GLOBAL CRISIS 2008

Presented by :Yamna khan

10330

Outline Introduction Crisis unfolds Spillovers from the Crisis

(1) Private Capital Flows and Financial Spillovers (2) Commodity Prices (3)Trade Impact (4) Trade Imbalances Pakistan and Global Crisis 2008 (1)BOP (2) Banking sector of Pakistan (3) IMF Loan (4)Exchange rate Conclusion

INTRODUCTIONHow it started and how it affected?

In 2008 the world economy faced its most dangerous crisis since the Great Depression of the 1930s. Global trade fell by nearly 30 percent relative to GDP during the Great Recession of 2008-2009.

The contagion, which began in 2007 when sky-high home prices in the United States finally turned decisively downward, spread quickly, first to the entire U.S. financial sector and then to financial markets overseas. 

the casualties in the United States included a) the entire investment banking industry, b) the biggest insurance company, c) the two enterprises chartered by the

government to facilitate mortgage lending,

d) the largest mortgage lender, e) the largest savings and loan, and f) two of the largest commercial banks.

The carnage was not limited to the financial sector, however, as companies that normally rely on credit suffered heavily.

banks, trusting no one to pay them back, simply stopped making the loans that most businesses need to regulate their cash flows and without which they cannot do business.

Share prices plunged throughout the world and by the end of the year, a deep recession had enveloped most of the globe. In December the National Bureau of Economic Research, the private group recognized as the official arbiter of such things, determined that a recession had begun in the United States in December 2007, which made this already the third longest recession in the U.S. since World War II.

By the end of the year, Germany, Japan, and China were locked in recession, as were many smaller countries. Many in Europe paid the price for having dabbled in American real estate securities. Japan and China largely avoided that pitfall, but their export-oriented manufacturers suffered as recessions in their major markets—the U.S. and Europe—cut deep into demand for their products. Less-developed countries likewise lost markets abroad, and their foreign investment, on which they had depended for growth capital, withered. With none of the biggest economies prospering, there was no obvious engine to pull the world out of its recession, and both government and private economists predicted a rough recovery.

The Crisis Unfolds

The first major institution to go under was Countrywide Financial Corp., the largest American mortgage lender. Bank of America agreed in January 2008 to terms for completing its purchase of the California-based Countrywide. With large shares of Countrywide’s mortgages delinquent, Bank of America was able to buy it for $4 billion on top of the $2 billion stake that it had acquired the previous August—a fraction of Countrywide’s recent market value.

Spillovers from the Crisis (1) Private Capital Flows and Financial Spillovers

Before theoutbreak of the global crisis, Europe was the main source of

(gross) capital flows to the rest of the world, with $1,600 billion per annum during 2004-07, higher than total

outflows from the US and Japan taken together. With the outbreak of the crisis and consequent bank deleveraging, total outflows from Europe fell sharply, registering barely $300 billion a year during 2008-11 . The EZ crisis has also led to considerable short-term, month-to-month volatility

in capital inflows to DCs(developing countries), which have become increasingly sensitive to news coming from the

region.

After the Lehman collapse, sovereign bond spreads shot up and stood, at the end of 2008, at about three times the level in the previous year, while the MSCI index (Morgan Stanley Capital International) fell to some 40% of the level reached in 2007. With the recovery in capital flows, spreads fell, and equity prices rose rapidly, but they both deteriorated after mid-2011 with the deepening of the EZ( European zone) crisis. The Lehman collapse also resulted in large drops in the currencies of most DCs against the dollar. It was described as a currency war by the Brazilian minister of finance, while the governor of the South African Reserve Bank remarked that DCs were in effect caught in a crossfire between the European Central Bank (ECB) and the US Federal Reserve (Marcus 2012).

(2) Commodity Prices The financial crisis in Aes(advanced economies) has

not depressed commodity prices to the extent seen in previous post-war recessions.

The boom that had started in 2003 continued until summer 2008 with the index for all primary commodities rising more than threefold (Figure 4). This was followed by a steep downturn in the second half of 2008, but, like capital inflows, commodity prices also recovered strongly from the beginning of 2009, rising until spring 2011 when they leveled off and started to fall, manifesting increased short-term instability. In early 2013, the index was 15% below the peak reached in summer 2008.

Commodity prices and China

China, whose import composition changed rapidly from manufactures to commodities as a result of its shift from export-led to investment-led growth. As its markets in major AEs started to shrink in 2008, China introduced a large investment package, notably in infrastructure and property, pushing the ratio of investment to GDP towards 50%.

Since such investment is much more intensive in commodities, notably in metals, than exports of manufactures, which rely heavily on imported parts and components, this shift led to a massive increase in Chinese primary commodity imports, which doubled between 2009 and 2011 compared to a 50% increase in its manufactured imports (Figure 5).

During the same period, prices of metals rose 2.4 times, much faster than other primary commodities. The severe swings seen during 2008 had an important speculative component. Within the first six months of that year, the overall price index rose by some 35%, followed by a sharp decline of 55% in the second half of the year.

(3)Trade Impact The decline in dollar terms was almost twice as

large because of a sharp decline in the prices of commodities.

Among major DCs, the trade impact has been particularly severe on China because of its dependence on exports to AEs.In the period 2002-07, Chinese exports grew by more than 25% per annum, accounting for about one-third of GDP growth, taking into account their import contents.

With the crisis in AEs, exports of Asian DCs slowed sharply in 2008 and then dropped in 2009,becoming a major drag on activity and reducing growth by 5-6 % points (Akyüz 2012). Import cuts in Europe have also hit Africa especially hard because of strong trade linkages (IMF 2011; OECD 2012; Massa et al 2012).

(4) Trade Imbalances The crisis resulted in a significant shift in global trade

Imbalances. On the eve of the crisis, DCs taken together had a

current account surplus of almost $700 billion and a little more than half of this was due to China. It fell by almost $300 billion by the end of 2012 despite a $130 billion increase in the surplus of the west Asia and North Africa as a result of increases in oil revenues.

The surplus of developing Asia fell from $400 billion to$130 billion, and China from $350 billion to $210 billion,while Latin America and sub-Saharan Africa moved fromsurpluses to deficits.

Pakistan and global crisis 2008 Pakistan was already under the affect of internal economic

crisis, when global crisis 2008 started.

Pakistan’s financial crisis predates the global financial crisis. For the past several years, Pakistan had been running unsustainable budgetary and trade deficits.

Reasons for Pakistan’s Economic Crisis Pakistan witnessed major disruptions in its normal economic activities as

the result of acute energy crisis, high rate of interest, high cost of production, inflation, deteriorating law and order situation, poor industrial infrastructure, decline in FDI and joint venture with foreign investors, a bewildering stock market, a perceptible slowdown in the manufacturing and services sectors The other international elements include global recession, credit crisis, weak economic prospects of the EU, USA, and limited access to international markets and specific countries.

The government of Pakistan routinely spends some $26 billion a year based on expected revenues of around $20 billion, incurring a budget deficit of over 7% of GDP. On the trade front, accumulated exports hardly ever cross the $20-billion-a year mark, but imports end up exceeding $35 billion: a trade deficit in excess of $15 billion a year and a current account deficit of over $1 billion a month.

BOP Pakistan’s balance of payment (BOP) crisis in

2007-08, which occurred as a consequence of $147-a-barrel oil and a spike in commodity prices, meant a frightful depletion of foreign exchange reserves, down to an import cover of less than three months.

Inflation, meanwhile, shot up to over 24%, and Pakistan was caught in a vicious cycle of stagflation—economic stagnation coupled with high inflation

Pakistan’s BOP crisis came at a time when the entire donor community, including the U.S. and Europe, were engrossed in their own subprime disasters. Desperate for a bailout package, Pakistan pleaded with the U.S., begged Saudi Arabia and urged China for a billion-dollar donation, all to no avail.

Finally, on 24 November 2008, the International Monetary Fund (IMF), reportedly lured by the United States Department of Defense, announced a 23-month Stand-By Arrangement (SBA) of $7.6 billion and released the first tranche of $3.1 billion. As a consequence, foreign exchange reserves jumped from a low of $6 billion to over $9 billion.

Banking sector of Pakistan According to the 2007-08 Financial Stability Review

from the State Bank of Pakistan (SBP), 'Pakistan’s banking sector has remained remarkably strong and resilient, despite facing pressures emanating from weakening macroeconomic environment since late 2007.

According to Fitch Ratings, the international credit rating agency with head offices in New York and London, 'the Pakistani banking system has, over the last decade, gradually evolved from a weak state-owned system to a slightly healthier and active private sector driven system'.

The data from the banking sector for the final quarter of 2008 confirms a slowdown after a multi-year growth pattern.

In October 2008, total deposits fell from Rs3.77 trillion in September to Rs3.67 trillion. Provisions for losses over the same period went up from Rs173 billion in September to Rs178.9 billion in October.

At the same time, the SBP has jacked up interest rates: the 3-month Treasury bill auction saw a jump from 9.09% in January 2008 to 14% in January 2009, and bank lending rates were as high as 20%.

IMF Loan

On 24 November 2008, the Executive Board of the IMF agreed to bail out Pakistan through a Stand-By Arrangement (SBA) valued at $7.6 billion. There were two conditions: Karachi must cut its budgetary deficit from around 7% of GDP to 4.2% of GDP, and increase taxation from 10% of GDP to 10.5% of GDP.

Exchange rate Exchange rate after remaining stable for

more than 4 years, lost significant value against the US dollar and depreciated by 21% during March–December 2008.

Most of the depreciation of rupee against dollar was recorded in post November 2007 owing to combination of factors like political uncertainty, trade related outflows and speculative activities. With successful signing of Standby arrangements with the IMF, the rupee got back some of its lost value.

Conclusion Not only has the Great Recession led to a Great

Slowdown inDeveloping countries(The Economist 2012), but also

the medium-term prospects for global economic conditions look unfavorable compared to the pre-crisis years and, in some respects, even the period since the onset of the crisis.

Of BRICS (Brazil, Russia, India, China, and South Africa),

only China promised sustained catch-up growth and graduation

even though it faced a bumpy road. Brazil, Russia, andSouth Africa continued to depend heavily on

commodities andhad deepened their dependence by expanding the

commoditysector relative to industry.

India has been relying on the supply of labor to the rest of the world, not by converting them into higher-value manufactures, but by exporting unskilled workers and information and telecommunications (IT) and other labor services of a very small proportion of its total labor force (Nabar-Bhaduri and Vernengo 2012). On the contrary, the role and impact of global market forces in the development of DCs has been greatly enhanced by continued liberalization of trade, investment, and finance, unilaterally or through bilateral investment treaties and free trade agreements with AEs. DCs need to be as selective about globalization as AEs, and reconsider their integration into the global economic system.

This implies rebalancing external and domestic forces of growth and development. Dependence on foreign markets and capital should be reduced. There is also a need to redefine the role of the state and markets, not only in finance but also in all key areas affecting industrialization and development, keeping in mind that there is no industrialization without active policy.

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