Global Financial Crises Final Report 2012 Lahore Business School University of Lahore Macroeconomics Section-C BBA (Hons)

Batch# 20103
Submitted by: Ali Zulfiqar Reg#: BBA02103040 Mian Sajid Bilal Reg#: BBA02093080 Shahzaib Akram Reg#: BBA 02093157

Submitted To: Mam, Mehar Afroz

Table of Contents

Reason of Choosing This Topic Introduction The Term Financial Crises Forecasting of the Crises Causes Financial Crises and Pakistan Sectorial Impact of Crises in Pakistan Findings Challenges going Forwards Conclusion Further Recommendation References

 Reason of 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:

The global financial crisis of 2008 was the worst of its kind since the Great Depression of the 1930s. It surfaced to notice in September 2008 with the failure of several large United States based financial firms. Its underlying causes had been reported following the subprime mortgage crisis. The failures of large financial institutions in the United States rapidly evolved into a global crisis resulting in European bank failures, declines in various stock indexes, and significant reductions in the market value of equities and commodities worldwide. The crisis led to liquidity problems and the de-leveraging of financial institutions especially in the United States and Europe, which further accelerated the liquidity crisis. World political leaders and central bank directors coordinated their efforts to reduce fears but the crisis progressed into a currency crisis with investors transferring vast capital resources into stronger currencies leading many emergent economies to seek aid from the International Monetary Fund. International Monetary Funds and World Banks Structural Adjustment Programmers have returned to countries, including Pakistan, which were doing well before the ongoing financial crisis.1 Therefore, 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.

 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. The financial crisis of 2008 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.

Forecasting of the Crises:

Besides many other studies by international financial institutions (IFIs), a Deloitte Research Study titled Global Economic Outlook 2007 (Is a crisis imminent or are things better than we thought?) predicted the crisis in these words, 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 US from 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.3 The international financial system has failed to deliver on two accounts; 1. Preventing instability and crises 2. Transferring resources from richer to poorer economies.

 CAUSES:
Causes Leading To Crises: 1. High Commodity Prices: In 2008, the prices of many commodities, notably oil and food, rose so high as to cause genuine economic damage. In January 2008, oil prices surpassed $100 a barrel for the first time, the first of many price milestones passed that year. By July the price of oil reached as high as $147 a barrel although prices fell soon after. 2. Trade: In mid-October 2008, the Baltic Dry Index, a measure of shipping volume, fell by 50 per cent in one week, as the credit crunch made it difficult for exporters to obtain letters of credit.

3. Inflation: In February 2008, Reuters reported that global inflation was at historic levels, and that domestic inflation was at 10 to 20 year highs for many nations. "Excess money supply around the globe, a surge in growth supported by easy monetary policy in Asia, speculation in commodities, agricultural failure, the rising cost of imports from China and rising demand of food and commodities in the fast growing emerging markets," have been named as possible reasons for the inflation. In mid-2008, IMF data indicated that inflation was highest in the oil-exporting countries and developing Asia on account of the rise in oil and food prices. 4. Unemployment: The International Labour Organization predicts that at least 20 million jobs are likely to be lost by the end of 2009 due to the crisis - mostly in "construction, real estate, financial services, and the auto sector" bringing world unemployment above 200 million for the first time.

 Financial Crises 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 $ 16.4billion 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 countrys 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. Pakistans 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. Pakistans 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 Pakistans financial grounds? How should Pakistans 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.

Sectorial Impact of Crises 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: 1. 2. 3. 4. 5. 6. Weaker export revenues Further pressure on current accounts and balance of payment (BOP) 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.

 Findings:
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 study 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 Reserves 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 Forwards:

Pakistan faces a plethora of challenges that stem 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 impact of the global crisis has so far been very limited, but a few credible threats still remain. 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. With regards to external financing, 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 re-establish domestic economic growth.

Conclusion: The newspapers in the last quarter of 2008 were stirring emotions with headlines such as meltdown, economic crisis, global recession and billions written-off. For the developing world, the rises in food prices as well as the knock-on effects from the financial instability and uncertainty in industrialized nations are having a compounding effect. High fuel costs, soaring commodity prices together with fears of global recession are worrying many developing countries, including Pakistan. There is a need to accept the challenges emerging out of this crisis, learn the lessons from other nations like China, explore opportunities in adversity and equip ourselves to pre-empt such challenges in future. A Chinese proverb will suffice to say, A crisis is an opportunity riding the dangerous wind. The global financial crisis is an ongoing issue which put a number of countries into a recession and the major stock indexes into a downward spiral. The events described above started a plethora of problems in the economic and political world and continued through the end of 2008 into the beginning of 2009. Its effects are not likely to end soon.

 Further Recommendation:
Policy Measures: Following policy measures may be adopted to address the challenges of financial crisis: 1. Significant cuts be made in the expenditures to curtail aggregate demand. 2. Tight monetary policy should be followed by the State Bank of Pakistan to contain inflationary spiral; 3. Prioritize the scarce government expenditures available for development-related programmers. 4. Implement improved and transparent targeting of income support and other programmers aimed at the poor and the vulnerable groups; 5. Intensify public-private partnerships with the objective of making private investments, including foreign investors, the most important funding source for economic development; 6. Reinforce the importance of sound governance, managerial and systemic mechanisms to ensure that 7. investments in the social sector are cost-effective and aimed at output-oriented service delivery. 8. Agrarian Solutions: Pakistan is an agrarian economy. The input industry for agriculture and livestock including dairy sector be domestically developed and cost of production be reduced to encourage farmers. If we become self-sufficient in food, half of our problems will be addressed. 9. Contingency Planning: Government and other institutions including the defense ministry should evolve a comprehensive system of contingency planning to meet the unexpected financial/economic crisis. 10. Checks and Balances: A system of checks and balances should be enforced in the national economic system to effectively monitor the irregularities like illegal flight of capital etc. and eliminate corruption. This measure will curtail depletion of foreign exchange in the country and ensure availability of funds for social development.

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