on October 11, 1990, to 956.1 by January 25, 1991), reflecting significant volatility and correction in the stock prices.
• Interest Rates: With increasing risk perception interest rates rose. The Statutory Liquidity Ratio (SLR) was raised to 38.5% in September 1990 by the RBI, while the Cash Reserve Ratio (CRR) had already been at 15% since July 1989. Reflecting the extreme tightening of liquidity in the money markets and overall financial stress in the economy, the weighted average call money rates reached a high of 40.3% in May 1991. 

Dot-com Bubble (2000)

The dot-com bubble, also known as the internet bubble was a period of intense speculation in internet-based companies from 1995 to 2000, culminating in a market crash in 2000. Beginning in the 1990s, there was rapid growth in Internet and tech-based start-up companies. The widespread use and adoption of Internet and technology-based businesses led to inflated valuations and speculative investments in these internet firms. Unreasonable valuations ultimately led to a market crash, and according to research, the investor losses were estimated at around $5 trillion by 2002. Also with several tech companies declaring bankruptcy, the market bubble resulted in massive layoffs in the technology sector. Although the impact of the dot-com bubble burst was initially less severe in India, stock markets crashed by around 50% between February 2000 and September 2001. The NSE Nifty regained its February 2000 levels in December 2003, after crashing to a low of 854.2 points on September 21, 2001. 

The dot-com bubble emphasises the risks involved in speculative investments, particularly when investors lack a deep understanding of the market and fundamental analysis. Seeking professional advice to avoid falling into such investment traps is essential especially if you are not well-versed in market dynamics. This bubble also serves as a reminder to maintain a balanced investment portfolio and concentrate on sustainable business strategies rather than only cyclical market trends.

Causes, Crash and Consequences (1995 to 2000)

• Market crash: The NASDAQ Composite index, which rose from 743.4 on January 3, 1995, to a high of 5,132.5 on March 10, 2000 (590%), fell to a low of 1,108.5 as on October 10, 2002 (363% down from the peak). The BSE Sensex also crashed by 56% from its peak of 5933.6 as of February 11, 2000, to a low of 2,600 by September 21, 2001.
• Skyrocketing valuations: The research conducted by studying the PE ratios of dotcom companies reveals an overvaluation of more than 40% and these companies were valued based on metrics like "eyeballs" or website traffic rather than revenue or profits. Most tech and internet companies that held IPOs during the dotcom era were highly overvalued. In India too, the Nifty 50 PE ratio rose to a high of 26.4 as of 29 February 2000. BSE Sensex nearly doubled from 2810.7 points to 5,447.0 points between November 1998 and February 2000. Based on CMIE data, the PE ratio of the ‘Information Technology Industry Index’ touched a high of 124.0 in 1999-2000 and its market cap increased by more than 4.5 times in a single year. 
• Excessive IPO activity: Globally, many internet companies with unproven business models went public at extremely high valuations. Widespread hype and unrealistic expectations fueled by media coverage led to the easy availability of funding for internet startups by venture capitalists, often without proper due diligence. However, many VC firms suffered significant losses as their portfolio companies failed.

Global Financial Crisis (2008) 

The US housing bubble sparked the Global Financial Crisis (GFC) between mid-2007 and early 2009, causing enormous havoc in the banking and financial institutions around the world. Though the crisis originated in the United States (US) it swiftly expanded to other countries, impacting the global economy. The consequences were so severe that government intervention was inevitable to rescue the financial system from collapsing. 

When the US bank Lehman Brothers filed for bankruptcy in September 2008, the global financial system collapsed, and by then the crisis had spread to Belgium, France, Germany, Italy, the Netherlands, Sweden and Switzerland. Major advanced economies experienced their most severe recessions since the Great Depression of the 1930s, which resulted in millions of job losses. Eventually, the global financial crisis also morphed into a sovereign debt crisis in the eurozone. 

The impact on India was not immediate, as India’s financial sector was not deeply integrated with the global financial system during that time. However, the adverse effects of the global financial and economic crisis hit the Indian economy gradually, and stock markets sank, asset prices fell and unemployment rose. 

The downturn in the US housing market was the root cause of the GFC. Loose lending practices and subprime mortgages led to substantial losses for many banks across the globe. Popularly termed the Great Recession, this crisis prompted strict regulatory vigilance by the government authorities. One of the unique features of this financial crisis was the slow recovery from the fall, which had a long-lasting impact on the financial system. The crisis was so severe that the aftermath was marked by a prolonged period of economic uncertainties and sluggish recovery. It also taught many important lessons about managing one’s finances and emphasised the dangers of taking on too much risk as well as the value of emergency funds and diversification. 

Harbingers and Aftershocks

• Stock Market Volatility: The stock markets experienced significant uncertainty worldwide and the NASDAQ Composite crashed by 52.5% between October 2007 (4,303.0) to February 2009 (2,042.0). Financial markets in India also witnessed significant volatility and the BSE Sensex fell by 43.5% between September 2, 2008 ( 15049.9) and October 27, 2008 (8,509.6). 
• Foreign Investments Outflows: Foreign institutional investors (FIIs) withdrew $438.8 billion in funds from Indian equities in 2008 (May to November) to meet liquidity needs abroad. In FY2009, FIIs net sold $10.4 billion in equities. 
• Domestic Currency Depreciation: The Indian rupee depreciated significantly following the FII outflows. There was an increased demand for the US dollar, hence the rupee depreciated by 27.5% in a year to cross ₹ 50.5/$ as of November 20, 2008.
• Depletion of Forex Reserves: Due to the reversal of capital inflows and the RBI’s intervention in forex markets to prevent excessive volatility in the rupee exchange rate, India’s forex reserves dropped by $66.9 billion between May and November 2008. Yet, the reserves were adequate to cover 10.5 months of imports.
• Impact on Trade: Due to the depreciation of the rupee the cost of imports increased, while India’s exports were hit by a fall in global demand. This led to a sharp contraction in export growth between October 2008 and September 2009 (an average 18.4% fall in 12 months).
• Volatile Commodity Prices: Crude oil prices remained volatile and reached a high of $143.9/barrel on 3 July 2008, and a low of  $33.7/barrel on December 26, 2008. As India imports nearly 80% of its oil requirements, volatile prices have a significant impact on India’s trade balance and inflation.
• Slowdown in Economic Growth: The global challenges gradually led to an economic slowdown, largely impacting the financial sector of the economy. India’s GDP growth decelerated to 3.1% (YoY) in FY2009 from 8.1% in FY2007.
• Rise in Fiscal Deficit: With the increased government spending to support the economy, the fiscal deficit crossed 6% of GDP in FY2008 and FY2009.
• Inverted Yield Curve: The spread between 1-year and 10-year G-sec yields turned negative during mid-2008, indicating the possibility of a sharp economic slowdown in India. Negative yield occurs when long-term bond yields are lower than short-term yields as investors perceive possible recessionary conditions ahead.
• Varying Monetary Policy Responses: The monetary policy decisions varied from sharp tightening to easing between 2008 and 2009. The banking sector faced a huge liquidity crunch amid weak external credit flows, impacting the availability of credit for businesses. The repo rate was increased by 75 basis points in June 2008 and another 50 basis points in July 2008 following a rise in inflation. However, from October 2008 onwards, the RBI started cutting the repo rate which was brought down to a low of 4.75% by April 2009 as the economy was suffering from weak demand.

COVID-19 Pandemic (2020)

The Coronavirus Disease 2019 (COVID-19) pandemic which originated in late 2019, caused more than 6 million deaths worldwide. The rapid spread of the virus led to stringent and repeated lockdowns, travel restrictions, and business closures across the world, causing unprecedented disruptions to global supply chains and economic activity. 

The impact of the COVID-19 pandemic surpassed even the GFC of 2008, in terms of severity on the global economy. The GFC 2008, primarily affected the financial sector, whereas the pandemic’s impact was instant and vast across sectors including services, manufacturing, and trade. The impact on India was also huge as the strict lockdowns and restrictions led to massive disruptions in economic activities, business losses, and unemployment, particularly in the unorganised sectors of the economy. The crisis prompted unprecedented fiscal and monetary responses from the government and the RBI, while the uncertainty and disruptions took a toll on individual's financial well-being.

Economic Consequences of the Pandemic

Stock Market Volatility: The declaration of COVID-19 as a “pandemic” by the WHO on March 11, 2020,  created huge uncertainty and resulted in huge volatility in stock markets. The market crashed much before the coronavirus was detected in India. Following the announcement of the lockdown on March 24, the India VIX peaked at 83.6 on March 24, 2020, reflecting the panic buying and selling, while the Nifty 50 fell to a low of 7,511 during intra-day trades. 

Foreign Investment Flows: Emerging markets, including India, experienced massive capital outflows as investors sought safe-haven assets. In March 2020, foreign portfolio investors withdrew $15.0 billion from Indian markets. Foreign investors preferred to invest in Indian debt markets ($37.0 billion in FY2021), but remained cautious and continued to withdraw funds from Indian equities ($6.7 billion in FY2021), eventhough Indian equities recovered and outperform many global markets. 

Domestic Currency Depreciation: The Indian rupee depreciated by about 4.4% against the US dollar in March 2020 over February, as demand for the dollar increased amid huge FPI outflows.

Impact on Trade: Global trade volumes contracted sharply due to supply chain disruptions and reduced demand. The world merchandise trade declined by 7.2% in 2020 to $17.7 trillion. India’s trade was also hit by the pandemic resulting in a sharp contraction in exports (7.1%) and imports (17.1%) in FY2021.

Volatile Commodity Prices: Due to oversupply and lack of storage capacity, crude oil prices crashed on April 20, 2020, with WTI spot prices turning negative ($37.0/barrel) for the first time in history. The Indian basket of crude oil prices dropped to a low of $16.2/barrel on April 28, 2020. However,  the prices of essential commodities, particularly those India imports, such as edible oils increased sharply. 

Spike in Inflation: Inflation remained relatively high due to supply chain challenges. Increase in money supply following the stimulus measures announced by the RBI and the government also led to inflationary pressures in the economy. High level of persistent inflation resulted in 250 basis points increase in repo rate by RBI in FY2023. 

Contraction in Economic Growth: The global economy contracted by 3.1% in 2020, and India's GDP fell by 5.8% in FY2021. All the sectors of the economy witnessed a huge contraction in growth except for the agriculture sector. Both Services GVA and Industrial GVA fell significantly.

Accomodative Monetary Policy: The RBI in its bid to improve market functioning and to ease financial stress, cut the repo rate by 125 basis points to 4% in a span of three months, and maintained it till April 2022 to support the economic recovery.

Unemployment Surge: Global unemployment rose dramatically and according to reports 114 million jobs were lost in 2020. In India, the unemployment rate rose to 23.5 in April 2020, according to CMIE.

Personal Finance Lessons

Various crises in the past have led to economic disruptions impacting personal finances. Economic crises, while challenging, offer valuable lessons in personal finance. Macroeconomic factors play a vital role in shaping financial decisions, asset prices, and investment opportunities. Hence by leveraging macroeconomic insights, advisors and investors can make informed financial decisions, manage risk effectively by taking timely actions, and identify promising opportunities for investments. By understanding how these events impact different asset classes and adopting prudent financial strategies, individuals can enhance their financial resilience and be better prepared to face potential economic storms.

COVID-19 is one of the best examples of how an unforeseen crisis can have catastrophic effects on individual lives. It emphasised the need for strong and all-rounder financial planning. On the other hand, the 1991 BOP crisis and GFC 2008 both signify the importance of aligning personal finances during domestic and global economic challenges, while the Dot-com Bubble highlights the need for taking financial advice while making investment decisions in the stocks. 

Following are some of the lessons we can draw from this major economic crisis:

Importance of Diversification

An economic crisis impacts different asset classes disproportionately. This underscores the need to:

• Maintain a balanced investment portfolio across asset classes based on your risk appetite. Consider parameters such as age during various economic phases 
• Avoid overexposure to a single industry or asset class, and be wary of excessive hype around particular stocks or sectors with unreasonable valuations
• Regularly rebalance your portfolio tracking the macroeconomic environment, prioritise companies with solid business models and financials during an economic slowdown

Importance of Maintaining Emergency Funds

Economic crises lead to higher unemployment due to business losses. For instance, with widespread job losses, sudden income losses due to business closures and unexpected health expenses, the COVID-19 pandemic highlighted the importance of building an emergency fund (6 to 12 months of expenses) to cover extended periods of unemployment and unexpected expenses

Importance of Health Insurance

The severity of the health crisis such as the COVID-19 pandemic can erode the entire savings of households.  The unforeseen health crises highlight the need for comprehensive health coverage. Individuals should:

• Ensure adequate health insurance for self and family members
• Consider additional critical illness coverage for unforeseen health crisis 
• Regularly review and update health insurance policies