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By: Nauman Ayubi Butt Roll # 8511
Table of contents
1) Reason of choosing this topic
3) The term ‘Financial Crises’ 4) Financial Crisis 2007-2009 5) Causes of the crisis 6) The crisis getting global 7) The Financial crisis and Pakistan: 8) Sectoral impact of the crisis in Pakistan: 9) External sector impact
i) Exports ii) Imports 10) Financial Sector impact on
i) Foreign exchange ii) Banking sector iii) Circular debt iv) Stock market: 11) Inflation 12) Economic business sector impact i) Impact on textile industry 13) Social Sector Impacts 14) Poverty and unemployment: 15) IMF 16) Technique to tackle the situation
Reason for choosing this topic: The reason for choosing this topic is that it has a direct relationship with the poverty, unemployment, literacy, wealth distribution and also with the increased level of terrorism in Pakistan.
Introduction: Capitalism is an economic system in which land labor production pricing and distribution are all determined by the market. There is a strong history of capitalism that it can shift from extended period of rapid growth to very short periods of contraction The global financial crisis in 2008-09 which are still on the go, they actually started from the 20th century and they have been increasing since then. In the end of 20th century the U.S housing prices after a multiyear started declining, the mortgage prices had been at a very high rise before that and suddenly they started declining at the end of 20th century. Around mid 2008 there was a striking increase in the mortgage delinquencies. This increase was also followed by mortgages and this great loss in value meant an equally great decline in the capital of America’s largest banks and trillion dollar government. This also affected the backed mortgages lenders like Freddie Mac and Fannie. Outside of the U.S, the bank of China and France BNP Paribas were the first international institutions to declare substantial losses from subprime catastrophe, Ireland, Portugal, Spain and Italy were the worst hit. The U.S Federal Reserve, the European Central bank, the bank of Japan, the reserve bank of Australia and the bank of Canada all began injecting huge chunks of liquidity into the banking system. France, Germany and the United Kingdom announced more than $222 billion of new bank liquidity and nearly $1 trillion in interbank loan guarantees, towards the end of 2007, it had become quite clear the subprime mortgage problems were truly global in nature. The global financial crises also effects South Asian exports and could hurt income. Pakistan is another country in South Asia that has been severely affected by the financial crises. In fact, Pakistan seems to be one of the hardest hit with this global crisis. Its economy is already in crises. Pakistan is also facing a serious liquidity crunch, with the only solution being international support. Saudi Arabia has refused to give Pakistan a financial concession on the oil trade, as well. The only option for Pakistan is to approach international monetary fund, which will set highly stringent conditions for the nation. The term ‘Financial Crises’: The term financial crises is broadly used for many things means if there is great loss happen than its called financial crisis but its mainly related to banking panics. Other situations in which we often use this term is in stock market crashes.
Financial Crisis 2007-2009: The financial crisis of 2007-2009 has been called the most serious financial crisis since the great depression by leading economists, with its global effects characterized by the failure of key businesses declines in consumer wealth estimated in the trillions of
U.S dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity. Causes of the crisis: It is not clear yet whether we stand at the start of a long fiscal crisis or one that will pass quickly, like most other post World War II recession. 1) Fundamental mispricing in the capital markets. 2) Mistakes made by the Fed and the others banks by keeping the federal funds rate too low for too long created bubble and housing bubble. In other words, with artificial low fed funds target, banks filled themselves on cheap funding and made cheap loans available. There has been great disparity in the quantity and quality of loans in the recent years. In terms of quantity, there was an increase in low-rated issuances of shares from 2004-2007. Moreover loans that were issued were mainly given to finance leveraged buyouts. Over the same period average debt leverage ratios grew rapidly to levels never seen previously. In terms of quality, there was also a general increase in non documentation and high loan-to-value subprime mortgages.
3) Plus the failure to control poor underwriting standards in the mortgage markets
means no down payment, no verification of income, assets, and jobs, interest only mortgages, negative amortization, and teaser rates were widespread among subprime, near- prime and even prime mortgages. With defaults in interest payments and simultaneously in the Abs, prices drop drastically, leading to a huge loss of wealth severity of the crisis The crisis getting global: Countries around the world had invested in these defaulted securities, unaware of the fact that returns from them would eventually end up in them paying instead. By the end of 2007 everyone from the world was aware that a crisis is growing very rapidly now. The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures, declines in various stock indexes, and a large reduction in the market value of equities and commodities.
Europe: The global crisis is already causing a considerable slowdown in most developed countries. Governments around the world are trying to contain the crisis, but many suggest the worst is not yet over. Stock markets are down more than 40% from their
recent highs. Investment banks have collapsed, rescue packages are drawn up involving more than a trillion US dollars, and interest rates have been cut around the world in what looks like a coordinated response. The world economy is likely to contract by 1.3% in 2009 with almost all developed countries are to post negative growth. Despite stimulus packages and government action of unprecedented scale and nature, advanced economics are expected to contract by 3.8% in 2009. Growth in world trade volume fell to 3.3% in 2008, as a compared to 7.2% in 2007, and is expected to contract substantially be 11% till the end of 2009. Africa: Growth performances vary considerable among developed and developing countries. As for Africa, IMF world economic outlook report in April 2008, a decline in world growth of one percentage point would lead to a 0.5 percentage point drop in Africa’s GDP, so effects of global turmoil on Africa would be quit high.
Asia: East Asia is diverging as much as it did during the last significant global economic downturn in the early 1990s. Several Asian countries have build up healthy government reserves, and solid export performances has helped their strong current account position. However, there are also signs of a slowdown in Asia, the engine of recent world growth. In the space of couple of months, the Asian development bank has revised its forecast for Asian countries downwards by 1-2 percentage points,. The IMF growth forecasts have been revised significantly, especially for the UK ( 1.8 percentage points down from the last forecast for 2009 , but also India (-1.1 percentage points down to 6.9% real GDP growth), and China and Africa ( both down by -0.5 percentage points to 9.3% and 6.3% respectively)
Pakistan, Sri Lanka, and Maldives were particularly vulnerable because difficult political and social environments prevented adequate policy measures to adjust to the terms of trade shock. Additionally, their reliance on foreign funding has been relatively large. The global financial crisis worsened their macroeconomic difficulties as sources of funding contracted. Although India was well advanced in responding to the food and fuel price crisis and has generally maintained prudent macroeconomic management, the magnitude of the financial crisis has hit India very hard because of the strong connectivity to global financial markets. The Financial crisis and Pakistan: The world is thus taken a new hydra-headed crisis, with three essential components: food, fuel and finance. The three components have different geographical
origins and their effect on different segments of the globe and their inhabitants if highly uneven, but the transmission of these crisis in the global economy has become much easier and faster since the regime of liberalization of trade, capital flows, deregulation and privatization was imposed through the Washington consensus in the early 1990s in the name of achieving higher growth and reducing global poverty. The developing nature of the financial sector has been a saving grace for the Pakistani economy. Less developed linkages with international markets have meant that the direct impact of the financial crisis has not been felt by the Pakistani financial sector. However; effects of the crisis have been felt, even though in a limited manner, by the real sectors of the economy. The effects of the global slowdown have been transmitted through the trade balance; with a slowdown in global demand and fall in commodity prices having varying effects, the capital account; with a significant reduction in private inflows to Pakistan. Pakistan, a fragile economy, has been facing both economic and political crisis which predate the global financial crisis. Inflation, trade deficit, balance of payment, foreign exchange reserves, circular debt, poor performance of banking sector and Karachi stock exchange political instability have remained the key indicators of Pakistan economic crisis. Political and economic stability complement each other. Pakistan is an interesting case since both are in crisis. The war on terror has become a hanging sword overhead the rate of suicide bombing is increasing day by day. GDP growth rate is a significant indicator to access the health of an economy; It becomes worse since 2004-05 from 9.0% to 2.0%in 2008-9.Goverment of Pakistan spends approximately $ 26 billion per year based on the expected revenues of approximately $ 20 billion incurring a huge balance of payment (BOP) crisis when the entire donor community was also going through financial collapse. IMF aided with $ 7.6 billion and with the first tranche of $ 3.1 billion Pakistan foreign reserve rose from $ 6 billion to $ 9 billion. There had been 2.6 percent negative growth of exports, decreasing from $ 16.4 billion last year to $ 16.0 billion in July to April 2008-09. Imports also showed a negative growth of 9.8 percent in July to April 2009. Imports stood at $26.77 billion as against $28.715 billion in the comparable period of last year. Continuous increase in the import bills due to higher oil prices has increased the current account deficit which significantly depleted the foreign exchange reserves thus enhanced the country’s default risk. Given the unsafe investment climate and security situation the foreign direct investment inflows also fell more than 20 percent in calendar year 2009. Pakistan’s total external debt is also increasing with the appreciation of dollar and continuous relying on the foreign debt. The national savings are also on decline. The core inflation which represents the rate of increase in cost of goods and services excluding food and energy prices also went up to 18.0 percent and for a brief period it even crossed 20 percent.
Pakistan’s local banking sector has shown recoil to the weak macroeconomic environment even though it experienced a decline in decline in deposits. Circular debt is another critical issue which is still a potential indicator of the economic problem. Government of Pakistan is unable to billions of rupees to oil marketing companies (OMCs) and independent power producers (IPPs). The long hour power failures have not only affected the common people, but also shut down many businesses. There are no doubts that 2008 global financial crisis has not affected Pakistan with a huge blow though the government claimed entirely different. The country has seen some of the worst situations but survived. Pakistan is going through a critical phase at this stage. The country was already facing economic burdens because of its participation in the war on terror. According to the government of Pakistan, it has suffered economic losses worth US$34 billion so far because of the war. While the aid that it received is far below. The continued global economic crisis has hit Pakistan hard. Remittances sent to the country by the overseas, Taliban can take advantages of the bad economic conditions of the country. The price of oil fell to $77 a barrel, almost one-half of the level it had reached a couple of months ago. This put a strain on the spending plans of a number of countries in the Middle East. Some of these countries had large investments planned in Pakistan. In the light of these developments the question arises as to what is the likely impact on Pakistan’s financial grounds? How should Pakistan’s policy makers respond to the developments in America, Europe and the Middle East as they begin to address the problems the country is already confronted with? The writer will attempt to answer these questions. Pakistan recent period of economic growth was based on a combination with political instability, led to a rapid in inflation, a spike in the trade and current account deficits, and a devaluation of the Pakistani rupee. Although global fuel and food prices are on the decline, the U.S financial crisis has precipitated a possibly extended global recession. For Pakistan, a global recession will likely reduce demand for its exports, inward FDI flows and overseas remittent. Official Pakistan estimates for inward foreign direct investment in 2009 reportedly show a decline of over 32% when compared ran into problems in 2008. Real GDP growth, which had been averaging above 7% per year since fiscal year 2000/2001, declined to 5.8% in fiscal year 2007/2008 and is expected to decline to 2.5% in fiscal year 2008/2009.
Sectoral impact of the crisis in Pakistan: Though the impact of this crisis varies from country to country, but no country will be left alone to benefit or detriment from the prevailing crisis. Analysts believe that countries with large macro-economic balances, poor governance and regulation are
more prone to the negative effects of the crisis. According to a report presented by overseas development institute, UK, the economic, financial as well as social impacts could include: Weaker export revenues
Lower investment and growth rates Lost employment Lower growth translating into poverty More crime, weaker health systems and even more difficulties meeting the millennium development goals In Pakistan, the sectors that are most severely hit could financial, business and social. A sum up of all the sectors that are hit by the current crisis and the subsequent increase in price of commodities and energy, and their present performance could help explain where the country is heading. External sector impact: The country macroeconomics environment is affected by increase of war on terror and deepening of the global financial crisis which penetrated into the domestic economy through a route of large decline in Pakistan’s exports and a visible drop in foreign direct inflows. Although contraction in export receipts is more than compensated by massive imports compression send out from global crash of crude oil and commodity prices, the external sector vulnerabilities remain a threat. Pakistan’s economy continues to remain exposed to the vagaries of international developments as well as internal security environment. When people stop borrowing and start savings to pay off debt, it acts like a shrink in money supply. Thus goods and services get cheaper, and money get more valuable compared to others things. Economies that depend on exports are also affected because others such as US and Europe start importing less.
Exports: The financial crisis made countries realize that they don’t have much to spend on external goods and that recovery is possible only if demand as well as production for internal goods is increased. As a result, countries that hugely relied on exports like Pakistan suffered huge losses,. Even their most loyal customers, the US didn’t have the
capacity to pay for exports. As a result, the export sector of Pakistan was badly hit. Its major exports include textiles, surgical instruments, sport goods etc. Imports: The flow in global energy and goods prices coupled with poor agricultural production in Pakistan over the past two years had played destruction to the countries import expenditure. However, the recent lowering of these prices did provide some relief to the countries trade deficit. Imports registered a negative growth of 9.8 percent in July to April 2009. The imports stood at $26.77 billion as against $28.715 billion in the comparable period of last year. The growth in imports reflects impact of substantial fall in oil and food imports in monetary terms and these two items were responsible for 80 percent of additional imports bill last year. Financial Sector impact Foreign exchange: Pakistan’s exchange reserves decreases throughout 2008. The state bank holding of foreign exchange reserve fell from $14.2 billion at the end of October 2007 to #3.4 billion at the end of October 2008. Exchange rate after remaining stable for more than four years, lost significant value against US dollar and decrease by 21% during March-December 2008. Most of the decrease of rupee against dollar was recorded in post November 2007. However, with the successful signing of standby arrangements with the IMF, the rupee got back some of its lost value. With substantial import compression and revival of external inflows from abroad in the current fiscal year, the exchange rate will remain stable at Rs 80-82 per dollar. External Financing: The global crisis has restricted Pakistan’s ability to tap international debt capital markets to raise funds. An increasing cost of borrowing internationally, coupled with deterioration in the country’s credit rating has ruled out issuance of government paper as a financing mechanism. Pakistan’s presence in the international capital markets in 2008-09 was limited to the repayment of Eurobond amounting to US$ 500 million made in February 2009 with no new issuance at the backdrop of financial crisis engulfing the global markets. Banking sector: According to Fitch ratings, “the Pakistani banking system has, over the last decade, gradually evolved from a weak state-owned to a slightly improved and active private sector motivated system. But as of end 2008, data from the banking sector confirms a slow down. As of October 2008, total deposits fell from Rs 3.77 trillion in
September to Rs 3.67 trillion. Provisions for losses over the same period went up from Rs 173 billion in September to Rs178.9 billion in October. Market analyst Muhammad Suhail told the Los Angeles times. “The global crisis has really fuel to the fire. There was a time window earlier this year to address all this, and we missed it.” The drying up of credit internationally has hit Pakistan hard with the banking system suffering a severe liquidity problem. Overnight call rates rises so much and its ranging from 32 to 40 percent. Circular debt: On 26 January 2009, Raja Pervaiz Ashraf, Minister for water and power, told the senate that the “federal government will settle half of the Rs 400 billion circular debt by the end of January.” Circular debt arises when the Government of Pakistan owes and is unable to pay billions of rupees to oil marketing companies (OMC) an to independent power producers (IPPs). Stock market: The Karachi stock market exchange (KSE) is Pakistan’s largest and the runniest exchange. It was the “Best performing stock market of the world for the year 2002.” Due to the global financial crisis stock market also disturbs very much. As of the last day of December 2008 , Karachi stock exchange had a total of 653 companies listed with an accumulated market capitalization of Rs 1.85 trillion ( $23 billion). On 26 December 2007, Karachi stock exchange, as represented by the KSE-100 index closed at 14814 points, its highest close ever, with a market capitalization of Rs 4.57 trillion ($58 billion). As of 23 January 2009, KSE-100 index stood at 4929 points with a market capitalization of Rs 1.58 trillion ($20 billion), a loss of over 65 percent from its highest point ever.
Inflation: Rising food and fuel prices have been a major source of inflationary pressure in South Asian countries especially Pakistan. In Pakistan, food prices mad a bigger impact on inflation than fuel, and wheat prices more than doubled, due to poor domestic production and export restrictions. The combined effects of lower food and fuel prices along with demand management are reducing inflationary pressure in most South Asian countries but conditions have not been that favorable in case of Pakistan. In the year 2009 core inflation rose to 18% from the 14.7% 2008. In year 2009 inflation accelerated at rapid speed mainly because of food prices which increased as a result of high prices of widely consumable items such wheat, wheat flour , sugar and meat etc, owing to their to their supple shortage.
Economic business sector impact: Economic activity is the life blood of a nation. For a country to survive it is important that its economy is sound and successful and that business activity flourishes, but the global credit crisis and liquidity problems of many global corporations have already led to net capital outflows from rising markets, uncertain new investment projects. With fast depleting international reserves there is growing fear that the country may be forced into failure to pay on its foreign obligations. It was because of the fear that on October 6, standard and poor’s and moody’s, two of the largest rating agencies, downgraded Pakistani bonds. This has a created a terror and investors have begun to fear weathers’ Pakistan will be able to pay them back. Impact on textile industry: Pakistan textile industry is facing an uncertain environment. Following few factors like increase in input cost of minimum wage by 50 percent, increasing interest rates, non-guaranteed energy supplies, lack of R and D and reduction in cotton production, put a negative impact on the industry’s competitiveness internationally, because of the entire situations the companies are downsizing. Production units are being shut down
and around 5000000 of the workers lost their jobs. After surviving load shedding now industries have face gas load shedding this also increase their cost so that’s why our industry didn’t progress and gets into loss. When light is gone in industry it take almost 30 minutes to start work again and that’s the big problem your time also waste and your cost also increasing. Social Sector Impacts: Every problem that enters the society has its social costs that the country has to bear. Pakistan where poverty and unemployment is much already, financial crisis increases the situation. Poverty and unemployment: Food prices have a large bearing on poverty rate. A review of price trends of essential items during 2007-08 indicates that the prices of daily life such as wheat, flour, rice, edible, oil, vegetables and pulses. Since April 2007, the economy has witnessed over 200% increase in the price of palm oil; and an increase of 150% in wheat prices, while over 100% increase in the price of oil in the international market. The government estimates that about 25% of population live below the poverty line and this average increases just because of food inflation. Economic growth has slowed down considerably during the last three years. The industry and construction sectors have contracted due to the domestic slowdown and energy shortage and also due to global recession. People are being laid-off especially from foreign or multinational companies in order to reduce costs through downsizing. It has become even tougher for a freshman to find a suitable job than it was five years from now. According to one estimate, Pakistan’s unemployment rate in urban areas is nearly 40% and in rural areas over 60%. Increase in poverty means, decrease in average standard of living, poor health and education, and low-paying job, more population which is again makes it difficult to maintain their needs. IMF: Solution or more pain? On 24 November 2008, the executive board of the IMF agreed to bail Pakistan out by agreeing to a stand-by arrangement (SBA) valued at $7.6 billion. The two conditions are a cut in the budgetary shortage from around 7 percent to GDP of 4.2 percent of GDP and an increase in the taxation from 10 percent of GDP to 10.5 percent of GDP. The fact of the matter is that 2 out of 3 Pakistanis are already at or below $2 a day. An increase in taxation would mean a further slowdown in the economy. A further slowdown would mean increased unemployment. Same thing with the rate of interest this high cost of capital is bound to shut down a lot of our industrial units and that means even more unemployment’s.
All this slowdown and all this additional unemployment could very well bring Pakistanis out on the streets and that means a full blown political crisis.
Did financial crisis benefit Pakistan: So far the only sector that has shown growth prospects, regardless of the economic crisis has been the agriculture sector. While the rest of the south Asian economics suffered a huge loss of income. Pakistan and India actually gained, being large rice exporters. Technique to tackle the situation: When the first global recession came in the world, it destroyed the whole economy of the world. The reason of that recession was world War II. The studies made at that time does not apply on our problem. The crisis which we are facing currently is due to free market system. There was no government intervention in the economy. Now after the recession the mix system strategies are now being applied. Now there is government involvement in the economy to support the economy. The crisis in the whole world has been cured by the bail out plans given by the government. They have used Federal Reserve’s to cover-up. Although these strategies has not given the instant recovery yet, it is expected that in few years the position of the markets will be stable and on track. Pakistan has different criteria to survive in this critical situation as the effect was not usual. By following methods we can survive from this crisis.
1) Tax breaks will be given to the industry to produce the product. We have a
problem of energy crisis but if we develop plans by keeping in mind our resources than the industry crisis can be cured.
2) Agriculture sector needs a greater support; we are not using the resources of our
agriculture. We have an ideal land for agriculture but we are not utilizing it. Government has to empower the farmers so that they could produce more. Once we have our own produce we will be good enough to overcome the problem of hunger. People will not prefer to have migration towards cities if we will develop the agriculture the shortage of labor faced in the fields will be covered if the agriculture will be given boost. People will prefer to have cultivation on their lands.
3) Cash subsidies and food fixed amount programs regarding the economic
financial shortage will be good to obtain stability.
4) Reduction of the financial policy and decreasing the rates of productive sector
will be helpful to deal with the problem faced by our country.
5) Increasing supporting programs for the labor demanding activities. It will help to
fulfill the need of employment. The wages paid to the poor keeps the poor always
poor so if we will start to overcome the poverty due to unemployment the half of the situation can easily be handled.
Challenges going forward Pakistan faces a number of challenges that comes from both the domestic environment as well as the negative outlook of the global economy. Having successfully stabilized the economy, reinforced its reserve position, curtailed fiscal and current account deficits and managed a reduction in inflationary pressure, the government can now focus on boosting economic activity and providing growth impetus. In order to achieve an increase in production and the desired level of growth, efforts must be concentrated on increasing capacity of industry, and removing inefficiencies which would allow productive sectors to function at optimal levels. While the targets set by fiscal and monetary policies are a considerable step towards this, implementation and coordination going forward will be key factors. The future of workers’ remittances is uncertain given the fact that employment in host countries is limited. The external sector still faces multiple threats in the form of a further reduction in international demand and secondly, a recent rally in international commodity prices as investors seek refuge could potentially reverse the gains registered in the current account balance. If current conditions in international markets persist, the government will have to increase reliance on funding from multilateral and bilateral agencies. It is vital that fiscal, monetary, and external debt policies work in tandem to protect the sectors exposed to the international crisis, while striving to reestablish domestic economic growth.
1) Reference from: scribd title global financial crisis page no 10 2) Reference from magazine named Pakistan and gulf economist (Jan 3, 2010) Page no 6 topic recalling economic history 3) http://www.docstoc.com/docs/14820293/A-shortreport-on--Global--Financial--Crunch--Its-Impacts-on--Pakistans--Textile--Industry 4) www.scribd.com and the topic is global financial crisis and its impact on Pakistan 5) http://pakistanization.wordpress.com/2008/10/28/impact-of-global-financial-crisis-on-pakistan/ And topic is save Pakistan 6) Wikipedia through the topic financial crises 7) Reference from article of Department State Bank of Pakistan Mohammed Mansoor Ali , Director of Economic Analysis
8) South Asia Region, The World Bank Group http://siteresources.worldbank.org/SOUTHASIAEXT/Resources/2235461171488994713/3455847-1232124140958/gfcsouthasiafeb172009.pdf
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