global financial crises

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SUBMITTED TO

PROF. DR. SHAFIQ-UR-REHMAN

UNIVERSITY OF KARACHI

October 10, 2011

Submitted by: Muhammad Atif Khan (EP-101124)

Muhammad Anwer (EP-101135)

Usama Bin Tariq (EP-101168)

Najeeb Siddiqui (EP-101140)

Global Financial Crises

ReportClass: MEF After PGD


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seeing more and more countries around the world being affected by these rather profound

and persistent negative effects from the reversal of housing booms in various countries.

Review the Literature:-

The financial crisis carries many pertinent lessons for the economies of countries like

Pakistan. The paper aims at highlighting the salient aspects of the global financial crisis, its

impact on developing countries and drawing lessons for Pakistan.

Huzaima Bukhari and Dr Ikram ul Haq, Is Capitalism at bay?, The News(Islamabad), November 9,

2008.

It is not the first time that the global financial system has suffered a crisis. The

1997 crash caused devastation in countries like Indonesia and Thailand. Thebursting of the IT bubble in 2000 led to a recession in the US in 2001. The lowering

of interest rates in the US to overcome the recession led to liberal lending for

mortgages and building. The housing bubble finally burst in 2007 inspiring the sub-

prime crisis. The innovative financial engineering concealed and dispersed the risk

attached to bad lending practices of the lending institutions.

Arvind Gupta, Global Financial Crisis: Is There a Way Out?, Institute of Defence Studies and Analyses,

New Delhi, (November 5, 2008).

The US invests far more than it saves (its current account deficit) and the rest of

the world saves far more than it invests (a current account surplus). This is the big

imbalance in the global economy. It involves a massive flow of capital to the USfrom the rest of the world. The magnitude of this transfer is unprecedented in

recent history and probably cannot be sustained indefinitely. Therefore, when it

ends, it could have a destabilizing effect on the global economy, if only because of

the shifting of gears.

Global Economic Outlook 2007: Is A Crisis Imminent, or Are Things Better Than we Thought?, A

Deloitte Research Study.

The international financial system has failed to deliver on two accounts, (i)

preventing instability and crises and (ii) transferring resources from richer to poorer

economies.

Jayati Ghosh, Global Inequity Must End, Daily Times (Islamabad), October 26, 2008.

Fallout from the collapse of the US mortgage market and the reversal of the

housing boom in various important countries has turned out to be more profound

and persistent than expected in 2007 and beginning of 2008. As more and more

evidence is gathered and as the lag effects are showing up, we are seeing more and

more countries around the world being affected by these rather profound and


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persistent negative effects from the reversal of housing booms in various

countries.

Kanaga Raja, Economic Outlook Gloomy, Risks to South: Say UNCTAD, Third World Network,

September 4, 2008.

http://www.twnside.org.sg/title2/finance/twninfofinance20080804.htm .

The IMF foresaw the global economy's growth slowing to 3.7 per cent in 2008 and

2.2 per cent in 2009, i.e., well below the 3 per cent level the fund traditionally

considers the threshold for a world recession.

Tom Barkley, IMF Slashes World Growth Forecasts Again, Silicon Investor.

http://siliconinvestor.advfn.com/readmsg.aspx?msgid=25152632

Opponents of the rescue plan argued that since the problems of the American

economy were created by excess credit and debt, a massive infusion of credit and

debt into the economy would only exacerbate the problems with the economy. They

asked for better alternatives to resolve the crisis.

Emergency Economic Stabilisation Act of 2008.

http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008 .

Of historically unprecedented magnitude and scope, this crisis has serious

implications for people, particularly for poor people in poor countries.

Sakiko Fukuda- Parr, The Human Impact of the Financial Crisis on Poor and Disempowered People

and Countries, The New School, New York, October 30, 2008.

In fact, when crisis strikes, whether it is an economic meltdown like what South

Korea experienced in 1998 or a natural disaster in rich countries such as Katrina in

the United States in 2005 or the Kobe earthquake in 1998 in Japan, it is the poorand the disempowered whose lives are most thrown off balance and are the slowest

to recover. Not only is it occurring in a world of unprecedented financial

globalization, where the financial sector plays a historically large role in economic

activity, but it is also an imported crisis, with origins outside the developing world.

The crisis also comes on the heels of a major global shock from high food and fuel

prices. The World Bank Report on Global Financial Crisis and Implications for

Developing Countries described the impact of financial crisis in following broad

terms.

World Bank, Global Financial Crisisand Implications for Developing Countries, G-20 Finance Ministers

Meeting, Sao Paulo, Brazil, November 8, 2008.

http://www.worldbank.org/financialcrisis/pdf/G20FinBackgroundpaper.pdf

The challenges faced by developing countries earlier are now compounded by the

pressures emanating from the global financial crisis. For vulnerabilities in emerging

and developing countries, while the effects will vary from country to country, the

economic impacts could also include.
http://www.twnside.org.sg/title2/finance/twninfofinance20080804.htmhttp://www.twnside.org.sg/title2/finance/twninfofinance20080804.htmhttp://siliconinvestor.advfn.com/readmsg.aspx?msgid=25152632http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008http://www.worldbank.org/financialcrisis/pdf/G20FinBackgroundpaper.pdfhttp://www.twnside.org.sg/title2/finance/twninfofinance20080804.htmhttp://siliconinvestor.advfn.com/readmsg.aspx?msgid=25152632http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008http://www.worldbank.org/financialcrisis/pdf/G20FinBackgroundpaper.pdf


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Dirk Willem te Velde, The Global Financial Crisis and Developing Countries, Overseas Development

Institute (ODI), UK, (October 2008).

Global economic summit of G-20 comprising Argentina, Australia, Brazil, Britain,

Canada, China, European Union, France, Germany, India, Indonesia, Italy, Japan,

Mexico, Russia, South Africa, Saudi Arabia, South Korea, Turkey and United States

was held at Washington on November 15, 2008. The 3,600-word declarationmentioned the following actions to be taken:

a. Continue vigorous efforts and take whatever further actions are necessary to

stabilize the financial system.

b. Recognize the importance of monetary policy support, as deemed

appropriate to domestic conditions.

c. Use fiscal measures to stimulate domestic demand to rapid effect, as

appropriate, while maintaining a policy framework conducive to fiscal sustainability.

d. Help emerging and developing economies gain access to finance in currentdifficult financial conditions, including through liquidity facilities and programme

support. We stress the International Monetary Fund's (IMF) important role in crisis

response, welcome its new short-term liquidity facility, and urge the ongoing review

of its instruments and facilities to ensure flexibility.

e. Encourage the World Bank and other multilateral development banks to use

their full capacity in support of their development agenda, and we welcome the

recent introduction of new facilities by the World Bank in the areas of infrastructure

and trade finance.

G-20 Declaration on Financial Crisis, CNN-Money (Online), November 15, 2008.

http://money.cnn.com/2008/11/15/news/international/g20_declaration/inde x.htm

Ensure that the IMF, World Bank and others have sufficient resources to continue

playing their role in overcoming the crisis.

www.independent.co.uk, (accessed November 16, 2008).

The prospects for an economic recovery, essential for alleviating poverty, are

highly dependent on effective policy actions to restore confidence in the financial

system and to counter falling international demand. While much of the

responsibility for restoring global growth lies with policy makers in advanced

economies, emerging and developing countries have a key role to play in improving

the growth outlook, maintaining macroeconomic stability, and strengthening the

international financial system. In World Banks view;

a. The world faces the severest credit crunch and recession since the Great

Depression. Developing countries growth prospects and access to external

financing are subject to unusually large downside risks.
http://money.cnn.com/2008/11/15/news/international/g20_declaration/inde%20x.htmhttp://money.cnn.com/2008/11/15/news/international/g20_declaration/inde%20x.htm


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b. Though originating in advanced countries, the crisis is hitting developing

countries hard.

c. While transmission channels may differ, both emerging market and low-

income countries will be severely impacted.

d. Economic policy responses should be adapted to country circumstances:countries with strong fundamentals may have room for monetary and fiscal

stimulus, while those in weaker macroeconomic positions and with limited access to

external financing will have less room for policy maneuver; some may need to

undertake fiscal consolidation.

e. Advanced, emerging, and developing countries should take comprehensive

action to resolve liquidity and solvency problems in the banking system and

strengthen prudential supervision.

f. Development aid must be increased to help countries cope with the crisis.

g. It is crucial to maintain an open trade and exchange system.

Global Financial Crisis and its Impact on Developing Countries: Global Monitoring Report 2009, World

Bank, 23.

In South Asia, the second largest economy, Pakistan, faces serious vulnerability in

the region. High fiscal and current account deficits, rapid inflation, low reserves, a

weak currency, and a fragile economy put Pakistan in a very difficult situation to

face the global financial crisis. China and India adopted stimulation packages and

have recovered sooner than other countries. These countries had sufficient foreign

exchange reserves and could afford stimulation package. Pakistan could not do so

due to weak foreign exchange position at the time of onset of the crisis. Pakistanwas also faced with political upheaval at that time. Therefore, Pakistan was forced

to cut back on its expenditure and could not afford stimulation packages like those

of China and India. Efforts are now underway to arrest the decline of the macro

economy through demand management including tightening of monetary and fiscal

policies. Pakistan's ability to borrow externally is already heavily constrained and

bond spreads are very high. The global financial crisis means that non-official

foreign capital flows will be even more expensive. The contagion effects on

domestic financial sector could be substantial, but stress tests suggest that the

banking sector as a whole is likely to withstand the shocks.

Global Financial Crisis: Implications for South Asia.

This is mainly due to the improved health of the financial sector based on past

reforms. In November 2008, to avoid a default on foreign debt payments, Pakistan

developed a stabilization programme, which was supported by the International

Monetary Fund (IMF).

Pakistan Country Overview 2009: Banks Assistance to Pakistan, World Bank.


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countries and how are the effects being felt in developing countries? Whichdeveloping countries will be able to withstand the international macro economicchallenges created by the downturn in developed economies, and which are most atrisk? What is the role for development policy and what do developing countrypolicy-makers need to know?

This note discusses recent growth performance in developed and developing

countries, the channels through which the global crisis affects developing countries,which countries might be most at risk, and possible policy responses.

Growth in developed and developing countries; decoupling or delayedcoupling?With a recession already underway in the UK, Germany, France, the USA and otherdeveloped countries, it is quite startling to hear the Malawian finance minister arguethat Malawis economy is projected to grow by more than 8% this year. Yet this istodays stark reality. The USA is going through the greatest financial crisis since the1930s, but, as the Financial Times has reported, Lagos is not Lehman. Nigeria, heldback by decades of economic mismanagement, is growing at nearly 9%. Leaders in

China suggest that they can help the world by offering growth rates of up to 10%,and many African countries still gain significantly from this (they are growing at 6-7%).

Growth performances vary substantially among developed and developingcountries. African growth exceeds OECD growth by margins not seen for 25 years;East Asias growth is diverging as much as it did during the last significant globaleconomic downturn in the early 1990s (see Figure 1).


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The relationship between OECD GDP and Africas GDP has weakened as a result of

the emergence of countries such as China, as well as structural changes in Africaneconomies. According to the IMF World Economic Outlook report in April 2008, adecline in world growth of one percentage point would lead to a 0.5 percentagepoint drop in Africas GDP, so the effects of global turmoil on Africa (via trade, FDI,aid) would be quite high. The correlation between African GDP and World GDP since1980 is 0.5, but between 2000 and 2007, it was only 0.2. As there have beensignificant structural changes (and a move into services that were able to withstandcompetition much better) as well as the rise of China, African growth has


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temporarily decoupled from OECD GDP.

Several Asian countries have built up healthy government reserves, and solidexport performance has helped their strong current account position. LatinAmerican countries are currently in a much better fiscal and external positioncompared to the 1990s, the decade in which several financial crises struck.

However, there are also several worrying signs. The combination of high foodprices and high oil prices has meant that, while the current account of oil and foodimporters was in balance by 2003, it was in deficit by 4% in 2007. Inflation has alsodoubled. Many developing and especially small and African countries are, therefore,in a bad position to face yet another crisis. The terms of trade shock tend to behighest in small importing countries such as Fiji, Dominica, Swaziland. However,African countries such as Kenya, Malawi, Tanzania are projected to have facedterms of trade shocks of greater than 5% of GDP (World Bank paper for the October2008 Commonwealth Finance Ministers meeting).

And there are also signs of a slowdown in Asia, the engine of recent world growth.In the space of a couple of months, the Asian Development Bank has revised itsforecast for Asian countries downwards by 1-2 percentage points. The IMF growth

forecasts have been revised significantly, especially for the UK (-1.8 percentagepoints down from the last forecast for 2009), but also India (-1.1 percentage pointsdown to 6.9% real GDP growth), and China and Africa (both down by -0.5percentage points to 9.3% and 6.3% respectively).

The magnitude of the crisis will depend on the response of the USA and EU. Trillion dollar rescue packages are launched around the world, but while themarkets may eventually respond, the UK is already in a recession. Its magnitude willdepend, in part, on how accommodative monetary policy can be, with the recentinterest rate cut a sure sign the authorities are concerned more about the financialcrisis than recent inflationary pressures. There is less scope for expansionary fiscalpolicy in fact these rescue measures have increased public debt.


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Impact of the current financial crisis on developing countriesThe current financial crisis affects developing countries in two possible ways.

First, there could be financial contagion and spillovers for stock markets inemerging markets. The Russian stock market had to stop trading twice; the India

stock market dropped by 8% in one day at the same time as stock markets in theUSA and Brazil plunged. Stock markets across the world developed anddeveloping have all dropped substantially since May 2008. We have seen shareprices tumble between 12 and 19% in the USA, UK and Japan in just one week, whilethe MSCI emerging market index fell 23%. This includes stock markets in Brazil,South Africa, India and China. We need to better understand the nature of thefinancial linkages, how they occur (as they do appear to occur) and whetheranything can be done to minimise contagion.

Second, the economic downturn in developed countries may also have significantimpact on developing countries. The channels of impact on developing countriesinclude:

Trade and trade prices. Growth in China and India has increased imports and

pushed up the demand for copper, oil and other natural resources, which has led togreater exports and higher prices, including from African countries. Eventually,growth in China and India is likely to slow down, which will have knock on effects onother poorer countries.

Remittances. Remittances to developing countries will decline. There will befewer economic migrants coming to developed countries when they are in arecession, so fewer remittances and also probably lower volumes of remittances permigrant.


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Foreign direct investment (FDI) and equity investment. These will come underpressure. While 2007 was a record year for FDI to developing countries, equityfinance is under pressure and corporate and project finance is already weakening.

The proposed Xstrata takeover of a South African mining conglomerate was put onhold as the financing was harder due to the credit crunch. There are several otherexamples e.g. in India.

Commercial lending. Banks under pressure in developed countries may notbe able to lend as much as they have done in the past. Investors are, increasingly,factoring in the risk of some emerging market countries defaulting on their debt,following the financial collapse of Iceland. This would limit investment in suchcountries as Argentina, Iceland, Pakistan and Ukraine.

Aid. Aid budgets are under pressure because of debt problems and weakfiscal positions, e.g. in the UK and other European countries and in the USA. Whilethe promises of increased aid at the Gleneagles summit in 2005 were already offtrack just three years later, aid budgets are now likely to be under increasedpressure.

Other official flows. Capital adequacy ratios of development financeinstitutions will be under pressure. However these have been relatively high

recently, so there is scope for taking on more risks.Each of these channels needs to be monitored, as changes in these variables

have direct consequences for growth and development (see e.g. Te Velde, 2008, onpro-poor globalisation). Those countries that have done well by participating in theglobal economy may also lose out most, depending on policy responses, and this isnot the time to reject globalisation but to better understand how to regulate andmanage the globalisation processes for the benefit of developing countries. Theimpact on developing countries will vary. It will depend on the response indeveloped countries to the financial crisis and the slowdown, and the economiccharacteristics and policy responses, in developing countries.

Which countries are at risk and how?The list of channels above suggest that the following types of countries are most

likely to be at risk (this is a selection of indicators): Countries with significant exports to crisis affected countries such as the USA

and EU countries (either directly or indirectly). Mexico is a good example; Countries exporting products whose prices are affected or products with high

income elasticities. Zambia would eventually be hit by lower copper prices, and thetourism sector in Caribbean and African countries will be hit;

Countries dependent on remittances. With fewer bonuses, Indian workers inthe city of London, for example, will have less to remit. There will be fewer migrantscoming into the UK and other developed countries, where attitudes might hardenand job opportunities become more scarce;

Countries heavily dependent on FDI, portfolio and DFI finance to address theircurrent account problems (e.g. South Africa cannot afford to reduce its interest rate,and it has already missed some important FDI deals);

Countries with sophisticated stock markets and banking sectors with weaklyregulated markets for securities;

Countries with a high current account deficit with pressures on exchangerates and inflation rates. South Africa cannot afford to reduce interest rates as itneeds to attract investment to address its current account deficit. India has seen adevaluation as well as high inflation. Import values in other countries have already


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weakened the current account; Countries with high government deficits. For example, India has a weak fiscal

position which means that they cannot put schemes in place; Countries dependent on aid.

While the effects will vary from country to country, the economic impacts could

include: Weaker export revenues; Further pressures on current accounts and balance of payment; Lower investment and growth rates; Lost employment.

There could also be social effects: Lower growth translating into higher poverty; More crime, weaker health systems and even more difficulties meeting the

Millennium Development Goals.Possible policy responses

The current macro economic and social challenges posed by the global financial

crisis require a much better understanding of appropriate policy responses: There needs to be a better understanding of what can provide financial

stability, how cross-border cooperation can help to provide the public good ofinternational financial rules and systems, and what the most appropriate rules arewith respect to development;

There needs to be an understanding of whether and how developingcountries can minimise financial contagion;

Developing countries will also need to manage the implications of the currenteconomic slowdown after a period of strong and continued growth in developingcountries, which has promoted interest in structural factors of growth, internationalmacro economic management will now move up the policy agenda. Do countrieshave room to use fiscal and monetary polices?

Developing countries need to understand the social outcomes and provideappropriate social protection schemes;

There will also be implications for development policy:There will be limits to financial solutions if the problems lie in the real economy,

but development finance institutions may be able to take some risks and supportinvestment flows to developing countries, counteracting reductions in otherfinancial flows. Whether DFIs can take higher risks might be informed by pastexperience, for example by looking at what happened during the Asian financialcrisis of the late 1990s. During this period DFI portfolios were riskier, loan losseshigher and returns lower than they are at present. And yet this poorer financialperformance has not had an adverse affect on institutional credit ratings. The EBRDargued in 2007 that is able to withstand the impact of a major shock with an impactequivalent to 3.5 times the magnitude of the financial crisis in 1998, without a needto call capital;

o Aid volumes will come under pressure,1 but there may also be implications forthe composition of aid. Should aid be provided to countries with high risks, and howshould this be channelled? Are existing IMF and World Bank schemes sufficient forthis, as they already need to address balance of payment problems in countries dueto high food and oil prices?

global financial crises

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