Articles 3

ARTICLE NO 1
Introduction
Capitalism, an economic system in which land, labour, production, pricing
and distribution are all determined by the market, has a history of moving from
extended periods of rapid growth to relatively shorter periods of contraction. The
ongoing global financial crisis actually has its roots at the end of the twentieth
century, when U.S. housing prices began declining after an uninterrupted, multi-year
escalation. By mid-2008, there had been an increase in mortgage delinquencies that
was striking. This increase in delinquencies was followed by an alarming loss in
value of securities backed by housing mortgages, and this loss meant an equally
alarming decline in the capital of America’s largest banks and government-backed
mortgage lenders, such as Freddie Mac and Fannie Mae, who held some $5 trillion in
mortgage-backed securities.
The $10 trillion mortgage market went into a state of severe turmoil. The Bank
of China and France’s BNP Paribas were the first institutions outside of the United
States to declare substantial losses from subprime-related securities. The European
subprime catastrophe was a close second to the U.S. subprime debacle, with Ireland,
Portugal, Spain and Italy 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 €163 billion ($222 billion) of
new bank liquidity and €700 billion (nearly $1 trillion) in interbank loan guarantees.
It became quite clear in the final quarter of 2008 that the subprime mortgage
problems were global in nature. Of the $10 trillion in the mortgage market, around
50% belonged to Freddie Mac and Fannie Mae. In September 2008, the U.S.
Department of the Treasury was forced to place both Freddie and Fannie into federal
conservatorship. Then on 15 September 2008, Lehman Brothers, one of the largest
financial services entities in America, filed for bankruptcy. On September 16, the
large U.S. insurer American International Group (AIG), saw its market value drop by
95% (AIG shares fell to $1.25 from a 52-week high of $70).
Germany, the fourth largest economy on the planet, is economically,
technologically and politically integrated with the world around it. When financial
institutions went belly-up across the globe, the credit institutions, investment firms,
insurance companies and pension funds in Germany also came under severe
financial stress. Amid other countries' domestic bailouts, the German finance ministry
managed to get its €480 billion package through the Bundestag in less than a week:
the Financial Market Stabilization Act was Germany’s answer to the global financial
crisis, creating a bailout package that would 'stabilize financial markets, provide
needed liquidity, restore the confidence of financial market players and prevent a
further aggravation of the financial crisis'.
On 11 October 2008, finance ministers from the Group of Seven (G7) of
Canada, France, Germany, Italy, Japan, the United Kingdom and the United States
met in Washington but 'failed to agree on a concrete plan to address the crisis'. On
October 13, several European countries nationalized their banks in an attempt to 3
increase liquidity. On November 14, leaders from twenty major economies gathered
in Washington to design a joint effort towards regulating the global financial sector.
Pakistan’s twin deficits
Pakistan’s financial crisis predates the global financial crisis. For the past
several years, Pakistan has been running unsustainable budgetary and trade deficits.
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-ayear
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.
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.
Pakistan’s banking sector
Pakistan’s banking sector is made up of 53 banks, which include thirty
commercial banks, four specialized banks, six Islamic banks, seven development
financial institutions and six micro-finance banks.
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 [sic] 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 4
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 are now as high as 20%.
Overall, Pakistan’s banking sector has not been as prone to external shocks
as have been banks in Europe. Liquidity is tight, certainly, but that has little to do with
the global financial crisis and more to do with heavy government borrowing from the
banking sector, and thus tight liquidity and the ‘crowding out’ of the private sector.
Circular debt
On 26 January 2009, Raja Pervaiz Ashraf, Minister for Water and Power,
told the Senate that the 'federal government [would] settle half of the Rs400 billion
circular debt by the end of January'. The circular debt in Pakistan has arisen because
the government of Pakistan owes—and is unable to pay—billions of rupees to oil
marketing companies (OMCs) and independent power producers (IPPs). As a
consequence, OMCs are unable to import oil or supply oil to IPPs, and IPPs in turn
are unable to generate electricity. Neither can refineries open letters of credit (LCs) to
import crude oil.
According to BMA, a leading financial services entity, 'The circular debt
problem is seriously impacting the operations of the entire energy value chain....Due
to low cash balances and liquidity as a result of the debt problem, the companies
have to resort to short-term financing at high interest rates. Refineries are having
problems opening LCs to import crude oil due to mounting payables and receivables.
The same can be said about the OMC sector, including the fact that financing costs
in the entire energy sector have skyrocketed. IPPs like HUBCO and KAPCO are also
having difficulty purchasing oil and continuing operations'.
The Karachi Stock Exchange (KSE)
The Karachi Stock Exchange (KSE) is Pakistan’s largest and most liquid
exchange. BusinessWeek cited it as the ‘best-performing stock market in the
world' for the year 2002. 5
On the last trading day in December 2008, the KSE listed a total of 653
companies, with an accumulated market capitalization of Rs1.85 trillion ($23 billion). ,
The KSE—as represented by the KSE-100 Index—had its highest close ever on 26
December 2007, at 14,814 points with a market capitalization of Rs4.57 trillion ($58
billion). As of 23 January 2009, the KSE-100 Index stood at 4,929 points with a
market capitalization of Rs1.58 trillion ($20 billion), a loss of over 65% from its
highest point.
According to estimates of the State Bank of Pakistan (SBP), foreign
investment in the KSE stands at around $500 million. Other estimates put foreign
investment at around 20% of the total free float. During the 2006 and 2007 calendar
years, foreign investors were actively investing in KSE-listed securities. In September
2007, however, Standard & Poor’s cut its outlook for Pakistan’s credit rating to
'stable' from 'positive' on concerns over deteriorating security. On 5 November 2007,
Moody’s Investors Service announced that Pakistan’s credit rating had been placed
'under review'.
The end of 2007 was a bleak one for the KSE. Uncertainties over the
upcoming Pakistani general election, a troubling macroeconomic scenario, an active
insurgency in the Federally Administered Tribal Areas (FATA), double-digit inflation,
a ballooning trade deficit, an unsustainable budgetary deficit and a worrying drop in
foreign currency reserves created a dark, threatening cloud over the market.
IMF: Panacea or more pain?
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. 6
The fact of the matter is that 2 out of 3 Pakistanis are already earning $2 a
day or less. An increase in taxation would mean a further slowdown in the economy.
A further slowdown would mean increased unemployment. A rise in the interest rate
would lead to the same thing: this high cost of capital would shut down a lot of
Pakistan's industrial units—and this would mean even more unemployment.
This heavy slowdown and additional unemployment could very well bring
Pakistanis out into the streets—and that would signal a full-blown political crisis.
There is no denying that the country is in a terrible financial mess. With the IMF in the
equation, the question now is whether a serious, full-blown political crisis can
somehow be averted. According to the IMF’s own estimates, the SBA package will
slow real GDP growth to 3% in 2008-09 and add an additional 2 to 3 million to
bottom-line unemployment.
The role of the Coalition Support Fund (CSF)
The Coalition Support Fund (CSF) was created by the United States
Congress after 9/11 to reimburse key U.S. allies, particularly Pakistan and Jordan, for
their assistance to the U.S. in the Global War on Terror. The Defense Security
Cooperation Agency (DSCA) maintains that The Department of Defense programs
for supporting our coalition partners and building partner military capacity enable
coalition partners to participate in U.S. operations and conduct counterterrorist
operations when they otherwise lack the financial means to do so. Under CSF, direct
overt U.S. aid and military reimbursements to Pakistan over U.S. fiscal years 2002
through 2009 totalled almost $12 billion, of which $3.1 billion was economic aid and
almost $9 billion was for security.
The CSF has helped to narrow Pakistan’s ever-widening current account
deficit. Under the new Obama Administration, Pakistan requested a reimbursement
of $156 million, but the United States unilaterally deducted $55 million and
reimbursed a total of $101 million.
Conclusion
The two major external culprits behind Pakistan’s macroeconomic
imbalance were a sharp spike in the international price of crude and an
unprecedented jump in commodity prices. Oil has since come down from a high of
$147 a barrel to under $40 a barrel, while commodity prices have experienced a
drastic trimming. Taken together, the two should provide welcome relief to Pakistan’s
trade account and inflation woes. 7
At the same time, the world economy is slowing down as never before.
Consider this: the United States buys nearly 30% of Pakistan’s exports. America is
the only major trading partner with which Pakistan enjoys a trade surplus. American
investors account for nearly 30% of foreign direct investment (FDI) into Pakistan.
Now America is facing an unprecedented economic slowdown.
The global financial crisis and the accompanying global credit crunch have so
far had only a minor direct impact on Pakistan, but the Pakistani economy remains in
dire straits. For the 2008-09 fiscal year, Pakistan needs a colossal $13.4 billion
foreign inflow of capital. Of that $13.4 billion, the IMF contribution is expected to be
$4.7 billon. Pakistan must find other multilateral and bilateral donors to bridge the
whopping gap.
ARTICLE NO 2
GLOBAL FINANCIAL CRISIS:

ITS IMPACT ON DEVELOPING COUNTRIES
AND LESSONS FOR PAKISTAN
Muhammad Usman
∗
Abstract
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 marketvalue 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
Fund’s and World Bank’s Structural Adjustment Programmes
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.
Towards a Global Financial Crisis
Historical Perspective
orldwide, the Great Depression started in 1929 and ended
between the late 1930s or early 1940s for different countries.
As the largest and most important economic depression in
∗
Defence Analyst.
1
Huzaima Bukhari and Dr Ikram ul Haq, “Is Capitalism ‘at bay’?,” The News
(Islamabad), November 9, 2008.
W
IPRI Journal X, no.1 (Winter 2010): 93-118 94 Muhammad Usman
modern history, it is now a benchmark for how far the world's economy
can fall. The Great Depression originated in the United States starting
with the stock market crash on October 29, 1929, known as Black
Tuesday. The end of the depression in the U.S. is associated with the
onset of the war economy of World War II, beginning around 1939.
The
depression had devastating effects in the developed and developing
countries. International trade was deeply affected, as were personal
incomes, tax revenues, prices, and profits. Cities all around the world
were hit hard, especially those dependent on heavy industry.
Construction virtually halted in many countries. Farming and rural areas
suffered as crop prices fell by 40 to 60 per cent. Facing plummeting
demand with few alternative sources of jobs, areas dependent on primary
industries, such as farming, mining and logging, suffered the most.
However, even shortly after the Wall Street Crash of 1929, optimism
persisted; John D. Rockefeller said that "these are days when many are
discouraged. In the 93 years of my life, depressions have come and gone.
Prosperity has always returned and will again." Most countries set up
relief programmes, and suffered political upheavals, pushing them to the
left or right.
The present financial crisis began in the developed countries and
spread to the rest of the world, touching the emerging economies like
Russia, China, India, Brazil and East Europe.
2
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. The bursting 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.
Global Financial System
The global financial system comprises institutions and regulations. The
main players are the institutions, such as International Monetary Fund
and Bank for International Settlements, national agencies and government
departments, e.g. central banks and finance ministries, and private
2
Arvind Gupta, “Global Financial Crisis: Is There a Way Out?,” Institute of
Defence Studies and Analyses, New Delhi, (November 5, 2008). Global Financial Crisis:
Its Impact on Developing Countries 95
institutions acting on the global scale, e.g., banks and hedge funds or
private investment funds.
Forecast of the Crisis
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, (i) preventing instability and crises and (ii)
transferring resources from richer to poorer economies.
4
Global Trends
Global trends leading to the crisis were:
a. 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.
b. 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
“Global Economic Outlook 2007: Is A Crisis Imminent, or Are Things Better
Than we Thought?”, A Deloitte Research Study,
http://www.deloitte.com/assets/Dcom-Global/Local%20Assets/Documents/
dtt_GlobEcon07_091506.pdf.
4
Jayati Ghosh, “Global Inequity Must End,” Daily Times (Islamabad), October
26, 2008. 96 Muhammad Usman
c. 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.
d. Unemployment: The International Labour Organization
predicts that at least 20 million jobs are likey 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.
Impact of Global Financial Crisis

Following a period of economic boom, the financial bubble has burst.
The collapse of the US sub-prime mortgage market and the reversal of the
housing boom in other industrialized economies had ripple effects around
the world. Other weaknesses in the global financial system have also
surfaced. Some financial products and instruments have become so
complex and twisted, that as things started to unravel, trust in the whole
system started to fail. The problem was so severe that some of the world’s
largest financial institutions collapsed. Others were bought out by their
competition at low prices and in other cases, the governments of the
wealthiest nations in the world had to resort to extensive bailout and
rescue packages for the remaining large banks and financial institutions.
Towards the end of October 2008, the Bank of England said the world’s
financial firms had now lost £1.8 trillion ($2.8 trillion) as a result of the
continuing credit crisis. As a result, says the United Nation’s Conference
on Trade and Development in its Trade and Development Report 2008 as
summarized by the Third World Network: The global economy is
teetering on the brink of recession. The downturn after four years of fast
growth is due to the global fallout from the financial crisis in the United
States, the bursting of the housing bubbles in the US and in other large
economies, soaring commodity prices, increasingly restrictive monetary
Global Financial Crisis: Its Impact on Developing Countries 97
policies in a number of countries, and stock market volatility. “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 persistent negative effects from the reversal
of housing booms in various countries”.
5
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.
6
US Bailout Plan – 2008
The US has implemented a $700 billion bailout package. Other countries
are not far behind. The combined European Union bailout packages ran
about $2.3 trillion. UK’s bailout package amounts to about $692 billion;
Germany has offered about $670 billion; France $490 billion; Ireland
$545 billion and Spain $140 billion. Japan has announced $275 billion
worth of bailout package. Several countries have coordinated their
interest rate cuts to overcome liquidity problems. Despite these massive,
unprecedented bailouts, the financial system remains risk prone and
volatile.
7
The Emergency Economic Stabilization Act of 2008, commonly
referred to as a bailout of the U.S. financial system, is a law authorizing
the United States Secretary of the Treasury to spend up to $700 billion to
purchase distressed assets, especially mortgage-backed securities, from the
nation's banks. Opinions about the plan clashed:
a. Proponents’ View: Proponents of the bailout plan argued
that the market intervention called for by the plan was vital
to prevent further erosion of confidence in the U.S. credit
markets and that failure to act could lead to an economic
depression.
5
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.
6
Tom Barkley, “IMF Slashes World Growth Forecasts Again,” Silicon
Investor,
http://siliconinvestor.advfn.com/readmsg.aspx?msgid=25152632
7
Op. cit., 2. 98 Muhammad Usman
b. Opponents’ View: 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.
8
Global Financial Crisis- A Timeline

A timeline
9
of salient events of the global financial crisis from 2007 to
2009 is attached as Annex A.
Impact on Developing Countries
Impact on Developing Countries
Of historically unprecedented magnitude and scope, this crisis has serious
implications for people, particularly for poor people in poor countries
10
.
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 poor and 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
8
“Emergency Economic Stabilisation Act of 2008”,
http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2
0
08.
9
Mauro F. Guilen, “The Global Economic & Financial Crisis: A Timeline”,
The
Lauder Institute, University of Pennsylvania, May 15, 2009,
http://lauder.wharton.upenn.edu/pdf/Chronology%20Economic%20%20Fina
ncial%20Crisis.pdf.
10
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, http://docs.google.com/viewer?a=v&q=cache:eH5-Xq7H1mcJ:
www.un.org/ga/president/63/interactive/gfc/sakiko_p.pdf+Sakiko+Fukuda-
+Parr,+“The+Human+Impact+of+the+Financial+Crisis+on+Poor+and
+Disempowered+People+and+Countries,”+The+New+School,+New+Yo
rk+(October+2008).&hl=en&gl=pk&pid=bl&srcid=ADGEESi0JFapewuzd
t_lKsqP39dhEdXiSt7qHDvo7g1nLPFLu0SnfxTNApRQQrWmgxzjYgUO2
E
P5qhnCJrwENhbi8w9LU8j2YC7inBDqLfnbXaoO-K-
5GK0Q9qTxtTtMsrL6gyirCOUg&sig=AHIEtbSuCOdC00xmqwHk8sEuww
moFPC1w. Global Financial Crisis: Its Impact on Developing Countries 99
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:
11
a. Virtually no country, developing or industrial, has escaped

the impact of the widening crisis, although those countries
with stronger fundamentals and less integration into the
global economy going into the crisis have generally been less
affected.
b. Consensus growth projections for developed countries in
2009 are being slashed and world trade volumes may fall for
the first time since the 1982 recession.
c. Earlier concerns about rapid credit growth in some
developing countries have been proven valid.
d. Investment is expected to suffer as it bears much of the direct
impact of the financial crisis.
e. Should the freeze in credit markets not thaw quickly enough,
the consequences for developing countries could be severe.
f. Remittances from host countries are expected to decline in
response to the global slowdown but the impact on flows to
recipient countries will depend significantly on exchange
rates.
g. Low-income countries will be significantly affected by the
crisis even though the channels of transmission are likely to
be quite different from those operating in emerging markets.
h. As a result of the food and fuel crises, the number of
extremely poor was estimated to have increased by at least
100 million.
i. Recent declines in food and fuel prices do not imply that
pressures and problems have disappeared.
11
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.
100 Muhammad Usman
j. 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, see fig below.
k. While the effects will vary from country to country, the
economic impacts could also include:
12
(1) Weaker export revenues;

(2) Further pressures on current accounts and balance of
payment;
(3) Lower investment and growth rates;
(4) Lost employment.
l. There could also be social effects:
(1) Lower growth translating into higher poverty;
12
Dirk Willem te Velde, “The Global Financial Crisis and Developing
Countries,” Overseas Development Institute (ODI), UK, (October 2008).
(2) More crime, weaker health systems and even more
difficulties meeting the Millennium Development
Goals.
The Way Forward
Developing countries especially South Asian countries can do a number
of things to reduce the adverse effects of the financial crisis and prepare
the way for a resumption of rapid growth in 2010:
a. Policy attention needs to focus on creating as much additional
fiscal space as possible to prop up the domestic economy
while preserving macro economic stability. As noted, the
decline in global fuel and food prices has provided a welcome
opportunity to regain the loss in fiscal space owing to
previous higher prices. This gain should not be wasted in
reversing the policy changes made in aligning domestic prices
better to the global prices, especially domestic fuel prices.
Additionally, efforts must intensify to raise public revenues.
All South Asian countries have scope for raising revenues
through strengthening tax compliance and aligning better
public utility prices to their production costs.
b. A careful look at expenditure priorities is in order. Public
spending that creates jobs, especially for the poor, will be
essential. Important examples include rural and other
infrastructure (rural roads, irrigation facilities, rural power);
basic urban services; and well-designed safety net
programmes.
c. The ongoing efforts to increase the efficiency and
effectiveness of the banking sector must continue. These
measures should aim at lowering intermediation cost,
reducing non-performing loans, improving banking services,
and strengthening prudential regulations.
d. In the face of sliding world demand, efforts to raise domestic
productivity and competitiveness become critical factors for
protecting export market shares. The scope for increasing the
competitiveness of the South Asian economies is large and
includes policies to improve the availability of infrastructure,
lower the transaction cost of private investment through 102 Muhammad
Usman
better governance, and reduce restrictions on trade and
investment.
e. In an environment of constrained resources, greater attention
to improving implementation capacity and corruption
prevention in public spending becomes even more important.
Global Economic Summit
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 declaration mentioned the following
actions to be taken:
13
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 current difficult 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.
13
“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.Global Financial Crisis: Its Impact on Developing Countries 103
f. Ensure that the IMF, World Bank and others have sufficient
resources to continue playing their role in overcoming the
crisis.
14
World Bank’s Global Monitoring Report-2009

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 Bank’s view:
15
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.
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.
14
www.independent.co.uk, (accessed November 16, 2008).
15
“Global Financial Crisis and its Impact on Developing Countries: Global
Monitoring Report – 2009,” World Bank, 23. 104 Muhammad Usman
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:
a. There needs to be a better understanding of what can provide
financial stability, how cross-border cooperation can help
to provide the public good of international financial rules and
systems, and what the most appropriate rules are with respect
to development;
b. There needs to be an understanding of whether and how
developing countries can minimize the financial contagion;
c. Developing countries also need to manage the implications of
the current economic slowdown – after a period of strong
and continued growth in developing countries, which has
promoted interest in structural factors of growth;
d. Developing countries need to understand the social outcomes
and provide appropriate social protection schemes.
Islamic Banking - The Silver Lining
A number of financial crises that gripped the world over the last three to
four decades have put the international financial system in question. The
weaknesses of the prevailing interest-based financial system create a
strong rationale for introducing a new system of the international
finance. The principles of Islamic banking deter interest and introduce in
its place the principle of risk/reward-sharing. Financing through the
Islamic modes expands in tandem with the real economy and helps to
curb excessive credit expansion, which leads to lavishness and contributes
to the instability in the international financial markets. There is a need to
find out solutions of current crisis through the principles of Islamic
financial system. This alternative system does not allow short selling
because one may only sell something one owns. Islamic banking is
currently one of the fastest growing types of finance in some Muslim
countries. There are advantages in considering or even applying some of
the basic Islamic principles involved to come out of the current crisis. To
be sure, while the world’s first Islamic bank was founded back in 1975, it
is only in the last five years or so that Islamic finance has surged. Salient
aspects of Islamic banking are: Global Financial Crisis: Its Impact on
Developing Countries 105
a. Size of Islamic financial industry reached US$ 250 billion and
is growing annually at the rate of 15 per cent per annum;
16
b. 42 countries had Islamic banking institutions out of which 27
are Muslim countries including Bahrain, UAE, Saudi Arabia,
Malaysia, Brunei and Pakistan and 15 are non-Muslim
countries including USA, UK, Canada, Switzerland, South
Africa and Australia;
c. Leading foreign banks, Standard Chartered Bank, Citibank,
HSBC and ABN AMRO, had opened Islamic banking
windows or subsidiaries.
Pakistan’s Perspective
Impact on Pakistan
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.
Pakistan was 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
nonofficial 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.
17
This is mainly due to the improved health of the financial sector
16
Muhammad Imran, “Islamic Banking Current Scenario and Way Ahead,”
Standard Chartered Bank, November 17, 2005.
17
“Global Financial Crisis: Implications for South Asia,”
http://docs.google.com/viewer?a=v&q=cache:AK3NB-
PJoLAJ:siteresources.
worldbank.org/SOUTHASIAEXT/Resources/223546-
1171488994713/3455847-1212859608658/5080465-106 Muhammad
Usman
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)
18
In 2007-08, the .
sharp rise in international oil and food (specifically wheat) prices had led
to rapidly expanding macroeconomic imbalances in Pakistan. The effects
of the global slowdown have also been transmitted through the trade
balance, with a slowdown in global demand and fall in commodity prices
having varying effects. These effects are enunciated as under:
a. Financial Sector: The operating environment of the financial
sector experienced significant deterioration in 2007 and 2008,
due to a confluence of factors emanating from both the
domestic and international economic and financial
developments. While the domestic environment was
characterized by weakening macroeconomic indicators and the
uncertainty caused by the prolonged period of political
transition, the global financial crisis and the commodity price
hike had a feedback impact on the financial sector through the
real sector of the economy.
b. Capital Flows and Workers’ Remittances: A beleaguered
international economic environment has held back Foreign
Investment as it posted a decline of 47.5 per cent during the
first ten months of 2008-09 compared to the corresponding
period of the previous year.
19
Some Asian economies have
witnessed an anticipated fall in workers’ remittances as
unemployment grew in advanced host economies. However,
workers’ remittances to Pakistan remained vigorous and
unaffected by the crisis, totaling US$ 6.36 billion in July-April
1224618094138/SARGlobalFinancialCrisis.pdf+“Global+Financial+Crisis:
+I
mplications+for+South+Asia,”+www.worldbank.org&hl=en&gl=pk&sig=
AHIEtbSRIsJaFpx_N7tNjCJXBoTT9IzvMQ (accessed October 21, 2008).
18
“Pakistan Country Overview 2009: Bank’s Assistance to Pakistan”, World
Bank,
http://www.worldbank.org.pk/WBSITE/EXTERNAL/COUNTRIES/SOU
THASIAEXT/PAKISTANEXTN/0,,contentMDK:20131431~menuPK:2930
57~pagePK:1497618~piPK:217854~theSitePK:293052,00.html.
19
Mohammed Mansoor Ali, “Global Financial Crisis: Impact on Pakistan and
Policy Response” (paper presented at Regional High-Level Workshop on
Strengthening the Response to the Global Financial Crisis in Asia-Pacific:
The Role of Monetary, Fiscal and External Debt Policies, Dhaka,
Bangladesh,
July 27-30, 2009). Global Financial Crisis: Its Impact on Developing
Countries 107
2008-09 as against US$ 5.32 billion in the corresponding period
last year, a rise of 19.5 per cent.
c. Commodity Prices and Trade: An unprecedented hike in
international commodity prices wreaked havoc on Pakistan’s
external sector during 2007-08, with the current account
widening significantly.
20
However, in the wake of a reduction
in global demand and the resultant decrease in commodity
prices, the import bill has reduced significantly, decreasing the
current account deficit
d. External Financing: The global crisis has restricted Pakistan’s
ability to tap international debt capital markets to raise funds.
Pakistan’s presence in the international capital markets in
2008-09 was limited to the repayment of Eurobond amounting
to US$ 500 million
21
made in February 2009 with no new
issuance at the backdrop of financial crisis engulfing the global
markets.
Macro-Economic Stabilization Plan 2008-10
A panel of Planning Commission of Pakistan comprising economists
have unveiled a proposed macro-economic stabilization plan for 2008-10
seeking a Rs 115 billion cut in the country’s expenditures. However, the
macroeconomic situation remains fragile and the medium-term outlook is
uncertain. Progress with the implementation of reforms has been uneven,
with inadequate measures taken to boost revenue and control public
spending.
22
However, the scope for counter cyclical fiscal policy is limited
at this time, but Pakistan is taking measures to protect social spending to
help reduce the adverse effects of the crisis on the poor.
Fiscal Year 2008-09
Economic activity significantly slowed down in 2008-09. The current
account deficit narrowed to 5.1 per cent of GDP. Overseas remittances
have increased but financial inflows (such as FDI and portfolio
investment) dropped sharply—by over 37 per cent—due to
macroeconomic instability, deteriorating security situation and global
20
“2009 Pakistan Economic Update”, World Bank, http://web.worldbank.org/
WBSITE/EXTERNAL/COUNTRIES/SOUTHASIAEXT/0,,contentMDK:2
21
Ibid.
22
Ibid. 108 Muhammad Usman
recession. But with the assistance of IMF disbursements, SBP foreign
exchange reserves rebounded to about $9.1 billion (2.9 months of
imports) by end-June 2009.
23
However, fiscal problems continued during
2008-09 and the fiscal deficit target was 5.2 per cent of GDP. Overall
revenues fell substantially short of the target primarily due to a drop in
tax revenues as the economic slowdown reduced Pakistan’s two main tax
bases-manufacturing and imports.
Economic Growth and Investment 2008-2009
While the economic environment in Pakistan remained inhospitable for
growth and investment during the first half of 2008-09, firm policy action
to restore macroeconomic stability paid off dividends by December. The
Rupee stabilized, after losing 19.3 per cent in value against the US
Dollar.
24
This occurred on a build-up of foreign exchange reserves from
November onwards, when Pakistan entered an IMF programme, after the
country’s international liquidity had declined to an import cover of only
several weeks. Confidence in the banking system and financial markets
was largely restored from December, with the second half of 2008-09
exhibiting greater stability and positive trends in virtually all
macroeconomic indicators barring inflation.
Fiscal Year 2009-10
The first two months of FY 2009-10 suggest that fiscal instability will
continue, and the first quarter fiscal deficit target will likely exceed the
estimates. Revenues have continued to under perform.
25
Vulnerability
Pakistan’s vulnerability has been summarized by World Bank as under:
26
23
Ibid.
24
“Economic Survey 2008-2009,” Ministry of Finance, Government of
Pakistan,
Islamabad.
25
26
a. Failure to raise revenues in future would further intensify
Pakistan’s vulnerability to external shocks, and jeopardize
development efforts by limiting resources available for
planned investments in human and physical infrastructure.
b. Pakistan’s high economic growth in the earlier part of this
decade was in part by heavy reliance on external financing
and on expansionary fiscal stance, while revenues and savings
remained stagnant.
c. Reliance on external financing left the economy vulnerable to
external shocks, which came in 2007-08 and led to a balance
of payments crisis. To reduce the economy’s vulnerability,
expanding domestic revenue mobilization would be critical.
Friends of Pakistan Forum
Friends of Pakistan (now called Friends of Democratic Pakistan) forum
comprising Saudi Arabia, UAE, China, France, England, US, Canada,
Turkey, Australia, Italy, UN and European Union was launched on
September 26, 2008. On November 17, 2008, the Friends of Pakistan met
at Abu Dhabi acknowledging that Pakistan is facing “formidable
challenges and needs a well-coordinated international cooperation”. The
forum agreed on a broad framework for cooperation with Pakistan in
four major sectors including cooperation in the fields of development,
security, energy and institution-building.”
27
The Friends of Democratic
Pakistan forum held its first Summit in New York on September 24,
2009, under the co-chairmanship of President Barack Obama, President
Asif Ali Zardari, and Prime Minister Gordon Brown. Also attending
were twelve heads of government and senior representatives of nine
countries and five multilateral institutions. The pledges made so far have
yet to materialize.
Lessons Learnt
The ongoing global financial crisis has a negative impact on the
economies of developed countries in general and developing economies in
particular. Nevertheless, a few lessons can be drawn to minimize the
negative fallout of global financial crisis:
27
Dawn (Online Edition), November 18, 2008. 110 Muhammad Usman
a. 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 programmes;
(4) Implement improved and transparent targeting of income
support and other programmes 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
investments in the social sector are cost-effective and
aimed at output-oriented service delivery.
b. 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.
c. Contingency Planning: Government and other
institutions including the defence ministry should evolve a
comprehensive system of contingency planning to meet
the unexpected financial/economic crisis.
d. 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.
e. Banking Sector Reforms: Pakistan’s banking sector is made
up of 53 banks, which include 30 commercial banks, four
specialized banks, six Islamic banks, seven development
financial institutions and six micro-finance banks. Reforms
should be introduced in the banking sector to channel savings Global
Financial Crisis: Its Impact on Developing Countries 111
for productivity rather than for non-productive loans to
customers. The banks should transfer benefits and profits to
the customers and help in poverty alleviation in the
country.
f. International Finance Institutions (IFIs): The bailout
packages offered by IFIs are very hazardous and may be
adopted as a last resort because conditions like the withdrawal
of subsidies badly affects the poor. Moreover, these IFIs ask
for imposing agricultural tax etcetera, which can impede that
sector’s growth.
g. Friends of Democratic Pakistan: Forums like the Friends of
Democratic Pakistan should be asked to provide meaningful
support beyond mere rhetoric and promises. Regular
interaction with these forums is likely to bring positive
response from them.
h. Forex Remittances: Some countries are much smaller than
Pakistan but receive more forex remittances from their
expatriates. Our overseas community needs to support the
country by increasing forex remittances. Government should
provide more incentives to the overseas community in this
regard.
i. Economic and Financial Intelligence: “The Economist”
Intelligence Unit compiles the economic and financial
forecast of all countries. Similarly, we need to have economic
and financial intelligence outfits to give feedback and early
warning to national finance institutions regarding emerging
trends in these fields for timely steps to counter the crisis.
j. Economic Activity Bureau (EAB): There is a need to
establish an Economic Activity Bureau to accelerate
economic activity in the country.
k. Islamic Banking: State Bank of Pakistan has already taken a
quantum jump and concrete steps in this direction. We need
to capitalize on this base for betterment of our economy.
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 rise in food prices as
well as the knock-on effects from the financial instability and uncertainty
112 Muhammad Usman
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.„ Global
Financial Crisis: Its Impact on Developing Countries 113
Annex-A
GLOBAL FINANCIAL CRISIS – A TIMELINE (2007-2009)
Date Event
7 February 2007 HSBC announces losses linked to U.S. sub
prime mortgages.
17 May 2007 Federal Reserve Chairman Ben Bernanke said
growing number of mortgage defaults will not
seriously harm the U.S. economy.
17 August 2007 The Fed cuts the rate at which it lends to banks
by half of a percentage point to 5.75%, warning
the credit crunch could be a risk to economic
growth.
3 September 2007 German corporate lender IKB announces a $1bn
loss on investments linked to the US sub-prime
market.
4 September 2007 The rate at which banks lend to each other rises
to its highest level since December 1998. The socalled Libor rate is
6.7975%, way above the
Bank of England's 5.75% base rate; banks either
worry whether other banks will survive, or
urgently need the money themselves.
18 September 2007 The US Federal Reserve cuts its main interest
rate by half a percentage point to 4.75%.
1 October 2007 Swiss bank UBS is the world's first top-flight
bank to announce losses $3.4bn - from subprime related investments. The
chairman and
chief executive of the bank step down. Later,
banking giant Citigroup unveils a sub-prime
related loss of $3.1bn. A fortnight on Citigroup
is forced to write down a further $5.9bn.
Within six months, its stated losses amount to
$40bn.
30 October 2007 Merrill Lynch's chief resigns after the
investment bank unveils a $7.9bn exposure to
bad debt.
9 January 2008 The World Bank predicts that global economic
growth will slow in 2008, as the credit crunch 114 Muhammad Usman
hits the richest nations.
21 January 2008 Global stock markets, including London's
FTSE 100 index, suffer their biggest falls since
11 September 2001.
31 January 2008 A major bond insurer MBIA, announces a loss
of $2.3bn – its biggest to date for a three-month
period -blaming its exposure to the US subprime mortgage crisis.
10 February 2008 Leaders from the G7 group of industrialized
nations say worldwide losses stemming from
the collapse of the US sub-prime mortgage
market could reach $400bn.
7 March 2008 In its biggest intervention yet, the Federal
Reserve makes $200bn of funds available to
banks and other institutions to try to improve
liquidity in the markets.
8 April 2008 International Monetary Fund (IMF), which
oversees the global economy, warns that
potential losses from the credit crunch could
reach $1 trillion and may be even higher. It says
the effects are spreading from sub-prime
mortgage assets to other sectors, such as
commercial property, consumer credit, and
company debt.
4 August 2008 Global banking giant HSBC warned that
conditions in financial markets are at their
toughest "for several decades" after suffering a
28% fall in half-year profits. Of Europe's top
banks, HSBC has among the heaviest exposure
to the troubled US housing and credit markets.
15 September 2008 Bank of America agrees to a $50 billion rescue
package for Merril Lynch. Lehman files for
bankruptcy and thousands of its employees are
told it’s all over. This is the largest bankruptcy
filing in the history of the United States at $ 639
billion.
19 September 2008 Asia starts to recover with the Nikkei closing
up 431 points at 11,920. Russian stock markets
bounce back after the government pledges 500 Global Financial Crisis: Its
Impact on Developing Countries 115
billion roubles to fight the crisis. The British
government increases its guarantee for British
banks deposits to £50,000 and the Bank of
England announced it will auction £ 10 billion.
On Wall Street, the Dow Jones Industrial closes
at 11,388.44 points, up 368.75, despite
employment data being worse than expected.
Bush Administration announces Bailout Plan to
Confront Crisis. Congress is asked to give the
administration new powers to execute a plan
that could cost taxpayers billions to buy toxic
debt and bad mortgages.
2 October 2008 The U.S. Senate approves the bailout. Congress
passes the $700 billion asset relief bailout.
European leaders, lead by French president
Nicolas Sarkozy, consider their own bailout,
which would cost € 300 billion.
9 October 2008: The IMF announces emergency plans to bailout
governments affected by the financial crisis,
after warning that no country would be
immune from the ripple effects of the credit
crunch. The Dow falls to a five-year low,
ending the day at 8,579 points. The
FTSE ends at 4,313.8 its lowest level since
August 13, 2004.
9 November 2008 China announces a two-year $ 586 billion
stimulus package to help boost the economy by
investing in infrastructure and social projects
and by cutting corporate taxes. Economic
growth has slowed in China with sharp drops in
property and stock values. The money from the
stimulus package will be spent on upgrading
infrastructure, particularly roads, railways,
airports and the power grids throughout the
country and raise rural incomes via land reform.
Also spending will be made on social welfare
projects such as affordable housing and
environmental protection. Some Chinese
factories engaged in low-end export 116 Muhammad Usman
manufacturing have gone out of business.
15 November 2008 International Summit in Washington to
reinvent the international financial system.
Leaders agreed to cooperate with respect to the
global financial crisis and issued a statement
regarding immediate and medium term goals
and actions considered necessary to support and
reform the international economy.
25 November 2008 The International Monetary Fund (IMF)
approves a $7.6bn (£5.1bn) loan for Pakistan to
shore up the country's economy. Pakistan needs
the money in order to avoid defaulting on
international debt.
12 December 2008 A $14bn (£9.4bn) bail-out deal for the US car
industry has failed to get Senate support, raising
fears of job cuts and a possible industry collapse.
15 January 2009 Asian Markets Fall Sharply: The Nikkei 225
index in Tokyo shed 4.9 per cent. By
midafternoon the Hang Seng in Hong Kong
was down 5 per cent the benchmark Kospi in
South Korea 6 per cent. The key indexes in
Singapore and Taiwan were 3.2 and 4.4 per cent
lower.
22 January 2009 Microsoft has said it will cut up to 5,000 jobs
over the next 18 months, including 1,400
immediately.
27 January 2009 Chancellor Angela Merkel's cabinet approved a
€50bn (£46.7bn) stimulus package today, the
biggest programme in Europe, to tackle
overcome the country's deepest economic crisis
since the second world war.
29 January 2009 President Barack Obama took the troubled
Wall Street banks to task yesterday for paying
out billions of dollars in bonuses to staff,
accusing them of displaying "the height of
irresponsibility" and of letting down the
American people.
9 March 2009 The financial crisis wiped $50 trillion (£35tn) off
the value of financial assets last year, the Asian Global Financial Crisis: Its
Impact on Developing Countries 117
Development Bank (ADB) said.
11 March 2009 Chinese exports plunged by more than a
quarter in February from a year ago as the
world's third-largest economy was hit by a drop
in demand for its goods.
13 March 2009 The White House has sought to assure China
that its $1 trillion (£0.7tn) in investments in the
United States is safe despite the economic
downturn.
14 March 2009 Finance ministers from the G20 group of rich
and emerging nations have pledged to make a
"sustained effort" to pull the world economy
out of recession.
18 March 2009 World Bank has cut its prediction for China's
economic growth in 2009 from 7.5% to 6.5%,
saying it could not "escape the impact of global
weakness".
25 March 2009 Barack Obama has told Americans he sees signs
of economic recovery, but urged them to be
patient and look beyond their "short-term
interests".
31 March 2009 Germany's unemployment rate rose to 8.6% in
March as the global economic downturn
continued to tighten its grip on Europe's largest
economy.
30 April 2009 Unemployment across the 27 EU member states
reached 20 million in March 2009.
7 May 2009 President Barack Obama has said he aims to cut
$17bn (£11bn) from next year's US government
budget, saying he had found examples of
"stunning" waste.
24 Sep 2009 Friends of Democratic Pakistan forum held its
first Summit in New York under the cochairmanship of President Barack
Obama,
President Asif Ali Zardari, and Prime Minister
Gordon Brown. Also attending were twelve
Heads of Government and senior
representatives of nine countries and five
multilateral institutions. 118 Muhammad Usman
17 December 2009 American weekly news magazine, Time, has
named Chairman of the U.S. Federal Reserve,
Ben Bernanke as man of the year 2009. Time
magazine’s rationale for picking Bernanke: “The
main reason Ben Shalom Bernanke is Time’s
Person of the Year for 2009 is that he is the
most important player guiding the world’s most
important economy. His creative leadership
helped ensure that 2009 was a period of weak
recovery rather than catastrophic depression,
and he still wields unrivalled power over our
money, our jobs, our savings and our national
future. The decisions he has made, and those he
has yet to make, will shape the path of our
prosperity, the direction of our politics and our
relationship to the world.”
ARTICLE NO 3
Global Financial Crisis: Implications for South Asia

I. Overview
The global financial crisis is hitting South Asia at a time when it is already
reeling from the
adverse effects of a severe terms-of-trade shock. Countries have responded
by partially adjusting
domestic fuel prices, cutting development spending and tightening monetary
policy. The
adverse effects of these terms of trade losses have been substantial, reflected
in a slowdown
of growth, worsening of macroeconomic balances and huge inflationary
pressures.
The global financial crisis will likely worsen these trends, particularly on the
growth and balance
of payments front. Slowdown in global economy will adversely affect South
Asian exports and
could hurt income from remittances. Lower foreign capital flows and harder
terms will reduce
domestic investment. Both will lower growth prospects.
II. Terms of Trade Shocks: 2003-2008
Huge Terms of Trade Shock: Between January 2003 and May 2008 South
Asia suffered a huge
loss of income from a severe terms-of-trade shock owing to the surge in
global commodity prices
(Figure 1). While MENA, LAC and ECA gained from higher prices on a net
basis, South Asia
lost substantially from both higher food and petroleum prices. Within South
Asia, losses range
from 36 percent of GDP for the tiny Island country of Maldives to 8 percent
for Bangladesh
(Figure 2). Much of the loss came from higher petroleum prices, where all
countries lost.
On the food account, Bangladesh lost most, followed by Nepal and Sri
Lanka. Pakistan and India
actually gained, being significant rice exporters. Although reliable data is
not available for
Afghanistan, losses from the oil and food price crisis are believed to be
substantial.
Figure 1 South Asia Region, World Bank
October 21, 2008 2
Figure 2
Deterioration in external and fiscal balances: The large loss of income from
the terms of
trade shock was partially compensated by rising remittances. Nevertheless
there has been a
negative impact on the external balances of most South Asian countries
(Figure 3). Pakistan
suffered the most rapid deterioration in the current account balance, which
turned from a surplus
of around 4 percent of GDP in 2003 to a deficit of over 8 percent in 2008.
Sri Lanka similarly
registered a sharp increase in current account deficit. Even in India, the
current account widened
sharply from a surplus of more than 2 percent of GDP in 2004 to a deficit of
over 3 percent in
2008. The current balance in Nepal that was in surplus for a fairly long
period finally turned into
a deficit in 2008. Only Bangladesh continued to enjoy a surplus in its current
balance.
Figure 3
These differential effects reflect a number of factors including: the relative
magnitude of terms
of trade shocks, the differences in compensating growth of remittances, and
policy responses. South Asia Region, World Bank
October 21, 2008 3
Bangladesh in particular benefitted tremendously from the growth in
remittances. Pakistan and
Sri Lanka have been facing balance of payments pressures from
expansionary fiscal and
monetary policies; the terms of trade shocks accelerated the deterioration.
Concerning fiscal balance, all countries except Sri Lanka registered sharp
deterioration
(Figure 4). The fiscal deficit widened most for Pakistan, rising from 2.4
percent of GDP in 2004
to 7.4 percent in 2008. India had made good progress in reducing fiscal
deficit between 2003
and 2007. This progress was reversed in 2008 as sharp increase in fuel
subsidies (growing from
1 % of GDP in FY2007 to an estimated 4% of GDP in FY2009) threatens to
wipe off the gains
made so painfully over the past few years. Bangladesh also struggled quite a
bit.
Budget deficit widened to almost 4 percent in 2008 and is projected to grow
further to over 5
percent, mostly due to increases in food and petroleum subsidies. Nepal’s
fiscal deficit has
grown from its low level in 2004 owing mainly due to fuel subsidy. Sri
Lanka has long suffered
from high fiscal deficits; as a result, it seceded to pass on the global price
increases in petroleum
to consumers.
Figure 4
Impact on inflation: Rising food and fuel prices have been a major source of
inflationary
pressure in South Asian countries (Figure 5). In Afghanistan, Sri Lanka,
Pakistan, Bangladesh
and Nepal, food prices made a bigger impact on inflation than fuel. In India,
however, the main
surge to inflation came from fuel price increases. Afghanistan saw the
steepest increase in staple
food prices between 2007 and August 2008, with wheat prices more than
doubling, due to poor
domestic production and export restrictions by Pakistan.
Other South Asian countries saw staple food price increases ranging from a
low of only 12
percent for India to 83 percent for Sri Lanka. Prices of staple food have
started to come down in
all South Asian countries owing to good harvests in 2008 and falling global
prices. The global oil
prices have also come down sharply to around $70/barrel level as compared
with the spike at
$150/barrel. The combined effects of lower food and fuel prices along with
demand South Asia Region, World Bank
October 21, 2008 4
management are reducing inflationary pressure in most South Asian
countries except
Pakistan.
Figure 5
III. Effects of the Emerging Global Financial Crisis
As noted, the South Asia economies are already limping from the adverse
effects of the huge
terms of trade shocks of the past 6 years. The reduction in global petroleum
and food prices
observed over the past few months provides a silver lining for South Asia in
an otherwise
difficult external environment. Yet this silver lining is now heavily clouded
by the emerging
global financial crisis that poses tremendous downside risks to South Asia.
These risks can transmit from both the financial sector in terms of volume
and price of foreign
capital flows as well as from the real sector based on adverse effects of a
global slowdown on
South Asian exports, possible downward pressure on remittances, and
slowdown in private and
public investment owing to higher interest rates as well as lower export
demand.
(a) Financial sector effects: South Asia is fortunate to have a broadly

resilient financial sector
due to a combination of past financial sector reforms and capital controls
that insulate these
economies to a great extent from the risk of a financial crisis transmitted
from abroad. However,
individual country risks vary substantially as the macroeconomic
performances, financial sector
health and exposure to foreign capital markets differ considerably by
countries.
The largest economy, India, is relatively more exposed to the contagion
effects of global
financial markets through adverse effects on capital flows from portfolio and
direct foreign
investments, and also through exposure of domestic financial institutions to
troubled
international financial institutions and to contracts—including derivatives—
that have undergone
large value changes. The evidence so far shows significant losses in the
stock market and a
reduction in the flow of foreign capital. Yet these risks are countered by a
fundamentally strong
macro economy including prudent foreign debt management, high savings
rate, solid financial
sector health, and a pro-active monetary policy management that will likely
allow India to ride
the crisis without destabilizing the financial sector. South Asia Region,
World Bank
October 21, 2008 5
The Central Bank has already responded by letting the exchange rate
depreciate to stem the
outflow on the current account, by providing extra liquidity to the financial
sector, and by raising
the limit on private foreign borrowing. The nature and depth of the global
financial crisis is still
evolving and there is a significant downside risk of further slowing down of
net capital flows and
a hardening of terms. But these are countered by an overall healthy banking
sector with low
non-performing loans and a comfortable capital base and a pro-active
monetary and exchange
rate management. Foreign debt and debt service is low, and reserve cover
($274 billion) is still
substantial. The high domestic saving rate (34 percent of GDP) provides
added cushion. The
main effects of the global financial crisis will be to reduce the availability of
funds leading
to higher interest rates and lower public and private investment that will hurt
growth.
The second largest economy, Pakistan, is much more fragile and faces the
most
vulnerability in the region. High fiscal and current account deficits, rapid
inflation, low
reserves, a weak currency, and a declining economy put Pakistan in a very
difficult situation to
face the global financial crisis. Efforts are now underway to arrest the
decline of the macro
economy through appropriate 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 would be
even more expensive than now. 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. This is mainly due to the improved health of the financial sector
based on past reforms.
Sri Lanka suffers from high inflation and large current and fiscal account
deficits. To stem
the deteriorating macro-balances Sri Lanka has started tightening monetary
policy and is also
trying to contain the fiscal deficit by passing on the energy price increases to
consumers. The
performance of the financial sector has improved over time, although there
is a slight upward
trend in Non-performing loans (NPL) in recent years. The role of foreign
capital in Sri Lanka's
domestic financial sector is limited. The main downside risk on the financial
sector is a reduction
in capital flows from outside, including for the government. There is
already evidence of a rise
in spreads for Sri Lanka bonds. Switching of demand to domestic financing
in an environment
of high inflation and further tightening of monetary policy would raise
interest rates and
slowdown economic activity. Financial difficulties in domestic firms could
also adversely affect
NPLs. Overall, though, there is little risk of a financial collapse.
Bangladesh has maintained generally prudent macroeconomic policies.
Balance of
payments is in surplus owing to rapidly rising remittances and prudent
demand management.
Inflation, which reached double digit, is now coming down due to falling
food prices. Fiscal
deficit has increased to 5-6 percent, but remains manageable in view of
falling global oil and
food prices from their global peaks last fiscal year. The financial sector is
showing signs of
improved health from past reforms and is mostly insulated from foreign
markets because of very
low private capital inflows. External debt is low and reserves are
comfortable. In this
environment, the effect of the global financial crisis on the financial sector is
likely to be
negligible. Bangladesh is relatively more exposed from the real economy
effects of a possible
slowdown in exports, especially garments, and from remittances. South
Asia Region, World Bank
October 21, 2008 6
Nepal is emerging from a conflict situation with low growth and the adverse
effects of a
global food and fuel crisis. Inflation is showing signs of deceleration due to
reduction in
international food and fuel prices. Its domestic financial sector is very weak
in terms of financial
indicators with large non-performing loans and low capital adequacy.
However, the financial
sector is pretty much insulated from global finances due to the negligible
amount of foreign
private capital flows. The risks to the macro economy come from a potential
expansionary
budget in an environment of a deteriorating global economy.
(b) The real sector effects: The possible downside effects of the financial
sector crisis are much
more direct and substantial from the real economy implications. These will
work through trade,
remittances and investments.
Exports: Based on progress on trade reforms, South Asian economies have
become much better
integrated with the global economy than in the early 1990s. Exports are now
over 20 percent of
GDP and are a major source of growth stimulus. The recession in OECD
countries will almost
certainly lower the export prospects for all South Asian countries, but
especially India that has
done remarkably well in the services sector and now faces a sharp slowdown
in demand. South
Asia is also a major exporter of textiles and garments that are vulnerable to
the recession in the
OECD economies. Depending on the magnitude and the period of this
recession, the adverse
effects on exports can be large.
Imports: One redeeming feature emerging from the import side is the
observed downward trend
in commodity prices, especially food and fuel. The import bills on these
accounts, especially
fuel, are already coming. The recession in OECD countries will likely cause
a further reduction
in commodity prices with positive effects for South Asia.
Remittances: Foreign remittances have grown rapidly in South Asia over the
past few years.
These have not only provided an offsetting cushion on the balance of
payments, but more
importantly they have been a huge source of income and safety net for a
large number of poor
households in South Asia, especially in the poor countries of Afghanistan,
Bangladesh and
Nepal. Much of these remittances come from low-skilled workers engaged
in the oil-rich
countries of the Middle East. These earnings do not face an immediate risk
as these economies
have huge earnings and reserves from the oil price boom and oil prices are
still substantially
higher than in 2002 in real terms. However, remittances from OECD
countries can be adversely
affected. India and Pakistan are particularly exposed to this slowdown. On
balance the
downside risk of substantial lower earnings from remittances appear low.
Investment: The main risk to growth comes from the likely adverse effects
on investment of the
combined effects of a slowdown of foreign funding and a possible increase
in non-performing
assets of domestic banks owing to lower profitability of firms producing for
export markets. At
the same time, higher inflation has required tightening of monetary policy.
All of these factors
will reduce the availability of domestic financing of private investment.
Public investment is
already constrained by rising fiscal deficits. Overall, there is likely to be a
slowdown in the rate
of domestic investment. Improvements in saving rates in South Asian
economies have been an
important cushion. But inadequate adjustment to the losses from terms of
trade, combined with a South Asia Region, World Bank
October 21, 2008 7
possible slowdown of exports earnings and foreign capital flows will almost
certainly reduce
investment and growth.
(c) Impact on macroeconomic balances: As noted South Asia’s
macroeconomic balances had
already worsened considerably owing to the term of trade shocks. The
falling commodity prices
of the past few months from their peak levels were providing some relief in
FY09. Inflation also
has been coming down in most South Asian countries. The global financial
crisis could offset
some of these improvements. A slowdown in earnings from exports and
remittances would tend
to hurt the current account, while lower growth of important demand and
falling commodity
prices would tend to improve. The fiscal picture will improve from lower
subsidies due to falling
prices, but revenue earnings can decline from lower growth. On balance,
though, we expect
inflation to fall and much of the impact will be absorbed by lower growth
IV. Growth Prospects
Since 1980, South Asia has been on a rising growth path, reaching a peak of
9 percent in
2006. Growth has been on a declining trend since then. In particular, the
adjustment to the
terms of trade shock brought about a slowdown in growth in 2008 for all
South countries, not
withstanding the benefits of a strong agriculture recovery. The onset of the
global financial crisis
suggests a significant slowdown in South Asia’s growth prospects for 2009-
10 (Figure 6). The
slowdown will be particularly notable for India and Pakistan. India‘s
prospects will be hurt by
the reduction in capital flows and possible slowdown in the growth of
exports. Pakistan’s
economy is already facing difficulties; the financial crisis will aggravate it.
Figure 6 South Asia Region, World Bank
October 21, 2008 8
IV. Policy Issues and Challenges Moving Forward
Growing fiscal deficits due to food and fuel subsidies and rising inflation
suggest that South
Asian countries have basically run out of fiscal space and do not have the
option of riding out
further shocks with expansionary fiscal and monetary policies. So, in the
near term growth will
need to fall to absorb the shock from the financial crisis. Indeed, as noted, all
South Asian
countries have responded with some degree of monetary tightening and
cutbacks in development
spending, and have also adjusted domestic fuel and fertilizer prices in
varying degrees to stem
the widening of the fiscal deficit.
The policy option of full pass through of fuel and fertilizer prices to
consumers is not a
politically viable option, although further reduction of the gap between
domestic and
international prices and better targeting of open-ended subsidies are possible
options especially
in Pakistan which faces the largest macroeconomic imbalances.
Falling global prices also provide some relief. On the balance of payments
side, the flexibility
of the exchange rate has been a positive factor, although this has happened
only recently in
Pakistan. Nevertheless, further tightening of demand, especially in Pakistan
and Sri Lanka, will
be necessary. Demand management will obviously need to focus on the right
mix between fiscal
and monetary policies with a view to ensuring that there is enough liquidity
in the short-term to
avoid a financial crunch while also ensuring that aggregate demand falls to
reduce inflation and
improve the macroeconomic balances.
Over the medium term, there is substantial scope for domestic resource
mobilization
through the tax system that will play a key role to regain the growth
momentum. All South
Asian countries can benefit from it. In the short term, countries have tended
to cut development
spending to contain the rise in fiscal deficits, which is contributing to the
growth slowdown. So,
better expenditure management is also a medium-term option for reconciling
stabilization
with growth objectives.
Since 1980, South Asia’s growth benefitted from prudent macroeconomic
management and both
structural and institutional reforms. Refocusing policy attention to the next
phase of
structural and institutional reforms will also help growth to recover.
ARTCLE NO 4:
Global Financial Crisis: Impact on Pakistan and Policy Response

The global recession has posed policymakers around the world with
unprecedented challenges.
Severely damaged financial sectors seemed immune to most responses,
while fiscal stimuli and
other policy tools have, at best, been sluggish to establish some stability in
economies dealing
with the spill-over of the financial crisis into other sectors and a general
economic slowdown. In
a little over a year, what started off as a sub-prime crisis in US mortgage and
housing markets,
has amplified to a global economic downturn of an extraordinary scale,
bringing to an end four
years of booming economic growth across the world.
In developed economies, strains in the financial sector, a drying up of credit,
and an increasing
amount of risk aversion in the face of limited information about potential
losses, led to the
closing of many credit lines and the evaporation of financing mechanisms.
Commodity
producing sectors in these economies were hard hit by these events,
resulting in a general
economic deceleration rather than a crisis limited to the financial sector.
In emerging economies, the slowdown manifested itself through various
channels. Volatility in
financial markets led to a flight of capital. Furthermore, access to external
financing became all
but impossible and spreads on bonds widened to record levels. Countries
relying on trade as a
primary means of boosting economic growth saw trade volumes disappear as
trading partners in
the rest of the world struggled to deal with the slowdown in their domestic
economies.
The global financial crisis is impacting the real and social sectors of
developing countries
through multiple channels. The linkages between developed and developing
economies have
deepened as well as broadened over the past two decades in the wake of
intensifying
globalization.
As the slump in the global economy prevailed, the Pakistan’s economy
witnessed a period of
significant instability and a deterioration of most macroeconomic indicators.
The timing of the
crisis, and Pakistan’s response to domestic developments might seem
contradictory to a layman.
As governments around the world lowered interest rates and implemented
expansionary fiscal
measures to revitalize their economies, Pakistan underwent a phase of fiscal
tightening, and a
stringent monetary stance with discount rates remaining relatively high for
most of the period
(discount rates remained at 15 percent till April 2009). Fiscal, Monetary, and
External debt
policies of Pakistan have primarily been driven by the underlying need to
resurrect significant
macroeconomic imbalances in the domestic economy, rather than as a
response to the financial
crisis and global economic slowdown. The financial sector of the economy
is still in its
developing stages with limited, albeit growing, linkages with global markets.
As a result,
Pakistan has been relatively well-insulated against the contagion in
international financial
markets. It is remarkable to note that Pakistan is among a handful of
countries with a positive
rate of growth, and among a very few with the lowest decline in real GDP
growth as compared to
other countries affected by the global financial crisis.
Domestic Imbalances
The performance of Pakistan’s economy in fiscal year 2008-09 has been
vastly influenced by the
macroeconomic imbalances created in fiscal year 2007-08. Persistent
inflationary pressures and
1weak performance of key sectors of the economy have made 2008-09 an
exigent year. The
domestic environment was not conducive as major disruptions like
intensification of war on
terror, acute energy shortages and resource constraints were threatening
macroeconomic
fundamentals. As a result of these pressures, Pakistan’s economy has not
only been impacted
with regards to overall performance but has also undergone a medium-term
shift in policy
orientation. Policy intervention has been geared to stabilize the domestic
economy, with a
targeted recovery phase beginning in fiscal year 2009-2010.
Being an open and highly import dependent economy, Pakistan has been hit
severely by the
surge in global commodity prices whose impact magnified as the oil and
other strategic import
prices rose. This led not only to an unprecedented rise in inflationary
pressures but also made
balance of payments position unsustainable. The month-on-month headline
CPI inflation
reached as high as 25.3 percent by August 2008 compared to 6.5 percent in
August 2007. The
current account deficit which was 4.8 percent of GDP in FY07, almost
doubled to 8.6 percent of
GDP in FY08.
The stress on macroeconomic stability worsened further due to a significant
rise in fiscal deficit
which was mainly explained by government’s effort to protect domestic
consumers from the pass
through effect of rising fuel and commodity prices in the international
market. Excessive
subsidization of oil and food products, which grew from Rs 76 billion
budgeted level to Rs 395
billion, distorted the natural demand adjustment mechanism. Thus, it not
only resulted in huge
fiscal deficit of 7.6 percent of GDP, but also cost the country dearly in terms
of foreign exchange
spent on importing large volumes of these commodities. These subsidies
were clearly
unsustainable as they accounted for 47 percent of the fiscal deficit. . The
aggregate demand
pressure from fiscal imprudence compounded as the government had to
resort to highly
inflationary central bank borrowing for deficit financing due to larger than
projected fiscal deficit
and less than expected availability of external budgetary flows. The
government could not raise
the desired amount from other domestic sources due to tight liquidity
conditions in the interbank
market and strong credit demand from the private sector. The borrowing
from the public through
NSS instruments also remained relatively low compared to previous year.
The challenges for central bank were exacerbated due to temporary liquidity
shortages in the
money market, and strains in the overall banking system. The domestic
socio-political upheavals
also contributed to these multifaceted problems.
Impact of the Global Crisis
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.
2Financial Sector: The operating environment of the financial sector
experienced significant
deterioration in 2007 and 2008, due to a confluence of factors emanating
from both the domestic
and international economic and financial developments. While the domestic
environment was
characterized by weakening macroeconomic indicators and the uncertainty
caused by the
prolonged period of political transition, the global financial crisis and the
commodity price hike
had a feedback impact on the financial sector through the real sector of the
economy. Pakistan,
which remained largely unscathed from a direct impact of the crisis, has
been more concerned
with issues relating to monetary stability due to rising inflation since before
the advent of the
crisis. With a thriving banking sector, increasingly resilient to a wide
variety of shocks,
increasing but still relatively less correlation of domestic financial markets
with global financial
developments, a proactive and vigilant regulatory environment, and most
importantly, no direct
exposure to securitized instruments, risks to financial stability were largely
contained and well
managed as the crisis unfolded and impacted the financial sectors in
advanced economies.
Capital Flows & Workers’ Remittances: A beleaguered international
economic environment has
held back Foreign Investment as it posted a decline of 47.5 percent during
the first ten months of
2008-09 compared to the corresponding period of the previous year. Most of
this decrease has
come in the shape of an outflow of private portfolio investment of US$ 1
billion. Investment
from countries such as the United States, United Kingdom, Singapore, and
Hong Kong, which
have been at the apex of the international crisis, has dropped significantly.
Some Asian
economies have witnessed an anticipated fall in workers’ remittances as
unemployment grew in
advanced host economies. However, workers’ remittances to Pakistan
remained vigorous and
unaffected by the crisis, totaling US$ 6.36 billion in July-April 2008-09 as
against US$ 5.32
billion in the corresponding period last year, thereby displaying a rise of
19.5 percent.
Commodity Prices & Trade: An unprecedented hike in international
commodity prices wreaked
havoc on Pakistan’s external sector during 2007-08, with the current account
widening
significantly. However, in the wake of a reduction in global demand and the
resultant decrease in
commodity prices, the import bill has reduced significantly, decreasing the
current account
deficit. A key loss to developing countries during the current crisis has been
a decrease in
exports as demand from advanced economies contracts. Pakistan has
witnessed a slowdown in
exports, but this reduction stands apart from that witnessed by other Asian
economies for two
reasons. Firstly, the fall in exports is partly due to a fall in domestic
productivity and it is hard to
distinguish between the impact of the crisis and internal factors on exports.
Secondly, the fall in
imports has outpaced the fall in exports, having a positive effect on the trade
balance.
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.
3Policy Response
Recognizing the complexity and depth of economic challenges, the
government and the central
bank (State Bank of Pakistan- SBP) jointly initiated an aggressive
macroeconomic stabilization
program with the help of International Monetary Fund (IMF). Several
stabilization measures
were taken by the government and the central bank to put the economy back
on a stable path.
The response included measures in the area of monetary policy, fiscal policy
and external debt
policies.
Monetary Policy: SBP which was gradually raising its policy rate from 7.5
percent in April 2005
to 12 percent by May 2008, aggressively increased the policy rate to 15
percent by November
2008. Further, CRR and SLR were increased for effective liquidity
management. In addition,
adjustment in the exchange rate helped in putting a dent in an otherwise
unsustainable growth
rate of imports.
In the meanwhile, SBP had to respond to severe liquidity crunch faced by
the banking system
following heavy withdrawals of deposits triggered by rumor-fed concerns
over the stability of
local banks in the backdrop of the international financial crisis. In
particular, SBP provided
extensive liquidity support to banks so that (a) their lending ability
remained intact, (b)
confidence on the banking system was restored quickly. These measures
had effectively diluted
the impact of the policy stance on the already stressed domestic economy.
Further, in order to support industry, and particularly the export-oriented
sectors that were
pressured by the impact of the global recession, measures were introduced
such as; easing access
to concessional financing schemes, and lengthening maturities.
The crisis has allowed the government and SBP to undertake some key
reforms in domestic
public debt market. For example, (1) government has started announcing
quarterly targets for Tbill auction, (2) the decisions on cut-off rate for
auction are now based on target and more
importantly this cut-off is now decided by the Ministry of Finance (instead
of SBP), (3) SBP is
aiming to adopt a transparent liquidity management framework, including
the announcement of
an explicit corridor for money market interest rates and making it public.
These changes have far-reaching implications. Besides improving
transparency, these changes
will allow the market and SBP to better assess demand pressures on the
Rupee liquidity in the
inter-bank market. Also, it is expected that market interest rate will become
more sensitive to
government borrowings needs. Further, the market will not take changes in
cut-off rate (which
are purely driven by government borrowings needs) as signal for monetary
policy changes.
As a part of monetary policy management SBP has also introduced a number
of reforms in the
foreign exchange market. More importantly, the SBP decided to gradually
phase out the
provision of foreign exchange for import of oil. Now the inter-bank market
is already meeting
the foreign exchange demand for import of furnace oil. By February 2010,
SBP will shift all oil
payments to the inter-bank market.
4Fiscal Policy: On account of massive government subsidies, policy
inaction, and general
expenditure-revenue mismatch, the fiscal position of the government
deteriorated significantly
during 2007-08. In order to arrest this deterioration, the fiscal response has
been two-staged. The
initial stage which was implemented during 2008-09 consisted of fiscal
tightening, with
expenditure being curbed in order to lower fiscal deficit and a net zero
quarterly limit on
government borrowing from the State Bank of Pakistan. The fiscal
consolidation efforts faced
headwinds such as the deteriorating security environment and the domestic
political uncertainties
along with the deepening of the global financial crisis and the overall
depressed macroeconomic
environment. The unanticipated persistence of inflationary pressures on the
economy kept fiscal
policy options under check. There has been a significant improvement in
fiscal performance
during 2008-09 due to the policy shift, with the overall fiscal deficit
estimated to have dropped to
4.3 percent of GDP. The fiscal improvement in 2008-09 has been largely
based on reduction of
oil subsidies and a slash on development spending. With fiscal consolidation
being one of the
primary objectives of the government during 2008-09, there has not been
much space for fiscal
stimuli to neutralize the impact of the financial crisis.
The second stage of the fiscal policy response is geared towards recovery.
After attaining fiscal
consolidation in 2008-09, fiscal policy is now focused towards providing
fiscal stimuli in order
to boost economic activity. Fiscal deficit is likely to rise to 4.9 percent of
GDP in 2009-10
mainly owing to a much needed increase in growth-enhancing development
expenditure. As a
result of the targeted stimuli, development expenditure is projected to
increase to 3.8 percent of
GDP in 2009-10 and further to 4.7 percent in 2010-11. The goal of the
second stage of the fiscal
response is to revitalize the economy by a targeted increase in development
expenditure that
boosts production, while increasing revenues and rationally curtailing non-
effective expenses.
The stimuli provided under this phase will ease the challenges faced by the
industrial sector, and
negate the impact of the global crisis on Pakistan’s exports.
External Debt Policy: The crisis in international financial markets has
significantly increased the
cost of acquiring external financing through debt creating inflows. Keeping
this in mind,
Pakistan has refrained from any foray in the international debt capital
markets. As part of the
response to the slowdown, external debt policy has put issuances of new
government paper and
access to international markets on hold till the environment becomes more
favorable to any such
venture. However, the government is committed to re-enter the global
capital markets, when the
overall horizon becomes conducive, in order to endorse its existence among
international
investors and more specifically, to create a benchmark for Pakistan. Hence,
the much needed
financing has been provided by the International Monetary Fund through the
Stand-by
Agreement established in November 2008. However, this financing was
mainly in response to
factors other than the impact of the global economic slowdown.
The global crisis has impacted Pakistan’s external debt through the
depreciation of the US dollar
against major international currencies leading to significant translational
losses. A receptive debt
policy is currently being formulated in order to monitor, assess, and take
steps to mitigate this
currency risks. On the other hand, the current low interest rate environment
amidst the ongoing
crisis has provided Pakistan with an opportunity to capitalize on lower
servicing costs on its
existing stock of floating rate external debt. Furthermore, there is greater
realization for close
coordination between debt policy, monetary policy, fiscal policy and cash
management
5operations of the government and development of domestic debt capital
markets to ensure
sustainable source of funding.
Challenges going forward
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.
ARTICLE NO 5:
The Impact of Recent Global Financial Crisis on the Financial

Institutions in the Developing Countries – the need for Global
Solutions
Nida Iqbal Malik
1
, Subhan Ullah
2
, Kamran Azam
3
, Anwar khan Marwat
4
Abstract
The purpose of this paper is to examine the recent impact of financial crisis
on
the financial institutions in the developing countries. This study contributes
to the
knowledge of investors and market practitioners to be well aware of the
risks
attached with investments in developing countries. The global financial
crisis set
off by the sub-prime credit crisis in the US. This has destabilized the
financial
markets of the developed world causing the fall down of prominent names in
the
banking business. Primary cause of this crisis can be Banks and other
financial
institutions in the United States of America have gone through a long period
of
inappropriate lending. Another cause of this crisis as according to latest
studies
may be the effect of the global financial crisis was worsened by rising global
energy and commodity prices which pushed up inflation. Developing
countries
have mainly faced strong rises in prices. In order to study the impact of this
1
Nida Iqbal Malik is student of Master in Business Administration at the
Department of Management Sciences at
COMSATS Institute of Sciences and Technology, Attock Pakistan. Email:
Taurus_nida11@hotmail.com
2
Lecturer, COMSATS Institute of Sciences and Technology, Attock,
Pakistan, Email: s.ullah@lancaster.ac.uk
3
Kamran Azam is lecturer at the department of Management sciences,
COMSATS Institute of information
Technology Attock.
4
Anwar Khan Marwat is lecturer at the department of Management sciences,
COMSATS Institute of
information Technology Attock. Page 2
financial crisis content analysis of various articles and research papers
related to
development literature was carried out. Our findings are in line with the
previous
research done by Eichengreen et al., (2008) and Yifu Lin (2008) which
support
the fact that the Banks in the developing economies will see their credit lines
from foreign banks squeezed and the increasing financial flows that these
economies have been experiencing are going to dry up. Based on this study
certain recommendations can be made such as role of loss sharing and the
policies of developing counties regarding stabilization and crisis
management as
well as rule of law and good governance. The government should introduce
programs to recapitalize banks, guarantee bank liabilities, and provide
liquidity to
banks by funding markets and in some cases support troubled asset markets.
Asset price inflation should be made under the control of monetary policy
authorities by government. Responses to global crises must be methodical,
inclusive, decisive, and organized. As Global problems may require global
multilateral solutions. If the crisis will continue for long period, state and
local
governments may begin to restrict as they try to shore up new financing
arrangements for their operations.
Field of Research: Banking
Keywords: Emerging markets, fiscal policy, monetary policy, Development
economics, IMF, Asian development bank. Page 3
Introduction
During the 20
th
century, the world experience two major financial crises. The first
global financial crisis was seeing during 1929-30, which affected the
developed
nations, Europe and America. While the second crisis came in 1997 and
remained till 1999 and was experienced by emerging economies of Asia
Pacific.
The recent financial crisis has taken the attention of the world in current
months;
it was seen with serious anxiety as it falls outwards from the regions
originally
affected. Alan Greenspan recently called it a “once-in-a-century credit
tsunami”,
born of a collapse deep inside the US housing sector. On the other hand the
discussions from the other previous or recent disaster come to mind too, as it
was seen that the great wave of the financial crisis overtop one economic
levee
after another. Instability has rushed forward from sector to sector, firstly
from
housing into banking and other financial markets, and then into all parts of
the
real economy. The recent financial crisis has also been rushed across the
publicprivate boundary, which has hit the private firms and the financial
statements has
forced the new heavy demands on the public sector's finances. The crisis has
surged across national borders within the developed world, and now there
are
some reasons which has alarmed that the crisis will swamp other developing
countries, affecting the significant economic progress of recent years. (Yifu
Lin,
2008)
According to Hyun-Soo., 2008, anxieties have augmented over the global
financial crisis, which began from the US sub prime mortgage disaster with
the
help of the governments of major countries which are coming up with
measures
such as provision of liquidity and bailout packages for distressed banks, the
fear
that has gripped financial markets shows little signs of abating. Major stock
exchanges are tumultuous while a series of indicators that gauge investors’
risk
aversion are posting all-time highs.
The developing world – what it has recently achieved, how these
achievements
are now at risk, and what it must now do – is the focus of this paper.
Understandably, perhaps, until now the focus of policymakers has mostly
been
on the actions of the governments at the epicenter of the crisis, as well as
those
of other developed countries like Japan and Korea. But now we must also
focus
on the developing world, as it faces the surge of instability. The 1.4 billion
people
who live in or on the verge of extreme poverty are all in the developing
world; Page 4
given their slim margin for survival, any economic crisis will have its most
severe
human consequences in the developing countries. So there are altruistic
reasons
for concern about the developing countries in the crisis. But there are also
strong
reasons of self-interest. As I will argue, demand from the investment-led
booms
in developing countries did much to drive the rapid global economic
expansion of
this decade, and preventing deflation and depression could very well depend
on
keeping that growth going.
This study begins with a brief discussion of the dynamics of global growth
in
2002-07, which mainly focused on strengthening of the booms in the
developed
and developing world. This study then discusses that how global recession
crises
begin due bad mortgages in 2007-08, starting with the US housing crisis. At
the
end, it discusses that how government can respond to the crisis to guarantee
that
the costs to the developing world are as small as possible.
Literature Review
As Nikolson, 2008 recognized that financial crisis which initiated in United
States
has now become a global phenomenon. At present, not only in United States
but
across Asia and Europe, stock exchanges crashed; collective losses of the
London, Paris and Frankfurt markets alone amounted to more than 350
billion
Dollars. Stock Exchange 100 index closed more than 323 points down in
January
2008 (Times online 2008). This crisis apart from affecting the capitalist
economies has distressed the Socialist economy like Russia as well; in May
2008 Russian stock market was fallen by 50% and the Russian central bank
had
to buy rouble in massive amount to prevent the severe falling against US
Dollar
and Euro (Erkkilä, 2008). About the cause of current crisis Bartlett (2008)
said
that crisis was started with the downfall of US sub-prime mortgage
industry , the
intensity of this collapse was significant; “Mark-to-market losses on
mortgagebacked securities, collateralized debt obligations, and related assets
through
March 2008 were approximate $945 billion.” He further stated that it is “The
largest financial loss in history”, as compared to Japan’s banking crisis in
1990
about $780 billion, losses stemming from the Asian crisis of 1997-98
approx
$420 billion and the $380 billion savings and loan crisis of U.S itself in
1986-95.
Yılmaz (2008) charged U.S subprime mortgage industry to be the major
reason
of current global financial crisis, he also stated that the total loses estimated
initially up to $300 to $600 billion are now considered to be around $1
trillion.
While enlightening the factors that why this US sub-prime mortgage crisis
turn
into global banking crisis, Khatiwada and McGirr (2008) stated “Many of
these
sub-prime mortgages actually never made it on the balance sheets of the
lending
institutions that originated them”; and they were made attractive to foreign
banks
by high investment grading, “when sub-prime borrowers failed to repay their
mortgages, the originating institution needed to finance the foreclosure with
their
own money, bringing the asset back on its balance sheet. This left many
banks in
a financially unviable situation, in a rather short, unmanageable timeframe”.
However Hyun-Soo (2008) argues that it was the “Trust Crisis” which
caused this Page 5
global predicament. DeBoer (2008) believes that it was series of events
which
caused the crisis; it begins with the collapse of currencies in East Asia in
1997
and became edgy due to the financial crisis of Russia in 1998. Next, in USA
was
the “dot-com” stock collapse in 2001, and the final stroke was again in USA,
when after a swift decline in housing prices and “rapid contraction in credit,
it fell
into recession. Rasmus (2008) has the same thoughts; he, while discussing
the
reasons of economic recession of U.S said “The ‘real’ ailments afflicting the
US
economy for more than a quarter-century now include sharply rising income
inequality, a decades-long real pay freeze for 91 million non-supervisory
workers,
the accelerating collapse of the US postwar retirement and healthcare
systems,
the export of the US economy’s manufacturing base, the near-demise of its
labor
unions, the lack of full time permanent employment for 40 per cent of the
workforce, the diversion of massive amounts of tax revenues to offshore
shelters,
the growing ineffectiveness of traditional monetary and fiscal policy, and the
progressive decline of the US dollar in international markets.”
Conceptual Framework
According to this study the proposed model which explains various variables
which explains the impact of the Global recession on the financial markets
in
developing countries, is as follows.
Global
Financial Crisis
Contagion
Effect
Financial
institutions
• Subprime mortgages in US
• Failure of IMF
• Melt Down of Major
Investment Banks In America
• Bailout Packages
• Monitory Policy of Central
bank Page 6
Global financial Crisis
The causes behind the recent global crisis are complex, and are linked to the
financial market decline of the last 20 months or so.
In US economy, Banking industry has been
badly hit due to mortgages backed by subprime mortgages fallen in value.
Due to bad
debts financial institutions were reluctant to
lend money and thus firm especially
construction industry’s output faced
contractions in credit lines which contributes
15% of US output. (Mvula, 2008)
On April 8, 2008 the International Monetary
Fund released information regarding the
magnitude of the Global financial crisis:
Mark-to-market losses on mortgagebacked securities, collateralized debt
obligations, and related assets
through March 2008
approximate $945 billion.
In absolute terms this
represents the largest
financial loss in history,
exceeding asset losses
resulting from Japan’s
banking crisis in the 1990s
($780 billion) and far
surpassing losses
emanating from the Asian
crisis of 1997-98 ($420 billion) and the U.S. savings and loan crisis o f
1986-95 ($380 billion).
The damage extends across a wide range of investor classes.
Commercial banks stand to lose $440-510 billion, insurance companies
$105-130 billion, pension funds $90-160 billion, governments $40-140
billion, and other financial institutions $110-160.
Innovations in mortgage securitization in the early- and mid-2000s
enabled loan originators to sell high-risk assets to downstream financial
institutions around the world, thereby globalizing the American subprime
crisis. Against U.S. bank losses of $144 billion, European financial entities
stand to incur $123 billion in mortgage-related losses. Within the latter
group, British institutions face $40 billion in asset write offs, nearly Page 7
matching the combined losses of the Euro area ($45 billion). Financial
institutions in Asia and other regions are far less exposed.
The imprudent lending practices that precipitated the American subprime
collapse are not confined to the United States. The IMF estimates that
housing prices in Ireland, Netherlands, and United Kingdom are 30
percent higher than justified by economic fundamentals. British housing
prices fell by 2.5 percent in March; the sharpest monthly fall in that country
since 1992. Australia, Belgium, Denmark, France, Norway, Spain, and
Sweden also face sizable housing bubbles.
Housing prices in OECD countries with more conservative lending
practices (Austria, Canada, Finland, and Germany) are more closely
aligned with market fundamentals, underscoring wide country variations in
mortgage markets.
Effects on Financial Institutions in Developing countries
The financial institutions in developing countries haven’t been effected by
financial crisis in developing countries due to of usage of traditional
financial
system where unlike US, individuals and groups need to have good track
record
in order to gain credit or loans and therefore risk is minimal.
As 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', Pakistan’s banking sector has not
been
as prone to external shocks as have been banks in Europe.
However, banks in developing economies have to suffer contractions in
credit
lines and reduced financial flows. Due failure of leading financial
institutions such
as IMF. IMF failed to response to Asian crisis during second great recession.
IMF
recommended contracted fiscal policies as economies were going into
recession.
IMF failed to predict banking crisis coming due to currency crisis.
Indonesia
suffered bank runs courtesy of IMF and Malaysia pulled back IMF
conditionality.
(Stiglitz., 2002)
Government’s Role
World of Work Report 2008 argues, governments need to take into account
the
social impact of financial globalization while allowing financial institutions
to
benefit from the global capital markets. Having institutions and structures in
place
to ensure that a country is not vulnerable to sudden capital outflows is key.
Governments are providing support and doing what so ever they can to
prevent
their economical structure; US government injected $800 billion in the
economy
to support the structure, UK government has announced a package of $692
billion, European Union is about to start an economic recovery plan and IMF
has
called for minimum financial support of $100 billion (BBC news, 2008).
Also on
the research part, E. Philip Davis and Dilruba Karim suggested an “Early
warning Page 8
System” to cop better with such crisis; the proposed two models “Logit” as a
global early warning system and “Signal Extraction” for country specific
early
warning system. DeBoer (2008) believe that such bailout programs and other
supporting packages from governments is like offering protection from a
negative
outcome which is more appropriate to be called as “moral hazard”; this trend
could increase the possibility of future bad upshots.
How long the crisis will prevail? It is indeed very difficult to answer this
question;
Warne (2008) believes that it’s the matter of confidence of investors, as long
as it
is restored, crisis will be over; but it cannot be done when we daily hear
news
about the abandonment of financial institutions, it needs some financial
stability.
OECD Secretary General, Gurría (2008) hopes that the effective
macroeconomic
policies and vital financial reforms will turn down the heat and normal
financial
conditions as well as the growth rates will return to normal in 2009. Yılmaz
(2008)
acknowledged that the worst part of the crisis is already over and the
markets are
suffering from what can be called ‘the after shocks’. Sha Zukang (2008) says
that
normalization of economic activities need “global and symentic” solutions,
he
stated that current “global Economic Governance System” is derisory for the
prevention of such crisis
Research Design
This study is an explanatory study which is aimed at explaining the impact
of
global crisis and what effect it will have on the financial institutions of
developing
countries. For this purpose content analysis was technique was used and
several
research papers and articles related to development economics were
examined.
As in conceptual analysis, a concept is chosen for examination, and the
analysis
involves quantifying and tallying its presence. Also known as thematic
analysis. A
specific no and set of concepts were examined such as “effects of global
financial crisis”, its “contagion effect” on “financial institutions” of
“developing
countries”. In this content analysis the existence of a concept e\was
examined.
Set of rules were defined in this research regarding the existence of concepts
and the linkages between these concepts. As Weber, 1990 suggested
irrelevant
data was also decided. By applying above stated content analysis process the
researcher is able to generalize the concepts and to form results of the study.
Results
Data from various sources was examined thoroughly and conclusive
evidence
was formed that current global crisis has significant impact on the financial
institutions of developing countries The current financial crisis affects
developing
countries in two possible ways.
First, there could be financial contagion and spillovers for stock markets in
emerging 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
the
USA and Brazil plunged. Stock markets across the world – developed and
developing – have all dropped substantially since May 2008. We have seen
Page 9
share prices tumble between 12 and 19% in the USA, UK and Japan in just
one
week, while the 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 the financial linkages, how they occur (as they do appear to
occur)
and whether anything can be done to minimize contagion.
Second, Commercial lending. Banks under pressure in developed countries
may
not be 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 such countries as Argentina, Iceland, Pakistan and Ukraine.
Means
Banks in the developing economies will see their credit lines from foreign
banks
squeezed and the increasing financial flows that these economies have been
experiencing are going to dry up
Conclusion
This study confirms that the global financial crisis has a significant effect on
the
financial institutions of developing countries. Our findings are in line with
the
previous research done by Eichengreen et al., (2008) and Yifu Lin (2008)
which
support the fact that the Banks in the developing economies will see their
credit
lines from foreign banks squeezed and the increasing financial flows that
these
economies have been experiencing are going to dry up. As developing
countries
Asia and Latin America are at a crossroads, and the next twelve to eighteen
months will be very difficult. The perception that they had broken the links
with
the larger economies has been painfully refuted by the hard facts of the last
18
months. Financial markets of the world are closely interconnected, and the
impact of the world financial collapse on Emerging Economies is a witness
to this
fact.
Recommendation
The government should introduce programs to recapitalize banks, guarantee
bank liabilities, and provide liquidity to banks by funding markets and in
some
cases support troubled asset markets. Asset price inflation should be made
under the control of monetary policy authorities by government. Responses
to
global crises must be methodical, inclusive, decisive, and organized. As
Global
problems may require global multilateral solutions. If the crisis will continue
for
long period, state and local governments may begin to restrict as they try to
shore up new financing arrangements for their operations. Page 10
References
Bartlett, D., 2008, “Fallout of the Global Financial Crisis”
Davis E.P., Karim, I., 2007, “comparing early warning systems for banking
crises”
Journal of Financial Stability 4 (2008) 89–120
DeBeers, R.D., 2008, “Understanding the Financial Crisis: Origin and
Impact.”
Erkkilä, M., 2008, “Impact of financial crisis on the Russian economy”
Gurria, A., 2008, “The Global Financial Crisis: Where to next, and what
does it mean for
OECD countries?”
Hyun-Soo, P., 2008, “Future Direction of the Global Financial Crisis”
Khatiwada S., McGir E., 2008, “Financial Crisis: a review of some of the
consequences,
policy actions and recent trends.”
Nicholson, R., et al, 2008, “Impact of the Financial Crisis on Technology
Spending in the
Utility Industry”
Rasmus, J., 2008, 'The Deepening Global Financial Crisis: From Minsky to
Marx and
Beyond', Journal of Socialist Theory, 36:1, 5 —29
Warne, K., “Gaining a better understanding of the financial crisis”, Canadian
Strategy
Report.
World Economic Forum, 2008, “Network of Global Agenda Councils”,
Summit on the
Global Agenda, Dubai, United Arab Emirates 7-9 November 2008
Yılmaz, K., 2008, “Global Financial Crisis and the Volatility Spillovers
across Stock
Markets
ARTICLE NO 6:
Global Economic Crisis and Poverty in Pakistan

Vaqar Ahmed
1
and Cathal O’ Donoghue
2
1
Planning Commission of Pakistan; email: vahmed@gmail.com
2
Rural Economy Research Centre (RERC), Teagasc, Ireland; email:
Cathal.ODonoghue@teagasc.ie
ABSTRACT: In this case study we adopt a macro-micro framework in
order to evaluate the impact of the
current global crisis on the Pakistan economy. We use a ‘top-down’
approach to combine a static
computable general equilibrium model with a microsimulation model.
Our results suggest that between
2007 and 2009 the poverty headcount ratio is likely to have increased by
almost 80 percent, from 22 to
40 percentage points. However, our results also show that this increase
is attributable in part to the fuel
and food crisis that preceded the financial crisis. Our results also
indicate a differential impact, with wage
increases for farm workers and a decrease in wages for skilled labour.
Keywords: CGE; micro-macro; global economic crisis; Pakistan
I. INTRODUCTION
The global economic crisis impacts developing
economies through trade, aid, remittances and
investment channels. The precise magnitude of
effect across countries differs, depending on their
level of integration into the world economy. The
economy of Pakistan, which during this decade
witnessed steady growth along with rising foreign
direct investment, remittances and exports, has
found itself recently with declining foreign
exchange reserves
1
, rising twin deficits
2
, and
falling overall economic growth
3
.
Table 1 provides a snapshot of recent economic
performance. The real GDP growth rate declined
from 9 percent in 2005 to as low as 2 percent in
2009. Before the crisis, poverty had fallen
substantially with the headcount ratio declining
from almost 35 percent in 2001 to 22 percent in
2006. However for 2009, it is provisionally
estimated to have climbed to as much as 40
percent, an increase of almost 80 percent.
The reduction in poverty and progress toward the
achievement of the Millennium Development Goals
were to some extent attributable to the
unprecedented increase in poverty-related public
spending that was possible due to the increased
fiscal space available to the federal government
during this period. However, soon after the global
economic crisis, a sharp reduction was observed in
this spending. The shares of public sector
development expenditure on for example health
and education were cut by 34 and 26 percent,
respectively. The overall poverty related public
spending declined by 45 percent.
There have been several attempts to trace the
impacts of external shocks such as the global
financial crisis on national poverty profiles in
developing countries. For the impact on monetary
poverty, see Friedman and Levinsohn (2001),
Robilliard et al. (2001), Bourguignon et al. (2003),
and Weeks (2009). For the impact of economic
crises on nutritional status and welfare in general,
see Block et al. (2004), Chapman-Novakofski
(2009), and Chen and Ravallion (2009). In this
paper we have adopted a macro-micro framework
in order to evaluate the impact of the current
global crisis on the Pakistan economy.
II. DATA AND METHODOLOGY
We use a static computable general equilibrium
(CGE) model following Decaluwé et al. (2009). We
link this model in a top-down manner with an
income generation framework shown in Alatas and
Bourguignon (2005). The Social Accounting Matrix
(SAM) for our Computable General Equilibrium
(CGE) model is derived from Dorosh et al. (2006).
The main data source for the microsimulation
model is the 2002 Household Integrated Economic
Survey (HIES).
In the agricultural sector, capital and land are
assumed to be fixed and in non-agriculture sector
only capital is fixed. Unskilled non-farm labour is
fully mobile between sectors, whereas unskilled
Table 1 Pakistan - Macroeconomic Situation 2001 - 2009
Indicators 2001 2005 2006 2007 2009*
GDP growth (%) 2.0 9.0 5.8 6.8 2.0
Exports (US $ billion) 9.2 14.4 16.4 16.9 17.8
Imports (US $ billion) 10.7 20.6 28.6 30.5 34.8
FDI (US $ billion) 1.5 3.5 5.1 3.7
Remittances (US $ billion) 4.2 4.6 5.5 7.8
External debt and liabilities (US $ billion) 35.4 37.2 40.3 52.8
Poverty headcount ratio 34.5 23.9 22.3 35 – 40
Poverty related expenditure (US $ billion) 5.3 6.3 7.0 3.8
Exchange Rate 58.4 59.4 59.9 60.6 78.0
Source: Economic Survey of Pakistan, State Bank of Pakistan - Annual
Reports 2001-2009.
Notes: *provisional estimatesAHMED AND O’DONOGHUE Global
Economic Crisis and Poverty in Pakistan 128
farm labour is only used in agriculture and skilled
labour is only used in non-agricultural sectors,
where they are also fully mobile. Supply of land is
fixed and sector-specific. Total investment is fixed
and equal to total savings, which is comprised of
household, firm, foreign and government savings.
Real government expenditure is held fixed and the
public deficit is flexible. The nominal exchange
rate is kept flexible, which implies that foreign
savings, which are fixed in nominal terms, are
flexible in domestic currency terms. Thus the
external account is cleared by the nominal
exchange rate.
III. RESULTS
In what follows we analyse the impact of the crisis
in a two-pronged manner. First, we simulate the
poverty effect of observed changes in wage rates,
self-employment and consumer prices between
2007 and 2009. However, these changes are not
necessarily only attributable to financial crisis, as
other factors may have come into play such as the
rise in fuel and food prices preceding the crisis.
Second, we use our combined CGE and
microsimulation models to simulate the macromicro impact of a 25
percent decline in external
resource inflows (foreign savings). This reflects
what has been observed during the financial crisis,
leading to a depreciation of the Pakistani Rupee by
almost 28 percent.
In the first analysis, we note that, between 2007
and 2009, wages for skilled and unskilled labour
fell by almost 9.5 and 3.6 percent. Returns to self
employment declined by 11 percent. Food prices
increased by almost 28 percent and the price for
fuel went up by almost 70 percent.
4
Using only the
micro model we estimated that this will have led
to an increase in poverty by almost 39.6 percent.
5
The poverty gap and severity will also have
increased by 26.8 and 19.4 percent, respectively.
The overall decline in per capita caloric intake is
estimated at around 8.5 percent, with urban
households facing a higher magnitude of decline.
Average per capita daily caloric intake was 2349
calories in 2007. With an 8.5 percent decline, this
will now be around 2149 calories.
In the second analysis, using the macro-micro
framework, we see that the decline in external
resources will have reduced real investment by
1.2 percent (Table 2). Imports decrease on
account of the currency depreciation and there is
some increase seen in exports, which become
relatively more competitive. Textile exports
increase by 5 percent. This is of particular
importance as textiles constitute around 60
percent of Pakistani exports and an important
source of employment. Wages increase for farm
workers
6
, remain unchanged for unskilled nonfarm workers, rise marginally in
the case of the
self employed and decline for skilled labour.
7
A
general increase in consumer prices is observed as
a result of the depreciation of rupee and the rising
food and fuel import bill.
8
As a result, food
consumption falls by 1.3 percent. The poverty
headcount ratio increases by almost 4 percent,
with the poverty gap and severity increasing by
1.5 and 1 percent, respectively.
Table 2 Decline in External Resource
Inflow (foreign savings)
Variables Percentage
Change
Real Investment -1.2
Government Revenue 0.9
Wages
Unskilled_farm 3.6
Unskilled_non farm 0.0
Skilled -2.8
Self employment 0.2
Returns to Land 3.9
Exports
Cotton yarn 0.8
Textile 5.0
Consumer Prices
Food 3.4
Fuel 1.9
Poverty
FGT 1 3.6
FGT 2 1.5
FGT 3 0.9
Consumption (food) -1.3
The impact of fall in foreign inflows on
disaggregated food consumption is shown in Table
3 and reveals adjustments in consumption
patterns in response to changes in relative prices
and falling incomes. The consumption of cereals
and pulses increases, which are staples, while that
of meat, fish, sugar products, vegetables and
processed food, (which are also imported)
decreases. This substitution away from nonessential food items toward
staples is a common
coping strategy to preserve caloric intake.
Table 3 Change in food consumption (quantity)
Product
Percentage
change
Milk products 0.2
Meat & fish -0.5
Fruits -1.6
Vegetables -1.7
Sugar products -0.4
Beverages -1.5
Cereals 1.3
Pulses 1.2
Oil & fats -1.4
Tea -1.5
IV. CONCLUSION
In this short case study we have tried to show the
impact of the global economic crisis on Pakistan
economy. Our results estimate that between 2007
and 2009, poverty increased by almost 40
percent. However this is also attributable to the
fuel and food crisis that preceded the financial
crisis. More recently Pakistan witnessed a sharp
reduction in foreign capital inflows on account of AHMED AND
O’DONOGHUE Global Economic Crisis and Poverty in Pakistan
129
the global recession, among other reasons. This
led to a sharp depreciation, a decline in
investment, falling wages for skilled workers, and
a general rise in consumer prices. At the micro
level, we estimate that this resulted in a 4 percent
increase in poverty with food consumption
declining by 1.3 percent.
Dealing with the crisis is difficult for Pakistan due
to fiscal constraints. Balance of payments
weaknesses forced the country to resort to an IMF
stand-by arrangement, which imposed further
conditionalities on the budget. Subsidies on
wheat, electricity, fertilizer and oil had to be
phased out, which in turn increased the
inflationary burden on the consumer. While there
are some social safety nets at the federal and
provincial level, access to these has generally
become more difficult. Reforms to better target
social safety nets are still underway.
Acknowledgements
The authors would like to acknowledge funding
from the Poverty and Economic Policy (PEP)
research network which is financed by the
Australian Agency for International Development
(AusAid) and the government of Canada through
the International Development Research Centre
(IDRC) and Canadian International Development
Agency (CIDA). Acknowledgements are also due
to John Cockburn, Paul Dorosh, Stefan Boeters,
and Saira Ahmed for their comments and technical
help.
Notes
1
The accumulated forex reserves declined to
record low levels in the wake of rising cost of
importing fuel and food.
2
The import bill reached to unprecedented
levels. The fiscal deficit worsened as the
government continued subsidies on wheat,
electricity, fertilizer and oil, in order not to pass
on the full effect of rising prices abroad.
3
The domestic manufacturing sector found it
difficult to maintain the growth momentum due
to infrastructure shortages particularly poor
provision of energy. Consequently in 2008-09
the growth rate of large scale manufacturing
turned negative and remained so consecutively
for the next 17 months. The textile sector was
also hit to some extent by declining external
demand.
4
Also attributable to the removal of a subsidy as
a result of IMF conditionality.
5
Our findings are in line with the Panel of
Economists Report submitted to Pakistan’s
Planning Commission, which found an increase
in poverty from 22 to almost 40 percent.
6
Shown separately from other unskilled
workers.
7
The increase in textile and particularly cotton
based textile exports are also partly
responsible for increased returns to farm
workers and also helped the change in returns
to unskilled workers from turning negative.
8
In the overall imports, food and fuel imports
have 7 and 23 percent share respectively.
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of Income Distribution during Indonesia's Fast
Growth, 1980-1996’, in Bourguignon F, F H G
Ferreira and N Lustig (Eds.) The
microeconomics of income distribution
dynamics in East Asia and Latin America, New
York: World Bank and Oxford University Press,
175-218.
Block S A, Kiess L, Webb P and Kosen S (2004)
‘Macro shocks and micro outcomes: child
nutrition during Indonesia’s crisis’, Economics
& Human Biology, 2(1), 21-44.
Bourguignon F, Robilliard A-S and Robinson S.
(2003). Representative versus real households
in the macroeconomic modelling of inequality.
Dial document de travail dt/2003-10.
Chapman-Novakofski, K (2009) ‘The Economic
Crisis—What Is the Role for Nutrition
Educators?’, Journal of Nutrition Education and
Behavior, 41(1), 1-2.
Chen S and Ravallion M (2009) ‘The impact of
global financial crisis on the world's poorest’,
Working Paper, World Bank, Washington D.C..
Decaluwé B, Lemelin A, Maisonnave H and
Robichaud V (2009) PEP-1-1 Standard PEP
Model, Single-Country, Static Version
(Provisional Edition). Poverty and Economic
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Dorosh P, Niazi M K and Nazli H (2006) Social
Accounting Matrix for Pakistan, 2001-02:
Methodology and Results. Pakistan Institute of
Development Economics, Islamabad.
Friedman J and Levinsohn J (2001) The
Distributional Impacts of Indonesia's Financial
Crisis on Household Welfare: A Rapid Response
Methodology. National Bureau of Economic
Research, Inc, Cambridge.
Robilliard, A-S, Bourguignon F and Robinson S
(2001) ‘Crisis and Income Distribution: A Micro
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Development Programme, New York
ARTICLE NO 7:
The Impact of Recent Global Financial Crisis on the

Financial Institutions in the Developing Countries :
Global Perspectives
Nida Iqbal Malik
1
, Subhan Ullah
2
, Kamran Azam
3
, Anwar Khan
4
The purpose of this paper is to examine the recent impact of financial
crisis on the financial
institutions in the developing countries. This study contributes to the
knowledge of investors
and market practitioners to be well aware of the risks attached with
investments in developing
countries. The global financial crisis set off by the sub-prime credit
crisis in the US. This has
destabilized the financial markets of the developed world causing the
fall down of prominent
names in the banking business. Primary cause of this crisis can be
Banks and other financial
institutions in the United States of America have gone through a long
period of inappropriate
lending. Another cause of this crisis as according to latest studies may
be the effect of the
global financial crisis was worsened by rising global energy and
commodity prices which
pushed up inflation. Developing countries have mainly faced strong
rises in prices. In order to
study the impact of this financial crisis content analysis of various
articles and research papers
related to development literature was carried out. Our findings are in
line with the previous
research done by Eichengreen et al., (2008) and Yifu Lin (2008) which
support the fact that
the Banks in the developing economies will see their credit lines from
foreign banks squeezed
and the increasing financial flows that these economies have been
experiencing are going to
dry up. Based on this study certain recommendations can be made such
as role of loss
sharing and the policies of developing counties regarding stabilization
and crisis management
as well as rule of law and good governance. The government should
introduce programs to
recapitalize banks, guarantee bank liabilities, and provide liquidity to
banks by funding
markets and in some cases support troubled asset markets. Asset price
inflation should be
made under the control of monetary policy authorities by government.
Responses to global
crises must be methodical, inclusive, decisive, and organized. As Global
problems may
require global multilateral solutions. If the crisis will continue for long
period, state and local
governments may begin to restrict as they try to shore up new financing
arrangements for
their operations.
Field of Research: Banking
I. Introduction
Although their happened several financial crises in the past but the
economist
still not learn a lesson from them. “We all lived happily for a while —
but not for
ever after” (Paul Krugman, 2008). The financial crises that started in
the mid of
2007 came as a surprise to many people, but not for others. The crisis
that
shaken the world in the last 18 months, and brought down top names in
the
1
Nida Iqbal Malik is student of Master in Business Administration at the
Department of Management Sciences at
COMSATS Institute of Sciences and Technology, Attock Pakistan.
Email: taurus_nida11@hotmail.com
2
Lecturer, COMSATS Institute of Sciences and Technology, Attock,
Pakistan, Email: subhan_ullah@comsats.edu.pk
3
Lecturer, COMSATS Institute of Sciences and Technology, Attock
Campus, Pakistan, Email:
anwar_khan@comsats.edu.pk
4
Lecturer, COMSATS Institute of Sciences and Technology, Attock
Campus, Pakistan, Email:
kamranazamkhan@yahoo.com Malik, Ullah, Azam & Khan
86
United States and Europe is the most severs since the stock market
crash of
1929. In the last few months we have seen several major financial
institutions
absorbed by other financial institution, receive government bailout or
completely
bankrupt. During the 20
th
century, the world experience two major financial
crises. The first global financial crisis was seeing during 1929-30, which
affected
the developed nations, Europe and America. While the second crisis
came in
1997 and remained till 1999 and was experienced by emerging
economies of
Asia Pacific. According to Hyun-Soo. (2008) anxieties have augmented
over the
global financial crisis, which began from the US sub prime mortgage
disaster with
the help of the governments of major countries which are coming up
with
measures such as provision of liquidity and bailout packages for
distressed
banks, the fear that has gripped financial markets shows little signs of
abating.
Major stock exchanges are disorderly while a series of indicators that
determine
investors’ risk aversion are posting all-time highs. The recent financial
crisis has
been rushed across the public-private boundary, which has hit the
private firms
and the financial statements has forced the new heavy demands on the
public
sector's finances. The crisis has surged across national borders within
the
developed world, and now there are some reasons which has alarmed
that the
crisis will swamp other developing countries, affecting the significant
economic
progress of recent years. (Yifu Lin, 2008).
A regular financial crises remind us the un reliable financial support on
which
companies rely for example the “south sea bubble” of 1720, the over end
gurney
collapse of 1866, the Australian financial crises of 1893, the wall street
crash of
1929, the black Monday of 1987, and the meltdown of high-tech stocks
in 2001-
02, (Gordon Boyce and Simon Ville, 2002). This study begins with a
brief
discussion of the dynamics of global growth in 2002-07, which mainly
focused on
strengthening of the booms in the developed and developing world. This
study
then discusses that how global recession crises begin due bad mortgages
in
2007-08, starting with the US housing crisis. At the end, it discusses that
how
government can respond to the crisis to guarantee that the costs to the
developing world are as small as possible.
2. Literature Review
As Nikolson, 2008 recognized that financial crisis which initiated in
United States
has now become a global phenomenon. At present, not only in United
States but
across Asia and Europe, stock exchanges crashed; collective losses of the
London, Paris and Frankfurt markets alone amounted to more than 350
billion
Dollars. Stock Exchange 100 index closed more than 323 points down in
January
2008 (Times online 2008). This crisis apart from affecting the capitalist
economies has distressed the Socialist economy like Russia as well; in
May
2008 Russian stock market was fallen by 50% and the Russian central
bank had
to buy rouble in massive amount to prevent the severe falling against US
Dollar
and Euro (Erkkilä, 2008). Malik, Ullah, Azam & Khan
87
About the cause of current crisis Bartlett (2008) said that crisis was
started with
the downfall of US sub-prime mortgage industry , the intensity of this
collapse
was significant; “Mark-to-market losses on mortgage-backed securities,
collateralized debt obligations, and related assets through March 2008
were
approximate $945 billion.” He further stated that it is “The largest
financial loss in
history”, as compared to Japan’s banking crisis in 1990 about $780
billion, losses
stemming from the Asian crisis of 1997-98 approx $420 billion and the
$380
billion savings and loan crisis of U.S itself in 1986-95.
Yılmaz (2008) charged U.S subprime mortgage industry to be the major
reason
of current global financial crisis, he also stated that the total loses
estimated
initially up to $300 to $600 billion are now considered to be around $1
trillion.
While enlightening the factors that why this US sub-prime mortgage
crisis turn
into global banking crisis, Khatiwada and McGirr (2008) stated “Many
of these
sub-prime mortgages actually never made it on the balance sheets of the
lending
institutions that originated them”; and they were made attractive to
foreign banks
by high investment grading, “when sub-prime borrowers failed to repay
their
mortgages, the originating institution needed to finance the foreclosure
with their
own money, bringing the asset back on its balance sheet. This left many
banks in
a financially unfeasible situation, in a rather short, out of hand
timeframe”.
However Hyun-Soo (2008) argues that it was the “Trust Crisis” which
caused this
global predicament. DeBoer (2008) believes that it was series of events
which
caused the crisis; it begins with the collapse of currencies in East Asia in
1997
and became edgy due to the financial crisis of Russia in 1998. Next, in
USA was
the “dot-com” stock collapse in 2001, and the final stroke was again in
USA,
when after a swift decline in housing prices and “rapid contraction in
credit, it fell
into recession.
Rasmus (2008) has the same thoughts; he, while discussing the reasons
of
economic recession of U.S said “The ‘real’ ailments afflicting the US
economy for
more than a quarter-century now include sharply rising income
inequality, a
decades-long real pay freeze for 91 million non-supervisory workers, the
accelerating collapse of the US postwar retirement and healthcare
systems, the
export of the US economy’s manufacturing base, the near-demise of its
labor
unions, the lack of full time permanent employment for 40 per cent of
the
workforce, the diversion of massive amounts of tax revenues to offshore
shelters,
the growing ineffectiveness of traditional monetary and fiscal policy,
and the
progressive decline of the US dollar in international markets.”
3. Conceptual Framework
According to this study the proposed model which explains various
variables
which explains the impact of the Global recession on the financial
markets in
developing countries, is as follows. Malik, Ullah, Azam & Khan
88
4. Global financial Crisis
The causes behind the recent global crisis
are complex, and are linked to the financial
market decline of the last 20 months or so. In
US economy, Banking industry has been
badly hit due to mortgages backed by subprime mortgages fallen in
value. Due to bad
debts financial institutions were reluctant to
lend money and thus firm especially
construction industry’s output faced
contractions in credit lines which contributes
15% of US output.
On April 8, 2008 the International Monetary Fund released information
regarding
the magnitude of the Global financial crisis:
ƒ Mark-to-market losses on mortgage-backed securities, collateralized
debt
obligations, and related assets through March 2008 approximate $945
billion. In
absolute terms this represents the largest financial loss in history,
exceeding
asset losses resulting from Japan’s banking crisis in the 1990s ($780
billion)
and far surpassing losses emanating from the Asian crisis of 1997-98
($420
billion) and the U.S. savings & loan crisis o f 1986-95 ($380 billion).
Global
Financial
Crisis
Contagion
Effect
Financial
institutions
• Subprime mortgages in US
• Failure of IMF
• Melt Down of Major
Investment Banks In
America
• Bailout Packages
• Monitory Policy of Central
bank Malik, Ullah, Azam & Khan
89
ƒ The damage widens across a wide range of investor classes.
Commercial
banks stand to drop $440-510 billion, insurance companies $105-130
billion,
pension funds $90-160 billion, governments $40-140 billion, and other
financial
institutions $110-160.
ƒ An innovation in mortgage securitization in the early- and mid-2000s
facilitates
loan originators to sell high-risk assets to downstream financial
institutions
around the world, thereby globalizing the American subprime crisis.
Against
U.S. bank losses of $144 billion, European financial entities stand to
sustain
$123 billion in mortgage-related losses. Within the latter group, British
institutions features $40 billion in asset write offs, nearly matching the
combined losses of the Euro area ($45 billion). Financial institutions in
Asia and
other regions are far less revealed.
ƒ The irresponsible lending practices that precipitated the American
subprime
collapse are not confined to the United States. The IMF speculates that
housing
prices in Ireland, Netherlands, and United Kingdom are 30 percent
higher than
justified by economic fundamentals. British housing prices cut down by
2.5
percent in March; the sharpest monthly fall in that country since 1992.
Australia,
Belgium, Denmark, France, Norway, Spain, and Sweden also face
sizable
housing bubbles.
ƒ Housing prices in OECD countries with more conventional lending
practices
(Austria, Canada, Finland, and Germany) are more closely aligned with
market
fundamentals, underscoring wide country variations in mortgage
markets.
5. Effects on Financial
Institutions in Developing
countries
The financial institutions in
developing countries haven’t been
effected by financial crisis in
developing countries due to of
usage of traditional financial system
where unlike US, individuals and
groups need to have good track
record in order to gain credit or loans and therefore risk is minimal.
However, banks in developing economies have to suffer contractions in
credit
lines and reduced financial flows. Due failure of leading financial
institutions such
as IMF, IMF failed to response to Asian crisis during second great
recession. IMF
recommended contracted fiscal policies as economies were going into
recession.
IMF failed to predict banking crisis coming due to currency crisis.
Indonesia
suffered bank runs courtesy of IMF and Malaysia pulled back IMF
conditionality.Malik, Ullah, Azam & Khan
90
As 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', Pakistan’s banking sector has
not been
as prone to external shocks as have been banks in Europe.
6. Effects on Financial Institutions of Pakistan
Overview: Pakistan’s economic situation has worsened, with capital
outflows
compounding the impact of a substantial current account deficit.
Downward
pressure on the rupee has been persistent, making debt financing more
costly,
while foreign exchange reserves have continued to reduce in size.
Inflationary
pressures also remain evident, and are being worsened by government
borrowing from the central bank. Finally, political tensions are
prominent and
could be intensified by economic strictness
measures, once settled.
Money markets: Domestic money markets have

been hit hard by liquidity scarcity. The primary
cause has been a sharp reduction in net foreign
assets, which has led to a tightening of the money
supply. In response, the central bank has injected
significant amounts of liquidity, lowered cash reserve requirements by
400 basis
points to 5 percent, increased the types of securities suitable for the
statutory
liquidity reserve requirement and fixed a temporary waiver of SLR on
one-year
and above deposits. Helped by these actions, overnight rates have come
down
to about 14 percent, a minor premium over the policy discount rate of
13 percent.
Equities: The Karachi Stock Exchange has been in a severe downward
spiral
since mid-April, losing more than 40 percent of its value through early
October.
The government has imposed a floor on the index at 9144 and banned
short/blank selling. Since then, the index has hovered around this level,
while
trading volumes have been extremely thin. The floor is to stay in place
for now,
while the government will establish an Rs 20 billion ‘market
stabilization’ fund
along with an Rs 30 billion sovereign guarantee for foreign investors.
Local equity
houses are expecting a large downward correction once the floor is
removed.
Inflation: Inflation is being driven
by on going supply shocks,
especially for food. Additional
pressures have been generated by
policy actions: since January 2008,
there has been a 65 percent
increase in petroleum product
prices, a 60 percent rise in power Malik, Ullah, Azam & Khan
91
tariffs, and a 40 percent hike in retail gas prices. Most recent data
suggest that
food prices and international commodity prices have peaked, indicating
softer
inflation going forward. Nevertheless, inflation will remain high, given
still-strong
aggregate demand and a weakening rupee. Inflationary pressures have
also
been generated by the unprecedented levels of central bank fiscal
financing,
equivalent to around 2.1 percent of projected 2009 GDP. At the current
rate,
central bank financing of the fiscal deficit will top last year’s 6.9 percent
of GDP.
The government’s failure to adhere to its policy commitment of
reducing its
reliance on the central bank is not only a reflection of higher financing
needs, but
also the fall in available external financing and the dominance of fiscal
policy over
the monetary sphere.
External sector: Much of Pakistan’s current financial troubles stem
from the
balance of payments. The current account balance has turned sharply
negative
over the past five years, driven by higher deficits on the trade, services
and
income accounts owing to rising international oil prices, higher
profit/interest/dividend repatriation, and greater freight and insurance
charges on
imports. Until the end of FY08, this deficit was financed quite
comfortably from a
surplus on the capital account, itself the result of high levels of foreign
direct
investment, rising portfolio investment and greater borrowing.
However, political
volatility and mounting security challenges since 2007 have resulted in a
sharp
slowdown in non-debt creating inflows. This and high oil prices have
led to
dwindling central bank reserves and a depreciating rupee. The rupee/$
exchange
rate depreciated by 32 percent over this calendar year to October 21,
despite
substantial intervention by the State Bank of Pakistan, totaling some
$2.0 billion
as of end-September. The weakening of the currency has implications
for
inflation and the fiscal deficit: external debt servicing is expected to
amount to
$4.3 billion this fiscal year. Given greater risk aversion amongst
investors and
donor countries’ own domestic financial commitments, an even sharper
reversal
in foreign currency inflows into Pakistan this fiscal year has led to a
pronounced
decline in the central bank’s foreign exchange reserves. Total foreign
reserves,
including those held by commercial banks, have fallen sharply from a
high of
$16.5 billion in October last year, and stood at $7.32 billion on Oct. 18,
of which
the central bank reported for $4.04 billion. The central bank's reserves
indicate
about one-and-a-half months of import cover. Indeed, at the current
rate of
decline, central bank reserves will run out by end-February 2009.
Samba
calculations indicate that Pakistan’s gross external financing
requirement (current
account deficit plus short-term debt and M/LT amortization payments)
will be
$17.2 billion for FY09.
7. Government’s Role
World of Work Report 2008 argues, governments need to take into
account the
social impact of financial globalization while allowing financial
institutions to
benefit from the global capital markets. Having institutions and
structures in place
to guarantee that a country is not susceptible to sudden capital outflows
is key.
Governments are providing support and doing what so ever they can to
prevent Malik, Ullah, Azam & Khan
92
their economical structure; US government injected $800 billion in the
economy
to support the structure, UK government has announced a package of
$692
billion, European Union is about to start an economic recovery plan and
IMF has
called for minimum financial support of $100 billion (BBC news, 2008).
Also on
the research part, E. Philip Davis and Dilruba Karim suggested an
“Early warning
System” to cop better with such crisis; the proposed two models “Logit”
as a
global early warning system and “Signal Extraction” for country
specific early
warning system. DeBoer (2008) believe that such bailout programs and
other
supporting packages from governments is like offering protection from
a negative
outcome which is more appropriate to be called as “moral hazard”; this
trend
could increase the possibility of future bad upshots.
How long the crisis will exist? It is indeed very difficult to answer this
question;
Warne (2008) believes that it’s the matter of confidence of investors, as
long as it
is restored, crisis will be over; but it cannot be done when we daily hear
news
about the abandonment of financial institutions, it needs some financial
stability.
OECD Secretary General, Gurría (2008) hopes that the effective
macroeconomic
policies and vital financial reforms will turn down the heat and normal
financial
conditions as well as the growth rates will return to normal in 2009.
Yılmaz (2008)
acknowledged that the worst part of the crisis is already over and the
markets are
suffering from what can be called ‘the after shocks’. Sha Zukang (2008)
says that
normalization of economic activities need “global and symentic”
solutions, he
stated that current “global Economic Governance System” is derisory
for the
prevention of such crisis
8. Research Design
This study is an explanatory study which is aimed at explaining the
impact of
global crisis and what effect it will have on the financial institutions of
developing
countries. For this purpose content analysis was technique was used and
several
research papers and articles related to development economics were
examined.
As in conceptual analysis, a concept is chosen for examination, and the
analysis
involves quantifying and tallying its presence, also known as thematic
analysis. A
specific number and set of concepts were examined such as “effects of
global
financial crisis”, its “contagion effect” on “financial institutions” of
“developing
countries”. In this content analysis the existence of a concept was
examined. Set
of rules were defined in this research regarding the existence of concepts
and
the linkages between these concepts. As Weber, 1990 suggested
irrelevant data
was also decided. By applying above stated content analysis process the
researcher is able to generalize the concepts and to form results of the
study.
9. Results
Data from various sources was examined thoroughly and conclusive
evidence
was formed that current global crisis has significant impact on the
financial
institutions of developing countries The current financial crisis affects
developing
countries in two possible ways. Malik, Ullah, Azam & Khan
93
First, there might be financial contagion and spillovers for stock
markets in
emerging 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 the
USA and Brazil plunged. Stock markets across the world – developed
and
developing – have all dropped considerably since May 2008. We have
seen
share prices tumble between 12 and 19% in the USA, UK and Japan in
just one
week, while the MSCI emerging market index fell 23%. These
comprises of stock
markets in Brazil, South Africa, India and China. We need to better
understand
the nature of the financial linkages, how they occur (as they do appear
to occur)
and whether anything can be done to minimize contagion. Second,
Commercial
lending. Banks under pressure in developed countries may not be
capable 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 crumple of Iceland. This would bound investment in such
countries
as Argentina, Iceland, Pakistan and Ukraine. Means Banks in the
developing
economies will see their credit lines from foreign banks squeezed and
the
increasing financial flows that these economies have been experiencing
are
going to dry up.
10. Conclusion
This study confirms that the global financial crisis has a significant
effect on the
financial institutions of developing countries. Our findings are in line
with the
previous research done by Eichengreen et al., (2008) and Yifu Lin
(2008) which
support the fact that the Banks in the developing economies will see
their credit
lines from foreign banks squeezed and the increasing financial flows
that these
economies have been experiencing are going to dry up. As developing
countries
Asia and Latin America are at a crossroads, and the next twelve to
eighteen
months will be very difficult. The perception that they had broken the
links with
the larger economies has been painfully disproved by the hard facts of
the last 18
months. Financial markets of the world are closely interconnected, and
the
impact of the world financial collapse on Emerging Economies is a
witness to this
fact.The government should introduce programs to recapitalize banks,
guarantee
bank liabilities, and provide liquidity to banks by funding markets and
in some
cases support troubled asset markets. Asset price inflation should be
made
under the control of monetary policy authorities by government.
Responses to
global crises must be methodical, inclusive, decisive, and organized. As
Global
problems may require global multilateral solutions. If the crisis will
continue for
long period, state and local governments may begin to restrict as they
try to
shore up new financing arrangements for their operations. Malik, Ullah,
Azam & Khan
94
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crisistalk.worldbank.org/files/Oct_31_JustinLin_KDI_remarks.pdf
ARTICLE NO 8:
GLOBAL FINANCIAL CRISIS: IMPLICATIONS FOR

MACROECONOMIC AND
DEVELOPMENT POLICIES IN PAKISTAN
*
Musleh ud Din
Chief of Research
Pakistan Institute of Development Economics
Abstract: The global financial crisis came at a time when Pakistan’s
economy was under severe
strain due to global fuel and food price hikes. The crisis has exacerbated the
macroeconomic imbalances
and has led to a sharp slowdown in economic growth. In this scenario,
putting Pakistan’s economy back
on track has become a major challenge. This paper spells out
macroeconomic and development policies to
mitigate the adverse impact of the crisis in the short to medium term and to
enhance competitiveness in a
longer term perspective. The paper also looks at prospects for regionally
coordinated policy measures to
deal with external economic shocks.
DECEMBER 2009
*
This paper draws on a larger study on the economic and social impact
of the global financial crisis on South Asia, being
conducted at the PIDE under the ADB-RETA Project.2
1 INTRODUCTION
Pakistan’s economy has been battered by two back-to-back shocks. The
global food and fuel
price hikes created serious macroeconomic difficulties as inflation
soared, public finances
worsened and economic growth slowed down. The global financial
crisis came at a time when
the economy was still reeling from the global price shocks, thus making
the situation worse as
macroeconomic conditions deteriorated further and economic growth
slowed down sharply. In
this scenario, putting Pakistan’s economy back on track has become a
major challenge. This
paper spells out key macroeconomic and development policies to
mitigate the adverse impact of
the crisis in the short to medium term and to enhance competitiveness in
a longer term
perspective. This analysis is preceded by a comparative perspective on
Pakistan’s economic
performance before and after the crisis with a view to identifying initial
conditions --- including
shock absorbers and shock amplifiers --- that prevailed before the crisis.
It is argued that
Pakistan’s ability to cope with the financial crisis critically hinges on the
initial conditions in the
domestic economy. The paper also looks at prospects for regionally
coordinated policy measures
to deal with external economic shocks.
The study is organized as follows. Section 2 explores the major
channels through which the
global financial crisis has spread to Pakistan. Section 3 analyzes the
economic performance
before and after the financial crisis. Section 4 examines the policy
responses and their role in
mitigating the impact of financial crisis. Section 5 spells out a broader
framework encompassing
both macroeconomic and development policies that are needed to put
the economy on a
sustainable growth trajectory. The prospects of regional economic
cooperation are explored in
Section 6, whereas Section 7 summarizes the substantive findings of the
study.
2 HOW PAKISTAN’S ECONOMY IS AFFECTED? THE CHANNELS
OF TRANSMISSION
The main channels through which the global financial crisis can
potentially have an impact
on the economy are trade in goods and services, capital flows,
remittances, and equity values.
The most important channel is Pakistan exports to the developed
world. The United States and
Europe remain the major markets for the bulk of Pakistan’s exports.
With sharp contraction in
demand in the western economies, the economy has witnessed a
significant decline in exports: in
2009 exports fell by 6.4 percent (Table 2.1). A similar trend is
observed for imports, which
declined in by 10.3 percent in 2009 on the back of a slowing economy.3
Table 2-1: Exports and Imports Growth Performance
Exports Imports
Year $ Million Growth Rate $ Million Growth Rate
2005 14,482 16.8 18,996 39.6
2006 16,553 14.3 24,994 31.6
2007 17,278 4.4 26,989 8.0
2008 20,427 18.2 35,397 31.2
2009 19,121 -6.4 31,747 -10.3
Source: GOP, 2009, SBP, 2009
Foreign direct investment plays an important role in the economy
providing necessary
resources, technology, and managerial expertise. With the global
economic slowdown on the
back of a deepening liquidity crunch in the developed countries, FDI
has also contracted from
$5410 million in 2008 to $3720 million in 2009. As investor confidence
plunged in the wake of
the global financial crisis, the economy witnessed an outflow of portfolio
investment amounting
to US$510.4 million in 2009.
Table 2-2: Foreign Private Investment (Million US $)
Year Portfolio FDI Total
2004 -27.7 949 922
2005 152.6 1524 1677
2006 351.5 3521 3872
2007 1820.4 5140 6960
2008 19.3 5410 5429
2009 -510.4 3720 3210
Source: SBP, 2009
Remittances are an important source of foreign inflows and are
believed to play an
important role in poverty reduction. Contrary to expectations,
remittances have held up. This is
partly due to the fact that majority of migrant labor works in middle-
eastern countries and these
countries have not significantly reduced hiring of migrants with the
exception of Dubai. On the
other hand, the growth in remittances may also be the result of retuning
migrants bringing back
their accumulated savings. In this case, however, one may expect a
decline in future remittances.
Another reason for this growth appears to be a switch in the motivation
for remittances from
consumption to investment: falling asset prices, rising interest rate
differentials and a
depreciation of the local currency have attracted investment from
migrants. 4
Table 2-3: Worker Remittances
Million US $ Growth Rate
Countries
FY-07 FY-08 FY-09
Share in
FY-09 (%) FY-08 FY-09
USA 1460 1762 1736 22.2 20.7 -1.5
U.K. 430 459 606 7.8 6.7 32.0
Saudi Arabia 1024 1251 1560 20.0 22.3 24.6
UAE 866 1090 1689 21.6 25.8 54.9
Bahrain 136 141 153 2.0 3.1 9.1
Kuwait 289 385 432 5.5 33.2 12.3
Qatar 171 233 340 4.3 36.7 45.5
Oman 162 225 278 3.6 39.1 23.5
Other Countries 954 903 1019 13.0 -5.3 12.8
Total 5491 6449 7811 100.0 17.4 21.1
Source: SBP, 2009
Globally integrated stock markets are also potential channels of the
financial crisis. In
Pakistan, however, the impact of financial crisis through the stock
markets is likely to be
minimal not least because of the rather limited exposure to global
financial institutions.
Nevertheless, the ripple effects of a world-wide decline in stock values
--- equities lost 42% of
their value across the globe in 2008 --- were also felt in Pakistan where
the KSE-100, the major
stock market index, plummeted from a peak of 14814 points in
December 2007 (market
capitalization of Rs. 4.57 trillion) to 5865 points (market capitalization
of Rs1.85 trillion) in
December 2008 declining further to 4929 points (market capitalization
of Rs1.58 trillion) in
January 2009.
As a result of world recession, the upsurge in global food and fuel prices
has abated and all
major commodity prices have declined in the recent period. This has
provided a welcome relief
to the economy which was under considerable strain as a result of spike
in global food and fuel
prices in the period immediately preceding the financial crisis.5
Figure 1: Selected Commodity Prices
Source: IMF (2009): The Implications of the Global Financial Crisis for
Low-Income Countries
3 AN OVERVIEW OF THE MACROECONOMIC PERFORMANCE
BEFORE AND AFTER
THE CRISIS
Pakistan’s the overall growth performance has been quite impressive in
the years preceding
the global financial crisis. Economic growth reached at 7.5% in 2005
before slowing down to
6.8% in 2007 (Table 3.1). The strong growth was driven mainly by
healthy growth momentum in
the manufacturing and services sectors. The industrial sector grew at an
average annual rate of
9.45 percent led by large and small scale manufacturing, electricity and
gas distribution, mining
and quarrying, and construction. The services sector also expanded
strongly with growth
reaching 7 percent in 2007. While growth in the services sector was
broad-based, the financial
sector provided a major impetus with an average growth of 15 percent.
Table 3-1: GDP and Sectoral Growth Rates
Indicators 2004 2005 2006 2007 2008 2009*
GDP 4.7 7.5 9.0 6.8 4.1 2.0
Agriculture 2.4 6.5 6.3 4.1 1.1 4.7
Manufacturing 14.0 15.5 8.7 8.3 4.8 -3.3
Services 5.8 8.5 6.5 7 6.6 3.6
Per capita GDP 6.5 6.5 3.9 5.3 4.3 1.2
Source: Economic Survey of Pakistan, 2009; * Provisional
Pakistan’s macroeconomic fundamentals started weakening even
before the financia l crisis.
Whereas Pakistan maintained low fiscal deficit until 2005, the deficit
began to rise gradually 6
thereafter reaching 7.4 percent of GDP in 2008 (Table 3.2). The rate of
inflation accelerated from
4.6 percent in 2004 to 12 percent in 2008 (Table 3.3).
Table 3-2: Fiscal Indicators as Percent of GDP
Fiscal Expenditure Revenue
Year Current Development Total Total
Fiscal
Deficit
2004 13.8 3.2 16.4 14.1 2.3
2005 14.3 3.9 18.4 13.8 3.3
2006 14.5 4.3 18.7 14.2 4.2
2007 15.8 4.4 20.2 14.9 4.3
2008 17.7 4.0 21.7 14.3 7.4
2009 19.1 3.5 19.3 14.1 5.2
Source: GoP, 2009; SBP, 2009
Table 3-3: Annual Average Inflation Rates
Year General Food Non Food
FY00 3.6 2.2 4.5
FY01 4.4 3.6 5.0
FY02 3.5 2.5 4.2
FY03 3.1 2.8 3.3
FY04 4.6 6.0 3.6
FY05 9.3 12.5 7.1
FY06 7.9 6.9 8.6
FY07 7.8 10.3 6.0
FY08 12.0 17.6 7.9
FY09 20.8 23.7 18.4
Source: SBP, 2009
During most of the pre-crisis period, Pakistan maintained sound
external balances. However,
the economy witnessed a gradual deterioration in its current account
balance from a surplus of
1.3 percent of GDP in 2004 to a deficit of 8.4 percent in 2008.
Table 3-4: Current Account Balance (Percent of GDP) and Exchange
Rate
Year
Current Account
Balance as % of GDP
Exchange Rate
(PKR/US$)
2004 1.3 57.51
2005 -1.6 59.4
2006 -4.0 59.9
2007 -4.8 60.6
2008 -8.4 62.5
2009* -5.3 78.0
Source: GoP, 2009; SBP, 2009; * Provisional7
During the period preceding the financial crisis, Pakistan witnessed a
substantial increase in
FDI from $906 million in 2004 to $5026 million in 2007. Also the
nominal exchange rate
remained fairly stable: in terms of the US$ the rate of exchange
gradually rose from Rs.57.6 in
2004 to Rs.60.6 in 2007 indicating only a slight depreciation in three
years. Pakistan’s exports
have also exhibited an increasing trend over the last few years with
exports increasing from
$9028 million in 2000 to $16553 million in 2006. However, Pakistan’s
export remain vulnerable
to slack in demand in major western markets as more than 40 percent
of its exports are marketed
in these economies (Table 3.5).
Table 3-5: Pakistan's Exports by Destinations
share in total exports
FY-07 FY-08 FY-09
U. S. A. 22.2 18.3 18.4
Europe 27.5 26.6 26.3
U. K. 5.8 5.2 5.0
Africa 4.7 4.6 5.6
Asia 35.2 36.4 38.2
Saudi Arabia 1.7 1.7 2.2
U. A. E. 7.3 8.4 7.3
Source: SBP
Figure 2: Exports and Imports Performance (Million US $)
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
2005 2006 2007 2008 2009
Million US$
Exports Imports8
3.1 AFTER THE CRISIS
The global financial crisis came at a time when the economy was
already reeling from terms
of trade shock resulting from the global food and fuel price hikes. The
financial crisis
exacerbated Pakistan’s economies woes resulting in a slowdown in
economic growth, widening
current account and fiscal deficits, sharply accelerating inflation,
dwindling foreign exchange
reserves and depreciating domestic currencies. In terms of GDP growth,
Pakistan has witnessed a
sharp slowdown in economic activity with growth decelerating from an
average of 7.3 percent
during 2004-07 to 4.1 percent in 2008. Growth further slowed down to
about 2 percent in 2009
as private investment remained weak and the security environment
posed an additional risk to
economic growth.
Figure 3: GDP Growth Rates
-4.0
0.0
4.0
8.0
12.0
16.0
2004 2005 2006 2007 2008 2009*
GDP Agriculture Manufacturing Services Per capita GDP
Source: Pakistan Economic Survey, 2009
Being highly import dependent and with external accounts already
under pressure, Pakistan
has experienced deterioration in the current account balances. The
current account deficit
widened to 8.4 percent of GDP in 2008 from 4.8 percent in 2007 and the
deficit is expected to
fall to 5.3 percent of GDP in 2009. With the worsening of the current
account the domestic
currency came under pressure and depreciated sharply in the wake of
the financial crisis. On the
fiscal side, the budgetary position has also worsened with a sharp
increase in fiscal deficit from
4.3 percent of GDP in 2007 to 7.4 percent of GDP in 2008 on the back of
a weak economy that 9
resulted in slower growth in public revenues. The tight budgetary
position and weak government
revenues have imperiled expenditure on public sector development
programs including social
spending. On the other hand, there is a risk of crowding out of private
investment with potential
increase in the rate of interest that may be triggered by the high fiscal
deficits.
Figure 4: Trends in Inflation
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Jul-07
Sep-07
Nov-07
Jan-08
Mar-08
May-08
Jul-08
Sep-08
Nov-08
Jan-09
Mar-09
May-09
Jul-09
Sep-09
Source: SBP, 2009.
The inflationary spiral spurred by the global food and fuel price hikes
continued for some
period after the economy was hit by the global financial crisis (Figure
4). The rate of inflation
increased sharply from about 12 percent in March 2008 to 25 percent
in September 2008 and
thereafter began to moderate as result of a tight monetary policy stance.
Pakistan is expected to cut 3 million jobs in different sectors of the
economy in the coming
years. The major sectors that are vulnerable to job losses are
automobiles, construction and
textiles. Over the years, growth in Pakistan has been driven by private
consumption on the back
of cheap consumer financing which helped consumers to buy cars and
other consumer durables.
As interest rates have risen due to strict monetary tightening, consumer
spending on durable
items has contracted and this will hit the automobile and other
consumer durable sectors.
Similarly, the construction boom fueled partly by the cheap availability
of bank financing has
receded with adverse consequences for employment in such activities.
Pakistan’s exports are
highly concentrated in cotton textiles and the global recession may lead
to significant layoffs in
this sector.10
Small and medium enterprises play an important role in the economy.
In recent years, there
has been an increasing export-orientation of SMEs in a variety of
industries including textiles
and clothing, leather and leather products, surgical instruments, sports
goods and information
technology. The export-oriented SMEs are particularly vulnerable to
falling international
demand for these products as most of these are specialized concerns
catering exclusively to the
export markets. Their problems have been compounded by high cost
of financing amid a tight
monetary policy environment.
3.2 SHOCK ABSORBERS AND SHOCK AMPLIFIERS
An economy’s ability to withstand external economic shocks depends on
the initial
conditions that can be characterized as shock absorbers and shock
amplifiers in the domestic
economy. Whereas a shock amplifier would exacerbate the adverse
economic shocks, a shock
absorber would help cushion the domestic economy from adverse
external shocks. Based the
foregoing analysis, an attempt has been made to identify shock
amplifiers and shock absorbers to
help determine how resilient the economy is to adverse economic
shocks.
A key shock absorber is the soundness of the domestic financial system.
It is generally
accepted that Pakistan has a reasonably sound financial systems that
has been largely insulated
from the financial turmoil in the developed world. The relatively
healthy and less exposed
financial systems have limited the transmission of financial shocks to the
domestic economy. A
second shock absorber is Pakistan’s reliance on domestic consumption
rather than exports:
private consumption stood at about 70 percent of GDP in 2009 (Table
3.6). The high dependence
on domestic consumption has insulated the economy from the
ramifications of a slump in
demand in advanced economies.
Table 3-6: Private Consumption and Investment (as Percent of GDP)
Year Private Investment Private Consumption
2004 10.9 71.7
2005 13.1 75.2
2006 15.7 71.5
2007 15.4 70.9
2008 15 68.6
2009 13.2 69.6
Source: Economic Survey 2009
Macroeconomic stability itself is an important shock absorber. On this
count, however,
Pakistan’s macroeconomic imbalances such as high inflation and fiscal
deficit made it difficult to
contain the effects of the external shock.11
A healthy foreign exchange reserves position also acts as a shock
absorber. It not only helps
stabilize the domestic currency but also underpins sound sovereign
ratings thus helping to
maintain investor confidence. Pakistan experienced declining foreign
exchange reserves and total
foreign exchange reserves as a proportion of total imports stood at 24
percent in 2008, hardly a
comfortable position for reserves to act as a shock absorber.
Table 3-7: Foreign Exchange Reserve
Indicators 2005 2006 2007 2008 2009
SBP Liquid Reserves (Million US $) 9,805 10,765 13,345 8,577 9,118
Gold and Foreign Exchange Reserves (Million US $) 12,956 14,303
17,924 13,299 13,593
Official Reserves in weeks of next year imports on cif basis 35 27.8 30.6
16.8 20.5
Ratio of Official Reserves to Broad Money (%) 19.8 19 19.8 12.5 14.4
Source: SBP, 2009
Lack of economic diversification and high dependence on external
financing are major
shock amplifiers. Pakistan’s economy lacks diversification and its
exports are highly
concentrated in textiles. This feature, therefore, acts as a shock
amplifier. Pakistan depends
heavily on external financing as is evident from the saving investment
gap which stood at 8.5
percent of GDP in 2008. A high dependence on external financing
works to amplify the impact
of adverse shocks which may lead to cuts in external inflows.
Table 3-8: Saving and Investment Gap (As Percent of GDP)
Year Investment Saving Gap
2004 16.6 17.9 1.3
2005 19.1 17.5 -1.6
2006 22.1 18.2 -3.9
2007 22.5 17.4 -5.1
2008 22.0 13.5 -8.5
2009* 19.7 14.3 -5.4
Source: Economic Survey of Pakistan, 2009; *
Provisional
To sum up, despite some shock absorbers in the economy, Pakistan’s
economy has suffered
from the global financial cris is. Two key factors are worth emphasizing
here. First, the
macroeconomic imbalances that the economy witnessed after the food
and fuel price hikes made
macroeconomic management difficult at a time when the economy was
hit by the global
financial crisis. For example, high fiscal deficit left little fiscal space to
prop up the economy. 12
Second, high concentration of Pakistan’ s exports in textiles and textiles
products combined with
geographical concentration in recession-hit markets made Pakistan’s
exports especially
vulnerable to global recession.
4 MACROECONOMIC POLICY RESPONSE
Pakistan’s economy has been under strain due to macroeconomic
imbalances that were
building up after years of expansionary policies. The global financial
crisis accentuated the
economic difficulties with widening current account and fiscal deficits,
soaring inflation and
weakening economic growth. Fearing an economic meltdown, Pakistan
sought the support of the
IMF in November 2008 to help sustain its macroeconomic recovery.
Under the IMF program,
Pakistan is committed to continue to follow tight monetary and fiscal
policies to restore
macroeconomic stability. In response to sharply rising inflation, the
Central Bank considerably
tightened the monetary policy by raising the discount rate by 250 basis
points during 2007-08.
The consequent rise in the rate of interest has severely constrained
private investment while the
impact on inflation has been moderate as the latter is driven more by
supply bottlenecks rather
than demand factors. The IMF agreement requires fiscal deficit to be
brought down from 7.4
percent of GDP in 2008-09 to 4.2 percent in 2009-10 and to be further
slashed to 3.3 percent in
2010-11.
Public finances remain precarious and there is little room for counter
cyclical fiscal
measures to boost economic growth. In this scenario, the government is
striving to reduce public
expenditure on the one hand and to enhance public revenues on the
other. In particular, the
government aims to phase out subsidies on electricity and gas, improve
the efficiency of public
development spending through better project monitoring and
implementation, and reform tax
Box 1: A Quantitative Assessment of the Impact of the Global Financial
Crisis
Using the Papanek-Basri (2009) framework, Amjad and Din (2009) have
estimated the impact of
global economic crisis on Pakistan’s economy. The methodology
involves a two-stage procedure to
estimate the direct and indirect impact of the global financial crisis. In
the first stage, the direct impact
is estimated through exports, foreign investment and fiscal deficits. In
the second stage, a Keynesiantype multiplier is used to estimate the
indirect impact of changes in key macroeconomic variables on
GDP. The results show that the total impact of the crisis on the economy
could amount to as much as
4.7 percent of GDP in nominal terms. 13
administration. Despite pressure on public finances, however, the
government has taken steps to
protect the vulnerable groups from the adverse impact of the financial
crisis.
There are emerging signs of macroeconomic stability: inflation has
eased, partly because of
decline in global food and fuel prices, foreign exchange reserves position
has improved, and the
current account deficit has been contained. However, the economy
continues to face serious
challenges --- law and order, energy shortages etc --- that may affect its
growth prospects in the
short to medium term.
5 DEALING WITH THE CRISIS: A BROADER FRAMEWORK
FOR MACROECONOMIC
AND DEVELOPMENT POLICIES
The global financial crisis has served to underscore the fact that
Pakistan remains vulnerable
to external shocks and its ability to deal with such shocks is severely
constrained by its inherent
weaknesses such as macroeconomic imbalances, lack of export
competitiveness, dependence on
foreign inflows, and inadequate physical infrastructure. Pakistan needs
to adopt a holistic
approach to tackle its development challenges so as to be able to
withstand external economic
shocks. This approach should encompass both macroeconomic policies
and development policies
aimed at attaining robust growth necessary for maintaining a steady
pace of job creation and
poverty reduction. This section spells out the key elements of these
policies.
5.1 MACROECONOMIC POLICIES
Macroeconomic stability is fundamental to fostering economic growth.
Therefore, the first
and foremost goal of macroeconomic policies should be to ensure a
stable macroeconomic
environment that encourages private investment and hence economic
growth. Prudent fiscal and
monetary policies must be designed so as to avoid the build-up of
macroeconomic imbalances
that ultimately weaken the growth process.
Fiscal policies must be geared towards creating room for public sector
programs to shore up
the domestic economies without jeopardizing macroeconomic stability.
So far, Pakistan has not
been able to do so because of its tight fiscal position. The tax-to- GDP
ratio remains below
potential and there is much scope for bolstering revenues through
streamlining tax
administrations. On the expenditure side, there is a need to reorient
public expenditures towards
raising the productive capacity of the economy through public
investment in critical physical
infrastructure, health, and education etc.
Prudent use of monetary instruments is essential to help cushion the
impact of external
economic shocks. Whereas Pakistan has followed an appropriate
monetary policy to deal with 14
the financial crisis, it is important to continue to align the monetary
policies towards achieving
price stability while ensuring robust economic growth.
A key issue that must be kept in view is the need for fiscal and monetary
policy coordination
to achieve the desired objectives. Lack of consistency between the fiscal
and monetary policies
may lead to macroeconomic imbalances with adverse consequences for
key macroeconomic
objectives including price stability and economic growth. In particular,
the use of expansionary
fiscal policy to stimulate the domestic economy may stoke inflationary
pressures especially when
the deficit is financed through borrowings from the central bank. In
recent years, deficit
financing through central bank borrowing has been significant; and this
partly explains the
persistence of inflationary pressure despite a tight monetary policy by
the central bank. An
expansionary fiscal policy may still conflict with the monetary policy
even if deficit is financed
through domestic and/or external borrowing. In this case, high fiscal
deficits may trigger an
increase in interest rates leading to crowding out of private investment
on the one hand, and
balance of payments difficulties on the other, both of which will be
problematic for maintaining
a given monetary policy stance.
Maintaining sustainable levels of current account deficits is essential
for macroeconomic
stability. High current account deficit not only leads to an accumulation
of external debt but also
constrains economic growth as it often results in import compression
policies to stabilize the
current account. A better response would be to improve export
competitiveness leading to
enhanced export earnings that can be important source of financ ing the
current account deficit.
Whereas the financial crisis has prompted reforms to streamline the
financial sector, the
reform process must continue to improve the functioning of the
financial system. A wellfunctioning financial system that efficiently
channels investible funds to most productive uses is
essential for industrial development and growth. It is therefore
imperative to improve the
efficiency of the financial sector and ensure its health by strengthening
the prudential regulations
and ensuring their effective implementation.
5.2 DEVELOPMENT POLICIES
A key aim of the development policies in a short term perspective must
be to protect the
vulnerable segments of the population from adverse economic shocks.
With endemic poverty,
there is a need to ensure that adequate social safety nets are in place
that provide a cushion to the
poorer households amid economic slowdown. Pakistan has launched the
Benazir Income Support
Program that provides direct income support to the poorest households
identified on the basis of
a poverty scorecard. The program started with an initial allocation of
$425 million, equivalent to 15
about 0.3 percent of GDP in 2008-09. During the current year, the
program would cover 3.4
million families and there are plans to double the allocation next year to
cover 7 million families.
It is important to emphasize that while such schemes provide immediate
relief to the poor
segments of society; these do not address the underlying problem of the
lack of effective
mechanisms to ensure inclusive growth. The key challenge here is to
reorient the public sector
development programs towards attaining the goal of inclusive growth
that generates employment
opportunities for the poor and thus helps in poverty reduction. In this
respect, the development
spending may be allocated for the development of labor intensive
sectors with a large potential
for job creation such as the small and medium enterprises and
construction. Also, the public
sector development programs need to focus on imparting the necessary
skills to enhance labor
productivity thus helping to raise incomes of the poor.
While the public sector programs are important tools to achieve various
development goals,
it is important to ensure effective mechanisms for program selection,
monitoring and evaluation.
Evidence shows that many development projects fail to achieve their
desired objectives not least
because of faulty procedures at various stages of the project cycle.
There is, therefore, a need to
evolve transparent selection procedures that would ensure the selection
of projects which
promise high returns. Also, the process of program monitoring and
evaluation must be
strengthened to improve the delivery of public services.
In a longer term perspective, the development policies need to be geared
towards improving
competitiveness and productivity. Attaining greater competitiveness
through productivity
improvements is the single most important development challenge
facing Pakistan. In this era of
rapid globalization and heightened competition, Pakistan can compete
only through improving
its long term competitiveness.
5.2.1 Human Resource Development
Human resource development is both the ‘means’ as well as the ‘end’ of
development. No
country has grown on a sustained basis without improving the lot of its
human resources.
Pakistan’s track record in the development of human resources is not
very impressive, though
education and health indicators show some improvement over time.
Business surveys show that
Pakistan is deficient in skilled human resources that are vital for
technological and industrial
advancement. The productivity of various industries is adversely
affected due to lack of skilled
workers and some of the industries do not get established because of the
lack of requisite skilled
workers. In order to build a sound and diversified production structure
in the industrial sector, 16
Pakistan needs to attach high priority to human resource development.
Pakistan has already taken
a step in that direction by bringing the idea of “investing in people” at
the heart of the 10th five
year plan.
5.2.2 Technological Advancement
It is widely recognized technological advancement is critical for long-
run industrial success.
In a rapidly changing international economic environment,
technological developments have
become ever more vital for sustaining the development momentum.
Unfortunately, the state of
technology has been far less satisfactory in Pakistan as compared with
other emerging
economies. The pursuit of the strategy of import substitution for such a
long period left very little
incentives for research and development by the local industries. To
prepare the economy to face
the emerging challenges, the development of technology and its interface
with the industry has to
be brought to the forefront of the industrial vision for the future. There
is a need to provide
incentives for R&D at the firm level: for example tax incentives aimed
at promoting corporate
R&D investment such as deduction of R&D expenditures and human
resource development costs
from taxable income, and reduced tariffs on import of R&D equipment
and supplies.
5.2.3 Physical Infrastructure
The provision of adequate infrastructural facilities including power
supply,
telecommunications, and transportation network is a prerequisite for
industrial development. The
availability of quality infrastructure lowers the transaction costs of
firms and hence directly
affects their ability to compete in the global market. However, the state
of physical infrastructure
remains less than satisfactory resulting in higher cost of doing business
and eroding
competitiveness. The underdeveloped state of infrastructure also
hinders FDI as foreign investors
favor locations with decent physical infrastructure that can cope with
logistics of modern
businesses. In view of domestic resource constraints, private sector
participation in infrastructure
projects would be crucial. A successful example of public private
partnership is Sialkot Airport
which was constructed by the local businesses in partnership with the
public sector.
5.2.4 Regulatory and Legal Environment
A business- friendly regulatory and legal environment is of
fundamental importance in
promoting industrial development. Though Pakistan has strived to
improve the overall business
climate, weaknesses remain in the regulatory and legal framework that
hinder private enterprises.
Businesses still have to comply with a host of regulations relating to
work environment including
health and sanitation, product standards, and taxation etc. Excessive
discretionary powers in the 17
hands of the enforcing agencies often lead to harassment of enterprises
and opens up avenues for
corruption resulting in loss of business confidence. To develop a viable
industrial sector, there is
a need to put in place a regulatory and legal environment that is
conducive for private businesses.
5.2.5 Industrial and Export Diversification
To diversify and broaden the industrial base, it is necessary to
encourage investment in the
new industries that are capable of exploiting dynamic comparative
advantage, exhibit strong
backward linkages, and have healthy future growth prospects. The
industrial diversification
policies need to be designed in close consultation with the private sector.
The experience of
Asian economies including Japan, Korea, and Singapore, has shown
that targeted intervention by
the government along with sound public-private partnership can be
instrumental in fostering a
wide range of new industries that can compete effectively in the global
marketplace.
A related issue is export diversification. Pakistan’s exports are highly
concentrated mainly in
cotton textiles and garments. The high concentration of exports in few
product categories makes
them particularly vulnerable to external demand shocks. A diversified
industrial structure would
help the countries to diversify their exports, strengthen their export
earnings, and ease foreign
exchange constraint that has often acted as a binding constraint on
growth.
5.2.6 Competitive Environment
It is widely recognized that a competitive business environment that
rewards
entrepreneurship, efficiency, and innovation is essential for sustained
economic growth. Such an
environment is characterized by market driven incentives and a level
playing field for investors;
and is supported by a transparent, predictable and consistent
regulatory framework and a liberal
trade regime. In contrast, state intervention in economic activities and
trade barriers are often
accompanied by distortions in economic incentives, rent-seeking
behavior, and inefficiencies, all
of which stifle the process of economic growth. Besides internal
competition, external
competition through openness to international trade plays a key role in
the process of economic
growth. There are a number of channels through which openness is
thought to influence
economic growth. First, a liberal trade regime enhances efficiency
through greater competition
and improved resource allocation. Second, greater access to world
markets allows economies to
overcome size limitations and benefit from economies of scale. Third
imports of capital and
intermediate goods can contribute to the growth process by enlarging
the productive capacity of
the economy. Fourth, trade can lead to productivity gains through
international diffusion and
adoption of new technologies. 18
In recent years, Pakistan has adopted policies to liberalize and
deregulate their economies
with a view to fostering greater competition in their economies. In
addition, the trade regimes
have been considerably liberalized. While these measures have
introduced greater competition in
the economies, there is still room for encouraging greater domestic
competition and more
opening up of the economies to international trade and investment.
5.2.7 Institutions and Governance
A growing and influential body of literature emphasizes that institutions
such as property
rights, judicial system, rule of law, and contract enforcement etc. play
an important role in the
process of economic growth. It is argued that a favorable institutional
environment reduces
transactions costs, encourages skill acquisition and innovation, supports
capital formation and
capital mobility, and allows risks to be priced and shared, all of which
positively influence
economic growth. Similarly, good economic governance fosters
productivity and growth by
ensuring a predictable and consistent policy environment. Pakistan
ranks low in terms of various
indicators of the quality of institutions and governance developed by the
World Bank. There is
therefore a need to improve the quality of institutional infrastructure to
improve the long term
growth prospects.
6 REGIONAL ECONOMIC COOPERATION
Even though South Asian economies are bound in the SAARC for over
two decades and
have signed a free trade agreement (SAFTA), intra-regional trade
remains minimal and the South
Asia region remains the least integrated region in the world.
Experience has shown that countries that are part of regional trading
arrangements are better
able to deal with external economic shocks. The recent spectacular
rebound of the Southeast
Asian economies amid the global recession only serves to underscore
this fact. These economies
have strong economic ties among each other, through ASEAN for
instance, and hence have been
able to at least partly insulate themselves from demand shocks in the
western markets.
It is increasingly being recognized that regional trading arrangements
provide an effective
framework for coordinated policy responses to deal with external
economic shocks. In South
Asia as well, there is significant potential for developing collective
approaches to safeguard the
interests of the region. Collective forums such as SAARC can help the
South Asian countries to
develop common position and effectively deal with the multilateral
negotiations on trade with
other regions and at international forums like WTO. Also, SAARC
member countries can
cooperate with each other in order to insulate the regional economy
against external shocks. 19
6.1 KEY AREAS FOR REGIONAL ECONOMIC COOPERATION
The South Asian countries can cooperate on a number of fronts to
strengthen regional
cooperation. To begin with, a key area for economic cooperation in
South Asia is monetary
cooperation. The South Asian countries have generally faced severe
foreign exchange constraints
owing to persistent imbalances in their current accounts. The paucity of
foreign exchange can be
an impediment to intra-regional trade ¾ as also to any other
international transaction ¾ if these
trade flows are transacted in terms of international currencies. Most of
the South Asian countries
are members of the Asian Clearing Union that facilitates intra-regional
trade by obviating the
need for hard currencies for settling regiona l trade balances. However,
not all regional trade
transactions are carried through the ACU and there is room for
strengthening this important
instrument of regional trade cooperation in South Asia. In particular,
there is a need to expand its
coverage to include all SAARC member countries as well as to settle all
intra-regional trade
transactions through its clearing mechanism. In addition to monetary
cooperation, a regional
trade financing facility will provide access to trade finance and thus
help boost intra-regional
trade. Such a facility would not only enable risk pooling across the
regional countries but will
also provide economies of scale.
The SAARC platform can also be used to bring together the SAARC
Ministers of Finance as
well as Central Bankers to devise regionally coordinated actions to
mitigate the adverse impact
of the global financial crisis. The regional economies face similar
development challenges and an
effective regional response can be instrumental in helping these
economies to realize their full
growth potential. For example, the regional countries can adopt
coordinated exchange rate
policies to ensure their competitiveness in global markets. Similarly, the
Central Banks can pool
their resources on a regional basis to address balance of payments
difficulties of the member
countries.
A regional system of surveillance to monitor potential risks to the
financial systems in the
wake of global crises can prove to be effective in helping the countries to
initiate timely
measures to insulate themselves from adverse external shocks. Such a
system can draw on both
national and international expertise working under the umbrella of
SAARC.
Another key initiative would be to bring issues of economic
management within the
framework of SAARC Planning Ministerial meetings. The South Asian
countries can learn from
each others’ experiences thus enabling them to develop coherent
strategies based on informed
knowledge to deal with the shared problems of under-development and
poverty. The regional
countries are struggling to provide support to the vulnerable groups
and in this area the regional 20
economies have a lot to learn from each others’ experience. By sharing
information and through
policy dialogue the regional economies can develop effective responses
to deal with the problem
of widespread poverty.
The SAARC Chamber of Commerce provides an important forum that
provides
opportunities for private businesses to interact and share information.
However, this forum is not
effectively utilized due mainly to lack of information to interested
businesses. There is therefore
a need to popularize this forum that can play an effective role in
bringing the businesses together
and helping to generate ideas for better integration of the regional
economies.
Finally, there is a need to strengthen and institutionalize the existing
efforts that have been
initiated to use bilateral and/or regional forums for developing
collective approaches to deal with
economic management issues. For example, Pakistan and India has
initiated a process for regular
meetings of their Planning Commissions. A delegation of the experts of
the Planning
Commission of Pakistan visited India to apprise their counterparts of
the process of development
planning in Pakistan and to learn from the Indian experience. Whereas
the visit of the Pakistani
delegation was quite successful, India has not reciprocated so far.
It needs to be emphasized that to sustain such initiatives, these efforts
must be
complemented by measures to enhance the degree of economic
integration through greater intraregional trade and investment. There
is a great potential to forge a viable regional trading block
thanks to close geographical proximity and shared cultural and
business values. It is therefore
essential to move the process of regiona l economic integration forward
through serious efforts in
several key areas including confidence building measures, reduction in
trade barriers,
harmonization of customs procedures and tariff structures, improving
transparency of trade and
investment policies, collectivism, and effective implementation of
SAFTA. These measures will
contribute towards strengthening economic ties in the region thus
helping to create an effective
platform for coordinated efforts to achieve the shared goal of economic
development and
prosperity.
6.2 CONFIDENCE-BUILDING MEASURES
First and foremost, confidence building measures are needed to create
the right atmosphere
for greater economic ties in the region. The region is dominated by two
large economies, India
and Pakistan, and these countries must lead the way towards regional
economic integration in
South Asia. Actions of these economies have a strong influence on trade
policies of other South
Asian countries. Both the countries need to work together to ensure
smaller regional countries
that their interests will be safeguarded and their apprehensions about
the domination of larger 21
economies will be addressed in regional matters. Possibilities of trade
expansion in South Asia
would be rather limited unless the benefits of trade liberalization accrue
to all the partners.
Easing of travel and visa restrictions would promote contact between
the business communities
within the region, leading to ushering of new possibilities for economic
cooperation. Opening up
of bilateral trade beyond what is covered by SAFTA would bring a new
wave of relations and
confidence, and may lead to a broader trade and economic ties within
the region. Finally, there is
a need to create awareness about the potential benefits of regional
economic cooperation. This
will make various regional economic cooperation initiatives more
acceptable to general masses
thus making it easier for governments to engage in such initiatives.
6.3 MAKING SAFTAWORK
The SAFTA agreement provides a useful framework for strengthening
trade ties in the
region. However, the success of SAFTA depends on its effective
implementation, which would
require a conducive economic and political environment and a strong
willingness for integration
and liberalization of the SAARC members. This will reduce the chance
of disruption of trade and
derailment of the agreement. Also, there must be a strong acceptance of
the members for the
subsequent economic adjustments. Continuous dialogues and
interaction along with sincere
efforts towards understanding each others’ point of view are the
essential ingredients for the
success of SAFTA and any other integration efforts in the region.
Whereas SAFTA provides tariff reductions across a range of
commodities, there is still
room for a freer trade regime in the region. The improvement in the
custom as well as tax
administrations must complement tariff reduction policies. This process
should be designed and
implemented in close consultation with the private sector. Reduction in
tariffs alone is not
sufficient to promote economic ties in the region. What is needed is a
regulatory environment
that facilitates trade through reduction in the transaction costs
associated with bringing goods
and services across borders. Trade facilitation involves a wide range of
initiatives, including, for
instance, reforms in the regulation and harmonization of standards,
promoting efficiency in
customs, and improvement in regional transport infrastructure. The
regional countries need to
adopt a coherent strategy to harmonize their trade policies, focusing in
particular on transport
and transit systems, and customs procedures. Domestic regulatory
procedures and institutional
structures based on international best practice models (for example of
ASEAN) can improve
transparency and introduce professionalism in border clearance
procedures. Streamlining
regulations on technical barriers and liberalizing transport and
telecommunications regimes can
also facilitate trade. Collective action to raise capacity in trade
facilitation in terms of upgrading 22
ports, and introduction of information technology in border processing
would lower transaction
costs and expand trade across the region.
7 SUMMARY AND CONCLUSIONS
This paper has examined the impact of the global financial crisis on
Pakistan’s economy
with a view to identifying a set of macroeconomic and development
policies that are essential to
enable the economy to withstand external economic shocks. Several
lessons have emerged from
the study. First, the extent of the impact depends as much on the initial
conditions preva iling
before the financial crisis as on handling of the crisis. For example,
Pakistan was always
susceptible to adverse external shocks because of macroeconomic
imbalances that kept the
economy under strain even before the crisis. These initial conditions
provided little room for
macroeconomic adjustments necessary to deal with the global financial
crisis. Second, political
will plays an important role in macroeconomic outcomes. Pakistan, for
instance, was unable to
pass on higher oil prices to the consumers which badly hurt its fiscal
position. Third, the tradeoff
between stabilization and economic growth assumes special significance
in LDCs because of the
problem of widespread poverty. Pakistan began monetary tightening
before the financial crisis to
stem the rising tide of inflation. After the financial crisis, Pakistan
entered into an agreement
with IMF which dictated the continuation of tight monetary policy
stance. This led to sharp a
slowdown in economic growth resulting in unemployment and poverty.
It is generally believed
that Pakistan continued the process of monetary tightening far longer
than was necessary and
thus has been unable to fine tune its macroeconomic management
keeping in view its
development challenges. Finally, the process of economic stabilization
has been helped by
favorable factors such as decline in global oil prices and steady inflow of
remittances. However,
Pakistan needs to be wary of future hikes in oil prices as well as the
possibility of a decline in
remittances. The latter is highly probable because the current inflow of
remittances may reflect
the accumulated savings of the return migrants and actual decline in
remittances may only show
up later. Future layoffs in the Gulf may also result in a squeeze in this
important source of
foreign exchange earnings.
The study has laid out a broader framework encompassing both
macroeconomic and
development policies that may help the economy to sustain robust
growth, create more and better
jobs, and alleviate poverty. An overriding goal of macroeconomic
policies should be to ensure a
stable macroeconomic environment that encourages private investment
and hence economic
growth. Prudent fiscal and monetary policies must be designed so as to
avoid the build-up of
macroeconomic imbalances that ultimately hamper the growth process.
In a shorter term23
perspective, development policies need to focus on social safety nets as
well as on programs to
empower the poor through skill development and productivity
improvement. In the long-run, a
key challenge is to enhance competitiveness and productivity. This can
be achieved by focusing
efforts on several key areas including human resource development,
technological advancement,
physical infrastructure, regulatory and legal environment, export
diversification, and institutions
and governance.
Regional forums such as SAARC can provide an effective framework
for coordinated policy
responses to deal with external economic shocks. The South Asian
countries can cooperate on a
number of fronts including, for example, monetary cooperation in the
form of Asian Clearing
Union, establishment of a regional trade financing facility, joint
meetings of SAARC Central
Bankers and Ministers of Finance for macroeconomic policy
coordination, incorporation of
economic management issues into the SAARC Planning Ministerial
meetings, and effective
utilization of SAARC Chamber of Commerce to promote busine ss to
business to contacts. At the
same time, efforts must be made to enhance the degree of economic
integration through greater
intra-regional trade and investment. The objective of greater economic
integration in South Asia
can be realized through concerted actions aimed at building confidence
and implementing
SAFTA in letter and spirit. Stronger regional ties will create mutual
stake-holding and encourage
the member countries to cooperate and work closely in dealing with
their macroeconomic and
development challenges. 24
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ARTICLE NO 9:
THE IMPACT OF THE GLOBAL ECONOMIC SLOWDOWN ON
POVERTY AND SUSTAINABLE DEVELOPMENT IN ASIA AND THE
PACIFIC
28-30 September 2009 in Hanoi, Viet Nam
Pakistan: Policy Paper
By
Ashraf M. Hayat and Zamir Ahmed*
The financial crisis originated earlier in US in the mortgage market and eventually landed
into the banking system. The financial crisis is further transmitted to the real economy
where liquidity-starved financial sector unable to provide credit for working capital and
productive investment. Thus, besides high energy and commodity prices and shortage of
liquidity are forcing advanced as well as other countries to move into recession.
Depriving the economic system of credit would eventually result in prolonged recession
or depression. World growth is expected to slow down to 3% in 2009 – 0.9% lower than
forecast. The direct impact of the global financial crisis on Pakistan has been limited due
to weak linkages of domestic financial sector with international financial markets.
However, both direct and indirect impact turns out to be moderate where the
macroeconomic fundamentals were weak at the outset of the crisis.
This policy paper seeks to examine the state of economy at the onset of global recession
and performance of the Pakistan economy thereafter. In the next section impact of the
global recession on Pakistan’s economy focusing on social outcomes of the transmission
channels are discussed. In the final section policy interventions and recommendations to
mitigate the negative impact of global economic slow down on growth & poverty and to
improve well being of the poor are presented.
STATE OF ECONOMY
Before the financial crisis set in motion global recession, Pakistan’s economy was facing
a number of challenges. High international food and energy prices (2007-08) fueled
inflationary pressure. Deficient infrastructure, power shortage and security concerns
combined with unemployment have also caused socio-economic instability. As the global
financial crisis unfolded (2008-09), financial crunch dried up FDI, privatization and
international loan prospects.
Pakistan witnessed investment rate decelerated, slow down of economic growth, less
employment opportunities, rising poverty level, debt burden reaching alarming
proportions, and foreign exchange reserves plummeted to the lowest level of US$ 6.7
billion in October, 2008, as a result of increase in international energy prices. The large
*The authors respectively are Secretary, Planning and Development Division and
Economic
Advisor, Ministry of Finance, Islamabad.
social and economic burden of fight against terrorism also stifled the economy. Since
2001, about 35 billion dollars have been lost in terms of infrastructure, output and foreign
investment opportunities; besides, large asset losses of the civilian population. All these
are undermining Pakistan’s economic environment for investment and inclusive growth.
Major macroeconomic indicators duly reflecting state of the economy before and after
increase in international commodity prices respectively in 2006-07 & 2007-08 and after
going through the global recession in 2008-09 are presented in the table below.
Major Macroeconomic Indicators
(%)
2006-07 2007-08 2008-09
GDP Growth 6.8 4.1 2.0
Large Scale Manufacturing Growth 8.7 4.0 -7.7
Investment (% of GDP) 22.5 21.9 19.7
Inflation 7.8 12.0 20.8
Tax Revenue Growth 10.2 10.6 10.5
Fiscal Deficit (% of GDP) 4.3 7.4 4.3
Current Account Deficit (% of GDP) 4.6 8.4 5.3
Foreign Direct Investment (US$ Bn) 5.1 5.4 3.7
Foreign Exchange Reserves (US$ Bn) 15.6 11.4 11.8
Remittances (US$ Bn) 5.5 6.4 7.8
Source: Annual Plan 2009-10, Planning Commission; Economic Survey of Pakistan
2008-09,
Ministry of Finance; Federal Bureau of Pakistan and State Bank of Pakistan
The global financial and economic crises have impacted on poor and vulnerable through
a variety of channels, including impact on domestic labor market, migration and
remittances, exports, balance of payments and exchange rate, development expenditures
and consequent upon incidence of poverty.
TRANSMISSION MECHANISM
Impact on Domestic Labor Market
Non-regular workers suffer more due to global recession. Subcontract, causal, temporary
and overseas migrant workers are among the most vulnerable to job cuts as they do not
qualify for the severance pay and benefits to which their regular counterparts are entitled.
*The authors respectively are Secretary, Planning and Development Division and
Economic
Job losses in export manufacturing often affect the rural-to-urban migrants and their
income. Retrenched workers not able to find new urban employment seek rural work
opportunities and swell the informal economy with accompanying risk of a rising share
of workers in lower productivity, precarious and hazardous employment. This process of
reverse migration has already begun. This shift often coincides with reduced wages and
eventually landing into poverty.
The rising level of inflation in recent years is not matched by equivalent broad-based
gains in real wages. In addition, there has been sharp increase in income inequality during
the high growth period (2003-07). The slowdown of growth since 2007-08 has resulted in
falling real wages and increase in the incidences of wage-related disputes and poverty.
Impact on Migration and Remittances
With increasing globalization of labor markets, flow of workers among different
countries is an important source of economic development. Overseas migration and
resulting remittances have served three purposes – easing pressure on employment,
incidence of poverty and current account deficit. It enables recipient country to acquire
imports needed for industrialization, help in paying off external debt and increase its
credit worthiness.
Total remittances received by Pakistan during 1972-2009 amounting to US$ 82.5 billion.
Only during the last year 2008-09 a record amount of US$ 7.8 billion has been received
on this account. The massive inflow of foreign remittances when translated into increased
expenditure on food, education, health, skills development and greater employment
opportunities generated through investment in construction and SMEs contribute to the
decline in poverty in the country. There are downside risks to remittances in the wake of
ongoing recession and lower demand for workers in the source countries. All such factors
are likely to serve as a stress on poverty.
Impact on Exports
The global recession has decreased demand for goods and services. Pakistan’s exports
have declined by 6% to US$ 19.2 billion in 2008-09 over previous year. Textile, tanned
leather, carpets and rugs and football industries and their workers have lost export
earnings. With the increase in the cost of doing business not only small industry units
have been closed but a large number of workers have also been laid off. The loss of jobs
and decrease in earning of workers has impacted adversely on the poverty.
Impact on Balance of Payments and Exchange Rate
Pak rupee has maintained stability against US dollar with depreciation of only 1% during
the three year period from October 2004 to October 2007. However, since the global
financial crisis and increase in international oil prices, domestic currency has depreciated
sharply by 36% in a period of less than 2 years from October 2007 – August 2009. As a
consequence the current account deficit increased from 4.6% to 8.4% of GDP from 2006-
07 to 2007-08. *The authors respectively are Secretary, Planning and Development
Division and Economic
Foreign reserves position till 2007-08 remained strong on account of increased inflow of
FDI as well as portfolio investment, proceeds from privatization and multilateral as well
as bilateral aid. This allows the State Bank of Pakistan to finance the heavy imports of oil
and thus provides stability to the exchange rate. With the onset of recession not only
capital inflows dwindled but the foreign reserves position also deteriorated considerably
in the late 2008. All these further worsened balance of payment position and depreciated
the value of Pak rupee. As a result of depreciation of exchange rate, prices of the
imported commodities increased and benefits of lower prices resulting from recession
could not be yielded ensuing further pressure on inflation impacting negatively on
poverty.
Impact on Development Expenditures
As earlier mentioned Pakistan’s macroeconomic indicators have worsened even before
the onset of global recession. The fiscal deficit increased as high as 7.4% of GDP in
2007-08. On account of global recession, fiscal position could not be improved much
during 2008-09. Short falls in government revenue and capital inflows from abroad were
the major contributing factors. To restore fiscal discipline government has to cut down
the Public Sector Development Programme (PSDP). Accordingly, The Federal PSDP was
slashed down from Rs 371 to Rs 219 billion in 2008-09. Projects in the areas of power,
water, education, health and environment were considerably affected with adverse
consequences on growth, employment and household income and poverty.
Impact on Poverty
Reliable indicators of the incidence of poverty are not available of the recent years.
However, estimates made available by different scholars and institutions point towards a
significant increase in poverty over 30%, during the last two years. Above all, all the
transmission channels reflecting impact of global crisis on Pakistan economy in relation
to slow growth of GDP and of large scale manufacturing, closure of industrial units and
subsequent laying-off of workers, lower exports and capital inflows from abroad, cut
down in development expenditure clearly indicate that the number of poor in the country
have increased. Expected decline in migration and remittances from abroad in the coming
years would further increase the level of unemployment and poverty head count.
POLICY ACTIONS AND RECOMMENDATIONS
The economic slow down with continuing high inflation has resulted in arising
unemployment and poverty. Macroeconomic imbalances, high fiscal and current account
deficit of the intensity that we have faced before and after the global recession could not
be sustained indefinitely. Under these circumstances fiscal stimulus could not be
administered to revive the economic growth. In response to these challenges the
Government of Pakistan decided to restore macroeconomic stability under the
homegrown stabilization programme “Nine-Point Economic Reform Agenda” with
support of
IMF. To this effect, general subsidy on fuel and food was withdrawn in 2008 and prudent
fiscal and monetary measures were adopted to control inflation. *The authors
respectively are Secretary, Planning and Development Division and Economic
Recognizing the adverse affects of stabilization measures on growth, employment and
poverty, the Government launched the flagship social safety net, Benazir Income Support
Programme (BISP) in addition to the direct cash transfers from Pakistan Bait-ul-Mal and
Punjab Food Support Programme. BISP is a comprehensive social protection scheme and
a platform for women empowerment. Besides cash assistance of Rs 1000 per household
per month, it also covers health and accidental insurance, vocational training and interest
free loans of Rs 300,000 (Waseela-e-Haq Programme) for self employment of the poor.
During 2008-09, Rs 22 billion were utilized, whereas, Rs 74 billion has been allocated for
the current year 2009-10. Key objectives of the programme to be pursued in the next 12 –
24 months are outlined as under.
• Extend outreach of Benazir Income Support Program (BISP) from the present
5 to 7 million vulnerable households.
• Improve transparency for identification of poor by completing nation wide
survey of poorest of the poor for preparation of poverty scorecard that meet
international standards for assessing poverty and targeting the poor.
Workers purchasing power is to be protected with carefully designed minimum wages,
effective collective bargaining system and well-designed social transfer programmes.
Social dialogues will be ensured to provide a constructive approach for workers and
employers to prevent conflict from the outset. This not only ensures respect for
fundamental labor rights but also imparts sustainability to the enterprise.
The National Employment and National Emigration Policies recently formulated aiming
at employment generation, better managing international migration; promoting safe
emigration, protecting rights of emigrants, remittances facilitation and effective
reintegration of returning migrants should be effectively implemented by strengthening
the
concerned institutions.
Monitoring labor market mechanism needs to be strengthened to provide feedback to
policy makers on key developments. Further, restrictive labor laws also need to be
reformed to remove barriers to creating jobs.
Socio-economic instability is manifested in high level of poverty, lack of remunerative
job opportunities and social protection available to a small percentage of population.
Solution lies in pursuing sustainable development strategy. Main elements of the
development strategy suggested for Pakistan are presented below.
• Ensure economic recovery and pave the way for sustainable high growth and
balanced development.
• Maintain momentum of agriculture growth and strengthen supportive policies
to stimulate industrial growth.
• Enhance total factor productivity and technology frontier by investing in
people and tapping global knowledge.
• Convert demographic dividend into a window of opportunity. Achieve MDGs
and implement a poverty exit strategy by overcoming social deficit. Poor and *The
authors respectively are Secretary, Planning and Development Division and Economic
vulnerable to be protected by increasing the scope and coverage of the social
safety nets.
• Upgrade infrastructure by increasing public and private investment and
encouraging PPP mode of financing.
• Increase self reliance by higher saving & exports and harness indigenous
energy resources.
• Rehabilitate and reconstruct the violence affected areas.
As poverty-exit strategy holds the key to sustainable development, important features of
the strategy in relation to education, health and skills development are discussed.
Education: Coverage and quality of education, alongwith gender and regional parities to
be ensured. Improvement of teacher education will greatly enhance the quality and
relevance of education to the needs of the society. To meet educational MDGs public
expenditure on education should be enhanced from 2 to 4 percent of GDP by 2015
Health: Maternal Mortality Rate (MMR) 0-5 Mortality and Infant Mortality Rate (IMR)
are to be reduced and national programmes on communicable diseases are to be
revamped. Emphasis should also be laid on reducing burden of non-communicable
diseases causing 54% mortality. Considerable attention is also needed to improve the
training of medical staff and strengthening of primary healthcare units. To achieve health
MDGs, public health expenditures to GDP ratio to be increased from <1 to 2 percent by
2015.
Skills Development: Coverage and quality of skills development and training institutes
should be enhanced by establishing technical training institutes, one in each district;
Hunarmand Pakistan Programme of National Vocational & Technical Education
Commission (NAVTEC) should be strengthened and workfare through social
mobilization be initiated. Further, allocation of skills development fund for private
technical training centers also needs to be enhanced.
CONCLUSION
To mitigate the adverse affects of the global economic slow down on Pakistan the need is
to achieve and sustain high growth rate with human face. The various components of the
social safety nets especially the recently launched Benazir Income Support Programme
should be further strengthened and sustained with well targeted and financing
mechanism. To protect the economy against internal and external shocks reliance should
be placed on enhancing savings & exports and higher utilization of indigenous energy
resources. Necessary resources are to be committed for internal security required for
economic development and social stability. To sustain growth, factor productivity and
skills of the people are to be enhanced by investing in people and infrastructure. The
scope and quality of technical and vocational institutions should be enhanced to produce
internationally certified skilled manpower to foster knowledge based economic activities
and increase international migration. Heavy investment and improved delivery of social
services is required in education, health and other social services to exit from strategy and
to ensure balance development in the country.
ARTICLE NO 10
Pakistan’s Economic Crisis

and the IMF Bailout Package
Iftikhar A. Lodhi+
The International Monetary Fund (IMF) has approved a US$7.6 billion bailout package to
prevent Pakistan from defaulting on its external debt. The 23-month Stand-By Arrangement
under the Fund’s fast-track Emergency Financing Mechanism has provided an immediate
US$3.1 billion funding to strengthen the country’s fast deteriorating foreign exchange
reserves. The programme seeks to preserve social stability and restore investor confidence in
Pakistan by addressing its current macro-economic imbalances. At the same time, it sends a
strong signal to the international donor community about the country’s improved
macroeconomic prospects.
Pakistan approached the IMF for assistance in November 2008 to avert a default on its
foreign payments. The country requires roughly US$15-US$20 billion over the next two
years to avoid a Balance of Payment (BoP) crisis. The Pakistani authorities were initially
reluctant to turn to the IMF because of the expected stringent conditions, terming it Plan C –
the last option. Plans A and B included frontload disbursements from multilateral institutions,
borrowing from the international market and making an approach to friendly countries for
help. Despite receiving some support from multilateral lenders and some friendly countries,
Pakistan’s primary request for immediate cash infusions were turned down, given weakened
investor confidence in the economy. The government then turned to the IMF.
This paper seeks to examine three key issues. Firstly, how did an economy with robust
macroeconomic indicators until last year reach this critical stage? Secondly, why did
Pakistan’s closest allies, including the United States and China, let it down? Lastly, what will
be the likely economic and political implications of the IMF arrangement?
Anatomy of the Crisis
There is no doubt that an adverse external economic environment in the shape of
unprecedented high levels of oil and commodity prices earlier this year and the current global
financial crisis have largely contributed to the crisis in Pakistan today. Nevertheless, the
genesis of the current crisis is internal. The key reasons for the current meltdown of the
+ Mr Iftikhar A. Lodhi is a Research Associate at the Institute of South Asian Studies, an autonomous
research institute within the National University of Singapore. He can be reached at isasial@nus.edu.sg.
economy are continued political turmoil, deteriorating security, structural issues and the
unsustainable growth policies in recent years.
1 All data, unless otherwise stated, is from the State Bank of Pakistan and the International Monetary Fund.
Pakistan’s economy has dramatically slid from high growth rates and burgeoning foreign
exchange reserves to a state of crisis in less than a year. Real gross domestic product (GDP)
growth has declined, foreign exchange reserves are depleted, the current account and fiscal
deficits have blown up, net capital inflows have reversed significantly, inflation hovers
around 25 percent and the Rupee has depreciated sharply by around 25 percent. The Karachi
Stock Exchange has been in a free fall, nose-diving from the year high of 15,000 points to
9,200 in three months, forcing the government to intervene by placing a floor and proposing
a bailout plan.1
An imminent BoP crisis loomed large when the current government assumed office in March
2008. The current account deficit (CAD) more than doubled in the fiscal year 2008 (ending at
30 June 2008). The CAD soared to US$14.04 billion (8.4 percent of GDP) from US$6.87
billion last year (see Figure 1), the highest in the history of the country. The fundamental
source of such a steep increase in the CAD was a 57-percent expansion in the trade deficit
over the year, in addition to an increase in net outflows from income account.
Since 2001, the fast-paced liberalisation of the economy, leading to sharp reductions in tariffs
and robust demand growth, caused a steady increase in imports. On the other hand, the
growth in exports could not keep pace with imports, resulting in huge trade deficits (goods
and services) over the years. The trade deficit rose to US$21.6 billion in FY2008 from
US$13.9 billion in FY2007 and a mere US$361 million in FY2003 (see Figure 1).
Consequently, the current account balance deteriorated steadily from a surplus of US$4
billion in FY2003 to a deficit of US$14 billion in FY2008, despite a robust growth in
remittances.
Figure 1: Pakistan’s Trade and Current Account Balance (FY2003 – FY2008)
-22-20-18-16-14-12-10-8-6-4-20246FY2003FY2004FY2005FY2006FY2007FY2008US$ billion-22-20-18-
16-14-12-10-8-6-4-20246% of GDPTrade Balance (Goods & Services) (US$ bn)Current Account Balance (US$
bn)Current Account Balance % of GDPTrade Balance (Goods & Services) % of GDP
Data Source: State Bank of Pakistan and the IMF
2
2 Oil prices surged from US$55 per barrel in January 2007 to US$140 per barrel in May 2008, a jump of
more than 155 percent. Similarly international food price index increased by roughly 40 percent in 2007
and, in the first three months of 2008, prices rose by about 50 percent. The prices of rice, wheat and palm
oil also increased by 78 percent, 120 percent and 102 percent respectively between April 2007 and April
2008. Islam, M. Shahid, “Of Agflation and Agriculture: Time to Fix the Structural Problems”, ISAS Insight
No. 30, 5 May 2008 – Quoted International Monetary Fund. http://www.isasnus.org/events/insights/31.pdf.
Almost half of the additional merchandise import bill in FY2008 came from the food and oil
sectors, which registered 46 percent and 43 percent growth respectively. 2 Nevertheless, non-
oil and non-food imports grew by 21 percent, as compared to a 12 percent growth in exports.
In the first four months of the FY2009 (July-October 2008), a similar trend continues. The
trade deficit reached US$7.55 billion against US$5.47 billion in the same period last year, a
37 percent increase. Furthermore, net inflows have reduced substantially, resulting in almost
a doubling of the CAD to US$5.95 billion from US$2.99 billion over the same period last
year.
A sustainable moderate CAD may not pose a problem as such. However, the previous
government financed the deficit by unsustainable and expensive portfolio investments and
borrowings. Moreover, the rise in commodity prices was not passed on to consumers, due to
the political turmoil faced by the previous government, which resulted in large amount of
subsidies. The resultant fiscal deficit was financed by borrowing from the central bank and
this contributed in a double-digit inflation and the deterioration of country’s international
reserves. Furthermore, the pressure on the Rupee resulted in a 25-percent depreciation against
the United States dollar in the last six months.
Pakistan’s economic vulnerabilities stem from structural problems, three of which underscore
the nature of the BoP crisis that the country faces time and again. First, the economy is
heavily dependent on imports (including capital import, as domestic saving rate historically
hovers around 13 percent of GDP), which always surpasses exports. Exports, on the other
hand, are limited in commodity type and destination countries, leaving the country in the
current account deficit and vulnerable to external shocks. Second, the tax-to-GDP ratio (10
percent) is far below the average 17 percent of developing countries and less than two
percent of the population is covered by the tax net. The huge government expenditure on debt
payments, and defence and current spending resulted in huge fiscal deficits that reached 7.4
percent of GDP in FY2008. Last but not least, public debt remains as high as 55 percent of
GDP, albeit a significant improvement from 90 percent of GDP in FY2000. External debt
makes up 27 percent of GDP (FY2008), down from 43 percent in FY1999.
However, much of the improvement in the country’s debt position was the result of a
favourable external environment. Pakistan’s cooperation with the United States in the ‘war
on terror’ resulted in relief in public debt amounting to about US$3.7 billion, coupled with a
rescheduling of a US$12.5 billion Paris Club debt. These resulted in a substantially reduced
debt service burden which was 12.8 percent in FY2008, as compared to 28 percent in
FY1999. The military and economic assistance provided by the United States helped, to some
extent, to ease the burden on fiscal resources. Moreover, the liberalisation of the capital
account and international controls over informal money transfers after the September 11
attacks resulted in increased investments and remittances. Since the start of FY2008, the
external and internal environments have become less favourable for borrowing. There has
also been a significant decline in capital inflows. Consequently, the government failed to
3
3 Iqbal Anwar (2008), “IMF not Pressing for defence Cuts”, Dawn, 26 October, http://www.dawn.com/
2008/10/26/top18.htm
4 The FoP was formed during President Zardari’s visit to America in September 2008 on the margins of the
United Nations General Assembly session. The FoP includes the G7 countries, plus Australia, China,
Turkey, Saudi Arabia, the United Arab Emirates, the United Nations and the European Union.
float planned sovereign bond and global depository receipts, due to the political turmoil at
home and as a result of the global financial crisis. For all the above reasons, the foreign
exchange reserves began to shrink from US$15.6 billion in October 2007 to less than US$3.5
billion in October 2008, merely enough to support four weeks of imports, in the face of
maturing liabilities. As a result, external debt and liabilities, as a proportion of foreign
exchange reserves, reached a staggering 900 percent at the end of September 2008, against
300 percent a year ago, making it impossible to fulfil international obligations.
Friends of Pakistan: Economics and the ‘War on Terror’
After failing to mobilise capital from the international market, Pakistan turned to several
friendly countries. Saudi Arabia, a longtime friend of Pakistan which helped the country out
of a similar crisis in 1999 after the nuclear tests, was less than enthusiastic about Pakistan’s
requests for deferred payments on oil imports. Nevertheless, Pakistani government sources
claim that it received a ‘positive response’ from the Kingdom.
China, another all-weather friend of Pakistan with huge excess foreign reserves, declined any
major cash infusion and President Asif Ali Zardari’s visit to China in October 2008 only
yielded US$500 million, with promises of investments and trade opportunities to help
Pakistan. It is likely that Beijing wants to keep a low profile. Its growing investments and
cooperation with Pakistan have already raised eyebrows in Washington and New Delhi.
There have been suspicions that, after the India-United States nuclear deal, China and
Pakistan may attempt a similar nuclear cooperation. Furthermore, it is only wise for China to
let the Americans take care of their ‘front line ally’ in the ‘war on terror’.
The United States, wary of Islamabad’s commitment (and capacity) to fight militants
mounting insurgency in Afghanistan against United States-led forces, has been moving
towards a multilateral approach in tackling Pakistan’s crisis. The Bush administration,
bogged down by the worst financial crisis since the Great Depression, has also dragged its
feet on a bill promising US$1.5 billion annual economic aid over a period of 10 years for
Pakistan. The aid is conditional upon Islamabad’s ‘performance’ in the fight against
militants. Washington reportedly wants Pakistan to refocus its military strategy to fighting
the militants and normalising relations with India, said a Pakistani diplomat privy to the
negotiations while talking to the daily Dawn.3 Therefore, by involving major stakeholders in
regional stability, Washington wants to share its burden on the ‘war on terror’. Washington
threw its weight behind the formation of the Friends of Pakistan (FoP) 4 group to help
Pakistan overcome its political and economic challenges by developing a comprehensive and
coordinated approach to security, development and institutional issues facing the country.
The group reportedly demanded Pakistan to get an IMF loan approval which would assure
careful management of the economy and provide greater investor confidence.
The IMF Arrangement and its Implications
In fact, “by providing large financial support to Pakistan, the IMF is sending a strong signal
to the donor community about the country’s improved macro-economic prospects,” said IMF
4
5 The subsidies increased from a provision of Rs.114 billion (US$1.67 billion – 1.1 percent of GDP) in the
FY2008 budget to Rs.407 billion (US$6 billion – 3.9 percent of GDP).
6 The government also envisages, in the budget, to increase tax to GDP ratio from 10 percent to 15 percent
within the next five to seven years.
7 The 20-percent weighted trimmed measure of core inflation reflects steeper inflationary pressure as it rose
to 21.7 percent in October 2008 from 17.2 percent in June 2008.
Deputy Managing Director, Takatoshi Kato. The Managing Director of the Fund, Dominique
Strauss-Kahn, urged the donor community to “work together and act quickly to support
Pakistan’s programme in order to mitigate the impact of the current economic difficulties”.
The IMF arrangement is part of a broader package which involves other multilateral
institutions and donor countries. It aims to restore macro-economic stability and investor
confidence through a tightening of fiscal and monetary policies, while simultaneously
preserving social stability and adequate support for the poor, stated the press release issued
by the IMF. The loan tranches are subject to quarterly reviews by the IMF which has set forth
certain conditions. Nevertheless, most of the ‘conditions’ are already part of the
government’s economic agenda announced during the FY2009 budget in June this year.
The Fund stipulates bringing Pakistan’s fiscal deficit down from 7.4 percent of GDP in
FY2008 to 4.5 percent in FY2009 and 3.3 percent in 2009/10 by phasing out energy and
electricity subsidies and strengthening revenue mobilisation through tax policy and
administration measures.
These measures, if implemented successfully, will help to meet the target to some extent,
particularly the phasing out of subsidies.5 In the short run, reforms in tax administration and,
particularly the one percent increase in the general sales tax (from 15 to 16 percent
implemented in the FY2009 budget) will help raise tax-to-GDP ratio. In the medium-term,
the government will have to take a number of measures such as eliminating exemptions in the
general sales tax and the income tax, and introducing a commercial agriculture tax. 6 There
will also be cuts on development projects through ‘reprioritisation’, depending on loans from
elsewhere. To provide support to the poor and vulnerable, spending on the social safety net
will be increased from 0.6 to 0.9 percent of GDP in FY2009 with the help of the World Bank.
The IMF arrangement also stipulates tightening the country’s monetary policy, bringing
down inflation to six percent in FY2010 and ensuring zero government borrowing from the
central bank. These measures too are in congruence with the State Bank of Pakistan’s (SBP)
announced monetary policy goals. In fact, the SBP has raised interest rates three times since
January 2008, reaching 15 percent in November 2008.
Nevertheless, inflation remains uncontrollable. While food and energy inflation is expected
to come down with the easing of supply shortages and a fall in international oil prices, the
persistent acceleration in core inflation remains a matter of concern. By October 2008, the
year-on-year non-food-non-energy core inflation rose to 18.3 percent from 13 percent in June
2008.7 If this trend continues, the FY2009 inflation could reach 21 percent, far above the
target of 11 percent set for the current year, according to the IMF and the SBP estimates.
The Debate
Pakistan is in a ‘Catch-22’ situation. As a matter of fact, the current inflationary pressures are
largely due to higher government borrowings, besides exogenous price shocks. However, the
5
8 “Pakistan’s Plan C, Does the IMF has no Fresh Ideas?”, The Wall Street Journal, 28 October 2008.
http://online.wsj.com/article/SB122513397704572755.html?mod=relevancy
9 “Interim Monetary Policy Measures”, State Bank of Pakistan, November 2008. http://www.sbp.org.pk/m_
policy/MPS-MAY-FY08-EN.pdf
10 “IMF Executive Board Approves US$7.6 billion Stand-By Arrangement for Pakistan”, International
Monetary Fund”, 24 November 2008. http://www.imf.org/external/country/PAK/index.htm
measures taken (revoking subsidies, increasing sales tax, etc.) to arrest growing fiscal deficit
are fueling inflation. The large external account deficit and slowdown of capital inflows, due
to domestic turmoil and international crisis, are also exerting pressure on the Rupee, which
has depreciated 25 percent in six months. The net effect of depreciation in value of the
Rupee, in the presence of huge inflation, has exacerbated inflation by raising input costs.
Moreover, the recession in Pakistan’s top export markets is also likely to hurt export growth.
The IMF has already reduced Pakistan’s GDP growth projections to 3.5 percent in FY2009.
This vicious cycle is likely to cause a less than expected revenue generation and a more than
targetted fiscal and current account deficit.
In view of such a situation, a contractionary monetary policy and austere fiscal measures are
not enough. Many analysts in Pakistan and abroad have criticised the IMF and the Pakistan
government. A case in point is an editorial in the Wall Street Journal (WSJ) saying,
“Pakistan needs market-oriented reforms along the Chilean and Irish models, not the IMF’s
austerity prescriptions.”8 Though many in Pakistan may not agree with the alternative
suggested by the WSJ, there is an increasing concern over the high interest rates, cuts on
development expenditure and the increase in taxes.
The IMF and the Pakistani authorities, on the other hand, are of the view that the economic
crisis in Pakistan is different from global developments where many developed and
developing countries have gone for fiscal stimulus and monetary easing. In contrast,
Pakistan, says the SBP report,
“...hit by the global commodity price shock and given the delays in pass
through of this price effect, witnessed a growth in its fiscal and external
current account deficits that reached unsustainable levels and alarmingly high
inflation. With stagnating tax to GDP ratio, this not only enhanced recourse to
borrowings from the SBP but also resulted in a fall in foreign exchange
reserves, triggering depreciation in the exchange rate. Since there are
significant differences in ‘diagnostics’ among Pakistan and other countries it
must be recognised that the policy solutions will also be different.”9
The IMF pointed out in its press statement that “the program and its conditionality is based
on the targets and measures that the authorities have themselves set for the next two years.
The IMF is convinced that the best implemented programs are the ones that are home grown
and fully owned by the country”. Alongside the IMF’s financial support, “there is an urgent
need to mobilise additional donor support to strengthen Pakistan’s resilience to potential
shocks, help finance the expanded social safety net, and allow for higher spending on
development programs”, said the statement.10
To be fair, the above ‘conditions’ have nothing to do with the current IMF loan and were on
the government’s agenda earlier. Nevertheless, the Fund’s oversight will restore some
confidence in the economy. At the moment, Pakistan’s foreign credit rating is practically at
rock bottom. Standard & Poor’s has lowered Pakistan’s foreign credit rating three times in
67
the current year to ‘CCC’, eight levels below investment grade and it has kept Pakistan on the
watch list. Both the IMF and the Pakistani authorities are hoping that investor confidence will
be restored and foreign capital will start flowing in.
There has also been an intensive debate in Pakistan in favour of and against the expected IMF
‘conditions’. Two such reported ‘conditions’ included the cuts on defence expenditure and
the imposition of an agriculture tax. However, in reality, there were no discussions
whatsoever on the defence budget in the negotiations with the Fund11 while the tax on
commercial agriculture was set as a medium- to long-term agenda. In fact, tax on commercial
agriculture in Pakistan is less likely to hurt the poor than the feudal landlords. There have
been calls for an agriculture tax for a long time but this has always been put down by the
powerful landowners who also sit on the legislative benches.
Conclusion
Apart from the Musharraf regime, no other Pakistani government has been able to meet the
benchmarks of economic reforms imposed by the Fund since the first agreement between the
IMF and Pakistan in the 1980s. This has resulted in the premature termination of these
agreements. The Musharraf regime owed its performance to its undemocratic origins and to
indirect (and direct) assistance from the United States.
It remains to be seen if Pakistan will abide by the IMF conditions this time around. How
these measures would help or hurt the economy depends on several factors, including oil and
food prices, the global financial crisis, and Pakistan’s domestic security and its political
situation. In the final analysis, much would depend on Islamabad’s ability to quell militancy
and keep Washington and other donors on its side by providing stable and secure business
climate through good governance.
ARTICLE NO 11 :
Preface
This paper was prepared by a staff team including Patricia Alonso
Gamo, Udaibir Das,
Thomas Helbling, Rolando Ossowski, Kate Langdon, Jan Kees Martijn,
Stefania Fabrizio,
Shamsuddin Tareq, Mary Zephirin, Julie Kozack, Paul Jenkins, Paulo
Drummond, Paolo
Dudine, Pritha Mitra, Aurelie Martin, Felipe Zanna, Samar Maziad,
Alejandro Hajdenberg,
Abdoul Aziz Wane, Ding Ding, Peter Kunzel, Bozena Elzbieta
Radzewicz-Bak, Vahram
Stepanyan, Barbara Dabrowska, Aminata Toure, and Maria Coelho.
The project was overseen by Hugh Bredenkamp, Sanjeev Gupta,
Jonathan Ostry, and
Christopher Towe.
The views expressed in this paper do not necessarily reflect the views of
the Executive
Directors of the IMF, or national authorities. vii
Executive Summary
The global financial crisis is expected to have a major impact on low-
income countries
(LICs), especially in sub-Saharan Africa—and urgent action is required
by LIC policymakers
and the international community. The crisis is projected to increase the
financing needs of
LICs by at least US$25 billion in 2009, and much larger needs are
possible. Twenty-six LICs
appear particularly vulnerable to the unfolding crisis. Additional
external assistance and
foreign financing will be essential to mitigate the impact of the crisis on
LICs. The Fund is
deploying its own financing facilities for LICs, while making efforts to
sustain and catalyze
additional assistance from other institutions and donors. Fund financing
to LICs has already
increased significantly; new financing arrangements jumped from 5 in
2007 to 23 in 2008,
representing an increase in total (GRA and PRGF/ESF) disbursements
from US$0.6 billion
to US$5.4 billion. The Fund has also launched a broad examination of
its LIC facilities and
financing framework to ensure its financial assistance meets the diverse
needs of its lowincome members.
The global economy is in the midst of a deep downturn, affecting the
real and financial
sectors, that is taking its toll both in advanced and in emerging and
developing countries. All
major advanced economies are in recession, while activity in emerging
and developing
economies is slowing abruptly.
LICs are exposed to the current global downturn more than in previous
episodes, as they are
more integrated than before with the world economy through trade,
FDI, and remittances.
The crisis significantly impacts these countries through reduced
demand for their exports.
Since many are commodity exporters, they will be hard hit by the sharp
decline in demand
for commodities and in their prices. Many LICs are also hit by lower
remittances and foreign
direct investment (FDI) while aid flows are under threat. Growth of
remittances was flat in
the second half of 2008, and is expected to be negative in 2009. A sharp
slowdown in FDI is
expected in about half of all LICs. Prospects for higher aid to offset
these effects are
particularly uncertain, given budgetary pressures faced by many donor
countries.
LICs’ financial systems have so far not been strongly affected by the
global crisis. Their
banks have little, if any, exposure to complex financial instruments.
However, those LICs
that had begun to access international financial markets have seen this
access come virtually
to an end. Foreign lenders may become more reluctant or unable to roll
over sovereign and
private debt falling due. Domestic banks may be hit by second-round
effects, as the economic
downturn increases the number of borrowers unable to repay their
loans.
The global financial crisis will worsen the budgetary position of many
LIC governments.
Government revenues are expected to suffer as economic activity slows
and commodity
prices fall. Potential declines in donor support and tighter financing
conditions will likely
impose further pressures on LICs’ budgets. At the same time, many
countries will need to
increase spending to protect the poor, and additional spending
pressures may arise from
currency depreciation and rising interest rates, which could raise debt
service costs. viii
There is a risk that the impact on LICs could be more serious—26
countries appear
particularly vulnerable to the unfolding crisis. These include countries
heavily dependent on
commodity exports, such as oil exporters, as well as fragile states with
little room for
maneuver. Baseline projections for 2009 foresee a total balance of
payments shock of
US$165 billion. They also suggest that LICs may need at least US$25
billion to offset the
impact of the shock on their international reserves; given the heavy
downside risks to the
forecast, the needs could be much larger—approaching US$140 billion
in a “bad case”
scenario.
Countries in initially strong budget positions may have some scope to
accommodate the
cyclical fiscal deterioration and, in some cases, to increase spending to
cushion the impact of
the crisis. These are countries without public debt sustainability and
financing constraints
that have achieved macroeconomic stability. Commodity producers that
built up financial
cushions during the boom may be able to maintain spending or adjust
gradually.
In many LICs, however, the ability to offset adverse shocks through
spending hinges on
higher donor support. With many countries facing binding fiscal
constraints, and the outlook
for significantly increased bilateral aid flows unlikely, many countries
will need to
rationalize spending and increase its efficiency to create fiscal space for
protecting social and
MDG-related spending. Efforts will also be required to strengthen
revenue mobilization.
Given the economic downturn, efforts to strengthen safety net programs
to protect the poor
become more urgent. Transfer programs that effectively target the
poorest often result in a
larger stimulus to aggregate demand, given their higher propensity to
consume. The capacity
of many LICs to put in place new targeted programs will be limited in
the near term. There
may be scope, however, to scale up existing spending programs in
targeted ways. For
example, countries can implement public works programs and/or
provide income
supplements through existing programs. Additional resources can be
channeled to targeted
programs, such as targeted food distribution or school meal programs.
Countries should focus on macroeconomic stability. In some countries
with falling inflation
there may be scope for monetary easing; others, however, still
experience continued or
renewed price pressures. Those with flexible exchange rates should
allow them to move, so
that they function as shock absorbers. Fixed exchange rate regimes may
come under
particular pressure owing to the adverse direct impact of the crisis.
Steps are also needed to
prevent the global financial crisis from spreading to their domestic
financial sectors.
The Fund is assisting members in their crisis planning and response
efforts and will continue
to adapt its financial toolkit and policies to better serve its low-income
members. The Fund
will provide financial support to LICs that responds to their economic
circumstances, the
nature of the balance of payments problem, and their existing program
relationship, if any,
with the Fund. LICs’ demand for Fund financing has already increased
in 2008 and will
likely increase further, as will technical assistance needs. 1
I. Introduction
The global financial crisis has spread rapidly since the fall of 2008,
leading to a
global downturn of uncertain severity and duration. The impact of
financial sector turmoil on
real activity has become increasingly evident, propagating beyond its
initial epicenters to
affect other advanced economies, emerging markets, and LICs.
This paper analyzes the impact of the global financial crisis on LICs.
1
It provides an
overview of the possible impact of the crisis on the short-term
macroeconomic outlook. To
assess the magnitude of the effects, the paper compares current
(January 2009) projections
with those made before the crisis. In addition, simulations illustrate the
heavy downside risks
to these projections.
While for many LICs the effects of the crisis have lagged the rest of the
world, its
eventual impact may be severe, especially given their often limited scope
for countercyclical
policies. Many LICs have made great strides in strengthening their
policy frameworks and
robustness to shocks, reducing poverty, and reforming their financial
systems. But many
remain highly vulnerable to a deep global downturn that so closely
follows the 2007/08 food
and fuel price shocks. Financial market linkages are generally weak, but
second-round effects
of the economic slowdown on the financial system could be particularly
severe. Without
additional aid, the scope for countercyclical policies is limited for most
LICs due to binding
financing constraints and fragile debt positions. This could both deepen
and prolong the crisis
in LICs, and set back the fight against poverty.
Against this background, the paper provides policy advice on how best
to address the
impact of the crisis on LICs and describes the Fund support. The Fund
assists countries in
designing policies to support growth and mitigate risks to the financial
system. The Fund is
also deploying its own financing facilities for LICs, while making efforts
to sustain and
catalyze additional assistance from other institutions and donors.
The paper is structured as follows. Section II discusses the outlook for
global
economic growth and commodity prices, while Section III provides an
overview of the
changes in economic projections associated with the crisis. The various
financial channels
and spillovers from the global downturn are discussed in Section IV.
Section V analyzes the
fiscal and debt sustainability implications of the crisis. Country
vulnerabilities are
investigated in Section VI. Policy recommendations to help countries
weather the crisis are
considered in Section VII, with LICs’ potential additional financing
needs assessed in
Section VIII. Finally, Section IX concludes with a review of ways in
which the Fund can
assist its LIC membership.
1
Generally, references to LICs in Fund documents relate to all 78 PRGF-
eligible countries. However, because of
data limitations, and unless indicated otherwise, data for LICs reported
in this paper refer to the more limited set
of 71 countries listed in Appendix I. 2
II. Outlook for Global Growth and Commodity Prices
The global economy is in the midst of a deep downturn as an adverse
feedback loop between
the real and financial sectors is taking its toll both in advanced and in
emerging and
developing countries. As a result, commodity prices are unlikely to
recover in the short run.
All major advanced economies are in
recession, while activity in emerging and
developing economies is slowing abruptly.
Continued deleveraging by the financial sector
and dramatic declines in consumer and
business confidence have triggered a sharp
deceleration in domestic demand across the
globe. World trade and industrial activity are
falling sharply, while labor markets are
weakening at a rapid pace, particularly in the
United States. The decline in commodity prices is providing some
support to commodity
importers, but is weighing heavily on growth in commodity exporters.
Global growth is set to weaken
considerably. Activity is expected to
decelerate from 3½ percent in 2008 to ½
percent in 2009 before embarking on a gradual
recovery in 2010.
2
The advanced economies as a group
are facing their sharpest post-war contraction.
The euro area and Japan have been hard hit by
the decline in external demand, while
uncertainty about the course of the economy is dampening consumption
and business
investment in the United States. Activity in these countries is now
expected to contract by 2
percent in 2009, followed by a modest rebound in 2010.
Growth in emerging and developing economies is also slowing sharply.
Financing
constraints, lower commodity prices, weak external demand, and
associated spillovers to
domestic demand are expected to weigh on activity. As a result, growth
is projected at 3¼
percent in 2009—a markdown of 3¼ percentage points compared with
the April 2008 WEO
and less than half the pace in 2007—before rebounding to around 5
percent in 2010.
2
In line with WEO conventions, data reported in this section are country
averages weighted by GDP valued at
PPPs, and may differ from averages mentioned in other parts of the
paper.
-4
-2
0
2
4
6
8
10
80 85 90 95 00 05 10
Real GDP Growth and Trend
(Percent change)
Emerging and
developing economies
Advanced economies
Source: Fund staff calculations.
-18
-12
-6
0
6
12
18
00 01 02 03 04 05 06 07 08
World
Advanced
Emerging and developing
Industrial Production 1/
Sources: Global Data Source; and Fund staff calculations.
1/ Annualized percent change of 3-month moving average over
previous 3-month average.3
x Countries in central and eastern
Europe and the Commonwealth of
Independent States have been hit
particularly hard by capital flow
reversals and, in some countries,
falling commodity prices. Activity is
expected to contract by ½ percent in
2009.
x Commodity exporters, particularly
in Latin America, Africa, and the
Middle East, face a sharp decline in commodity prices, putting pressure
on
external accounts and government finances. In Latin America, growth
is also
constrained by weaker external demand (notably from the United
States) and
tighter financial conditions, and is expected to slow from 4½ percent in
2008 to
1 percent in 2009.
x For countries in emerging Asia—including China—terms of trade
improvements
from falling commodity prices and macroeconomic policy easing will
not prevent a
significant slowdown as export demand weakens and investment is cut
back.
Overall, growth in this region would decline from 7¾ percent in 2008 to
5½ percent
in 2009.
With growth well below trend in emerging and developing economies,
commodity
prices have collapsed over the past few months. Expectations of
resilience in these
economics had underpinned commodity prices for much of 2008, but
hopes for “decoupling”
have since evaporated. Commodity prices tend to be significantly
cyclical, as output
contraction in commodity-intensive sectors exceeds that in other sectors.
Financial turmoil and U.S. dollar appreciation have exacerbated the
downward
price momentum. Investors have sought to reduce their holdings of
commodity assets,
given increasing concerns about counterparty risks (many standard
commodity
investment instruments such as total return swaps involve such risks),
decreasing
availability of credit for leveraged commodity market exposure (e.g., by
hedge funds), a
rising preference for liquidity, and sizable recent appreciation of the
U.S. dollar in nominal
effective terms.
Commodity prices are unlikely to recover while global activity is
slowing.
x OPEC production cuts could eventually help to support oil prices if
implemented
close to target, as scope for increased production elsewhere seems
limited.
Nevertheless, still softening demand and rising inventories will continue
to weigh on
the market in the short term.
30
90
150
210
270
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09
30
60
90
120
150
Daily Commodity Price Indices
(December 31, 2008 =100)
Sources: Bloomberg, and Fund staff calculations.
Metals
(left axis)
Oil (APSP,
$/barrel
right axis)
Food (left axis)4
Selected Commodity Prices
(January 2004=100)
50
100
150
200
250
300
350
400
450
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Dec-10
Food
Metals
Energy
x Near-term metals price prospects depend
on construction and investment demand
in key emerging and developing
economies.
x Food prices are likely to be less affected
by the slowdown since food demand is
less income-elastic than other
commodities. Lower prices for energy
inputs will likely lead to some further
easing of prices, although the high fuel
and fertilizer prices through mid-2008
may weigh on supply in 2009.
Lower commodity prices and increasing
economic slack will help to contain inflation
pressures. In the advanced economies, headline
inflation should decline to below ¼ percent by
the end of 2009, and deflation risks are
becoming an increasing concern in some
countries. In emerging and developing
economies inflation is also expected to moderate.
III. How Are LICs Affected? An Overview
The global financial crisis is expected to have a severe impact on growth
and external
stability in many LICs. At the same time, inflationary pressures are
receding in most
countries. The crisis follows the commodity price shocks of 2007–08,
putting at risk an
extended period of improved macroeconomic policies and performance
through mid-2007
(See Box 1).
Going into the global financial crisis, the balance of payments of many
LICs had
already been severely weakened by the 2007–08 spike in global fuel and
food prices.
Between January 2007 and July 2008, LICs faced a food price shock,
which peaked in mid-
2008, of almost 1 percent of GDP, and a fuel price shock averaging
almost 3½ percent of
GDP. As a result, some 33 out of a group of 78 LICs were identified as
particularly
vulnerable, with reserve cover falling below 3 months of imports.
3
3
IMF (2008a).
0
2
4
6
8
10
12
00 01 02 03 04 05 06 07 08 09 10
Headline Inflation, 2000-2010
(Percent change from a year earlier)
Advanced
Emerging and developing
PRGF-eligible5
80
85
90
95
100
105
110
2007 2008 2009
LIC Reserves in Months of Imports
(Index, 2007=100)
Pre-shock (Spring 2008 WEO)
Post-shock
(Current projection)
Sources: WEO database; and Fund staff calculations.
The current crisis is expected to have serious adverse effects on LICs,
albeit with a
lag relative to the impact on more advanced economies. To date, many
LICs have seemed
fairly resilient to financial crisis, reflecting the still limited nature of
cross-border linkages in
their banking systems. However, the picture is expected to worsen as the
lagged effects on
real activity around the world feed through to LICs. In this context, the
fact that domestic
rather than export-driven agriculture accounts for a large share of the
economy in many
countries (particularly in Africa) might help attenuate somewhat the
impact of the crisis.
The emerging macroeconomic pressures are evident from the sharp
changes in the
economic projections for 2009 (Figure 1, and Appendix II). These
revisions—which remain
subject to much uncertainty, with risks mainly on the downside—reflect
both direct financial
effects of the crisis and the repercussions of global economic downturn.
x Growth projections for 2009 have been revised down since the spring
of 2008, from
6.4 percent to 4.3 percent, on average.
x Trade balance and current account projections are shaped by the
collapse of
commodity prices, and the anticipated adverse effects of the crisis on
LIC exports and
remittance inflows. While the net effect could be benign for some net
food and fuel
importers, the impact is decidedly negative for commodity exporters.
x Financial inflows are subject to large downside risks. For many LICs,
current
projections show a clear adverse effect of the crisis on inflows of foreign
financial
and direct investment, and on aid.
x Reflecting the above, projected
reserves accumulation by LICs in
2009 has declined significantly
since the April 2008 WEO, with
reserves now projected to fall from
4.4 to 4.2 months of imports in
2009, on average, compared with
previous projections of an increase
of 0.3 month.
x Inflation is expected to drop
sharply in 2009 from the peaks seen in 2008. Following the food and fuel
price
shocks, inflation spiked upwards in 2008, rising in many LICs to more
than 20
percent. With the recent declines in food and fuel prices, these initial
pressures are
receding. Falling demand in the wake of the global crisis will help lower
inflation
further. The latest projections show median inflation declining from
11¼ percent in
2008 to 7¾ percent in 2009—which remains above earlier projections. 6
Box 1. The Pre-Crisis Recovery
In many LICs, the years leading up to 2007 witnessed a strong recovery
in growth, while long-standing
challenges of high inflation and high debt were also successfully tackled.
Fiscal and current account deficits
were put on a downward path (except to reflect the spending of stepped
up aid), and international reserves were
raised to their highest level in decades (Appendix II, Figure 1). All of
this was accomplished, in varying degrees,
through a combination of better macroeconomic policies, higher aid,
debt relief, and the support of more
conducive global economic conditions (including better terms of trade).
Sources: WEO database, and Fund staff calculations.
1. Emerging and developing countries.
Real GDP Growth, 1980-2008
LICs
average
World
average 1/
-4
-2
0
2
4
6
8
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
Inflation, 1980-2008
LICs
median
World
average 1/
0
5
10
15
20
25
30
35
40
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
The improvement in macroeconomic conditions was fairly broad-based,
but particularly strong for African
countries, debt relief recipients, and (more recently) net oil exporters.
African countries saw their growth rates
almost double between the 1990s and the 2000-07 period (Appendix II,
Figure 2). In recent years, net oil
exporters saw sharp improvements in macroeconomic conditions
alongside large terms of trade gains.
However, the increased openness that has contributed to the improved
performance has also increased
exposure to external shocks. The accumulated macroeconomic gains
will assist LICs in withstanding economic
shocks: higher reserves permit countries to address temporary
financing shortfalls, while lower initial deficits
and debt create fiscal space for countercyclical policy. At the same time,
increased trade and financial links with
the outside world also imply greater dependence on external conditions:
exports now amount to more than a
third of GDP in LICs (from just 10 percent in 1990); FDI is close to 5
percent of GDP, a roughly five-fold
increase from 1990; and several LICs have gained access to financing on
international markets (see Section IV).
Remittances, FDI, and Exports
(In percent of GDP)
0
10
20
30
40
Remittances FDI/GDP Exports/GDP
1990-1999 2000-2007 2007
Sources: World Bank GDF, Fund WEO database, and staff
calculations.7
-5
-3
-1
1
3
Commodity
exporters
Non-commodity
exporters
All low-income
countries
2008 2009
1/ Including grants.
Average Overall Fiscal Balance by Country Groups
1/
, 2008
and 2009 (In percent of GDP)
Figure 1. The Changed Outlook for 2009
(Period averages, in percent, unless otherwise indicated)
GDP Growth (Percent)
0
2
4
6
8
10
All LICs SubSaharan
Africa
Asia Middle
East and
Europe
Latin
America
WEO Spring 2008
Latest projections
Inflation (Median, percent)
0
2
4
6
8
10
12
All LICs SubSaharan
Africa
Asia Middle
East and
Europe
Latin
America
WEO Spring 2008
Latest projections
Export Volumes (Percent change)
0
5
10
15
20
All LICs SubSaharan
Africa
Asia Middle
East and
Europe
Latin
America
WEO Spring 2008
Latest WEO
Terms of Trade (Percent change)
-15
-10
-5
0
5
10
All LICs SubSaharan
Africa
Asia Middle
East and
Europe
Latin
America
WEO Spring 2008
Latest projections
Current Account Deficit
(In percent of GDP)
0
5
10
15
20
All LICs SubSaharan
Africa
Asia Middle
East and
Europe
Latin
America
WEO Spring 2008
Latest projections
Reserves (In months of next year imports of
goods and services)
0
2
4
6
8
10
All LICs SubSaharan
Africa
Asia Middle
East and
Europe
Latin
America
WEO Spring 2008
Latest projections
The overall fiscal balances of
LICs are projected to deteriorate on
average by about 2½ percentage points
of GDP in 2009. The outlook varies
substantially across countries.
Commodity exporters are expected to
experience some of the largest negative
shifts in fiscal positions—by 5 8
percentage points of GDP, on average—due to significant revenue
declines.
4
The balances of
non-commodity exporters are expected to deteriorate on average by
close to 1 percentage
point of GDP, mainly due to their maintaining spending in the face of
lower growth and
revenues.
5
The global financial crisis could—in principle—lead to large exchange
rate
adjustments in LICs, but a number of attenuating factors may work to
limit prospective
depreciations. First, almost two-thirds of LICs have fixed exchange rate
regimes (including
countries with de facto pegs), shifting the burden of external adjustment
onto fiscal and
monetary policies. Second, import demand will tend to drop, not only as
a result of slower
growth but also because some declining inflows (such as FDI) have a
heavy import
“content.” And, third, import bills will shrink as a result of lower food
and fuel prices.
IV. The Impact of the Crisis: The Channels
The direct impact of the global financial crisis on LICs will be stronger
for countries with a
higher degree of financial integration. For most, this channel has played
a limited role so
far, though strains are starting to appear. But, the slowdown in global
growth will reduce
trade, remittances, foreign direct investment, and, possibly, aid, and
these factors will have a
major impact on LICs, including second-round effects on the financial
sector.
Direct Financial Channels
Structures and financial system conditions vary vastly across the LICs.
Despite
several initiatives for financial sector reform over the past decade, entry
of foreign financial
institutions, and the emergence of private external creditors and
investors, the breadth,
diversification, and competitiveness of LICs’ financial systems remain
shallow and
distortionary. Most have small derivatives and interbank markets, low
level of reliance on
international capital, and regulatory barriers constraining new financial
products and market
entry by new institutions.
As a consequence, thus far, the direct financial transmission of the
global crisis
appears to have been relatively limited. However, emerging signs that
the crisis is spreading
to LICs are evident, in particular, for those that had begun to access
international capital
markets (for example, Ghana and Sri Lanka), or where direct and
indirect foreign financing
4
Some oil producers like Angola, Azerbaijan, and the Republic of Congo
may suffer less due to rising oil
volumes.
5
This result is similar to the average projected deterioration in the fiscal
balance of non-commodity exporters
that are faced with below-trend growth, when the elasticities are
assumed to be one for revenues and zero for
expenditures and automatic stabilizers are allowed to work. 9
in local markets was on the rise (Kenya, Nigeria, Malawi, Ghana,
Uganda, and Zambia). The
global downturn and ongoing stress in the international credit markets
are curtailing private
capital inflows in a number of LICs (e.g. Uganda and Zambia) and the
operations of foreign
banks in the local markets, creating funding pressures in banking
systems.
6
LICs are
experiencing outflows of capital, and there are initial pressures on
foreign exchange markets
and the yield curve. The financial crisis is also sharply reducing private
sector credit, in
part reflecting banks’ need to increase liquidity buffers given expected
cuts in external
credit lines.
As the negative effects from a slowdown in the real sector gain ground,
the pressures
on financial systems are likely to rise. These second-round effects could
affect the corporate
sector, the balance sheets of banks, as well as the sovereign, placing
further pressure on
LICs’ ability to manage the fallout of the crisis. As domestic economic
conditions
deteriorate, the financial condition of the banks may deteriorate
rapidly, as borrowers’
capacity to repay is impaired, and banks’ funding bases shrink. Also,
exchange rate
depreciation could expose some bank borrowers to exchange rate risk,
or raise their costs of
operation, with negative effects on loan recovery performance.
Impact on Domestic Banks and Non-Bank Financial Institutions
To date, the direct impact on LICs’ banking systems remains modest.
The existence
of capital controls in several countries and structural factors have
helped to moderate both the
direct and the indirect effects of the financial crisis:
x Banking systems have little exposure, if any, to complex financial
instruments. This
has resulted in fewer exposures and risks of potential losses;
x Abundant low-cost domestic deposits and liquidity. This has allowed
banks to finance
themselves with domestic funds and thereby minimize wholesale
leverage on their
balance sheet. Many banks are highly liquid and, owing to weak
competition, have
high profit margins contributing to a buildup in capital buffers.
That said, some erosion can be expected in the quality of banks’ asset
portfolios as
well as in their financial performance. In a number of countries, the
financial soundness
indicators published in the third quarter of 2008 show some weakening
of nonperforming
loan (NPL) ratios, reversing past trends. Although, on average, banks'
profits remain high,
intensifying bank competition to retain deposits is likely to reduce
interest spreads
(Cambodia, Mongolia, and Pakistan).
7
6
There is also evidence of portfolio inflow reversal and capital flight,
even in countries with capital restrictions
(e.g., Kenya, Tanzania, and Nigeria).
7
Fitch Rating Reports (November 2008). 10
0
25
50
75
100
Lesotho
Djibouti
Albania
Guinea
El Salvador
Zambia
Mozambique
The Gambia
Uganda
Togo
Cape Verde
Benin
Senegal
Mali
Niger
Pakistan
Ghana
Tanzania
Kenya
Kyrgyz Rep.
Cambodia
Cote d’Ivoire
Moldova
Sri Lanka
Haiti
Nigeria
Foreign Ownership in LICs' Banks, 2008Q2
(In percent of the country's total banking assets)
Sources: Moody's and S&P, and Fund staff calculations.
Burkina Faso
2006 2008Q3 2006 2008Q3 2006 2008Q3 2006 2008Q3 2006 2008Q3
Armenia 34.9 27.2 3.6 2.9 15.9 13.1 2.5 3.9 51.5 35.1
Azerbaijan 18.7 17.7 1.3 2.2 9.9 18.7 6.6 2.3 … …
Cambodia 26.5 25.6 2.8 3.1 14.2 15.8 9.9 2.7 41.7 38.6
Ghana 15.8 15.4 4.8 3.6 39.6 31.5 7.9 8.7 46.3 39.1
India 12.4 12.7 0.9 1.0 … … 3.5 2.4 … …
Kenya 10.6 11.2 2.8 3.2 28.6 33.7 15.0 8.1 30.5 38.6
Kyrgyz Republic 28.5 30.8 3.4 3.8 23.2 20.4 6.2 4.1 77.8 81.0
Lesotho 19.0 15.0 2.0 2.4 27.0 31.7 2.0 3.5 … …
Moldova 27.9 30.8 3.4 4.1 20.5 23.3 4.4 4.6 33.5 31.4
Nigeria 22.6 22.0 1.6 2.4 10.4 13.9 8.8 6.1 32.5 31.0
Pakistan 12.7 13.4 2.1 2.0 23.8 20.6 6.9 7.4 31.9 34.0
Vietnam 6.6 7.4 1.5 1.5 … … 2.6 2.5 14.4 14.0
Zambia 20.4 17.0 5.1 5.0 30.6 36.6 11.3 6.0 41.3 32.8
Sources: National authorities, and Fund staff calculations.
1/ Regulatory capital to risk - weighted assets.
2/ Return on average assets.
3/ Return on average equity.
4/ Non-performing loans to gross loans.
5/ Ratio of liquid assets to total assets.
Note: Due to differences in national accounting, taxation and
supervisory regimes, FSI data are not strictly
comparable across countries.
Table 1. Selected Financial Soundness Indicators in LICs
Liquidity ratio
5/
CAR
1/
ROA
2/
ROE
3/
NPLs ratio
4/
Furthermore, prolonged liquidity pressure in domestic financial
markets is beginning
to have an impact on several LICs’ banking systems. Increasing
interlinkages between banks
and local capital markets as well as weaknesses in banks’ risk
management have begun to
expose banks to market volatility, particularly in countries where high
equity returns had
encouraged borrowing for investing in the stock market (Nigeria and
Kenya). At the same
time, as banks’ own share prices have fallen, their cost of capital has
gone up, which will
constrain their ability to grow.
Given the prevalence of foreignowned banks, LICs may face difficulties
from withdrawal of funds by their parent
companies. Countries with licensed
subsidiaries of foreign banks, rather than
branches, may be better positioned to
detect potential risks of capital
withdrawal, as their local operators are
subject to local supervision.
8
8
Among the typical channels through which such withdrawals take place
are (i) subsidiaries asked to sell
profitable loans in order to increase the capital-asset ratio on a
consolidated basis; and (ii) shift in deposits from
subsidiaries to headquarters. Where there is sufficient liquidity and
foreign exchange availability, foreign banks
have reduced their shareholding in foreign subsidiaries by selling to
domestic investors. 11
2006 2007 2008Q3 2006 2007 2008Q3
Armenia 183.5 475.2 687.4 234.2 311.6 357.3
Azerbaijan 235.5 973.3 1,978.2 16.0 5.9 10.2
Chad 100.1 120.6 205.4 75.7 162.9 198.9
Honduras 609.4 749.9 775.5 … … …
Lesotho 10.5 10.8 5.5 … … …
Liberia 22.2 13.3 12.7 0.9 1.0 …
Madagascar 39.0 50.5 87.8 264.8 281.1 280.9
Mali 171.9 225.2 … … … …
Niger 50.3 69.0 90.6 0.1 0.1 0.1
Sri Lanka 941.4 960.7 1,003.9 … … …
Sources : National authorities, and IMF staff estimates.
Table 2. Deposit Money Banks' Exposure to Foreign Creditors in
Selected LICs
(Millions of U.S. dollars) (Percent of liquid foreign assets)
Banks relying on foreign funding sources may also be subject to possible
rollover
risk. Lower availability of foreign capital due to tighter global liquidity
conditions may
hamper the ability of some banks to roll over maturing foreign
exchange obligations. This
situation may be worsened by tighter domestic financing in some LICs.
It has also become
increasingly difficult for many microfinance institutions to find foreign
sources of funds.
Some previously available foreign credit lines are now being cancelled.
9
Impact on Financial Markets
Access to International Markets and Costs of Financing
Access to market-based international financing was opening up to LICs
with
strong fundamentals, but it now appears to be closing. Sovereign
spreads have increased
dramatically for these countries, reflecting investor liquidity needs and
flight to higher
quality assets (i.e., U.S. treasury bills) rather than a negative credit
outlook—LICs’
sovereign credit ratings generally remained stable or even improved
during the second
half of 2008.
9
There have been fears that the failure of banks with liquidity/solvency
issues at home would require closure of
subsidiaries in low-income countries. In most cases, however,
guarantees by the parent country governments of
foreign banks have allayed these fears. The risk of sudden liquidity
withdrawal is also generally attenuated by
the low reliance on these markets by parent banks, as from a global
point of view the funds involved are small.
In some cases, foreign banks may prefer to leave their local interests
untouched for strategic reasons, such as
long-term prospects of the economy. The presence of exchange or
capital controls also tends to limit such
withdrawals. 12
LICs: Volume of Trade Financing
(In billions of USD)
2005
2006
2007
2008
-
2
4
6
8
10
12
14
16
Q1 Q2 Q3 Q4
Source: Dealogic Loan Analytics.
-
500
1,000
1,500
2,000
2,500
1/1/08 1/30/08 2/28/08 3/28/08 4/26/08 5/25/08 6/23/08 7/22/08 8/20/08
9/18/08 10/17/08 11/15/08 12/14/08 1/12/09
Source: Blo omberg.
In basis points)
Georgia
Ghana
Pakis tan
Sri Lanka
Vietnam
EMBI Global
Selected LICs with Market Access: EMBI Global Sovereign Spreads
(As of 01/26/2009)
Current market conditions have led several LICs to postpone their
issuance plans
(Albania, Kenya, Tanzania, Uganda, and Zambia), and roll-over and
liquidity risks are rising
(See Box 2).
10
This could also lead to an intensifying liquidity squeeze, in particular
for the
corporate sector which accounts for the bulk of the upcoming
maturities. Thus, the potential
for rollover risk is high, and LICs’ capacity to meet financial obligations
may be further
affected by reduced domestic resources as the crisis impacts the real
sector.
As global liquidity conditions have
tightened over the past few months, trade
financing has been adversely affected. The
financial crisis has constrained access to trade
financing (e.g., Lesotho, Pakistan, and Sri
Lanka) and put upward pressure on costs.
LICs’ volume of trade financing dropped by
18 percent in the last quarter of 2008.
10
For an in-depth review of recent debt management issues in LICs see
also joint IMF–World Bank Board paper
on “Managing Public Debt: Formulating Strategies and Strengthening
Institutional Capacity” March 2009
(forthcoming).
-
1
2
3
4
5
2009 2010 2011 2012 2013
Source: Dealogic.
1/ Includes callable bonds.
Sovereign
Supranational
Corporate
LICs-International Bonds
Oustanding Maturities
1/
(In billions of USD)
-
5
10
15
20
2009 2010 2011 2012 2013
Source: Dealogic.
Sovereign
Public Sector
Corporate Sector
LICs-Maturities Falling Due
on Syndicated Loans (In billions of USD)13
-
10
20
30
40
50
60
70
80
90
10 0
Q1-00
Q3-00
Q1-01
Q3-01
Q1-02
Q3-02
Q1-03
Q3-03
Q1-04
Q3-04
Q1-05
Q3-05
Q1-06
Q3-06
Q1-07
Q3-07
Q1-08
Q3-08
Source: Emerging M arket s Trading Associat ion (EM TA) .
1/ Both purchases and sales of assets in the secondary t rading market .
-
200
400
600
800
1, 0 0 0
1, 2 0 0
1, 4 0 0
1, 6 0 0
1, 8 0 0
Foreign Investors Trading of Local Debt
Instruments 1/ (In billions of USD)
Total EMs
(right axis)
Total LICs (left axis)
Box 2. Private Capital Inflows to Local Currency Sovereign Debt
Markets in LICs
Market participants indicate that nonresidents’ exposure in local LIC
markets is built not only through direct
position taking, but also through offshore derivative contracts. In
particular, nonresidents may engage in total
return swaps with residents, which at an agreed future date will deliver
the full return on the local LIC debt
security to the nonresident in exchange for another income stream
(often LIBOR plus a mark up). Given that the
balance of payments does not necessarily record a capital flow related
with such a transaction at the time of its
ratification, policymakers face a large degree of uncertainty as to the
magnitude of such exposures.
Risks associated with sizable nonresident investments in LIC local debt
markets are, however, qualitatively
different from those encountered in more developed markets. Several
characteristics of LICs and their debt
markets render these countries particularly vulnerable when private
external creditors suddenly run for the exit,
regardless of whether foreign investors reduce their exposure directly or
through the unwinding of derivative
contracts with domestic institutions: (i) domestic local-currency debt
typically involves very short maturities
reflecting factors such as a high susceptibility to exogenous shocks, the
lack of a strong macroeconomic track
record, and the absence of credible mechanisms to index the debt
instruments to inflation or GDP growth;
(ii) there tends to be a bunching of maturities due to an underdeveloped
yield curve and weaknesses in debt
management; (iii) investment risk often remains concentrated within
the domestic banking sector due to the lack
of a broader investor base; and (iv) the monitoring of investor sentiment
may be complicated by the fact that the
illiquidity of many financial markets delays the transmission of a
confidence shock to asset prices.
Over time, adverse balance sheet effects could affect the sovereign’s
solvency. As long as nonresidents remain
invested in the country, the net loss of interest income for the central
bank stemming from the large gap
between interest rates on domestic sterilization bonds and those on its
foreign assets would weaken the
institution’s profitability over time. When investor sentiment drops and
nonresidents sell their exposure, a
prolonged period of high interest rates combined with the realization of
contingent liabilities emanating from
the dynamics discussed below could turn a sovereign liquidity crisis into
a solvency crisis.
The spread for some trade financing widened in November 2008 to 500
bp over LIBOR from
80 bp a year earlier.
11
In trade transactions, customers are seeking longer repayment periods,
while banks are requesting more difficult terms and conditions.
Domestic Financial Markets
Domestic financing conditions are also
tightening in some LICs. Domestic interest
rates have increased considerably in a number
of LICs. The EMTA survey reports that,
between Q2 and Q3 of 2008, trades of local
debt by foreign investors had dropped 71
percent in LICs, compared to only 22 percent
for emerging market debt.
11
HSBC Global Research (November 2008). 14
Selected Equity Indices Performance
(As of January 26, 2009)
30
60
90
12 0
15 0
18 0
210
1/1/07 4/21/07 8/9/07 11/27/0 3/16/08 7/4/08 10/22/0
Source: Bloomberg.
Merrill Lynch Africa Lions Index
Selected LICs-Stock Markets Price
Indices (Dec-05 to Oct-08)
50
10 0
15 0
200
250
300
350
400
12/1/05 8/1/06 4/1/07 12/1/07 8/1/08
Source: S&P Emerging M arket s Dat abase.
Cote
d'Ivoire
Ghana
India
Kenya
Nigeria
Pakistan
Sri Lanka
Stock markets have similarly been impacted by the crisis. The Merrill
Lynch Africa
Lions Index, which tracks 15 African countries, declined by almost 70
percent during
March–December 2008. Exchanges in other LICs have fallen
considerably as well, reflecting
a decline in corporate valuations, particularly in sectors that are
vulnerable to the
retrenchment in global economic conditions.
12
12
These are typically export sectors. For instance, in the WAEMU region,
recent stock market declines have
particularly affected textiles, tourism, and agro-industrial sectors.
Vietnam
Jan-08
Dec-08
6
7
8
9
10
11
12
13
1Y 2Y 3Y 5Y 7Y 10Y 15Y
Tanzania
Dec -08
Jan-08
4
6
8
10
12
14
16
18
20
1M 3M 6M 1Y 2Y 5Y 7Y 10Y
Pakistan
Jun-08
Dec -08
8
10
12
14
16
18
20
2Y 3Y 5Y 6Y 7Y 8Y 10Y 15Y 20Y 30Y
Ghana
Jun-08
Dec -08
14
16
18
20
22
24
26
28
3M 6M 1Y
Selected LICs: Domestic Yield Curves
Source: Authorities' w ebsites.15
40
50
60
70
80
90
100
1983-1987 1988-1992 1993-1997 1998-2002 2003-2007
Sources: IFS, Direction of Trade Statistics, Fund staff calculations.
Share of LIC exports to
advanced economies
Openness and Trade Intensity in Low-Income Countries
(Averages, in percent)
Growth and Trade Openness
55
60
65
70
75
80
85
90
1991 1993 1995 1997 1999 2001 2003 2005
-4
-2
0
2
4
6
8
Source: WEO database.
Openness ratio
(left axis)
Average GDP growth
(right axis)
Openness
Spillovers from Global Recession
Reflecting their increased integration in the world economy, the global
recession is
expected to have a major impact on LICs (Boxes 3 and 4). LICs are
heavily dependent on
trade, which is shrinking because of lower global demand. Many LICs
will also be hit by
reduced remittances, and possibly lower aid. For net importers of food
and fuel, the negative
impact of these factors will be in part mitigated by the recent drop in
food and fuel prices.
The Trade Channel
Trade has become a significant source of growth in LICs over the past
20 years.
Trade openness, calculated as the ratio of the sum of exports and
imports to GDP, has
increased substantially since 1991 and has been accompanied by an
acceleration of growth.
Most LIC exports go to advanced economies, though this share has been
declining.
The structure of exports remains
highly concentrated on commodities. In the
past decade, the mean share of primary
commodities in the exports of LICs has
been close to 70 percent. The high
concentration on commodities may further
aggravate the impact of the global growth
slowdown on LICs, to the extent that the
demand for commodities is highly
procyclical, with implications for both
volumes and prices (WEO, 2001).
LICs are more exposed than in the past to a downturn in global demand
for services.
The share of services in total LIC exports has trended upward over the
past decade, the main
activities being transportation and tourism. For 29 countries in the
sample, services
0
20
40
60
80
100
1995-1998 1999-2002 2003-2006
Main Commodities Excluding Oil
Share of Commodities in Exports in Low Income
Countries (Averages, in percent)
Sources: UNCTAD Statistics, and Fund staff calculations. 16
accounted for at least 30 percent of exports in 2007, while 8 countries
are heavily dependent
on services receipts (ratio of services receipts greater than 70 percent of
exports).
13
The latest projections illustrate the
significant negative impact that LICs are
likely to face in 2009 via the trade channel
(Table 3). On average, projected current
account balances for 2009 have
deteriorated by about 3 percent of GDP
since the April 2008 WEO, with a more
pronounced decline in export growth than
in import growth. The terms of trade are
also projected to deteriorate, reflecting the
sharp drop in commodity prices. The
impact of declining trade in services, by contrast, appears limited.
Table 3. WEO Projections; Selected Indicators
2007
Spring WEO
Current
Proj.
Spring WEO
Current
Proj.
Goods
Exports (Percent of GDP) 26.6 26.8 26.5 26.6 21.8
Imports (Percent of GDP) 40.1 40.6 42.5 39.7 38.6
Services
Exports (Percent of GDP) 9.7 9.5 9.2 9.5 9.0
Imports (Percent of GDP) 12.2 11.8 14.2 11.2 13.6
Terms of trade (annual change in percent) 2.2 -0.4 -4.7 0.4 -0.7
2008 2009
Remittances
For many LICs, remittances constitute an important source of external
financing,
providing income to the poor and contributing to growth. At a global
level, while data are
weak, remittances are estimated to have increased at a double-digit
annual rate since the
1990s (World Bank, 2006). In the past, they have been relatively stable
compared to other
external flows.
14
Remittance flows vary substantially across countries and regions, both
from
the recipient and country of origin point of view (World Bank, 2008).
13
These include Cape Verde, Comoros, Djibouti, Dominica, Eritrea,
Grenada, Maldives, St. Lucia, and St.
Vincent and the Grenadines.
14
For example, in sub-Saharan Africa, remittances have been less volatile
than both official flows and FDI
(Gupta, Pattillo, and Wagh, 2009).
15
16
17
18
19
20
21
22
23
1991 1993 1995 1997 1999 2001 2003 2005 2007
LICs Share of Services in Exports,
and 5-year Averages17
Middle East
Asia
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1978 83 88 93 98 03 2008
Latin America
Africa
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1978 83 88 93 98 03 2008
CEE CIS
Output Comovements Between G-7 Countries and Emerging and
Developing Countries
(Rolling eight-year correlation windows)
Emerging
Asia
Emerging
-0.8 Mar kets
-0.4
0.0
0.4
0.8
1.2
1990 1993 1996 1999 2002 2005 2008
Source: Datastream; and IMF staff est imates.
1/ Twelve-month returns.
Stock Returns Comovement: Emerging
Markets and the G-7 Countries 1/
(Correlation; rolling 12-month w indow s)
Box 3. Comovements in Output and Financial Markets
Output fluctuations in emerging and developing
economies have been fairly synchronized with output
fluctuations in the G-7 countries over the past 15
years. These linkages are quite important—a 1
percent change in real GDP growth in the G-7
countries is associated with a 0.4 percent change in
growth in emerging and developing countries.
1/
For
LICs, correlations have closely tracked those of other
emerging and developing countries since the early
1990s.
The degree of correlation has varied substantially over time and by
region, reflecting idiosyncratic shocks in
both emerging and developing countries and the seven major advanced
economies. Notably, rolling moving
averages of these correlations indicate that the comovement between the
G-7 countries and emerging and
developing countries in Asia, Latin America, and the Middle East fell
markedly in the 1990s. This decrease
appears to stem from the diversification of export markets away from
the G-7 countries and the series of
emerging market crises in Asia and Latin America. However, output
synchronization between G-7 countries
and economies in these regions has increased steadily since the late
1990s. In Africa, central and eastern
Europe, and the Commonwealth of Independent States, comovements
increased sharply in the run-up to the
current crisis.
Financial channels
are also becoming
increasingly
important as
mechanisms through
which shocks are
transmitted between
advanced and
emerging
economies,
including LICs that
are “frontier”
emerging markets.
In particular, equity markets tend to be highly
correlated and the correlation between advanced and
emerging market equity prices has been rising over
time. With the exception of the bursting of the
dotcom bubble and initial divergence of equity
markets in the 2007 in the current crisis, the
correlation between G-7 and emerging economy
equity markets has been near one for much of the
past decade. As a result, capital flows—particularly
in regions that depend more heavily on portfolio
equity flows—are likely to be increasingly
procyclical.
1/See IMF (2001). World Economic Outlook, Chapter II.
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1978 83 88 93 98 03 2008
PRGF-Eligible
Emerging and
Developing
1/ Rolling eight-year correlation windows.
Output Comovements Between G-7 and Emerging and
Developing Countries 1/18
Box 4. Spillovers from the Rest of the World into Sub-Saharan Africa
(SSA)
Historically, SSA growth has moved quite closely with
global real GDP growth. As global growth slows, SSA
is affected mainly by lower real external demand for its
exports and declines in commodity prices and the terms
of trade.
To quantify the impact of a global slowdown on
individual African countries, a series of dynamic panel
regressions were estimated for countries in the region,
relating real growth in domestic output to world growth
in trade weighted by partner countries and to several
control variables: oil prices, non-oil prices, and country
fixed effects. The sample includes data for 40
countries, over the period 1970–2007.
Three key results stand out:
x A 1 percentage point slowdown in the rest of
the world has led to an estimated ½ percentage
point slowdown in SSA countries. The effect
is partly felt contemporaneously (0.2 percentage point) and partly in the
following year (0.3 percentage
point).
x A nonfuel commodity-price-induced income reduction by 10 percent
tends to reduce growth in subSaharan African exporters by about 1.5
percentage points after two years.
x An oil price shock tends to be significant only above a certain
threshold (5 percent change in prices). A
net oil importer in SSA (with oil imports of some 20 percent of GDP),
facing a decline in oil prices of
say 50 percent, could expect an increase in its growth rate by some 0.3–
0.4 percentage point.
The impact is linear on price changes above the threshold and on oil
intensiveness of the economy. It
appears symmetric for price increases and decreases.
These estimates reflect the average effects for the average country and
shock. While robust to different
specifications, three important caveats are in order. First, while the
cross-country regression estimates seem to
be broadly in line with structural cross-country regressions in the
literature, they explain only a small part of
the growth variation experienced by SSA countries. This is because a
broad range of domestic factors may be
at play, and may plausibly interact with the shock itself to determine the
effects; for example, the level of
reserves, the policy response, and the expected persistence. Second, the
specification does not control for the
financial channel. Third, estimates reflect short-term effects of changes
in the external environment on SSA
growth.
-2
0
2
4
6
8
1971 1976 1981 1986 1991 1996 2001 2006
Sub-Saharan Africa and the World: Real GDP
Growth
1
(Percent)
World
Sub-Saharan
Africa
Source: IMF, World Economic Outlook.
1
Periods of U.S. recessions shaded (National Bureau of Economic
Research).19
95
100
105
110
115
120
2007 2008 2009
LIC Remittances index (2007=100)
Pre-shock (Spring 2008 WEO)
Post-shock
Sources: WEO database; and Fund staff calculation.
-5
0
5
10
15
20
Jan-07
Feb-07
Mar-07
Apr-07
May-07
Jun-07
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Source: The World Bank.
Honduras: Growth of Remittances
(12-month percent change)
0%
10%
20%
30%
40%
50%
Tajikistan
Lesotho
Guyana
Kyrgyz
Armenia
Albania
Grenada
Togo
Sri Lanka
2002 2007
ova ld o M
uras d on H
iti aH
l apeN
ua g cara Ni
h es da gl an B
ed er V epaC
l ag ene S
ssau Bi nea- i u G
ca i ni om D
eone L erra Si
3
6
9
12
15
18
2003 2004 2005 2006 2007
Average Remittances-to-GDP Ratio by Recipient
Regions, 2003-07
Top 20 Recipient Countries: Remittance Inflows
(In percent of GDP)
Latin America
Sub-Saharan Africa
Asia
Middle East/Europe
Source: The World Bank. Source: The World Bank.
Current projections show remittances stagnating in the second half of
2008, and
shrinking in 2009. The largest decline is expected in European, Asian,
and Pacific LICs.
Most recent evidence suggests that in some countries the decline in
remittances can be
substantial: in Honduras, for example, remittances declined by 4.5
percent in October 2008
(year-on-year).
Foreign Direct Investment
Over the past two decades, the
importance of FDI in LICs has grown
dramatically. On average, FDI in LICs has
quintupled (in percent of GDP) since 1990.
The sources of investment have also
diversified.
15
15
UNCTAD (2006).
FDI to LICs
0
1
2
3
4
5
6
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
0
200
400
600
800
1000
1200
1400
In percent of GDP
(left axis)
In millions of USD
(right axis)
Sources: WEO database; and Fund staff calculations.20
80
90
100
110
120
130
140
2007 2008 2009
LIC FDI Index
(2007=100)
Pre-shock
(Spring 2008 WEO)
Post-shock
FDI flows to LICs are expected to
shrink sharply. Empirical evidence
suggests that FDI in LICs is dependent
on the health of the origin country’s
economy.
16
The latest WEO projections
show FDI inflows for 2009 falling by
almost 20 percent from their 2008 levels,
compared to over 10 percent growth that
was projected in the April 2008 WEO.
Multinationals’ reduced profit margins,
combined with difficult financing
conditions and volatile commodity prices (FDI in LICs is heavily
concentrated in natural
resource sectors), have already begun to trigger reduced FDI
commitments for 2009–10. In
Lao PDR and Mozambique, for example, FDI related to expansions of
hydroelectric and
mining projects has been delayed or suspended.
Overall, reduced FDI in 2009 is expected to have a significant impact in
over half of
all LICs. Countries in Latin America and Asia are expected to be most
affected. In Africa,
the impact is expected to be muted, due to FDI concentration in natural
resource sectors,
where new projects may be delayed but most ongoing projects are likely
to be continued. The
losses associated with withdrawing from natural resource projects prior
to their completion,
given the sizable up-front capital investment required for such
investments, reduce the
likelihood of FDI withdrawal.
Aid Flows
Poverty-reducing initiatives across the globe have led to sizable aid
flows during this
decade. Aid peaked in 2006, reflecting debt relief (driven by the HIPC
and MDRI
initiatives), coupled with increased flows from emerging donors such as
Russia, China, and
the GCC countries. However, excluding
debt relief grants, net official
development assistance remained
broadly unchanged in real terms in
2006–07 (OECD, 2008a).
Potential reductions in aid
flows are a serious concern. Empirical
evidence shows that aid is procyclical
with both donor and recipient incomes
16
World Bank (2004); Nonnemberg and Cardoso de Mendonça (2004);
Kalotay and Sulstarova (2008).
Aid to LICs: 1990-2008
0
2
4
6
8
10
12
14
16
1990 1994 1998 2002 2006
0
100
200
300
400
500
600
In percent GDP
(left axis)
In millions of USD
(right axis)
Sources: WEO database; and Fund staff calculations.21
60
80
100
120
140
160
180
2007 2008 2009
Pre-shock (Spring
2008 WEO)
Post-shock
(Current
projection)
LIC Aid index
(2007=100)
(BulíĜ and Hamann, 2006). In a sample of 18 donors, Pallage and Robe
(2001) show that the
comovements of total aid disbursements with donors’ output were
positive for almost threefourths of donors during 1969–95. Given the
severity of the slowdown in growth in advanced
economies, a potential reduction in aid cannot be ruled out.
Projections of aid to LICs already
started to decline in 2009. Growth in aid
to LICs during 2008 was higher than
initially anticipated by the WEO spring
projections. This high level of projected
aid partially reflected multilateral aid
packages approved during late 2008 to
help countries cope with food and fuel
shocks experienced in early 2008.
Notwithstanding international
commitments to scale up aid, projections do not suggest such scaling-up
is in the pipeline
for 2009.
V. The Fiscal and Debt Sustainability Impact of the Crisis
Fiscal vulnerabilities are emerging as revenues decline, pressures on
spending increase, and
financing conditions deteriorate. The crisis will aggravate risks of debt
distress in vulnerable
countries.
Fiscal Impact
The financial crisis and global
recession will aggravate the fiscal
vulnerability of LICs. Budget revenues
are expected to suffer as economic
activity slows and commodity prices
fall, pressures on spending rise, and
financing conditions continue to tighten.
The text chart shows a ranking of these
factors, based on a survey of LIC
country teams.
Revenue and Financing Prospects
Lower revenue is a key source of fiscal risk. The slowdown in economic
activity and
trade will affect fiscal revenues directly, given the reliance of many
LICs on trade taxes. In
addition, falling remittances from abroad can be expected to hit
domestic consumption, and
0
1
2
3
4
5
Lower revenues
from economic
slowdown
Lower
commodityrevenues due to
lower prices
Decrease in
concessional
financing (lower
aid flows)
Higher spending
on social safety
nets
1/ Rating: 5=Very important, 4=Important, 3=Somewhat important,
2=Unimportant, 1=Not applicable, and 0=no answer.
Key Fiscal Transmission Channels of the Global
Financial Crisis 1/ (Total averages)22
-20 -15 -10 -5 0
Mauritania
Guinea
Bolivia
Vietnam
Papua New Guinea
Mongolia
Sudan
Azerbaijan
Angola
Yemen, Republic
Nigeria
Congo, Republic of
Chad
Change in Ratio of Commodity Revenues to GDP, 2008
to 2009 (Percentage points of GDP)
hence revenues from consumption taxes.
The tourism industry, an important
source of revenue in some LICs, is also
likely to contract.
Commodity revenues would be
particularly affected—as emphasized by
over half of country teams. In several
countries, commodity-related revenues
constitute more than 20 percent of total
revenues. While all commodity exporters
are likely to be hit in 2009, the effect is
expected to be particularly marked for oil
and metal producers, where the recent
price declines have been steepest (e.g.,
Angola, Chad, Republic of Congo,
Mongolia, Nigeria, and Yemen). The
downturn has exposed some commodity
exporters that embarked on ambitious
spending plans on the basis of optimistic
revenue assumptions. In countries where
oil revenues accounted for at least 20 percent of total revenue in 2004,
the average non-oil
fiscal deficit rose from 22 percent of non-oil GDP in 2004 to 39 percent
in 2008 as a result of
rapidly rising expenditure.
17
This said, several countries (including Angola, Azerbaijan, the
Republic of Congo, and Nigeria) accumulated fiscal cushions during the
boom years, which
now reduce their vulnerability.
Overall, revenue ratios are projected to decline in more than half of
LICs in 2009. In
close to a quarter of the countries, the decline is expected to be more
than 2 percentage points
of GDP. The extent to which revenue
declines would contribute to vulnerability
depends on the overall fiscal position and
availability of financing. It should be
noted that revenue losses will take place
even if the revenue ratio is constant, due
to lower activity. The expected increases
in the revenue ratio in a number of
countries mainly reflect ongoing efforts
to strengthen revenue-raising capacity.
17
Oil exports increased significantly in some countries, including Angola,
Azerbaijan, and Timor-Leste.
0 20 40 60 80 100
Vietnam
Guinea
Mongolia
Mauritania
Papua New Guinea
Sudan
Azerbaijan
Yemen, Republic
Angola
Nigeria
Chad
Congo, Republic of
Commodity Revenues to Total Revenue, 2008
(Ratio, in percent of total revenue)
5
16
23
10
6
8
0
5
10
15
20
25
30
Decline of more than
2 percentage points of
GDP
Decline of less than 2
percentage points of
GDP
Rise in revenue to
GDP
Commodity exporters
Non-commodity exporters
1/ Excluding grants.
Change in Revenue to GDP Ratio; 2008 to 2009 1/
(Number of countries)23
Uncertainty about aid flows,
potential declines in donor support, and
tighter financing conditions are likely to
impose further pressures on LICs’
budgets. In about half of the countries, the
ratio of aid to current spending exceeds 20
percent, and in 14 countries this proportion
surpasses 50 percent. In particular, fiscal
vulnerabilities are high in LICs where
domestic revenue mobilization has not
kept pace with rising public spending.
18
These countries have relatively small revenue bases, which limits their
ability to increase tax
collections in the short run to offset declines in aid flows. Falling aid was
rated as very
important or important by more than one-third of country teams.
Countries such as
Afghanistan, Burundi, and Rwanda are particularly vulnerable to
declines in aid flows.
Spending Pressures
Spending pressures may arise from various sources, starting with the
sectors more
directly affected by the external shock.
x Falling export revenues may exert pressure on government
expenditures.
Commodity export sectors that are hit by lower demand and falling
prices may seek
government transfers to offset part of the falling revenues. This will
happen if
commodity marketing boards or state-owned export enterprises are
called upon to
subsidize domestic producers by maintaining higher domestic prices
than the
corresponding export prices.
x Poverty may increase with the slowdown in growth and falling
commodity prices. If
output declines in capital-intensive industries (such as oil), the impact
on employment
would be limited, at least in the short run. However, in countries that
export
agricultural commodities, falling commodity prices would cut into rural
employment
and incomes, thereby increasing rural poverty. The urban poor,
however, may benefit
as food and energy prices decrease. Various estimates suggest that on
average, when
mean growth declines by 1 percentage point, the poverty head count
increases by
2 percent.
19
x Countries may need to expand social spending to address rising
poverty levels.
Spending pressures to strengthen safety nets were considered important
or very
18
Gupta and Tareq (2008).
19
The poverty elasticity to growth varies across countries; the estimated
elasticity of two is the average obtained
from a cross section of developing and transition countries. See
Bourguignon (2003) and Ravallion (2004).
0 20 40 60 80 100
Niger
Guinea-Bissau
Tanzania
Haiti
Bhutan
Madagascar
Congo, Dem. Rep. of
Afghanistan, I.R. of
Rwanda
Burundi
Ratio of Aid to Current Expenditure in 2008 for Large
Recipients of Aid (In percent)24
important by almost one-third of country teams. Countries that are
already planning
to expand or introduce new programs include Dominica, The Gambia,
Guyana,
Madagascar, Niger, and Senegal. On the other hand, countries that are
net importers
of food and fuel and that increased subsidies on these products during
the 2007–08
price hikes should now be able to scale back their subsidies.
20
For example, in
Pakistan and Yemen the reduction in international petroleum prices has
helped create
room for priority spending.
x The crisis could affect investment financing schemes. Public-private
partnerships for
public projects and concessions (such as ports and power generation)
could come
under strain because lower demand for services may trigger calls on
revenue
guarantees, and private operators may be affected by the credit crunch.
Additional spending pressures may arise from currency depreciation
and rising
interest rates.
x The share of foreign debt in public debt remains high (see next
section), and
depreciation would increase debt servicing costs. The cost of imported
goods and
services would also rise, thus offsetting, at least in part, the effect of
lower
commodity prices. Conversely, depreciation may boost border taxes
(including duties
and VAT on imports) and resource-related revenues.
x Countries able to access international capital markets may have to
pay higher interest
rates. For instance, the average spread of the four LICs included in the
EMBI rose by
about 1,000 basis points during the past year. And, as noted in the first
part of Section
IV, domestic funding costs have started to rise in a number of LICs—
including
Ghana, Mozambique, Pakistan, and Sri Lanka, according to the survey
of country
teams.
Public finances might also come under pressure if there is a need for
government
support to domestic financial institutions and depositors. Country teams
expect that fiscal
support to the financial system may be required in only a few countries
(Cambodia,
Comoros, Mongolia, and Pakistan), given the generally limited ties of
financial systems in
LICs to global financial markets. However, fiscal risks and
vulnerabilities could emerge from
contingent liabilities of the government and quasi-fiscal activities of
central banks if it is
decided to extend deposit guarantees (as some LICs have already done)
or to direct or
subsidize bank credit to the private sector.
20
IMF (2008). The median fiscal cost of fiscal policy responses to
increasing fuel and food subsidies incurred
since 2006 in a sample of 92 countries was estimated at 0.7 percent of
GDP in September 2008. Fiscal costs
were dominated by increases in fuel subsidies and reductions in fuel
taxes. In 24 countries, the combined fiscal
cost of fuel and food subsidies in 2008 was expected to exceed 2 percent
of GDP. 25
80
85
90
95
100
105
2008 2009
LIC Debt-to-GDP Index
(2008=100)
Pre-shock
(Spring 2008
WEO)
Post-shock (Current
projection)
The Impact of the Crisis on Debt Sustainability
In recent years, debt indicators in LICs have improved dramatically
(Appendix III).
Over the past decade, debt relief initiatives have significantly reduced
the large external debts
with which LICs have often struggled. With assistance from
development partners, including
the IMF and the World Bank, LICs have been working toward
maintaining future debts at
sustainable levels. Improved debt sustainability has helped create
investor and donor
confidence, as is evidenced by sizable FDI and aid flows to LICs over
the past two years. A
lower debt servicing burden has also freed greater resources for
development spending.
However, higher borrowing to help
offset the impact of the crisis could pose
serious risks, in particular for those LICs that
already have a high debt burden. Debt
indicators are projected to continue
improving in 2009 (see figure), albeit by less
than forecast last spring. However, 28
countries already have debt in excess of 60
percent of GDP. Moreover, simulations of
additional borrowing to offset the shortfalls
in external financing suggest that a handful
of countries that are currently on the verge of high risk of debt distress
would breach this
threshold (see Appendix IV). The simulations assume that reduced
investment expenditure
financing from aid and FDI is replaced with public external borrowing.
21
If sustained for one
year, this adds 4 percent of GDP to the average LIC debt burden.
Second-round effects also pose serious risks to debt sustainability. Given
that more
than half of LICs’ public debt remains external, a depreciation in
exchange rates will
aggravate the ratios of debt to GDP and fiscal revenues. Moreover,
contingent liabilities
resulting from pressures in the banking sector could further weaken the
structural
improvements in the sovereign balance sheet. Several governments have
extended explicit or
implicit guarantees for their banks’ deposits in response to public
uncertainty about domestic
banks. Finally, the decline in reserves poses a risk to LICs’ capacity to
service or roll over
external debt, which remains mostly at short maturities.
VI. Country Vulnerabilities and Risks of Further External Shocks
The external outlook varies widely across LICs and is subject to large
risks. The baseline
projections and illustrative scenarios suggest that 26 LICs could be
particularly vulnerable.
21
Aid and FDI are each assumed to be reduced by 30 percent of their
respective 2008 values. 26
The growth and balance of payments repercussions of the global
slowdown for LICs
remain highly uncertain. Accordingly, this section analyzes LICs’ short-
run vulnerabilities to
the global downturn on the basis of both the most recent projections
and various simulations
of possible further shocks that illustrate the downside risks to the
baseline projections.
The baseline projections show large adverse effects of the global crisis
for commodity
and oil exporters, and countries with entrenched policy weaknesses (see
Appendix V, Table
1). While, on average, projected growth in 2009 has been revised down
by 2.1 percentage
points relative to the April 2008 WEO, this decline amounts to more
than 2.5 percent for 24
countries. Hardest hit are LICs in the Middle East and Europe and, to a
lesser extent,
Latin America and oil-exporting countries. Reserve coverage is
projected to decline in 45
countries, by 0.6 month of imports, on average, with a particularly
sharp drop among oil
exporters.
Simulations of possible further shocks explore the balance of payments
effects of
lower prices of oil, commodities, and food; lower foreign demand for
LIC manufacturing
exports; and lower financial inflows. The simulations are simple partial
equilibrium exercises
to assess the immediate impact on the balance of payments and reserves
of the assumed
shocks to the trade balance (as a result of lower world market prices
and export volumes) and
to remittances, FDI, and aid.
22
The methodology is consistent with the one applied to the
analysis of the food and fuel price shocks in IMF (2008b). The exercises
do not incorporate
further effects on growth or demand. For each channel, and for all
shocks combined,
countries are ranked in three vulnerability categories—high (H),
medium (M), or low (L)—
depending on the impact of these shocks on reserves.
23
The simulation results illustrate the wide variation in vulnerabilities
across LICs
(Appendix V, Tables 2–7). Over 20 percent of the sample countries are
highly vulnerable to
the specified trade shock (lower world market prices and export
volumes). The majority of
these countries are in Africa. Of the 15 countries with remittances
exceeding 10 percent of
GDP in 2008, 10 appeared highly vulnerable to a decline in remittances.
Overall, about half
of the sample countries appear moderately vulnerable to a sudden
decline in FDI. Countries
22
The detailed specification of the shocks is described in Appendix V. In
view of the limitations of the partial
analysis, the simulation results are illustrative and should not be
considered as actual projections at the country
level. The final impact of the global slowdown is highly dependent on
policy responses and domestic factors, as
well as on the interaction of different shocks. In addition, the magnitude
of the shocks in the simulations is not
based on a projection of likely developments.
23
The H category encompasses countries that had reserve coverage below
the standard benchmark of 3 months
of imports in 2008 and that could suffer an additional loss of reserves
equivalent to more than 0.5 month in the
shock scenario. Countries in the M category either start with more than
3 months of import coverage and lose
more than 0.5 in the shock, or start below 3 months of coverage and lose
less than 0.5 month with the shock. In
the L category, countries start with more than 3 months of import
coverage and lose less than 0.5 in the shock
scenario. 27
Figure 2: Overall Country Vulnerabilities1
1
See Appendix V, Table 1, for methodology. Country borders or names
in this map do not necessarily
reflect the IMF's official position.
in Latin America have relatively high FDI inflows, and hence almost all
of them appear
vulnerable to an FDI shock. Almost 50 percent of countries that
received aid in excess of 10
percent of GDP in 2008 appeared highly vulnerable to reduced aid.
Considering both the current baseline projections and the simulations,
26 countries
could be considered highly vulnerable to the adverse effects associated
with the global
recession (Figure 2 and Table 4). The baseline projections and
simulations are combined to
provide an overall vulnerability assessment. The most vulnerable
countries are especially
sensitive to trade, aid, and remittances shocks, while FDI appears to be
a less important
transmission channel.
24
24
The results of this overall assessment are sensitive to the weights placed
on the baseline projections relative to
the simulations. The overall score is a weighted average of individual
scores assigned to the change in projected
2009 real GDP growth relative to the April 2008 WEO projection, the
projected change in reserves during 2009,
and the vulnerability score in a simulation of combined further shocks.
In this exercise, a GDP growth reduction
(continued) 28
Table 4. Vulnerability Table
Real GDP Growth Reserves (in Months of Imports)
2009 current less
Spring WEO proj. 1/ 2009 less 2008 2/
Albania -2.4 -0.7
Angola -8.6 -1.0
Armenia -5.0 -0.1
Burundi -2.0 -0.6
Central African Rep. -2.0 -0.9
Congo, Dem. Rep. of -7.3 0.6
Côte d'Ivoire -0.7 0.0
Djibouti -1.5 0.2
Ghana -3.4 -1.2
Haiti -1.5 -0.3
Honduras -2.6 -0.7
Kyrgyz Republic -4.6 -0.1
Lao People's Dem.Rep. -3.4 -0.9
Lesotho -3.3 -0.8
Liberia 0.7 0.0
Mauritania -2.8 -0.3
Moldova -4.5 -0.2
Mongolia -3.1 0.0
Nigeria -5.0 -3.9
Papua New Guinea 0.2 -0.9
St. Lucia -5.4 -0.1
St. Vincent & Grens. -4.7 -0.2
Sudan -6.7 0.2
Tajikistan -4.0 0.0
Vietnam -2.5 -0.9
Zambia -2.4 0.2
1/ Current projection for 2009 less Spring WEO projection for 2009
2/ Current projection for 2009 less 2008 actual.
3/ Combined Shock: Trade, Remittances, Aid, FDI. See section IV for
description of shocks and Appendix V tables for magnitudes
of individual shocks.
4/ H = High risk; M=Medium risk; L=Low risk.
Vulnerability Score
H
Simul. 3/ 4/
M
M
H
H
M
H
M
M
H
M
M
H
M
M
H
M
M
H
H
H
H
M
M
M
M
H
H
H
H
H
H
H
H
H
H
H
H
H
H
H
H
H
H
H
H
H
H
Overall Assessment 4/
H
H
H
H
VII. Policy Recommendations
Many LICs have little room for countercyclical policies to address the
impact of the global
crisis. This highlights the importance of donor support, which will need
to be stepped up to
enable LICs to attenuate the effects of the crisis on poverty. Important
domestic policy
responses include targeted spending to protect the poor, exchange rate
flexibility to facilitate
adjustment, and vigilant financial supervision.
The ultimate impact of the global financial crisis on LICs is likely to be
severe given
their unique vulnerabilities and limited scope for offsetting policies. In
principle, the choice
between financing and adjustment in response to an adverse shock
should depend on its
expected duration, with temporary shocks calling for financing and
permanent shocks
requiring adjustment. While the evolving global crisis—and its effects
on prices, foreign
demand, and financial inflows—remains very uncertain, arguably many
of its effects may be
in excess of 2.5 percentage points, and a reduction in reserves in excess
of 0.5 month of imports are considered
“large.” See Appendix V for details. 29
considered temporary. In practice, however, initial macroeconomic and
debt conditions and
available financing are likely to be the major factors determining the
scope for fiscal easing.
Fiscal Policy
Fiscal policy responses to the crisis should take into account important
characteristics
of LICs and how the global crisis is affecting these countries.
x The fall in demand largely originates abroad and is transmitted to
LICs through
foreign trade as a reduction in exports—mainly commodities—due to
lower prices
and volumes. The ability of expansionary fiscal policy to substitute for
this decline in
external demand may be limited, to the extent that resources cannot
quickly be
reoriented across sectors. Attempts to maintain domestic demand
through
countercyclical fiscal policy could spill over into imports, resulting in a
net loss of
foreign reserves (absent more aid), or inflation.
x Most LICs lack effective social programs to transfer income.
x Governments cannot ease the fiscal stance as readily as in other
countries because of
liquidity constraints. Access to external financing is typically limited;
thin domestic
financial markets constrain the ability to finance higher fiscal deficits;
and monetizing
larger deficits would likely jeopardize macroeconomic stability.
x The significant uncertainty about whether the shock is temporary or
long-lasting
argues for cautious policy responses, as government revenues in the
years ahead may
remain weaker than in the recent past.
Against this background, the fiscal policy response should depend on
country-specific
circumstances.
x Countries without binding public debt sustainability and financing
constraints that
have achieved macroeconomic stability may have scope to accommodate
the
(cyclical) fiscal deterioration. This would help address the negative
impact of the
crisis on economic activity. A few countries may also have scope for
discretionary
fiscal stimulus aimed at sustaining aggregate demand. In all cases, the
space for fiscal
easing will depend on the availability of financing from external sources
on
concessional terms and the scope to raise and use domestic resources in
a
noninflationary manner, without draining international reserves or
crowding out the
domestic private sector, as this sector is the main source of long-term
growth.
25
x In formulating spending policies, priority should be given to
protecting or expanding
social programs or bringing forward approved investments, and, in
general, to
25
For example, financing constraints are an issue in WAEMU, where
commercial banks that bought most of the
bonds and bills issued by WAEMU governments increasingly face
liquidity difficulties. 30
preserving the momentum toward achieving the MDGs. Most LICs
have pressing
infrastructure needs, and protecting or increasing spending in MDG-
related sectors
such as health, education, water and sanitation, and social protection
can help cushion
the impact of the crisis on vulnerable households. These countries may
also want to
reorient their spending composition in favor of programs that stimulate
domestic
economic activity. Spending that is intensive in domestic goods and
services is likely
to be more effective in supporting domestic activity. Existing
infrastructure should be
preserved by protecting spending on operations and maintenance.
Initiating new
infrastructure or social programs should be approached with caution
because of the
weak implementation capacity in many LICs. At a minimum, new
projects considered
for implementation should be properly appraised and prioritized.
x Some forms of spending increase would best be avoided. The
subsidization of
domestic exporters through the maintenance of higher domestic prices
above export
prices would not be well targeted, as large producers would benefit
more. Public
sector wage increases would also be a poorly targeted form of support
and may not be
sustainable.
Commodity exporters that built financial cushions during the boom
may be in a better
position to maintain spending or adjust gradually. Exporters with no
sustainability or
financing concerns despite the downturn in commodity prices may be in
a position to
maintain spending levels. Some countries that need to retrench because
of sustainability
issues might be able to do so gradually if they had built up financial
cushions.
26
However, many countries will be forced to adjust their fiscal position.
Those
countries with binding fiscal constraints, including some commodity
exporters, will have to
address a deteriorating fiscal position.
Those countries can create fiscal space for additional spending or to
preserve priority
spending, including for MDGs. They can do so through increasing
revenue or reprioritizing
spending.
x Countries with low tax-to-GDP ratios should try to mobilize
additional domestic
revenue. A tax-to-GDP ratio of 15 percent is considered a reasonable
target for most
LICs, and many non-resource-rich LICs have tax-to-GDP ratios well
below this
target. This does not mean that tax rates should be increased. Indeed, in
some
countries, high rates, particularly on mobile production factors (such as
skilled labor
and capital), may be hindering economic growth. In many LICs, low
revenues are
mainly associated with narrow tax bases, rather than low rates. In these
countries, a
rationalization of tax incentives (by reducing exemptions, tax holidays,
and
deductions) together with strengthening of revenue administration
should allow lower
26
Barnett and Ossowski (2003). 31
tax rates while mobilizing additional revenues. However, these reforms
—which
should be part of a medium-term strategy—take time. This said,
countries should
carefully review the scope for removing tax exemptions in the context of
the next
budget, with a view to generate revenue. Resource-rich countries should
continue to
make efforts to diversify their revenue base, which would reduce fiscal
risks.
x Fiscal space can also be created through expenditure rationalization
and increasing
spending efficiency. This is important in light of the difficulty of raising
revenues
through quality measures in the short run. Reducing unproductive
expenditures,
particularly those of a recurring nature, while often politically difficult,
should be the
first option. Examples include generalized subsidies, transfers to loss-
making
enterprises, excessively large government employment, and “white
elephant”
projects. Many countries increased subsidies in response to the surge in
international
fuel prices in recent years. With the fall in these prices, the fiscal cost of
the subsidies
should decline.
27
Strengthening public financial management systems would
contribute to improving expenditure efficiency, by ensuring that
resources reach their
intended users. It is important to avoid across-the-board spending cuts,
which can
lead to arrears and inefficiencies, and are often not sustainable.
In all cases, spending plans should preferably be cast in a medium-term
framework
(MTF). Increases in spending that would not be sustainable in the
future should be avoided.
While the design and implementation of an MTF is a complex process
that should be
approached gradually, many LICs could make greater efforts in this
area.
Care will have to be taken in strengthening safety net programs.
Transfer programs
that effectively target the poorest often result in a larger stimulus to
aggregate demand, given
their higher propensity to consume.
28
The capacity of many LICs to put in place new targeted
programs will be limited in the near term.
29
There may be scope, however, to scale up
existing spending programs in targeted ways:
x Countries can implement public works programs and/or provide
income supplements
through existing programs. Labor-intensive infrastructure projects can
be effective in
providing income support to the poor while simultaneously delivering
fiscal stimulus.
Setting the wage rate relatively low ensures that the schemes are self-
targeted to the
poor. The going wage for unskilled agricultural labor is often a good
benchmark.
27
This may also be an opportune time to reform domestic pricing
mechanisms (e.g., from ad hoc price
adjustment systems to automatic price formulas or price liberalization)
where appropriate.
28
Strengthening such programs would also reinforce automatic
stabilizers. In countries with financing
constraints, however, the operation of such stabilizers would require
flexibility in other spending areas.
29
Initiatives undertaken in response to the fuel and food price crisis have
improved the situation in some
countries. 32
x Additional resources can be channeled to targeted programs, such as
targeted food
distribution or school meal programs. Expanding conditional cash
transfer programs
that link cash transfers or subsidies to the receipt of health care or
education can be an
effective method of addressing potential losses in human capital.
Examples of such
programs include the Primary Education Stipend Program in
Bangladesh, Bolsa
Familia in Brazil, the Education Sector Support Program in Cambodia,
Programa de
Asignación Familiar in Honduras, Oportunidades in Mexico, and
Atención a Crisis
and Red de Protección Social in Nicaragua.
Monetary and Exchange Rate Policy
An important policy priority will be to maintain domestic
macroeconomic stability
amid deteriorating terms of trade. With declining food and fuel prices,
inflationary pressures
are quickly receding in the large majority of LICs. At the same time,
and unlike in some
advanced economies, risks of deflation seem limited for LICs. Sharp
depreciations in the
wake of balance of payments pressures clearly have the potential to feed
through to inflation,
offsetting the deflationary global environment. Accordingly, while there
may be scope for
monetary easing in some countries with falling inflation, countries
experiencing continued or
renewed price pressures may need to tighten monetary policy.
Inflationary challenges remain in some LICs where existing aggregate
demand
pressures have yet to be effectively tackled. In 18 LICs, inflation still
exceeded 15 percent as
of end-December 2008 and for 12 of these it is forecast to remain in
double digits throughout
2009, as earlier commodity price increases are still feeding through to
the economy, and have
affected wage demands and inflation expectations. Most of these cases
have been associated
with relatively loose monetary and/or fiscal policies—including in the
form of recent high
wage awards (Mongolia), an expansionary deficit (Ghana, Ethiopia),
and negative real
interest rates (Azerbaijan).
Countries with flexible exchange rates should allow them to function as
shock
absorbers in response to the negative external shock stemming from the
financial crisis. It
will generally not be effective to impede needed adjustment in the real
exchange rate or
dissipate reserves through intervention, which should be limited to
responding to temporary
instances of disorderly market conditions.
Countries with fixed exchange rates may face different challenges, with
pressure on
these arrangements owing to lower net exports, together with,
potentially, capital flight and a
reduction in available external financing. In light of the adverse shocks,
exchange rate
competitiveness and the adequacy of reserves will need to be carefully
assessed. For
countries with de facto rather than formal pegs, in particular,
introducing some degree of
exchange rate flexibility may be advisable (e.g., Armenia, Ethiopia). If
the financial crisis is
prolonged, the pattern of external adjustment—including the use of
exchange rates—would 33
shift over time. While exchange rate adjustment may be avoided in the
short term, extended
balance of payments pressures could make adjustment unavoidable.
Protectionist measures should be avoided. Limiting imports through
tariffs or
quantitative restrictions lowers welfare by distorting incentives, and
new barriers can be hard
to rescind when the current pressures subside.
Financial Sector
As mentioned above, potential negative fallout from the crisis on LICs’
financial
system remains high. In this context, LICs need to focus on immediate
crisis prevention
measures including by preparing contingency and remediation plans for
the financial system.
In the short term, it will be critical to monitor the risks and take actions
that focus on
reducing uncertainty and engender confidence. Dynamics in domestic
debt and financial
markets can have serious spillover effects on the domestic banking
system and hence on
credit availability. Analysis of such linkages should be undertaken at
both the institutional
and systemic levels.
At the private sector level, financial institutions could initiate balance
sheet repair.
Where capitalization is weak, fresh equity may need to be raised or
medium-term funding
sources sought, even if the cost of doing so is high. A critical evaluation
should also be
undertaken of institutions’ overall risk management systems,
particularly for liquidity and
counterparty risk management. Stress tests should be conducted to
identify potential balance
sheet vulnerabilities, account for possible longer periods of funding
illiquidity, and develop
firm-specific contingency plans. These should guide the formulation of
appropriate
adjustments in risk management.
Similar steps are required for the official sector. The channels through
which risks
could materialize should be subject to high-frequency monitoring, and
countries should
review their crisis management frameworks. Prudential rules should be
rigorously enforced,
and supervision extended to key non-bank institutions and local capital
markets. Given the
possibility of direct interventions utilizing the government balance
sheet, official reserve
holdings should be carefully monitored. Likewise, debt management
would need to focus
increasingly on liquidity risks in addition to the sovereign’s solvency,
take account of the
maturity structure and nonresident holdings of locally issued debt, and
optimize the mix
between local-currency domestic debt and external borrowing.
Countries could also improve coordination amongst the government,
the central bank,
and supervisory agencies. This will facilitate anticipation of liquidity
and solvency problems.
It will also help avoid a “rush to regulate” that may create further
illiquid conditions or a
credit squeeze, or a culture of non-repayment of bank loans. Central
banks must have reliable
access to financial information of all regulated financial institutions.
The medium-term 34
agenda of the financial sector reforms process should remain on track,
or even be advanced.
Deepening money and foreign exchange markets and developing the
investor base will help
to improve liquidity management. Progress would depend on
implementing appropriate
monetary policy frameworks, operating procedures, and instruments;
improving central bank
liquidity forecasting and its coordination with government cash
management; and
strengthening inter-bank money and foreign exchange markets, the
shallowness of which
often leads to excessive volatility. Reform of the non-bank financial
sector can be a powerful
tool to increase the demand for longer maturities and reduce rollover
risks.
VIII. Financing Needs of LICs as a Result of the Crisis
The additional financing needs of LICs resulting from the crisis could
amount to about
US$25 billion in 2009, and could rise much further.
At this stage, any projection of LICs’ balance of payments needs in light
of the global
financial crisis should be considered as highly tentative. Previous
sections have highlighted
the uncertainties surrounding the many variables that feed into a
calculation of financing
needs. Nevertheless, in this section we offer some preliminary estimates
of the amount of
additional external financing that LICs would need in order to
withstand the crisis-related
shocks without excessive import contraction or depletion of reserves.
30
Current baseline projections for 2009 suggest an aggregate additional
financing need
for LICs of about US$25 billion (Table 5). However much larger
financing needs would
result without import adjustment or if various downside risks were to
materialize. The
reserve level for end-2009 that was projected in the April 2008 WEO
projections serves as
the benchmark for calculating the additional financing need.
x Current projections foresee an adverse balance of payments shock for
38 LICs in
2009, amounting to about US$165 billion in total, relative to the April
2008
projections (Table 5 and Appendix VI). However, various downside
risks to the
baseline could result in a much larger impact, as illustrated in the “bad
case” scenario.
In this scenario, the shocks described in the simulation of Section VI
occur
simultaneously, with an overall balance of payments impact of US$216
billion.
31
30
The analysis in this section focuses on the availability of foreign
exchange reserves at the level of the central
bank. In practice, actual import adjustment depends not only on the
total financing available to the country, but
also on its availability to specific groups—households, firms, and public
entities—many of which are liquidity
constrained and may have no alternative but to contract their spending
in response to adverse shocks.
31
This simulation differs from the one for a combined shock in Section VI,
in that it does not include a
downward shock to aid. Otherwise, the estimated financing need—
which can be considered the need for aid—
would be artificially augmented by an ex ante aid decline. 35
(in US$, billions) number of
countries
(in US$, billions) number of
countries
Total balance of payments shock 3/ 165 38 216 60
Total reserves loss 4/ 131 35 216 60
Additional financing need 5/ 25 22 138 48
1/ All changes are relative to the Spring 2008 WEO projection for 2009.
See Appendix VI for details.
2/ This corresponds with the simulated combined shocks to exports,
remittances, and FDI described in Section VI and Appendix V.
3/ The sum of the shocks to exports, FDI, remittances, and the price
effects of food and fuel price changes (but excluding import responses).
4/ The total change in reserves for LICs with reserves losses.
5/ The total change in reserves for LICs with reserves coverage falling
below 3 months of imports or by more than 0.5 months to less than 4
months.
Current 2009 proj. "Bad case" scenario 2/
Table 5. LIC Balance of Payments Shock and Financing Needs in 2009
1/
x Since the projections incorporate some policy adjustment and import
compression in
response to the crisis, these shocks are projected to result in a loss of
reserves in 35
LICs. The total decline in reserves (again, relative to the spring 2008
projection) for
these countries amounts to US$131 billion.
32
x In 22 LICs, reserves are now expected to fall below 3 months of
imports.
33
The total
reserves loss in these countries amounts to US$25 billion—equivalent to
about 80
percent of the annual aid received by LICs over the past five years
(based on OECD
Development Assistance Committee data). This represents a minimal
estimate of the
additional financing need. Support on a larger scale would be needed to
help
countries avoid the procyclical adjustment that is assumed in the
projections,
including in countries that may not see significant balance of payments
needs but face
increased budgetary pressures. In addition, if the adverse shocks turn
out to be larger
than expected, more support would be needed, as shown in the “bad
case” scenario.
IX. Fund Support
The Fund is working actively with its partner institutions and national
authorities to assess
the economic and balance of payments impact of the financial crisis on
LICs, and assist them
through policy advice, financing, and technical assistance.
The Fund will provide financial support to LICs hit by the crisis in a
manner that
responds to their economic circumstances, the nature of the balance of
payments problem,
and their existing program relationship, if any, with the Fund:
32
As the “bad case” scenario does not incorporate any policy responses,
the reserve loss in this scenario equals
the total balance of payments impact of the shocks.
33
Also including cases where reserves fall by more than 0.5 month of
imports, to less than 4 months. 36
x For countries with existing PRGF arrangements, an augmentation of
the arrangement
is generally the appropriate mechanism. In 2008, 11 such augmentations
were granted
in response to the food and fuel price shocks.
x For countries without an existing IMF arrangement, the revised
Exogenous Shocks
Facility (ESF) may be a suitable mechanism for IMF financing to the
extent that the
shock is of an exogenous nature. In December 2008 and January 2009, 5
countries
benefited from support under the ESF.
x For countries with balance of payments needs that might require
longer-term program
engagement, a new PRGF arrangement may in principle be the most
appropriate
instrument, owing to its longer horizon and greater structural focus.
x The Fund has also launched a broad review of its financial facilities,
including for
LICs, to ensure its assistance is best tailored to its members’ needs.
The Fund also has an important role to play in providing policy advice
to members
responding to a more demanding macroeconomic and financial
environment. Surveillance
may be particularly relevant as a tool for ex ante LIC crisis
prevention/mitigation efforts and
for those LICs that are not yet in a position to implement Fund-
supported programs, and/or
lack the capacity to absorb technical assistance.
In several areas, LICs are likely to need enhanced technical support.
Most LICs face
significant capacity constraints. The Fund, along with its partners, may
need to scale up the
provision of technical assistance (TA) to help LICs address the crisis
and continue moving
ahead with broader public and financial sector reforms. Concerning the
latter, the Fund could
help implement best practices in crisis management, balance sheet risk
management, and
debt and liquidity risk management. The upcoming FSAPs in the LICs
could focus on these
areas. Several countries have set up crisis management committees and
technical groups,
which the Fund can support. TA also plays an important role for
members faced with the
need to strengthen public expenditure management systems, enhance
domestic revenue, and
improve debt management. 37
Appendix I. Countries Included in the Analysis
The group of LICs analyzed in the paper is formed by the 71 PRGF-
eligible countries for
which data were available, which include, by region:
Sub-Saharan Africa
Angola, Benin, Burkina Faso, Burundi, Cameroon, Cape Verde, Central
African Republic,
Chad, Comoros, Democratic Republic of Congo, Republic of Congo,
Côte d’Ivoire, Djibouti,
Eritrea, Ethiopia, The Gambia, Ghana, Guinea, Guinea-Bissau, Kenya,
Lesotho, Liberia,
Madagascar, Malawi, Maldives, Mali, Mauritania, Mozambique, Niger,
Nigeria, Rwanda,
São Tomé and Príncipe, Senegal, Sierra Leone, Somalia, Tanzania,
Togo, Uganda, and
Zambia.
Middle East and Europe
Albania, Armenia, Azerbaijan, Georgia, Kyrgyz Republic, Moldova,
Sudan, Tajikistan,
Uzbekistan, Republic of Yemen.
Asia
Afghanistan, Bangladesh, Bhutan, Cambodia, India, Lao People’s
Democratic Republic,
Mongolia, Myanmar, Nepal, Pakistan, Papua New Guinea, Sri Lanka,
Vietnam.
Latin America
Bolivia, Dominica, Grenada, Guyana, Haiti, Honduras, Nicaragua, St.
Lucia, St. Vincent and
the Grenadines. 38
Appendix II. The April 2008 WEO Projections and the Most Recent
Updates
2008 2009 2008 2009 2008 2009 2008 2009 2008 2009 2008 2009
Afghanistan, I.S. of 8.6 8.4 3.2 3.1 0.0 -1.0 3.6 7.7 3.2 3.5 -2.8 -2.3
Albania 6.0 6.1 3.9 3.8 -8.3 -5.5 6.0 3.7 4.8 4.1 -10.0 -7.5
Angola 16.0 13.2 6.1 7.3 12.0 11.8 12.2 4.6 4.1 3.1 5.8 1.3
Armenia 10.0 8.0 3.7 3.7 -6.8 -5.0 6.8 3.0 3.6 3.5 -13.7 -12.9
Azerbaijan 18.6 15.6 6.3 6.9 39.5 39.2 9.5 8.0 5.9 7.1 30.9 10.9
Bangladesh 5.5 6.5 2.4 2.4 -0.5 -0.7 5.0 5.3 2.7 2.7 0.7 0.5
Benin 5.4 5.7 8.2 7.9 -6.1 -6.0 5.1 3.6 7.5 6.9 -9.6 -8.3
Bhutan 7.8 6.7 10.7 10.8 9.5 2.3 6.6 5.7 11.9 11.7 11.7 2.8
Bolivia 4.7 5.0 9.8 10.3 12.3 8.6 5.9 4.0 14.9 14.2 11.0 -4.3
Burkina Faso 4.0 6.3 5.4 4.9 -11.5 -10.7 4.5 4.0 6.0 5.4 -11.3 -9.5
Burundi 5.9 5.7 3.3 4.4 -12.0 -12.2 4.5 3.7 4.4 3.8 -12.5 -8.0
Cambodia 7.2 7.0 2.3 2.2 -5.4 -6.2 6.5 4.8 3.3 2.9 -11.9 -7.1
Cameroon 4.5 4.6 5.7 6.5 0.0 -0.4 3.7 3.5 6.8 6.1 0.4 -5.4
Cape Verde 7.7 7.4 3.4 3.5 -11.6 -12.8 6.0 5.0 3.1 3.2 -13.0 -12.7
Central African Rep. 4.9 5.0 1.6 1.7 -6.4 -6.7 2.8 3.0 3.4 2.5 -8.7 -7.2
Chad 1.8 2.5 3.8 4.4 -2.2 -4.0 -0.4 3.6 5.6 3.5 -9.5 -19.6
Comoros 1.6 3.0 7.6 7.2 -3.5 -4.3 0.5 0.8 6.8 6.3 -8.7 -8.3
Congo, Dem. Rep. of 8.8 11.6 0.4 0.5 -10.7 -24.6 8.2 4.4 0.7 1.3 -12.4 -19.8
Congo, Republic of 9.2 10.6 7.8 14.3 6.0 10.9 7.6 10.3 8.3 7.1 -0.8 -18.1
Côte d'Ivoire 2.9 5.1 2.8 2.7 0.6 -0.5 2.9 4.4 2.8 2.8 0.1 -2.6
Djibouti 6.5 7.6 2.3 2.7 -22.6 -17.8 5.9 6.0 2.8 3.0 -38.2 -14.0
Dominica 3.5 3.0 3.5 3.5 -26.6 -23.9 2.6 1.5 6.6 6.7 -30.1 -24.4
Eritrea 1.2 2.0 2.1 1.7 -5.1 -5.5 1.2 1.6 1.1 0.9 -2.7 1.1
Ethiopia 8.4 7.1 1.5 1.6 -4.3 -6.1 11.6 6.5 1.2 1.7 -5.8 -5.9
Gambia, The 6.5 6.5 3.8 4.0 -12.1 -10.9 5.5 6.0 4.5 4.2 -13.9 -12.5
Georgia 9.0 9.0 1.8 1.6 -16.6 -13.2 2.0 2.5 2.7 3.1 -21.8 -17.7
Ghana 6.9 7.5 1.7 1.5 -9.8 -7.9 6.5 4.0 1.8 0.6 -20.2 -15.9
Grenada 4.3 4.0 2.6 2.5 -25.4 -25.8 1.6 0.6 3.0 3.2 -31.8 -31.8
Guinea 4.9 5.2 1.4 2.1 -10.9 -9.8 4.7 4.1 1.5 2.0 -4.1 -2.6
Guinea-Bissau 3.2 3.1 7.4 8.1 7.0 2.8 3.2 3.1 6.1 6.8 0.2 -11.6
Guyana 4.6 4.5 2.3 2.1 -16.6 -15.8 3.2 4.6 3.1 3.0 -20.8 -18.1
Haiti 3.7 4.0 2.0 2.1 -1.3 -2.5 1.3 2.5 3.1 2.8 -2.6 -4.4
Honduras 4.8 4.6 2.9 3.0 -9.5 -9.0 4.0 2.0 3.1 2.3 -13.3 -8.3
India 7.9 8.0 9.2 8.8 -3.1 -3.4 7.3 5.1 9.7 8.8 -2.5 -1.8
Kenya 2.5 3.4 3.2 3.0 -5.5 -3.8 2.0 3.0 3.2 3.5 -6.6 -2.7
Kyrgyz Republic 7.0 6.5 3.3 3.3 -8.3 -7.4 7.5 1.9 3.6 3.4 -6.0 -6.5
Lao People's Dem.Rep 7.9 8.2 2.2 2.5 -21.7 -15.5 6.8 4.8 3.1 2.2 -15.1
-11.9
Lesotho 5.2 5.4 7.8 8.5 5.0 4.5 3.9 2.1 6.7 5.9 -3.7 -8.5
Liberia 9.5 10.2 0.6 0.6 -42.1 -36.2 7.1 10.9 0.7 0.7 -31.8 -42.2
Madagascar 6.8 7.3 2.5 2.9 -27.4 -16.7 7.0 5.1 2.8 3.3 -22.6 -14.8
Malawi 7.1 6.2 1.9 2.4 -2.9 -4.4 8.0 6.6 0.9 1.3 -8.0 -4.6
Maldives 4.5 4.0 1.4 2.3 -35.7 -19.2 6.5 6.5 2.7 3.5 -46.0 -30.1
Mali 4.3 5.1 5.4 5.6 -7.5 -6.7 4.9 4.4 5.1 5.2 -6.1 -6.2
Mauritania 6.1 6.8 3.4 3.5 -8.6 -12.0 4.9 3.9 1.1 0.7 -6.1 -8.6
Moldova 7.0 8.0 3.2 3.6 -10.3 -10.6 6.5 3.5 3.3 3.1 -18.9 -19.2
Mongolia 8.7 8.1 4.4 4.5 -17.1 -17.6 9.8 5.0 2.3 2.3 -9.2 -7.1
Mozambique 7.0 7.0 4.2 4.5 -11.3 -10.3 6.2 5.5 4.9 4.8 -12.7 -11.8
Myanmar 4.0 4.0 3.8 3.8 2.9 2.0 4.5 5.0 0.7 0.7 3.3 1.3
Nepal 4.0 4.5 4.2 3.7 0.5 0.2 4.7 4.6 7.2 7.2 2.6 3.3
Nicaragua 4.0 4.2 1.4 0.8 -24.8 -24.4 3.0 1.5 2.7 2.8 -23.6 -17.7
Niger 4.4 4.5 3.4 3.3 -9.7 -14.0 5.9 4.5 3.9 3.1 -9.9 -22.6
Nigeria 9.1 8.3 14.8 18.7 6.5 5.7 5.3 3.3 14.2 10.3 5.0 -10.7
Pakistan 6.0 6.7 3.2 3.1 -6.9 -6.1 5.8 2.0 2.4 2.8 -8.4 -4.7
Papua New Guinea 5.8 4.7 4.1 4.2 3.3 1.7 7.0 4.9 5.7 4.9 3.2 -5.5
Rwanda 6.0 5.6 4.9 4.8 -9.5 -12.7 8.5 6.0 5.5 4.8 -6.9 -7.6
São Tomé & Príncipe 6.0 6.0 6.2 6.0 -36.1 -32.9 5.8 5.5 4.3 3.9 -34.0 -43.0
Senegal 5.4 5.9 3.7 3.8 -10.3 -11.1 3.9 4.5 3.5 3.6 -12.4 -10.4
Sierra Leone 6.5 6.5 3.4 3.7 -6.4 -5.9 5.5 5.0 3.6 3.5 -6.8 -4.5
Sri Lanka 6.4 5.6 2.5 2.5 -5.7 -4.9 6.0 3.8 1.6 1.5 -7.7 -5.9
St. Lucia 4.4 4.4 2.2 2.1 -18.5 -17.9 1.7 -1.0 2.2 2.1 -29.5 -23.7
St. Vincent & Grens. 5.0 4.9 2.2 2.0 -26.7 -23.3 1.9 0.2 2.6 2.4 -34.1 -28.4
Sudan 7.6 12.7 1.5 2.9 -9.8 -5.6 8.5 6.0 1.4 1.5 -7.0 -10.0
Tajikistan 4.1 7.0 0.8 1.0 -8.3 -7.1 7.9 3.0 0.6 0.5 -8.9 -8.6
Tanzania 7.8 8.0 4.3 3.8 -9.7 -10.1 7.0 5.3 5.6 5.8 -9.9 -8.6
Togo 3.0 4.0 2.6 2.5 -7.9 -6.7 0.8 2.0 3.5 3.2 -7.0 -6.4
Uganda 7.1 7.0 6.4 6.1 -7.7 -9.3 9.5 6.0 7.5 6.9 -6.1 -7.9
Uzbekistan 8.0 7.5 16.1 17.6 24.6 20.8 9.1 7.0 10.5 11.3 13.5 7.3
Vietnam 7.3 7.3 2.6 2.3 -13.6 -11.9 6.2 4.8 4.5 3.6 -10.3 -8.2
Yemen, Republic of 4.1 8.1 10.8 10.5 -1.4 0.9 3.9 7.7 13.2 11.6 -2.1 -2.8
Zambia 6.3 6.3 3.0 3.5 -5.5 -3.9 5.8 4.0 3.2 3.3 -8.9 -8.3
1/ Next year imports of goods and services.
2/ Including current transfers.
in percent of GDP
WEO Spring 2008 Current Projections
(months of imports 1/) in percent of GDP (months of imports 1/)
Current Acc. Balance 2/ Reserves GDP growth Reserves
Table 1. Selected Economic Indicator Projections, Spring 2008, and
Current Projection
(In percent average, unless otherwise indicated)
GDP growth Current Acc.Balance 2/39
2008 2009 2008 2009
All LICs 7.1 6.0 11.2 7.8
Sub-Saharan Africa 6.7 5.3 10.2 6.4
Asia 8.8 6.0 13.5 8.2
Middle East and Europe 10.3 7.9 14.4 8.7
Latin American countries 6.2 6.5 9.9 6.9
Net Oil importers 7.0 6.0 10.8 6.9
Net Oil exporters 8.3 7.3 11.8 8.2
Countries according to their per capita income 0.0 0.0 0.0 0.0
top 25% 6.0 4.5 9.0 4.5
mid 50% 8.5 6.1 12.0 7.9
bottom 25% 8.0 6.4 11.2 9.8
Table 2. Inflation Projections, Spring 2008, and Current Projection
(In percent, median)
WEO Spring 2008 Latest Projections
2008 2009 2008 2009 2008 2009 2008 2009 2008 2009 2008 2009
All LICs 6.2 6.4 4.2 4.5 -7.7 -7.3 5.4 4.3 4.4 4.2 -9.6 -10.2
Sub-Saharan Africa 5.9 6.3 4.3 4.8 -7.7 -7.9 5.3 4.6 4.3 3.9 -8.9 -11.0
Asia 6.5 6.4 4.0 4.0 -6.7 -5.7 6.2 5.0 4.4 4.2 -6.6 -5.5
Middle East and Europe 8.0 8.7 4.9 5.2 -2.6 -1.0 6.7 4.8 4.8 4.8 -7.5 -7.4
Latin American countries 4.3 4.3 3.2 3.1 -15.2 -14.9 2.8 1.8 4.6 4.4 -19.4
-17.9
Net Oil importers 5.9 6.0 3.5 3.6 -10.9 -10.1 5.2 4.1 3.8 3.6 -12.7 -11.3
Net Oil exporters 7.3 7.9 6.5 7.5 3.4 2.3 5.9 5.1 6.7 6.0 0.8 -6.5
Countries according to their per capita income
top 25% 7.7 7.0 4.0 4.5 -9.3 -7.6 5.5 3.9 4.2 4.1 -13.7 -13.6
mid 50% 5.5 6.3 4.8 5.0 -6.3 -5.9 5.1 4.1 5.0 4.6 -8.0 -8.7
bottom 25% 6.0 6.2 3.3 3.4 -8.8 -9.5 5.9 5.2 3.5 3.4 -8.7 -9.8
1/ Next year imports of goods and services.
2/ Including current transfers.
WEO Spring 2008 Latest Projections
Table 1 continued. Selected Economic Indicator Projections, Spring
2008, and Current Projection
(In percent average, unless otherwise indicated)
GDP growth Reserves Current Acc. Bal. 2/ GDP growth Reserves
Current Acc. Bal. 2/
(months of imports 1/) in percent of GDP (months of imports 1/) in
percent of GDP40
Figure 1. Selected Indicators; LICs versus the World, 1980-2008;1/
Current Projection
Sources: WEO, and World Bank WDI databases.
1. Emerging and developing countries.
Current Account Deficit/GDP
LICs
average
World
average 1/
-12
-10
-8
-6
-4
-2
0
2
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
External debt/GDP
LICs
average
World
average 1/
0
20
40
60
80
100
120
140
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
Government Balance/GDP
LICs
average
World
average 1/
-10
-8
-6
-4
-2
0
2
4
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
Reserve cover in months
LICs
average
World
average 1/
0
2
4
6
8
10
12
1980 1983 1986 1989 1992 1995 1998 2001 2004 200741
Figure 2. Selected Indicators; LICs by Regions
(Period averages, in percent, unless otherwise indicated)
Growth
-6
-4
-2
0
2
4
6
8
Sub-Saharan
Africa
Asia Middle East
and Europe
Latin America
1990-1999
2000-2007
Inflation (Median)
0
10
20
30
40
50
Sub-Saharan
Africa
Asia Middle East
and Europe
Latin America
1990-1999
2000-2007
Current Account Balance/GDP
-14
-12
-10
-8
-6
-4
-2
0
Sub-Saharan
Africa
Asia Middle East
and Europe
Latin America
1990-1999
2000-2007
External Debt/GDP
0
20
40
60
80
100
120
140
Sub-Saharan
Africa
Asia Middle East
and Europe
Latin America
1990-1999
2000-2007
Fiscal Deficit/GDP
-10
-8
-6
-4
-2
0
Sub-Saharan
Africa
Asia Middle East
and Europe
Latin America
1990-1999
2000-2007
Reserve Cover
0
1
2
3
4
5
Sub-Saharan
Africa
Asia Middle East
and Europe
Latin America
1990-1999
2000-200742
40
50
60
70
80
2006 2007 2008 2009 2010
Latin America
Europe/
Middle East
Sub-Saharan Africa
Average
(excl India)
Asia
(excl India)
Selected LICs: External to Total Public Debt Ratio
(In percent)
0
10
20
30
40
50
60
2006 2007 2008 2009 2010
Latin America
Europe/Middle East
Sub-Saharan Africa
Average
Asia
Selected LICs: Total Public Debt
(In percent of GDP)
0
10
20
30
2006 2007 2008 2009 2010
Latin America
Europe/Middle East
Sub-Saharan Africa
Average
Asia
Selected LICs: Interest Payments to Revenues
(In percent)
Appendix III. Selected Debt Indicators 43
Appendix IV. Debt Simulations
The global slowdown could have potentially important implications for
LIC debt
sustainability. The magnitude of these implications is highly uncertain.
Accordingly, this
section presents the details on the simulation to analyze LICs’ risk of
debt distress. The debt
simulations for 2009 assume reduced investment expenditure financing
from aid, and FDI is
replaced with public external borrowing (the reductions in aid and FDI
in this simulation are
identical to those in the simulations of Appendix V). Debt levels are
measured relative to
GDP and the corresponding debt service relative to exports. A country
is considered at high
risk of debt distress if these ratios exceed their corresponding
thresholds.
34
In order to provide
a broad range of results for each country, the simulations comprise two
scenarios — one
where new debt is contracted under nonconcessional terms and the
other under concessional
terms.
35
The results of this appendix are for illustrative purposes only and
should not be
considered as actual debt projections at the country level. The final
impact of the global
slowdown is highly dependent on policy responses and domestic factors,
as well as on the
interaction of different shocks. In addition, the magnitude of the shocks
to FDI and aid in the
simulations, and consequently any public debt that replaces these
financing sources, is not
based on a projection of likely developments.
The risks to debt sustainability posed by the current financial crisis
vary depending on
initial conditions (Table 1). The debt simulations for 2009 assume that
reduced investment
expenditure financing from aid and FDI is replaced with public external
borrowing. Relative
to GDP, the simulated increase in public external borrowing during one
year adds 4 percent
of GDP to the average LIC debt burden. For countries with already
high debt levels, this
further raises risks of debt distress. Moreover for some of the poorest
LICs, aid represents a
large portion of GDP. Consequently, replacing public debt for a portion
of that aid
significantly increases their already high debt burden. A handful of
countries that were
previously on the verge of high risk of debt distress become so as a
result of the simulation.
At the same time, with few exceptions, LICs with sustainable debt prior
to the crisis would
continue to avoid high risk of debt distress.
The results also illustrate the importance of new borrowing being on
concessional
terms. The distinction between concessional and nonconcessional debt
has an important
impact on the debt service burden.
34
The thresholds are commensurate with those applied in World
Bank/IMF debt sustainability analysis for LICs
and are designed to correspond to the World Bank’s Country
Performance and Institutional Assessment ratings.
35
Commercial interest rates are assumed to be 8 percent, consistent with
the World Bank/IMF debt
sustainability analysis assumptions, and concessional rates are assumed
to be on IDA terms. 44
Appendix IV. Table 1. Debt Implications 1/
Debt in percent of GDP
Debt Service in percent of Exports of Goods and
Services
High Risk of Debt Distress Measured
by Debt/GDP
High Risk of Debt Distress Measured
by Debt Service/Exports
2008 proj. 2009 proj. 2009 simul. 2008 proj. 2009 proj. 2009 simul. 2008
proj. 2009 simul. 2008 proj. 2009 simul.
Conc. 2/ Non-Conc. 2/ Conc. 2/ Non-Conc. 2/ Conc. 2/ Non-Conc. 2/
Conc. 2/ Non-Conc. 2/
Afghanistan, I.R. of . . . . . . . .
Albania 17 18 19 19 8 9 9 10
Angola 10 15 13 13 3 6 6 7
Armenia 14 16 16 16 2 3 3 4
Azerbaijan 6 10 6 6 1 2 2 2
Bangladesh 24 24 25 25 5 5 5 5
Benin 12 14 16 16 5 5 5 7
Bhutan 65 64 69 69 15 15 15 16 1 1 1
Bolivia 19 21 20 20 6 9 9 10
Burkina Faso 19 22 22 22 6 5 5 8
Burundi 127 27 132 132 3 2 2 7 1 1 1
Cambodia 26 26 31 31 0 1 1 1 1 1
Cameroon 6 8 7 7 8 10 10 10
Cape Verde 55 56 61 61 8 7 7 8 1 1 1
Central African Rep. 50 50 52 52 9 11 11 12 1 1 1
Chad 19 24 23 23 3 4 4 5
Comoros 47 48 50 50 13 10 11 12 1 1 1
Congo, Dem. Rep. of 87 23 93 93 4 7 7 9 1 1 1
Congo, Republic of 50 68 57 57 5 6 6 7 1 1 1
Côte d'Ivoire 83 80 84 84 9 12 12 12 1 1 1
Djibouti 64 65 76 76 7 13 13 15 1 1 1
Dominica 59 56 68 68 -26 -24 -24 -22 1 1 1
Eritrea 59 57 61 61 25 24 24 25 1 1 1 1 1 1
Ethiopia 11 14 14 14 1 3 3 5
Gambia, The 44 46 47 47 24 24 24 25 1 1 1 1 1 1
Georgia 34 39 39 39 15 24 24 25 1
Ghana 37 42 41 41 3 3 3 4
Grenada 78 77 86 86 15 18 18 20 1 1 1
Guinea 67 21 69 69 20 10 10 11 1 1 1 1
Guinea-Bissau 235 224 243 243 11 427 427 429 1 1 1 1 1
Guyana 80 89 89 89 0 1 1 1 1 1 1
Haiti 23 26 27 27 6 9 9 11
Honduras 17 16 20 20 2 2 2 2
India 19 19 19 19 7 7 7 7
Kenya 19 19 20 20 5 4 4 4
Kyrgyz Republic 52 49 55 55 3 4 4 5 1 1 1
Lao People's Dem. Rep. 98 104 105 105 14 16 17 18 1 1 1 1 1
Lesotho 39 38 52 52 3 5 5 7 1 1
Liberia 475 468 490 490 0 0 0 4
Madagascar 25 29 30 30 2 4 4 5
Malawi 17 18 22 22 4 4 4 5
Maldives 83 92 90 90 9 10 10 10 1 1 1
Mali 22 25 23 23 3 4 4 4
Mauritania 57 60 60 60 . . . . 1 1 1
Moldova 44 49 48 48 14 15 15 15 1 1 1
Mongolia 35 47 40 40 3 4 4 5
Mozambique 52 52 66 66 19 28 29 33 1 1 1 1 1
Myanmar 28 27 28 28 3 4 4 4
Nepal 28 29 29 29 9 9 9 10
Nicaragua 69 54 75 75 10 9 9 10 1 1 1
Niger 14 17 19 19 12 11 11 13
Nigeria 2 3 3 3 2 3 3 4
Pakistan 27 32 28 28 14 12 13 13
Papua New Guinea 20 18 21 21 6 8 8 8
Rwanda 15 15 21 21 3 2 3 7
São Tomé & Príncipe 70 50 88 88 . . . . 1 1 1
Senegal 38 44 41 41 5 8 8 9 1 1
Sierra Leone 17 16 20 20 1 2 2 3
Somalia . . . . . . . .
Sri Lanka 43 42 44 44 . . . . 1 1 1
St. Lucia 44 46 49 49 8 8 8 9
St. Vincent & Grens. 0 . 7 7 16 18 18 20
Sudan 58 65 61 61 4 11 11 13 1 1 1
Tajikistan 45 46 46 46 86 32 32 33 1 1 1 1 1 1
Tanzania 34 34 38 38 1 1 2 3
Togo 64 62 66 66 2 4 4 4 1 1 1
Uganda 13 15 16 16 3 3 3 4
Uzbekistan 14 13 14 14 6 7 7 7
Vietnam 30 33 37 37 3 5 5 6
Yemen, Republic of 22 22 23 23 2 3 3 4
Zambia 6 7 8 8 1 2 2 3
All LICs 48 46 52 52 8 14 14 15 28 31 31 4 6 7
SSA 55 50 60 60 6 18 18 20 15 17 17 3 4 4
Asia 37 40 40 40 6 7 7 7 4 5 5 0 1 1
Middle East/Europe 31 33 34 34 12 10 10 11 5 5 5 1 1 2
Latin America 43 43 49 49 4 5 5 7 4 4 4 0 0 0
Net oil importers 52 51 57 57 8 16 16 18 22 25 25 4 6 7
Net oil exporters 33 32 36 36 5 7 7 8 6 6 6 0 0 0
Countries with top 25%
per capita income
41 47 45 45 5 7 7 8 8 8 8 0 0 1
Countries with mid 50%
per capita income
37 36 40 40 9 8 8 9 13 16 16 2 2 2
Countries with bottom
25% per capita income
77 67 82 82 7 33 33 35 7 7 7 2 4 4
1/ Reduced FDI and aid, relative to 2008, are assumed to be fully
replaced by external debt (private and public) value to obtain 2009
simulations.
FDI and aid are each reduced by 30 percent of their 2008 value to
obtain 2009 simulations.
2/ Conc. (non-conc) indicates the scenario with concessional (non-
concessional) borrowing in 2009.
Sources: WEO database, and Fund staff calculations.45
Appendix V. Simulation Results
While the global slowdown is spreading worldwide, LICs are expected
to witness
serious macroeconomic effects, with important balance of payments
repercussions. The
magnitude of these repercussions is highly uncertain. Accordingly, this
section presents an
overall assessment of the LICs’ short-run vulnerabilities to the global
downturn,
incorporating in part LIC vulnerabilities resulting from a combination
of simulated shocks.
The details of various simulation channels to analyze LICs’ short-run
balance of payments
vulnerabilities to the global downturn are also presented. The balance
of payments
simulations relate to the channels highlighted in the second part of
Section IV. The
simulation exercises of possible shocks to trade, remittances, FDI, and
aid presented here are
consistent with the methodology applied to the analysis of the food and
fuel price shocks in
IMF (2008b).
The overall vulnerability assessment for LICs analyzes LICs’ short-run
vulnerabilities
to the global downturn on the basis of both its effects in the current
baseline projections
and the simulation exercise. The current baseline projections used in
this exercise are for
real GDP growth and reserves in months of imports.
36
The simulation is a simple partial
equilibrium exercise to assess the immediate impact on the balance of
payments and reserves
of the assumed shocks: the trade balance (as a result of lower world
market prices and export
volumes), remittances, FDI, and aid. The exercises do not incorporate
further effects on
growth or demand. The overall vulnerability assessment ranks
countries in three vulnerability
categories—high (H), medium (M), or low (L). A country is considered
to have high overall
vulnerability when the current baseline projects a sizable decline in real
GDP growth and
reserves in conjunction with significant vulnerability in the shock
simulation.
37
For the shock
simulation and each of its individual channels, countries are also ranked
in three vulnerability
categories—high (H), medium (M), or low (L)—depending on the
impact of these shocks
expressed in terms of the import coverage of reserves. The H category
encompasses countries
that had a reserve coverage of less than three months of imports in 2008
and could lose more
than an extra 0.5 month in the shock scenario.
38
While three months of import coverage is a
standard benchmark, actual vulnerabilities depend on a range of
factors, in particular the
36
In these exercises, reserve coverage is measured in terms of current year
imports rather than the following
year imports (the regular measure), as the latter would have required
assumptions on import in 2010, and thus
on the permanency and growth effects of the shocks, which goes beyond
the scope of this paper.
37
A reduction in excess of 2.5 percent of GDP is considered a large
reduction in projected real GDP. A
moderate decline in real GDP could correspond to a 0.5 percent drop. A
large reduction in reserves in months of
imports is a decline in excess of 0.5 month of imports. Any reduction
below this would be considered moderate.
38
Countries in the M category either start with more than 3 months of
export coverage and lose more than 0.5 in
the shock, or start below 3 months of coverage and lose less than 0.5
month with the shock. In the L bracket,
countries start with more than 3 months of import coverage and lose
less than 0.5 in the shock scenario. For
members of the CFA zone, the weight of reserves adequacy was
reduced. 46
exchange rate regime. Accordingly, the simple methodology presented
here offers only a
crude approximation of the country-specific vulnerabilities.
Stressing the limitations of the partial analysis conducted here, the
results of this
appendix should not be considered as actual projections at the country
level. The final
impact of the global slowdown is highly dependent on policy responses
and domestic factors,
as well as on the interaction of different shocks. In addition, the
magnitude of the shocks in
the simulations is not based on a projection of likely developments.
Therefore, the results
presented in this appendix should be considered only for illustrative
purposes.
Overall Vulnerability
About 30 percent of LICs could be considered highly vulnerable to the
consequences of
global financial crisis (Table 1). About 50 percent of these highly
vulnerable countries are
in sub-Saharan Africa (SSA). The majority of the highly vulnerable
countries face sizable
declines in projected GDP, some in excess of 5 percent. About 60
percent of the countries are
also found to be highly vulnerable to the simulated shock. More than
half of the countries
with high vulnerabilities resulting from the simulated shock are also in
SSA (Table 2).
Details on the individual channels that comprise the shock to the
balance of payments are
provided in the remainder of this appendix.
Trade
The analysis of the potential impact of the trade channel is summarized
in one shock
combining several commodities’ shock simulations together and in an
alternative trade
shock resulting from increased oil prices. In the combined shock, the
commodities are oil,
other commodities, food, other exports, and services exports. The shock
simulations are a
partial equilibrium exercise and the impact of all shocks affects exports
through prices or
volumes. The oil, other commodities, and food shocks are channeled
through a decrease in
international prices. The shock simulates a return of the prices from
their average 2008 levels
to their 1995–2007 averages. For manufactured exports and services,
the impact of the crisis
is expected to be channeled through a decrease in volumes. LICs are
assumed to be price
takers and the estimated drop in value as a result of the shock can be
attributed entirely to the
drop in the volume of exports resulting from lower global demand. The
shocks are simulated
as a 10 percent drop in the value of exports in line with an assumed
drop in demand in
trading partners. In LICs exports of services largely fall into two
categories: transportation
(e.g., for countries with an active port that act as regional hubs) and
tourism. Tourism
receipts are expected to be significant only in a handful of LICs, while
the majority of
services receipts are in the transport sector, i.e., trade-related.
The combined trade shock (Table 3) points to the vulnerability of LICs
in our sample to
the trade channel, where about a fifth of all countries were found to be
highly
vulnerable. The overall vulnerability seems to reflect regional
concentration in Africa, 47
where over 40 percent of the countries fall in the highly vulnerable
group, and the country’s
per capita income. Operating a fixed exchange rate regime seems to
contribute to a country’s
vulnerability, where a larger portion of LICs in that category (39
percent) appear to be highly
vulnerable compared with the floaters (29 percent).
The simulation of an increase in oil prices (Table 4) shifts most of the
countries in our
sample from the low-vulnerability category into that of high
vulnerability, where about
60 percent of LICs would fall. In this scenario, LICs in all regions are
highly vulnerable,
particularly oil importers. Contrary to the scenario where oil prices
drop to historical average,
the exchange rate arrangement does not appear to insulate the country
from the impact of an
increase in oil prices, where fixers and floaters appear equally
vulnerable. The lowest per
capita income category would be the hardest hit as over 70 percent of
them become highly
vulnerable.
Technical Summary
Combined Trade Shock
This combined trade shock adds all the below-mentioned shocks,
including a decrease in
international oil prices.
x Oil Price Decrease: The shock simulates a return of the prices from
their average
2008 levels (US$97 per barrel) to their 1995–2007 average (US$32.5 per
barrel).
x Food Price Shock: The shock simulates a drop in food commodity
prices from their
2008 level to their 1995–2007 average level, about 35 percent on
average. Consistent
estimates of food imports/exports for all LICs are not directly available.
Therefore,
values of individual food commodity imports/exports for 2002–04
39
are extrapolated
using the change in each individual commodity price and real GDP
growth to
estimate food imports/exports in 2008. This methodology suffers
shortcomings
because it assumes commodity volumes are a linear function of GDP
growth.
However, it ensures a consistent definition of food imports across
countries.
40
x Non-oil, Non-food Commodities Shock
41
: The shock simulates a drop in commodity
prices from their 2008 level to their 1995–2007 average level, about 52
percent lower
39
Computed by the IMF's Research Department based on WITS and desk
data for the terms of trade exercise.
40
Note that food imports can be defined in many ways. This paper looks
at food commodity imports and
excludes processed or industrial food since the consumption of such
products is likely to be small in LICs. The
following commodities are included in our food definition: bananas,
barley, beef, fish, fishmeal, groundnuts,
lamb, maize, olive oil, oranges, palm oil, poultry, rapeseed oil, rice,
shrimp, soy meal, soy oil, soybeans, sugar,
sunflower/safflower oil, pork, and wheat.
41
Other commodities comprises coffee, cocoa, tea, hardwood log,
hardwood sawn, softwood log, softwood
sawn, cotton, wool, natural rubber, hides, aluminum, copper, lead, tin,
zinc, iron, nickel, uranium, gold, natural
gas, and coal. 48
on average. As for food imports/exports, we estimate non-oil commodity
exports by
extrapolating their 2002–04 values by the change in each individual
commodity price
and real GDP growth.
x Drop in Other Exports: Other exports (non-food, non-commodity
exports) include
manufactured products. The shock simulates a 10 percent drop in value.
x Services Shock: The shock simulates a 10 percent drop in value.
x Total Trade Shock. The total trade shock adds all the above-
mentioned shocks,
including a decrease in international oil prices.
Oil Price Increase
The shock simulates a 25 percent increase in oil prices from their
average 2008 level (US$97
per barrel), to about US$125 per barrel.
Remittances
The shock of a sudden reduction in remittances is calibrated for each
region, and takes
into account both direct and indirect effects on the balance of payments.
For each region,
the shock was calibrated as half of the decline that is necessary to
reduce 2009 remittances to
the average remittances during 2000–05. Then, within regions, the
shock was applied
uniformly to all countries. This implied a reduction of 36 percent for
African LICs, 25
percent for Asian LICs, 24 percent for European LICs, 28 percent for
Middle East/Europe
LICs, and 30 percent for Latin America LICs. By considering only half
of the decline,
instead of the total decline, the proposed methodology acknowledges
that a reduction in
remittances will not only lead to a direct worsening of the balance of
payments and hence
reserves, but also to an indirect improvement as remittances-related
imports might decline.
The simulations reveal that around 50 percent of LICs could face a
vulnerable balance
of payments situation as a result of a sudden decline in remittances
(Table 5). Across
regions, Latin America would be most severely impacted, where almost
90 percent of LICs
would have reserves under 3 months of imports. In the rest of the
regions, except for Africa,
20 percent of the countries would have reserves under 3 months of
imports. In Africa, almost
50 percent of the countries could be vulnerable under this metric. Out
of all LICs in our
sample, just 20 percent of them would lose reserves in excess of half a
month worth of
imports.
FDI
A sudden reduction in FDI is assumed to have both direct and indirect
effects on the
balance of payments. The FDI simulations entail a shock reducing 2009
FDI to the average
FDI during 2000–05, equivalent to a 30 percent reduction in 2008 FDI.
The shock was 49
applied uniformly to all LICs in our sample. Given that a significant
portion of FDI is often
spent on imports, imports were also assumed to decline.
42
Consequently, the balance of
payments, and hence reserves, were worsened by the nominal amount of
the FDI reduction
and improved by the FDI-related import reduction.
Over 50 percent of LICs could face a vulnerable balance of payments
situation resulting
from suddenly reduced FDI—a consequence of global financial crisis
(Table 6). LICs in
Latin America would be most severely impacted, where almost 90
percent of them would
have reserves under 3 months of imports. In the rest of the world, 60
percent of LICs would
face reserves under 3 months of imports. About 10 percent of Asia’s
LICs would face a
decline of over 0.5 month of imports.
Aid
A substantial decline in aid could result in a vulnerable balance of
payments situation
in over 50 percent of LICs (Table 7). The aid simulations for 2009
assume aid will be
reduced by 30 percent relative to its 2008 value. This is equivalent to the
average aid
reduction for the three countries currently projecting the largest aid
reductions for 2009.
When aid is reduced by 30 percent, almost 90 percent of LICs in Latin
America would have
reserves under 3 months of imports. Meanwhile, 60 percent of LICs in
the rest of the world
would have reserves under 3 months of imports. Out of all LICs in our
sample, over 40
percent of them would lose reserves in excess of half a month of imports.
42
The marginal propensity of FDI-related imported expenditure is
assumed to be 0.5. Consequently FDI-related
imports are expected to decline relative to FDI-imports of 2008. No such
offset is included for the other shocks. 50
Appendix V. Table 1. Vulnerability Table
Real GDP Growth Reserves (in Months of Imports)
2009 current less
Spring WEO proj. 1/ 2009 less 2008 2/
Afghanistan, I.R. of -0.7 0.3
Albania -2.4 -0.7
Angola -8.6 -1.0
Armenia -5.0 -0.1
Azerbaijan -7.6 1.2
Bangladesh -1.2 0.0
Benin -2.0 -0.6
Bhutan -1.0 -0.2
Bolivia -1.0 -0.7
Burkina Faso -2.3 -0.6
Burundi -2.0 -0.6
Cambodia -2.2 -0.4
Cameroon -1.1 -0.7
Cape Verde -2.4 0.1
Central African Rep. -2.0 -0.9
Chad 1.1 -2.1
Comoros -2.2 -0.5
Congo, Dem. Rep. of -7.3 0.6
Congo, Republic of -0.3 -1.2
Côte d'Ivoire -0.7 0.0
Djibouti -1.5 0.2
Dominica -1.5 0.1
Eritrea -0.4 -0.1
Ethiopia -0.6 0.6
Gambia, The -0.5 -0.3
Georgia -6.5 0.5
Ghana -3.4 -1.2
Grenada -3.4 0.2
Guinea -1.1 0.5
Guinea-Bissau 0.0 0.7
Guyana 0.1 0.0
Haiti -1.5 -0.3
Honduras -2.6 -0.7
India -2.8 -1.0
Kenya -0.4 0.4
Kyrgyz Republic -4.6 -0.1
Lao People's Dem. Rep. -3.4 -0.9
Lesotho -3.3 -0.8
Liberia 0.7 0.0
Madagascar -2.2 0.5
Malawi 0.5 0.5
Maldives 2.5 0.8
Mali -0.7 0.1
Mauritania -2.8 -0.3
Moldova -4.5 -0.2
Mongolia -3.1 0.0
Mozambique -1.5 -0.1
Myanmar 1.0 0.7
Nepal 0.1 0.0
Nicaragua -2.7 0.1
Niger 0.0 -0.8
Nigeria -5.0 -3.9
Pakistan -4.7 0.4
Papua New Guinea 0.2 -0.9
Rwanda 0.4 -0.7
São Tomé & Príncipe -0.5 -0.4
Senegal -1.4 0.1
Sierra Leone -1.5 -0.1
Somalia . .
Sri Lanka -1.8 -0.2
St. Lucia -5.4 -0.1
St. Vincent & Grens. -4.7 -0.2
Sudan -6.7 0.2
Tajikistan -4.0 0.0
Tanzania -2.7 0.1
Togo -2.0 -0.3
Uganda -1.0 -0.6
Uzbekistan -0.5 0.8
Vietnam -2.5 -0.9
Yemen, Republic of -0.5 -1.6
Zambia -2.4 0.2
All LICs -2.1 -0.3 15 H 47 M 8 L 26 H 31 M 13 L
SSA -1.8 -0.2 9 H 24 M 3 L 11 H 19 M 6 L
Asia -1.4 -0.2 2 H 10 M 2 L 4 H 6 M 4 L
Middle East/Europe -3.6 0.0 3 H 6 M 2 L 7 H 2 M 2 L
Latin America -2.5 -0.2 1 H 7 M 1 L 4 H 4 M 1 L
Net oil importers -1.9 -0.1 10 H 39 M 5 L 18 H 26 M 10 L
Net oil exporters -2.8 -0.7 5 H 8 M 3 L 8 H 5 M 3 L
Countries with top 25% per
capita income -3.2 -0.1 0 H 16 M 1 L 7 H 8 M 2 L
per capita income -2.2 -0.5 10 H 20 M 5 L 16 H 13 M 6 L
Countries with bottom 25%
per capita income -0.9 0.0 5 H 11 M 2 L 3 H 10 M 5 L
1/ Current projection for 2009 less Spring WEO projection for 2009
2/ Current projection for 2009 less 2008 actual.
3/ Combined Shock: Trade, Remittances, Aid, FDI. See section IV for
description of shocks and Appendix V tables for magnitudes
of individual shocks.
Vulnerability Score
L
H
Simul. 3/ 4/
M
L
L
M
M
H
H
M
M
.
M
M
H
M
M
M
M
M
M
M
M
M
M
M
M
M
H
M
M
H
M
H
L
M
M
M
M
M
H
M
M
M
M
H
M
M
H
L
H
M
H
H
M
H
M
M
M
M
M
M
H
M
M
M
L
M
M
L
L
M
H
H
H
M
M
M
L
L
M
H
M
M
M
H
M
M
H
M
H
H
M
M
M
L
M
H
M
M
L
M
H
H
M
L
H
H
H
H
M
M
L
L
H
H
H
M
L
L
M
M
H
M
H
M
M
H
H
L
M
.
M
Overall Assessment 4/
H
L
H
M
M
L
L
H
H51
Appendix V. Table 2. Simulations' Vulnerability Table 1/
Shocks: Vulnerability Ratings
Trade FDI Aid Remittances
Afghanistan, I.R. of M L H H
Albania L L LM
Angola H L L L
Armenia L L LH
Azerbaijan H L L L
Bangladesh L M MH
Benin L L L L
Bhutan L L L L
Bolivia L L L L
Burkina Faso L L ML
Burundi L L HL
Cambodia L M M M
Cameroon H L L L
Cape Verde L M HM
Central African Rep. H M M M
Chad H L L L
Comoros L L MM
Congo, Dem. Rep. of H M M M
Congo, Republic of H L L L
Côte d'Ivoire H M M M
Djibouti M H MM
Dominica L M HM
Eritrea L M MH
Ethiopia M M H M
Gambia, The L L L L
Georgia M M M M
Ghana M M M M
Grenada L M M M
Guinea H M MH
Guinea-Bissau L L MM
Guyana L M MH
Haiti L L HH
Honduras L M MH
India L L L L
Kenya L M M M
Kyrgyz Republic L L LH
Lao People's Dem. Rep. L H MM
Lesotho L L ML
Liberia H M MH
Madagascar L M HM
Malawi M M H M
Maldives L M M M
Mali M L L L
Mauritania H M M M
Moldova L L LH
Mongolia M M M M
Mozambique L L HL
Myanmar M L L L
Nepal L L LM
Nicaragua L M MH
Niger M L M L
Nigeria M L L L
Pakistan L M M M
Papua New Guinea H L L L
Rwanda L L ML
São Tomé & Príncipe L L ML
Senegal L M MH
Sierra Leone L L HL
Somalia . . . .
Sri Lanka M M M M
St. Lucia M M M M
St. Vincent & Grens. M M M M
Sudan H M H H
Tajikistan M M M H
Tanzania L L ML
Togo L L MH
Uganda L L L L
Uzbekistan L L L L
Vietnam H L ML
Yemen, Republic of L L L L
Zambia H M M M
All LICs M M M M 15 H 47 M 8 L
SSA M L M M 9 H 24 M 3 L
Asia M M M M 2 H 10 M 2 L
Middle East/Europe M L L M 3 H 6 M 2 L
Latin America L M M M 1 H 7 M 1 L
Net oil importers L M M M 10 H 39 M 5 L
Net oil exporters M L L L 5 H 8 M 3 L
Fixed XR M L M M 5 H 29 M 5 L
Flexible XR M M M M 9 H 18 M 3 L
capita income
M M M M 0 H 16 M 1 L
Countries with mid 50% per
capita income
M M M M 10 H 20 M 5 L
Countries with bottom 25%
per capita income
M L M M 5 H 11 M 2 L
2/ The total vulnerability score combines the ratings for each of the four
simulated shocks, placing equal
weight on each shock.
H
L
L
M
L
H
H
M
M
.
M
M
M
M
M
M
M
M
M
M
H
M
M
M
M
M
H
M
M
H
M
H
M
M
M
M
M
M
H
M
L
M
M
H
M
M
H
L
M
M
H
H
M
H
M
M
H
M
M
M
M
L
L
L
M
M
M
M
M
H
Score 2/
Total Vulnerability
M52
Vulnerable
(IR<3)
Vulnerable
(IR drop >0.5)
2008 proj. 2009 proj. 2009 simul. 2008 proj. 2009 simul. 2009 simul.
2009 simul.
Afghanistan, I.S. of -2.8 -2.3 -4.6 3.2 2.9 1
Albania -10.0 -7.5 -8.5 4.2 4.9
Angola 5.8 1.3 -71.0 4.1 -10.2 1 1
Armenia -13.7 -12.9 -14.8 3.3 3.1
Azerbaijan 30.9 10.9 -15.1 6.4 -12.5 1 1
Bangladesh 0.7 0.5 1.6 3.0 3.7
Benin -9.6 -8.3 -6.7 7.3 10.0
Bhutan 11.7 2.8 9.2 13.3 13.4
Bolivia 11.0 -4.3 5.6 15.7 13.9 1
Burkina Faso -11.3 -9.5 -8.3 5.5 7.9
Burundi -12.5 -8.0 -10.7 3.7 4.7
Cambodia -11.9 -7.1 -5.4 3.0 4.7
Cameroon 0.4 -5.4 -10.0 6.5 2.7 1 1
Cape Verde -13.0 -12.7 -12.6 3.0 3.3
Central African Rep. -8.7 -7.2 -13.7 2.9 0.6 1 1
Chad -9.5 -19.6 -56.5 4.6 -2.8 1 1
Comoros -8.7 -8.3 -2.5 6.0 9.6
Congo, Dem. Rep. of -12.4 -19.8 -18.6 0.5 -0.3 1 1
Congo, Republic of -0.8 -18.1 -69.8 7.2 0.3 1 1
Côte d'Ivoire 0.1 -2.6 -11.6 2.5 -0.2 1 1
Djibouti -38.2 -14.0 -35.2 2.2 2.7 1
Dominica -30.1 -24.4 -27.7 2.9 3.6
Eritrea -2.7 1.1 4.2 0.9 4.9
Ethiopia -5.8 -5.9 -3.4 1.3 2.5 1
Gambia, The -13.9 -12.5 -13.7 4.8 5.2
Georgia -21.8 -17.7 -21.1 2.2 2.5 1
Ghana -20.2 -15.9 -19.2 1.6 2.0 1
Grenada -31.8 -31.8 -27.7 3.0 4.0
Guinea -4.1 -2.6 -9.3 1.3 -0.2 1 1
Guinea-Bissau 0.2 -11.6 7.3 6.0 9.7
Guyana -20.8 -18.1 -23.9 2.8 3.1
Haiti -2.6 -4.4 2.7 3.2 5.9
Honduras -13.3 -8.3 -11.1 2.7 3.3
India -2.5 -1.8 -2.2 9.4 10.7
Kenya -6.6 -2.7 -2.4 2.9 5.0
Kyrgyz Republic -6.0 -6.5 -7.0 3.2 3.6
Lao People's Dem. Rep -15.1 -11.9 -15.2 3.0 3.3
Lesotho -3.7 -8.5 -1.4 6.3 7.1
Liberia -31.8 -42.2 -50.8 0.7 0.2 1 1
Madagascar -22.6 -14.8 -20.0 2.3 3.1
Malawi -8.0 -4.6 -5.6 0.9 1.6 1
Maldives -46.0 -30.1 -33.1 2.7 4.4
Mali -6.1 -6.2 -10.1 4.6 4.0 1
Mauritania -6.1 -8.6 -77.8 0.9 -6.2 1 1
Moldova -18.9 -19.2 -17.1 3.3 3.8
Mongolia -9.2 -7.1 -10.5 1.9 2.1 1
Mozambique -12.7 -11.8 -13.0 4.8 5.4
Myanmar 3.3 1.3 0.0 6.3 4.7 1
Nepal 2.6 3.3 4.4 7.4 9.1
Nicaragua -23.6 -17.7 -18.9 2.5 3.4
Niger -9.9 -22.6 -14.8 5.6 4.7 1
Nigeria 5.0 -10.7 -16.1 12.8 5.2 1
Pakistan -8.4 -4.7 -6.2 2.2 3.5
Papua New Guinea 3.2 -5.5 -46.2 5.1 -1.5 1 1
Rwanda -6.9 -7.6 -5.3 5.9 7.3
São Tomé & Príncipe -34.0 -43.0 -24.0 5.5 7.9
Senegal -12.4 -10.4 -9.5 3.1 4.2
Sierra Leone -6.8 -4.5 -1.6 3.5 7.9
Somalia . . . . .
Sri Lanka -7.7 -5.9 -5.1 1.2 2.1 1
St. Lucia -29.5 -23.7 -29.6 2.2 2.3 1
St. Vincent & Grens. -34.1 -28.4 -34.1 2.4 2.6 1
Sudan -7.0 -10.0 -23.9 1.2 -6.6 1 1
Tajikistan -8.9 -8.6 -7.4 0.6 0.8 1
Tanzania -9.9 -8.6 -8.3 5.6 7.4
Togo -7.0 -6.4 4.6 3.1 7.2
Uganda -6.1 -7.9 -6.1 8.1 8.7
Uzbekistan 13.5 7.3 5.3 10.6 7.7 1
Vietnam -10.3 -8.2 -20.3 3.6 2.5 1 1
Yemen, Republic of -2.1 -2.8 -16.8 10.2 6.3 1
Zambia -8.9 -8.3 -15.6 2.6 0.7 1 1
All LICs -9.6 -10.2 -15.2 4.3 3.6 26 22 15 H 15 M 40 L
SSA -8.9 -11.0 -16.8 4.1 3.6 14 14 11 H 6 M 19 L
Asia -6.6 -5.5 -9.5 4.7 4.7 5 3 2 H 4 M 8 L
Middle East/Europe -6.4 -6.3 -13.6 4.5 1.8 5 4 2 H 3 M 6 L
Latin America -19.4 -17.9 -18.3 4.1 4.7 2 1 0 H 2 M 7 L
Net oil importers -12.7 -11.3 -11.5 3.7 4.6 15 7 4 H 14 M 36 L
Net oil exporters 0.8 -6.5 -27.8 6.1 0.5 11 15 11 H 1 M 4 L
Countries with top
25% per capita
income
-13.7 -13.6 -23.9 3.8 1.9 8 3 3 H 5 M 9 L
Countries with mid
50% per capita
income
-8.0 -8.7 -14.6 4.7 3.8 13 15 10 H 5 M 20 L
25% per capita
income
-8.7 -9.8 -8.2 3.8 5.0 5.0 4 2 H 5 M 11 L
1/ The combined trade shock simulates for 2009 a return of
commodities prices from their end-2008 levels to their 1995-2007
averages,
and a 10 percent decline in the 2008 value of other exports and services.
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Current Account in percent of GDP
Int. Reserves in Months of
Imports of G&S
M
Vulnerability
2009 simul.53
Vulnerable
(IR<3)
2009 simul.
Afghanistan, I.R. of -2.8 -2.3 -4.6 3.2 2.9 1
Albania -10.0 -7.5 -14.0 4.2 3.2 1
Angola 5.8 1.3 41.4 4.1 9.6
Armenia -13.7 -12.9 -16.2 3.3 2.6 1 1
Azerbaijan 30.9 10.9 75.3 6.4 13.3
Bangladesh 0.7 0.5 -0.8 3.0 2.4 1 1
Benin -9.6 -8.3 -11.5 7.3 6.1 1
Bhutan 11.7 2.8 4.9 13.3 11.4 1
Bolivia 11.0 -4.3 4.6 15.7 13.2 1
Burkina Faso -11.3 -9.5 -13.0 5.5 4.4 1
Burundi -12.5 -8.0 -18.8 3.7 1.8 1 1
Cambodia -11.9 -7.1 -21.5 3.0 1.2 1 1
Cameroon 0.4 -5.4 1.4 6.5 7.1
Cape Verde -13.0 -12.7 -18.6 3.0 2.0 1 1
Central African Rep. -8.7 -7.2 -8.8 2.9 3.1
Chad -9.5 -19.6 1.2 4.6 7.2
Comoros -8.7 -8.3 -7.5 6.0 6.8
Congo, Dem. Rep. of -12.4 -19.8 -18.5 0.5 -0.3 1 1
Congo, Republic of -0.8 -18.1 23.3 7.2 9.9
Côte d'Ivoire 0.1 -2.6 -6.5 2.5 1.1 1 1
Djibouti -38.2 -14.0 -44.4 2.2 1.2 1 1
Dominica -30.1 -24.4 -36.6 2.9 1.6 1 1
Eritrea -2.7 1.1 -5.8 0.9 -0.4 1 1
Ethiopia -5.8 -5.9 -9.0 1.3 0.0 1 1
Gambia, The -13.9 -12.5 -18.2 4.8 3.7 1
Georgia -21.8 -17.7 -26.4 2.2 1.2 1 1
Ghana -20.2 -15.9 -31.0 1.6 -0.2 1 1
Grenada -31.8 -31.8 -37.0 3.0 1.8 1 1
Guinea -4.1 -2.6 -17.1 1.3 -2.4 1 1
Guinea-Bissau 0.2 -11.6 -1.2 6.0 5.9
Guyana -20.8 -18.1 -56.0 2.8 -0.3 1 1
Haiti -2.6 -4.4 -4.7 3.2 2.5 1 1
Honduras -13.3 -8.3 -22.2 2.7 1.3 1 1
India -2.5 -1.8 -6.2 9.4 7.6 1
Kenya -6.6 -2.7 -11.3 2.9 1.3 1 1
Kyrgyz Republic -6.0 -6.5 -23.4 3.2 1.1 1 1
Lao People's Dem. Rep. -15.1 -11.9 -22.5 3.0 1.1 1 1
Lesotho -3.7 -8.5 -7.9 6.3 5.9
Liberia -31.8 -42.2 -67.4 0.7 -0.5 1 1
Madagascar -22.6 -14.8 -25.3 2.3 1.6 1 1
Malawi -8.0 -4.6 -11.7 0.9 -0.2 1 1
Maldives -46.0 -30.1 -55.9 2.7 1.1 1 1
Mali -6.1 -6.2 -17.6 4.6 0.7 1 1
Mauritania -6.1 -8.6 -38.1 0.9 -2.0 1 1
Moldova -18.9 -19.2 -26.2 3.3 2.3 1 1
Mongolia -9.2 -7.1 -29.4 1.9 -1.0 1 1
Mozambique -12.7 -11.8 -18.2 4.8 3.2 1
Myanmar 3.3 1.3 0.0 6.3 4.7 1
Nepal 2.6 3.3 0.3 7.4 6.4 1
Nicaragua -23.6 -17.7 -32.7 2.5 1.0 1 1
Niger -9.9 -22.6 -18.9 5.6 2.6 1 1
Nigeria 5.0 -10.7 14.9 12.8 16.6
Pakistan -8.4 -4.7 -10.9 2.2 0.9 1 1
Papua New Guinea 3.2 -5.5 -26.4 5.1 1.1 1 1
Rwanda -6.9 -7.6 -9.0 5.9 4.9 1
São Tomé & Príncipe -34.0 -43.0 -37.4 5.5 4.3 1
Senegal -12.4 -10.4 -14.1 3.1 2.5 1 1
Sierra Leone -6.8 -4.5 -10.9 3.5 1.5 1 1
Somalia . . . . .
Sri Lanka -7.7 -5.9 -12.0 1.2 -0.1 1 1
St. Lucia -29.5 -23.7 -37.3 2.2 1.0 1 1
St. Vincent & Grens. -34.1 -28.4 -41.9 2.4 1.0 1 1
Sudan -7.0 -10.0 -2.2 1.2 4.2
Tajikistan -8.9 -8.6 -14.4 0.6 -0.3 1 1
Tanzania -9.9 -8.6 -15.7 5.6 3.4 1
Togo -7.0 -6.4 -15.2 3.1 1.1 1 1
Uganda -6.1 -7.9 -9.6 8.1 6.6 1
Uzbekistan 13.5 7.3 5.3 10.6 7.7 1
Vietnam -10.3 -8.2 -20.0 3.6 2.6 1 1
Yemen, Republic of -2.1 -2.8 4.5 10.2 13.0
Zambia -8.9 -8.3 -20.5 2.6 -0.8 1 1
All LICs -9.6 -10.2 -14.3 4.3 3.3 43 57 42 H 9 M 19 L
SSA -8.9 -11.0 -12.6 4.1 3.3 19 27 19 H 6 M 11 L
Asia -6.6 -5.5 -14.6 4.7 3.0 10 13 9 H 2 M 3 L
Middle East/Europe -6.4 -6.3 -5.9 4.5 4.7 6 8 6 H 1 M 4 L
Latin America -19.4 -17.9 -29.3 4.1 2.6 8 9 8 H 0 M 1 L
Net oil importers -12.7 -11.3 -19.6 3.7 2.3 38 50 37 H 9 M 8 L
Net oil exporters 0.8 -6.5 3.3 6.1 6.9 5 7 5 H 0 M 11 L
per capita income -13.7 -13.6 -15.2 3.8 3.5 1 14 12 H 1 M 4 L
per capita income -8.0 -8.7 -13.8 4.7 3.6 1 27 20 H 3 M 12 L
25% per capita income -8.7 -9.8 -14.6 3.8 2.5 1 16 10 H 5 M 3 L
1/ The combined trade shock simulates for 2009 a 25 percent increase in
oil prices, a return of commodities prices from their end-2008 levels
to their 1995-2007 averages, and a 10 percent decline in the 2008 value
of other exports and services.
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Vulnerable (IR
drop >0.5)
Imports of G&S
Current Account in percent of GDP
Appendix V. Table 4: Combined Trade Shock, with a 25 percent
Increase in Oil Prices 1/
Vulnerability54
2009 simul.
Afghanistan, I.R. of 3/ 56.8 45.4 48.6 3.5 0.7 1 1
Albania 11.5 9.1 9.0 4.4 3.6 1
Angola 0.3 0.3 0.2 3.6 4.0
Armenia 2/ 11.0 . 8.1 3.8 2.4 1 1
Azerbaijan 2.6 2.9 1.9 8.0 6.1
Bangladesh 9.7 10.7 7.5 3.1 2.0 1 1
Benin 3.1 3.0 2.0 7.2 6.8 1
Bhutan 3/ -6.8 . -6.8 13.9 13.3
Bolivia 5.1 4.7 3.6 14.6 15.1 1
Burkina Faso 0.8 0.9 0.5 6.1 5.4
Burundi 3/ 3.2 . 2.1 4.0 3.3
Cambodia 2/ 3.3 . 2.5 3.1 2.8 1
Cameroon 2/ 0.7 . 0.5 6.2 6.4
Cape Verde 6.9 6.1 4.5 3.4 2.6 1
Central African Rep. -0.3 -0.3 -0.3 2.9 2.9 1
Chad 2.6 3.1 1.7 3.6 4.4
Comoros 21.2 20.8 14.6 6.8 3.9 1
Congo, Dem. Rep. of 1.8 . 1.2 1.4 0.4 1
Congo, Republic of 0.0 0.0 0.0 8.6 7.2
Côte d'Ivoire -2.6 -2.9 -2.6 3.1 2.5 1
Djibouti -4.0 -3.7 -4.0 3.8 2.2 1
Dominica 8.0 8.0 5.7 3.1 2.5 1
Eritrea 3/ 20.7 . 14.3 1.1 -1.9 1 1
Ethiopia 2/ 1.4 . 0.9 1.8 1.1 1
Gambia, The 1.1 1.1 0.7 4.5 4.7
Georgia 5.7 5.7 4.2 3.4 1.9 1
Ghana 2/ 0.7 . 0.5 0.6 1.5 1
Grenada 4.1 3.2 2.9 3.3 2.8 1
Guinea 7.0 6.6 4.6 2.2 0.5 1 1
Guinea-Bissau 7.5 6.0 4.9 7.1 5.4 1
Guyana 26.8 21.1 20.4 3.2 2.0 1 1
Haiti 19.3 16.0 14.3 2.9 1.5 1 1
Honduras 19.4 15.9 14.3 2.5 1.8 1 1
India 2/ 2.5 . 1.9 9.4 9.2
Kenya 3.3 3.2 2.1 4.0 2.5 1
Kyrgyz Republic 27.9 21.0 21.8 3.8 2.3 1 1
Lao People's Dem. Rep. 2/ 0.0 . 0.0 2.6 3.0 1
Lesotho 0.0 0.0 0.0 6.0 6.3
Liberia 2/ 86.5 . 80.4 0.7 -0.7 1 1
Madagascar 0.3 0.2 0.2 3.2 2.3 1
Malawi 2/ 0.0 . 0.0 1.4 0.9 1
Maldives 2/ 0.2 . 0.2 3.6 2.7 1
Mali 2/ 2.5 . 1.6 5.3 4.2
Mauritania 2.1 2.3 1.5 0.9 0.8 1
Moldova 17.1 14.4 13.6 3.3 2.8 1 1
Mongolia 1.7 1.3 1.3 2.6 1.8 1
Mozambique 2/ 1.0 . 0.7 4.9 4.7
Myanmar 2/ 0.6 . 0.4 6.9 6.2
Nepal 16.4 16.9 12.9 7.7 5.9 1
Nicaragua 12.9 11.8 9.4 3.0 1.9 1 1
Niger 2/ 1.5 . 1.0 3.7 5.4
Nigeria 1.6 2.1 1.0 11.1 12.6
Pakistan 4.0 4.4 2.9 2.8 1.7 1
Papua New Guinea 0.5 0.1 0.4 5.2 5.1
Rwanda 0.9 0.9 0.6 5.1 5.8
São Tomé & Príncipe 1.7 1.9 1.1 3.8 5.4
Senegal 8.2 6.8 5.4 4.0 2.3 1 1
Sierra Leone 0.7 0.7 0.4 4.0 3.4
Somalia . . . . .
Sri Lanka 7.4 7.0 5.7 1.3 0.7 1
St. Lucia 2/ 3.0 . 2.1 2.1 2.0 1
St. Vincent & Grens. 2.8 2.7 2.0 2.6 2.2 1
Sudan 2/ 3.1 . 2.3 1.7 0.7 1 1
Tajikistan 45.1 38.6 37.1 0.5 -1.3 1 1
Tanzania 2/ 0.1 . 0.0 5.8 5.6
Togo 16.2 13.5 11.0 3.5 2.0 1 1
Uganda 2/ 6.0 . 3.9 7.2 7.2 1
Uzbekistan 3/ 7.6 3.8 5.6 13.0 9.9 1
Vietnam 2/ 6.1 . 4.7 4.1 3.4
Yemen, Republic of 5.2 3.8 3.8 12.8 9.7 1
Zambia 2/ 0.4 . 0.3 3.4 2.6 1
All LICs 7.8 7.4 6.0 4.5 3.8 39 25 16 H 27 M 27 L
SSA 5.8 2.1 4.5 4.2 3.7 15 9 5 H 12 M 18 L
Asia 7.3 6.1 5.9 5.0 4.2 6 2 1 H 6 M 5 L
Middle East/Europe 11.1 8.0 8.6 4.9 3.4 9 7 5 H 4 M 3 L
Latin America 11.3 9.3 8.3 4.1 3.5 8 5 4 H 4 M 1 L
Net oil importers 9.0 8.8 7.1 4.0 3.2 35 20 15 H 23 M 16 L
Net oil exporters 3.6 3.4 2.5 6.5 5.8 4 5 1 H 4 M 11 L
capita income
6.2 6.4 4.4 4.3 3.5 12.0 4.0 3 H 10 M 4 L
Countries with mid 50% per
capita income
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Countries with bottom 25% per
capita income
12.4 10.6 10.2 4.0 3.2 8.0 7.0 4 H 6 M 8 M
1/ Remittances are reduced by regionally calibrated amounts, averaging
34 percent, to obtain 2009 simulations.
2/ The projection of remittances for 2008 is from the World Bank
(2008), since it was not available from Fund staff.
3/ As remittances data are not available, the projection for 2008
corresponds to private current transfers from World Economic
Outlook.
Sources: WEO database, Fund staff calculations, and World Bank.
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Vulnerability Rating
2009 simul.
H
Remittances in percent of GDP
Imports of G&S
Vulnerable
(IR<3)
Vulnerable
(IR drop >0.5)55
2009 simul.
Afghanistan, I.R. of 2.4 3.2 1.7 3.2 3.1
Albania 4.9 4.6 3.5 4.2 4.1
Angola 9.5 . 6.8 4.1 3.7
Armenia 6.6 6.2 4.7 3.3 3.1
Azerbaijan -4.1 -1.8 -4.1 6.4 6.4
Bangladesh 0.8 0.8 0.6 3.0 3.0 1
Benin 3.1 2.0 2.2 7.3 7.2
Bhutan 0.9 0.9 0.7 13.3 13.3
Bolivia 2.4 3.0 1.7 15.7 15.7
Burkina Faso 2.2 1.0 1.5 5.5 5.4
Burundi 0.0 0.0 0.0 3.7 3.7
Cambodia 7.4 4.1 5.2 3.0 2.8 1
Cameroon 1.7 2.8 1.2 6.5 6.4
Cape Verde 9.8 7.8 7.0 3.0 2.8 1
Central African Rep. 5.1 5.1 3.6 2.9 2.6 1
Chad 14.3 9.9 10.2 4.6 4.3
Comoros 1.6 1.5 1.1 6.0 6.0
Congo, Dem. Rep. of 14.5 5.6 10.4 0.5 0.2 1
Congo, Republic of 23.3 21.5 16.9 7.2 6.9
Côte d'Ivoire 2.2 2.6 1.5 2.5 2.4 1
Djibouti 31.4 9.8 23.0 2.2 1.6 1 1
Dominica 14.3 12.1 10.2 2.9 2.6 1
Eritrea 2.4 3.6 1.7 0.9 0.8 1
Ethiopia 3.2 1.9 2.2 1.3 1.2 1
Gambia, The 9.0 8.0 6.4 4.8 4.6
Georgia 9.7 7.7 6.9 2.2 1.9 1
Ghana 6.0 5.0 4.2 1.6 1.5 1
Grenada 19.2 21.8 13.8 3.0 2.6 1
Guinea 2.5 2.2 1.7 1.3 1.2 1
Guinea-Bissau 2.9 2.8 2.0 6.0 6.0
Guyana 13.4 11.4 9.6 2.8 2.6 1
Haiti 0.4 0.3 0.3 3.2 3.2
Honduras 7.4 4.0 5.2 2.7 2.6 1
India 1.6 1.2 1.1 9.4 9.4
Kenya 2.7 3.3 1.9 2.9 2.8 1
Kyrgyz Republic 6.1 4.2 4.3 3.2 3.1
Lao People's Dem. Rep. 18.5 16.5 13.3 3.0 2.4 1 1
Lesotho 5.4 3.9 3.8 6.3 6.3
Liberia 23.5 42.8 17.1 0.7 0.6 1
Madagascar 7.6 2.7 5.4 2.3 2.1 1
Malawi 5.2 2.9 3.7 0.9 0.7 1
Maldives 20.5 18.5 14.8 2.7 2.5 1
Mali 1.4 1.1 1.0 4.6 4.5
Mauritania 2.0 4.1 1.4 0.9 0.9 1
Moldova 11.1 9.5 7.9 3.3 3.2
Mongolia 12.6 7.0 9.0 1.9 1.7 1
Mozambique 4.7 4.7 3.3 4.8 4.6
Myanmar 0.9 0.9 0.6 6.3 6.3
Nepal 0.0 0.2 0.0 7.4 7.4
Nicaragua 7.1 6.1 5.0 2.5 2.3 1
Niger 8.1 13.4 5.7 5.6 5.4
Nigeria 2.2 3.9 1.6 12.8 12.8
Pakistan 3.0 2.1 2.1 2.2 2.0 1
Papua New Guinea 1.4 1.3 0.9 5.1 5.1
Rwanda 2.4 1.7 1.7 5.9 5.8
São Tomé & Príncipe 33.5 11.4 24.7 5.5 5.0
Senegal 4.5 3.8 3.2 3.1 3.0 1
Sierra Leone 2.5 1.1 1.8 3.5 3.4
Somalia . . . . .
Sri Lanka 1.5 0.6 1.0 1.2 1.1 1
St. Lucia 17.5 20.3 12.6 2.2 1.8 1
St. Vincent & Grens. 16.6 14.7 11.9 2.4 2.0 1
Sudan 3.8 5.0 2.7 1.2 0.9 1
Tajikistan 3.7 1.9 2.6 0.6 0.5 1
Tanzania 3.5 3.9 2.5 5.6 5.5
Togo 3.0 4.1 2.1 3.1 3.0
Uganda 6.5 5.4 4.6 8.1 7.9
Uzbekistan 2.7 2.9 1.9 10.6 10.6
Vietnam 8.7 4.5 6.1 3.6 3.5
Yemen, Republic of 1.8 0.8 1.2 10.2 10.2
Zambia 4.4 1.9 3.1 2.6 2.4 1
All LICs 7.0 5.9 5.0 4.3 4.1 33 2 2 H 31 M 37 L
SSA 6.6 5.5 4.7 4.1 4.0 14 0 0 H 15 M 21 L
Asia 5.7 4.4 4.1 4.7 4.5 6 1 1 H 6 M 7 L
per capita income
10.8 9.8 7.7 3.8 3.6 11.0 0.0 0 H 11 M 6 L
per capita income
6.0 4.1 4.3 4.7 4.6 16.0 2.0 2 H 14 M 19 L
5.5 5.8 3.9 3.8 3.7 6.0 0.0 0 H 6 M 12 L
1/ FDI is reduced by 30 percent of its 2008 value to obtain 2009
simulations.
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Appendix V. Table 6. Reduced FDI 1/
Vulnerable
(IR<3)
Vulnerable
(IR drop >0.5)
FDI in percent of GDP
Imports of G&S56
2009 simul.
Afghanistan, I.R. of 2/ 24.5 . 18.5 3.2 2.0 1 1
Albania 2.7 2.2 1.9 4.2 4.0
Angola 2/ 0.1 . 0.1 4.1 4.0
Armenia 0.5 . 0.4 3.3 3.2
Azerbaijan 0.8 2.4 0.5 6.4 6.3
Bangladesh 1.2 1.7 0.9 3.0 2.9 1
Benin 8.3 7.4 6.0 7.3 6.2 1
Bhutan 11.0 . 8.0 13.3 12.5 1
Bolivia 1.2 1.1 0.9 15.7 15.5
Burkina Faso 7.9 . 5.7 5.5 4.4 1
Burundi 17.8 . 13.2 3.7 2.3 1 1
Cambodia 6.4 6.4 4.6 3.0 2.7 1
Cameroon 0.1 0.9 0.0 6.5 6.5
Cape Verde 10.3 14.3 7.4 3.0 2.5 1 1
Central African Rep. 2.2 1.9 1.6 2.9 2.6 1
Chad 0.4 1.4 0.3 4.6 4.6
Comoros 9.1 6.1 6.6 6.0 5.3 1
Congo, Dem. Rep. of 6.4 . 4.6 0.5 0.2 1
Congo, Republic of 2/ 0.4 . 0.3 7.2 7.1
Côte d'Ivoire 0.6 0.4 0.4 2.5 2.4 1
Djibouti 10.0 10.2 7.2 2.2 1.8 1
Dominica 14.0 13.1 10.3 2.9 2.2 1 1
Eritrea 1.8 . 1.3 0.9 0.7 1
Ethiopia 5.2 . 3.7 1.3 0.7 1 1
Gambia, The 1.3 7.5 0.9 4.8 4.7
Georgia 6.3 9.5 4.5 2.2 1.8 1
Ghana 7.5 . 5.4 1.6 1.2 1
Grenada 6.8 5.5 4.8 3.0 2.6 1
Guinea 3.3 2.2 2.3 1.3 1.0 1
Guinea-Bissau 21.4 20.8 16.0 6.0 4.6 1
Guyana 17.6 18.2 13.0 2.8 2.3 1
Haiti 10.5 8.0 7.6 3.2 2.3 1 1
Honduras 3.2 2.2 2.3 2.7 2.5 1
India 0.0 . 0.0 9.4 9.4
Kenya 0.8 . 0.6 2.9 2.8 1
Kyrgyz Republic 3.6 4.7 2.6 3.2 3.1
Lao People's Dem. Rep. 4.5 . 3.2 3.0 2.7 1
Lesotho 38.2 . 30.2 6.3 5.1 1
Liberia 2/ 26.6 . 20.3 0.7 0.4 1
Madagascar 9.9 9.1 7.1 2.3 1.7 1 1
Malawi 11.6 16.6 8.4 0.9 -0.1 1 1
Maldives 2.7 . 1.9 2.7 2.6 1
Mali 3.3 . 2.3 4.6 4.2
Mauritania 8.5 9.3 6.1 0.9 0.5 1
Moldova 1.5 2.4 1.0 3.3 3.3
Mongolia 4.6 . 3.2 1.9 1.7 1
Mozambique 42.8 . 34.3 4.8 1.1 1 1
Myanmar 0.1 . 0.1 6.3 6.3
Nepal 2.1 3.5 1.5 7.4 7.2
Nicaragua 11.5 11.1 8.4 2.5 2.0 1
Niger 7.4 12.0 5.3 5.6 4.8 1
Nigeria 2/ 0.7 . 0.5 12.8 12.7
Pakistan 0.6 . 0.4 2.2 2.1 1
Papua New Guinea 1.7 3.9 1.2 5.1 5.0
Rwanda 17.6 16.0 13.0 5.9 3.8 1
São Tomé & Príncipe 26.5 41.5 20.1 5.5 4.2 1
Senegal 5.4 5.0 3.8 3.1 2.7 1
Sierra Leone 6.3 6.3 4.5 3.5 2.7 1 1
Somalia . . . . .
Sri Lanka 3.6 . 2.6 1.2 0.9 1
St. Lucia 0.3 . 0.2 2.2 2.2 1
St. Vincent & Grens. 5.3 6.0 3.8 2.4 2.1 1
Sudan 4.8 . 3.4 1.2 0.4 1 1
Tajikistan 1.8 . 1.3 0.6 0.5 1
Tanzania 10.7 . 7.8 5.6 4.5 1
Togo 2.1 3.5 1.5 3.1 3.0 1
Uganda 4.9 . 3.5 8.1 7.5 1
Uzbekistan 0.4 . 0.3 10.6 10.6
Vietnam 2/ 15.6 . 11.5 3.6 3.0 1
Yemen, Republic of 1.1 2.0 0.7 10.2 10.1
Zambia 4.5 6.0 3.2 2.6 2.2 1
All LICs 7.3 7.7 5.4 4.3 3.8 39 23 11 H 37 M 22 L
SSA 9.2 5.2 6.9 4.1 3.5 18 17 7 H 20 M 9 L
Asia 5.6 1.1 4.1 4.7 4.4 6 2 1 H 8 M 5 L
per capita income
5.3 8.2 3.8 3.8 3.6 11.0 3.0 2 H 9 M 6 L
per capita income
6.1 6.4 4.5 4.7 4.3 17.0 9.0 2 H 21 M 12 L
11.7 10.6 8.8 3.8 3.0 11.0 11.0 7 H 7 M 4 L
1/ Aid is reduced by 30 percent of its 2008 value to obtain 2009
simulations.
2/ Aid data for 2008 is estimated from the OECD Development
Assistance Committee aid database.
M
M
L
L
M
L
M
H
M
M
H
.
M
M
L
M
M
M
M
M
L
M
M
H
L
L
M
L
M
L
M
M
H
H
L
M
L
M
M
M
H
M
M
M
M
M
H
M
H
L
M
L
M
M
H
M
L
M
M
H
M
L
M
L
L
L
L
L
L
L
Appendix V. Table 7. Reduced Aid 1/
H
2009 simul.
Vulnerable
(IR<3)
Vulnerable
(IR drop >0.5)
Aid in percent of GDP
Imports of G&S57
Appendix VI. Scenarios for Financing Needs
This appendix shows various measures of LICs’ financing needs due to
the global crisis.
The measures of the external shock and of the financing need focus on
the change in balance
of payments flows and reserves since the April 2008 WEO, in the most
recent projections,
and in a simulation of possible further shocks (see Appendix IV for
details on the simulation,
although here the combined shock does not include a shock to aid). For
each case, and for all
70 LICs in the sample, the table shows reserves in U.S. dollars and in
months of (current
year’s) imports of goods and services. The total magnitude of the shock
or the financing need
for all countries that are adversely affected is presented in the bottom
part of the table.
The setup of the appendix table differs from that of the summary table
in the main text. For
both the most recent projections, and in a simulation of possible larger
shocks, the table
shows three results: The first column of the appendix table focuses on
the total reserve loss
and the resulting additional financing need. The second column focuses
on the magnitude of
the balance of payments shock before adjustment or import
compression.
The first two columns of the appendix table show the change in 2009
reserves since the
April 2008 WEO in U.S. dollars.
x As indicated at the bottom of the first column, the most recent
projections show
reduced projected reserves (in dollar terms) for 35 LICs (half of the
sample).
However, the very large overall revision, by US$131 billion, is largely
explained by
just two countries: Nigeria and India. 62 percent of the decline concerns
the 16 oil
producers in the sample. For 22 LICs, reserves are projected to fall
below 3 months of
imports at end-2009—a standard, but crude, measure of reserve
adequacy.
43
This
would imply a financing need of US$25 billion.
x The second column shows the change in reserves in the combined
simulation of the
effects of a larger global downturn on exports, FDI, remittances, and
food and oil
prices.
The third and fourth columns show the corresponding changes in
reserves expressed in
months of imports of goods and services.
The fifth and sixth columns assess the total balance of payments shock
(i.e., before
adjustment or import compression). This is computed by adding up the
declines in several
components of the balance of payments that may be considered
exogenous in the short run:
exports, FDI, remittances (measured here by current private transfers),
donor grants, and the
price effects on imports of the change in food and fuel prices. The fifth
column shows the
magnitude of these changes in the current baseline projections. The
sixth column shows the
corresponding results in the simulation. Given the assumed absence of
policy adjustment in
the simulation, the total shock equals the total reserves loss shown in the
second column.
43
Also including cases where reserves fall by more than 0.5 month of
imports, to less than 4 months. 58
Reserves Change in
percent Fund quota
Current 2009 proj. 2009 Simul. 2/ Current 2009 proj. 2009 Simul. 2/
Current 2009 proj. 2009 Simul. 2/ 2009 Simul. 2/
Afghanistan, I.R. of . . . . . . .
Albania 5 -349 0.3 -0.5 834 -349 -465
Angola -13,754 -45,258 -4.7 -16.2 -45,416 -45,258 -10,249
Armenia -49 -547 -0.2 -1.5 129 -547 -386
Azerbaijan -1,581 -31,789 -0.8 -27.3 -24,626 -31,789 -12,810
Bangladesh 432 -4,589 0.3 -1.9 3,122 -4,589 -558
Benin 39 67 -1.3 1.5 -145 67 70
Bhutan 30 -135 1.3 -1.5 -548 -135 -1,391
Bolivia 2,488 -468 3.2 -0.7 -897 -468 -177
Burkina Faso -1 -84 0.8 0.1 50 -84 -91
Burundi -69 -67 -0.7 -1.1 -15 -67 -56
Cambodia 278 -794 0.7 -1.0 -221 -794 -588
Cameroon -633 -2,196 -0.7 -3.7 -1,188 -2,196 -767
Cape Verde -181 -410 -0.6 -3.2 -519 -410 -2,769
Central African Rep. 18 -144 1.0 -3.7 -7,745 -144 -168
Chad -393 -1,789 -0.9 -5.8 -1,937 -1,789 -2,071
Comoros 7 8 -1.1 1.7 -31 8 56
Congo, Dem. Rep. of 452 -882 0.9 -1.1 -3,693 -882 -107
Congo, Republic of -2,267 -6,178 -5.3 -12.0 -2,973 -6,178 -4,735
Côte d'Ivoire -68 -1,074 0.2 -1.0 -88 -1,074 -214
Djibouti 20 -27 0.9 -0.2 -73 -27 -109
Dominica -8 -14 -0.5 -0.5 -23 -14 -112
Eritrea 125 -73 3.1 -2.2 -11 -73 -299
Ethiopia 73 -1,131 0.0 -1.5 1,182 -1,131 -548
Gambia, The 19 15 0.5 0.6 55 15 31
Georgia 540 -1,974 1.6 -2.9 -1,675 -1,974 -852
Ghana -1,002 -1,394 -1.0 -1.4 1,187 -1,394 -245
Grenada 22 -14 0.7 -0.2 -86 -14 -77
Guinea -88 -262 0.0 -1.5 177 -262 -159
Guinea-Bissau 18 -2 -1.5 0.8 41 -2 -7
Guyana 121 -170 1.0 -1.4 -34 -170 -121
Haiti 172 -498 0.6 -2.1 -308 -498 -395
Honduras -965 -1,683 -0.7 -1.7 -3,255 -1,683 -842
India -40,878 -15,610 -0.2 0.8 33,689 -15,610 -243
Kenya 283 -548 0.6 -0.2 1,896 -548 -131
Kyrgyz Republic 49 -153 0.3 -0.1 843 -153 -112
Lao People's Dem. Rep. 15 -235 0.1 -1.1 441 -235 -288
Lesotho -583 -385 -3.1 -2.3 -576 -385 -715
Liberia 67 -437 -0.1 -5.6 -23 -437 -398
Madagascar -34 -451 0.3 -1.1 -167 -451 -239
Malawi -158 174 -1.1 1.5 342 174 162
Maldives 654 130 5.8 1.4 415 130 1,031
Mali -115 -402 -0.6 -1.4 662 -402 -280
Mauritania -545 -646 -3.0 -3.6 -1,032 -646 -651
Moldova -614 -1,347 -0.7 -2.4 -145 -1,347 -709
Mongolia -539 -68 -1.8 0.3 -24 -68 -86
Mozambique -92 -933 0.2 -2.4 -891 -933 -532
Myanmar 2,090 -99 2.8 -0.1 585 -99 -25
Nepal 1,347 415 3.7 1.8 989 415 377
Nicaragua 811 -745 2.1 -1.5 -1,797 -745 -372
Niger 177 -396 0.0 -2.4 509 -396 -391
Nigeria -55,970 -55,188 -8.8 -9.4 -44,225 -55,188 -2,041
Pakistan -2,437 -2,947 -0.5 -0.4 7,490 -2,947 -185
Papua New Guinea 210 -2,451 0.9 -6.0 -820 -2,451 -1,208
Rwanda 32 -15 0.1 0.4 174 -15 -12
São Tomé & Príncipe -9 6 -2.7 1.2 13 6 53
Senegal -197 -287 -0.1 -0.3 508 -287 -115
Sierra Leone -34 -74 0.0 -0.9 41 -74 -46
Somalia . . . . . . .
Sri Lanka -1,789 -2,139 -1.4 -1.5 -1,511 -2,139 -335
St. Lucia -2 -97 -0.2 -1.5 149 -97 -412
St. Vincent & Grens. 7 -99 0.3 -2.9 8 -99 -772
Sudan -2,076 -10,397 -1.4 -9.1 -6,627 -10,397 -3,973
Tajikistan -29 122 -0.4 0.7 1,260 122 91
Tanzania 624 -961 1.5 -1.1 783 -961 -313
Togo 15 -111 0.8 -0.2 135 -111 -98
Uganda 293 45 0.7 0.5 1,063 45 16
Uzbekistan -3,369 -3,520 -8.2 -5.2 259 -3,520 -828
Vietnam 3,637 -7,752 1.5 -1.0 -10,052 -7,752 -1,527
Yemen, Republic of -142 -1,986 2.1 -0.6 -317 -1,986 -529
Zambia -151 -1,058 -0.1 -2.6 -1,217 -1,058 -140
Total balance of payment shock (billions) 3/
Total number 38 60
Total value -165 -216
Total Reserve loss (billions) 4/
Total number 35 60
Additional financing need (billions) 5/
Total number 22 48
1/ All changes are relative to the Spring 2008 WEO projection for 2009.
See Appendix VI for details.
2/ This corresponds with the simulated combined shocks to exports,
remittances, and FDI described in Section VI and Appendix V.
3/ The sum of the shocks to exports, FDI, remittances, and the price
effects of food and fuel price changes (but excluding import responses).
4/ The total change in reserves for LICs with reserves losses.
5/ The total change in reserves for LICs with reserves coverage falling
below 3 months of imports or reserves falling by more than 0.5 months
to less than 4 months.
Sources: WEO database, and Fund staff calculations
Appendix VI. Balance of Payments Financing Needs /1
Reserves Change in millions of
U.S. Dollars
Reserves Change in Months of
Imports of Goods and Services
Total Shock in millions of U.S.
Dollars 59
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GF CRISIS AND ITS IMPACT ON PAK (REPORT)
Executive Summary The global financial Crisis in the whole world has come after the
first recession in the world in
1930s. It has affected the poor areas of the world. People living under $2 per day have
been
mainly affected. Pakistan has bad effects of this crisis. The poor people of the Pakistan
got more
poor and unemployed.
We have carried out a study to find the relationship of the global financial crisis with the
bad
condition of Pakistan. Pakistan got this adverse trend by the imports and exports.
Pakistan was
totally depending on the imports and other countries raised the bill of imports. When we
were
unable to buy these imports we got shortage of food due to unplanned budget. Both made
the
situation more adverse. Unemployment and poverty took place when there were no
resources
available to industry. The economic factors behind this issue were financial sector of
Pakistan,
Capital Flows & Workers’ Remittances, Commodity Prices & Trade and External
Financing.
Their determinants were; Impacts of the crisis on aggregate poverty, Impacts of the crisis
on
growth and distributional impacts within countries. The determinants gave the clear
picture of
the prior and current situation of the Pakistan. Techniques have been used to overcome
the
situation. The mixed economy system has been followed by the other countries. Now
government is making intervention in the economy of these countries. The techniques to
be
followed by the Pakistan are; give breaks in taxes, agricultural uplift, cash subsidies,
easing the
monetary policy and increasing supporting programs for the labor intensive activities
Introduction What is Global Financial Crisis The Global Financial Crisis has been called
by leading economists the worst financial crisis since the one related to the Great
Depression of the 1930s1. It contributed to 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.
Many causes have been proposed, with varying weight assigned by experts. Both market-
based and regulatory solutions have been implemented or are under consideration, while
significant risks remain for the world economy. The collapse of a global housing bubble,
which peaked in the U.S. in 2006, caused the values of securities tied to housing prices to
plummet thereafter, damaging financial institutions globally. Questions regarding bank
solvency, declines in credit availability, and damaged investor confidence had an impact
on global stock markets, which suffered large losses during 2008. Economies worldwide
slowed in late 2008 and early 2009 as credit tightened and international trade declined.
Critics argued that credit rating agencies and investors failed to accurately price the risk
involved with mortgage-related financial products, and that governments did not adjust
their regulatory practices to address 21st century financial markets. Impact of the global
financial crisis on the world’s poorest As the financial crises started due to soft loaning
policies of the Europe and later on they were unable to recover those loans it has directly
affected the poor countries by making their balance of trade deficit. It has directly
affected the poverty of those countries. The issue of global poverty has many reasons at
its back. The stock markets of the developed countries were crashed; banks and financial
markets got crashed. All the industrial countries were badly affected by this downturn.It
leads to the poverty by the way of unemployment. It is expected that, the crisis will add
64 million people to the population living under $2 a day. It predicts that the global
poverty rate will fall from 42% to 39% in 2009, while the pre-crisis trajectory would have
brought the poverty rate down to 38%.
1(http://en.wikipedia.org/wiki/Financial_crises_of2007%E2%80%932009 ) 2
Prior to the crisis, the incidence of poverty in the developing world had been on a trend
decline. The poverty rates of the developing world as a whole during 1981 to 2005 were
$1.25 and $2.00 a day. In 2005 purchasing power parity (PPP) for consumption; the
former line is the average of the national poverty lines found in the poorest 15 countries
and the latter line is the average for the developing world as a whole. The trend rates of
decline in the $1.25 per day poverty rate over 1981-2005 was 1% point per year, and only
slightly lower (about 0.8% points per year) for the $2 a day line. This trend would have
almost certainly continued in the absence of the crisis, given the expected growth rates
prior to the crisis (World Bank, 2008). To assess what impact the crisis is likely to have
on aggregate poverty we need to estimate the difference between the expected levels of
poverty. Pakistan has been affected by the financial crises in terms of food price and oil
prices; rest of the disturbance was due to political instability
Topic Study Our topic of study is “Global Financial crises and its effects on Pakistan”.
The reason to choose this topic is that it has direct relationship with the poverty,
unemployment, literacy and wealth distribution. Research Objective Our research
objective is to find out the effect of global financial crises of the world in Pakistan. There
are many views that Pakistan was not affected like other world. The financial institutions
of the world were manly affected due to their soft loaning policy. Their assumption was
to facilitate the people life. But situation got an unexpected trend. Peoples were
facilitated but they were unable to pay off their loans. In Pakistan the loaning policy was
not soft enough that everyone could get loan against given terms and conditions. The
factors were of political instability or economic recession? It raised the question to be
answered. 2
Our Methodology After the study of factors which have lead to the down turn in Pakistan
we build a relationship of these factors with our variables that are poverty,
unemployment, wealth distribution. Due to the recession in the whole world the industry
and the financial institutions were affected. This effect decreased the exports of the
countries. Industries were unable to produce more because there was no cash available to
the industries to produce more as there was no cash in banks and in financial institutions,
by this effect an ultimate downturn came in the stock markets of these global economies
and their investors lost everything. This was on behalf of the whole world. Pakistan is an
agrarian economy and was totally dependent on the imports from other countries. Now
other countries were already running short of cash and resources to produce more, they
increased the prices of the commodities which they were exporting. Pakistan has to buy
these commodities at a very high price even their own produce of agriculture “the wheat”
this created a demand for basics of life as a whole. On other hand Pakistan’s political
instability in 2007 and 2008 ignite the downturn more. Our exports started to decrease as
there was no trade on the side of imports, foreign reserves were utilized to fulfill the
basics of life. Now both imports and exports were out of reach. Pakistan became trade
deficit due to the negative pressure from imports and exports. The global financial crises
raised the import bill. All the reasons gave a very worse picture to the employment in
Pakistan. Our textile industries to sugar industry all were unable to produce their own
products. Banks started to merge rather to provide the employments to the people as they
were becoming insolvent to their central banks. The effect on our industry was same as in
whole world, which is lack of cash and resources. The complete picture leads to
unemployment and unemployment to the poverty. Investors of Pakistan invested in other
countries and our economy got more down turn. Stock market indexes came to a very low
figure prior to the crises. The mass-scale unemployment came to the economy. Food
crises came due to our own wrong decision of the export but it got more worsen when we
were in need of it. We imported it at greater price rather we exported it. The reason was
financial crises. People of rural areas who were producing for their own could only
survive in this condition. But the people who were under the poverty line were largely
affected by this curse as they were having no land of their own. Here comes another
aspect of nourishment in the sense of food and poverty due to the crises. The nourishment
of the peoples especially female has been affected indirectly. Due to poverty the
female has to survive on the less available food and cash for medicine. Infant child
mortality did not have any improvement and the goal of MGD was seemed to be farther.
Mothers are unable to give time to their children if we see as a whole. This factor has also
leaded the child labor in our industry because people have no money to educate their
children. The wealth distribution among the rich and poor seemed to be unjustified.
People who were rich became richer due to our false paradigm of trickledown effect
applied by the government. In other sense one can say that the time of trickle down was
not came and the recession took place and situation got more worsen. Now the person
living under $1.25 has been increased. How to Achieve To achieve this we have made
survey of the people views. After the survey we consulted internet to find out the actual
background of the problem. The supporting discussion with the personnel from of
planning commission of Islamabad was made. After all we have got a hook to hang our
research. 2
Determinants 1.Impacts of the crisis on growth The poverty impact of the crisis in a given
country will depend on how it affects both average consumption and the distribution of
consumption relative to the mean. The World Bank has made projections for average
consumption at country level, which can be compared to the Bank’s pre-crisis projections
to assess the expected impact of the crisis. We use the World Bank’s latest growth
projections for 2009 and 2010 (as of mid-April 2009) as the “post-crisis” growth rates
while the counterfactual (pre-crisis) projections for those done by the Bank in December
2007 for 2009 and 2010. We have used the growth projections for private consumption
per capita. Consumption is more appropriate than GDP for predicting the short- term
impacts on poverty, since the shock to GDP is unlikely to be passed on fully to
consumption in the short term. The crisis is expected to sharply reduce growth in 2009. In
December 2007, the Bank forecast a growth rate of consumption per capita of 5.1% for
2009. (This is an expenditure-weighted mean for the same set of countries for which we
measure poverty using household surveys.) At the time of writing (mid-April 2009), the
expected growth rate in consumption per capita for 2009 is 0.7%. The expected growth is
lower in 2010, with a pre-crisis rate (as projected in December 2007) of 4.4% versus
2.6% post-crisis. 2.Distributional impacts within countries Past experience suggests that
relative inequality falls about as often as it rises during aggregate economic contractions,
with zero change on average. This is in keeping with one of the stylized facts to emerge
from research on growth and distributional change, namely that economic growth tends
to be distribution neutral on average (Ferreira and Ravallion, 2009). So the most
defensible assumption for the present purpose is that the burden of the crisis will be
more-or-less proportional to initial income leaving relative inequality unchanged within a
given country. To test this assumption we have estimated the poverty rates across
countries at each available survey using the most recent prior survey and assuming
distribution neutrality over the intervening period. In other words, we compare the
“actual” poverty rate calculated for a given country at a given survey. There is a sign of
underestimation at very high levels, though there are only a few observations involved.)
There is no significant difference in the means (the difference in means is 0.05% points
with a standard error of 0.28%). Statistically, one cannot reject the null hypothesis that
the predictions based on distribution neutrality are unbiased estimates of the actual
changes. It is of interest to see how well the assumption performs if we concentrate solely
on cases in which the mean was falling over the period. Then we find a slight tendency
for the distribution neutrality assumption to underestimate poverty on average, suggesting
that the actual changes in distribution were poverty increasing in contracting economies.
However, the underestimation is not statistically significant; the mean difference is
0.43% points, with a standard error of 0.54%. On applying the same tests to the $2 a day
measures we again find that the distribution-neutrality assumption tends to underestimate
poverty on average, again suggesting a distributional shift against the poor. For the full
sample the difference was 1.07% points with a standard error of 0.35%, indicating that
the difference is statistically significant in this case. However, this effect vanished
entirely when we confined attention to cases of a contracting mean; then the difference
dropped to 0.18% points with a standard error of 0.55%. 3.Impacts of the crisis on
aggregate poverty For each country, we project the distribution in levels forward to
estimate the poverty impacts of the crisis given the pre-crisis and post-crisis growth rates,
keeping the relative distribution unchanged from the latest available household survey.
This is done at the country level, for each of over 100 countries, allowing for different
initial conditions. The country-level results are then aggregated to obtain the overall
impact. Applying the country-specific growth projections to our survey-based data and
aggregating, we calculate that the crisis will add 53 million people to the 2009 count of
the number of people living below $1.25 a day and 64 million to the count of the number
of people living under $2 a day. Given current growth projections for 2010, there will be
a further impact on poverty in that year, with the cumulative impacts rising to an extra 73
million people living under $1.25 a day and 91 million more under $2 a day by 2010. 2
Given current growth projections, the aggregate poverty rate is still expected to fall over
time, albeit at a slower pace. The same (post-crisis) growth projections imply that the
aggregate $1.25 a day poverty rate will fall from 21% in the “pre-crisis” year of 2008 to
18% (1040 million people) in 2009; the pre-crisis growth rate for 2009 would have
instead brought the poverty rate down to 17% (987 million). Using the $2 a day line, the
poverty rate falls from 42% in 2008 to 39% (2,232 million) in 2009 under the lower
expected growth rate, while the pre-crisis trajectory would have brought the poverty rate
down to 38% (2,169 million). Impact of global financial crises on Pakistan The severity
as we discussed above, how it has affected poverty, growth, and distributions in the
whole world, in same way it has greatly affected the economy of Pakistan. There are
different views about the impact of the crises on Pakistan. Some peoples have said that
the recession was only in European countries and some has said that it has just affected
the poverty, unemployment and wealth distribution in Pakistan. It is true that the main
reason of the financial crises was due to the soft loans given by the European countries
and later on their recovery became impossible due to this banks were crashed and stock
markets along with them. But Pakistan has not suffered financial institutional crises; it
has been affected in terms of international relations. By these crises the goals made by
MDG (Millennium Development Goals) seemed to be far off. The variables under our
study are poverty, unemployment, wealth distribution and their related aspects in terms of
food and nourishment etc. Hypothesis After the study from determinants we build the
hypothesis that recession came into Pakistan due to the recession in the whole world but
the trend was different. The political instability has just ignited this issue.
Economic factors behind the Crisis in Pakistan 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. Following study about the factor will
describe the crises in Pakistan taken from report of State Bank of Pakistan2 “Global
Financial Crisis: Impact on Pakistan and Policy Response •Financial sector of Pakistan
The operating environment of the financial sector experienced significant deterioration in
2007 and 2008, due to a confluence of factors emanating from both the domestic and
international economic and financial developments. While the domestic environment was
characterized by weakening macroeconomic indicators and the uncertainty caused by the
prolonged period of political transition, the global financial crisis and the commodity
price hike had a feedback impact on the financial sector through the real sector of the
economy. Pakistan, which remained largely unscathed from a direct impact of the crisis,
has been more concerned with issues relating to monetary stability due to rising inflation
since before the advent of the crisis. With a thriving banking sector, increasingly resilient
to a wide variety of shocks, increasing but still relatively less correlation of domestic
financial markets with global financial developments, a proactive and vigilant regulatory
environment, and most importantly, no direct exposure to securitized instruments, risks to
financial stability were largely contained and well managed as the crisis unfolded and
impacted the financial sectors in advanced economies. • Capital Flows & Workers’
Remittances A beleaguered international economic environment has held back Foreign
Investment as it posted a decline of 47.5 percent during the first ten months of 2008-09
compared to the 2Report of Mohammed Mansoor Ali ,Director Economic Analysis
Department, State Bank of Pakistan on “ Global Financial Crisis: Impact on Pakistan and
Policy Response” in July 2009
corresponding period of the previous year. Most of this decrease has come in the shape of
an outflow of private portfolio investment of US$ 1 billion. Investment from countries
such as the United States, United Kingdom, Singapore, and Hong Kong, which have been
at the apex of the international crisis, has dropped significantly. Some Asian economies
have witnessed an anticipated fall in workers’ remittances as unemployment grew in
advanced host economies. However, workers’ remittances to Pakistan remained vigorous
and unaffected by the crisis, totaling US$ 6.36 billion in July-April 2008-09 as against
US$ 5.32 billion in the corresponding period last year, thereby displaying a rise of 19.5
percent. •Commodity Prices & Trade An unprecedented hike in international commodity
prices wreaked havoc on Pakistan’s external sector during 2007-08, with the current
account widening significantly. However, in the wake of a reduction in global demand
and the resultant decrease in commodity prices, the import bill has reduced significantly,
decreasing the current account deficit. A key loss to developing countries during the
current crisis has been a decrease in exports as demand from advanced economies
contracts. Pakistan has witnessed a slowdown in exports, but this reduction stands apart
from that witnessed by other Asian economies for two reasons. Firstly, the fall in exports
is partly due to a fall in domestic productivity and it is hard to distinguish between the
impact of the crisis and internal factors on exports. Secondly, the fall in imports has
outpaced the fall in exports, having a positive effect on the trade balance. •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.
Techniques 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 intervention 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. The FGT (Foster, Greer, Thorback) indicators of headcount index, poverty
gap index poverty severity index/ squared poverty gap index tell us the clear gaps and
state a true picture of the situation. Figures are given in annexure 1. 1-Tax breaks will be
given to the industry to produce the product. We have a problem of energy crises but if
we develop plans by keeping in mind our resources then the industry crisis can be cured.
2-Agriculture sector needs a greater uplift. We are agrarian economy and 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 and malnutrition. People will not prefer 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 uplift. People will prefer to have cultivation on their lands. 3-
Cash subsidies and food rationing programs regarding the monetary fiscal deficit will be
good in the procurement of stability. 4-Easing of the monetary policy and decreasing the
rates of productive sector will be helpful to tackle the problem faced by our country. 5-
Increasing supporting programs for the labor intensive 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.
Appendices The reference table for crises effect in Pakistan. Source: Economic Survey
2007-08, 2008-09, PSLM,Labor force Survey Table 1 Impact of Global Financial Crisis
on Macroeconomic Indicators Annex-I
Appendices The reference table for crises effect in Pakistan. Source: Economic Survey
2007-08, 2008-09, PSLM,Labor force Survey Table 1 Impact of Global Financial Crisis
on Macroeconomic Indicators Annex-I I
(IMAGE SAVED)
IMPACT OF GF CRISIS AND ITS IMPACT ON PAK

Table of contents
1)Reason of choosing this topic
2) Introduction
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)Infla tion
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
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) (Sameer khatiwada) 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 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. 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 re- establish domestic economic growth.
PAKISTAN AND THE GLOBAL FINANCIAL CRISIS
Introduction apitalism, an economic system whereby land, labor, production, pricing and
distribution are all determined by the market, has a history of moving from extended
periods of rapid growth to relatively shorter periods of contraction. The ongoing Global
Financial Crisis 2008-09 actually has its roots in the closing years of the 20th century
when U.S. housing prices, after an uninterrupted, multi-year escalation, began declining.
By mid-2008, there was an almost striking increase in mortgage delinquencies. This
increase in delinquencies was followed by an alarming loss in value of securities backed
with housing mortgages. And, this alarming loss in value meant an equally alarming
decline in the capital of America’s largest banks and trillion-dollar government-backed
mortgage lenders (like Freddie Mac and Fannie Mae; the government-backed mortgage
lenders hold some $5 trillion in mortgage-backed securities). The $10 trillion mortgage
market went into a state of severe turmoil. Outside of the U.S., the Bank of China and
France’s BNP Paribas were the first international institutions to declare substantial looses
from subprime-related securities. Just underneath the U.S. subprime debacle was the
European 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 €163
billion ($222 billion) of new bank liquidity and €700 billion (nearly $1 trillion) in
interbank loan guarantees. Towards the end of 2007, it had become quite clear that the
subprime mortgage problems were truly global in nature. Of the $10 trillion around 50
percent belonged to Freddie Mac and Fannie Mae. By September 2008, the U.S.
Department of Treasury was forced to place both Freddie and Fannie into federal
conservatorship. On 15 September 2008, Lehman Brothers, one of America’s largest
financial services entity, filed for bankruptcy. On September 16, American International
Group (AIG), one of
Page 2 of 11 © 2009. Center for Research and Security Studies, Islamabad www.crss.pk
America’s largest insurer, saw its market value dwindle by 95 percent (AIG’s share fell
to $1.25 from a 52-week high of $70). Germany, the fourth largest economy on the face
of the planet, is economically, technologically and politically integrated with the world
around it. With financial institutions going belly-up all around, credit institutions in
Germany, investment firms, insurance companies and pension funds also came under
severe financial stress. With bailout packages all around, Bundesministerium der
Finanzen also managed to get its €480 billion bailout package approved through
theBundestag in record time. Germany’s answer to the Global Financial Crisis has been
the Financial Market Stabilization Act. The Act creates a bailout package to “stabilize
financial markets, provide needed liquidity, restore the confidence of financial market
players and prevent a further aggravation of the financial crisis (the Act has been enacted
through federal legislation in less than a week’s time).” On 11 October 2008, finance
ministers from the Group of Seven, G-7, Canada, France, Germany, Italy, Japan, the U.K.
and the U.S. met in Washington but “failed to agree on a concrete plan to address the
crisis.” On October 13, several European countries nationalized their banks in an attempt
to increase liquidity. On November 14, leaders from twenty major economies gathered in
Washington to design a joint effort towards regulating the global financial sector.
PAKISTAN’S TWIN DEFICITS:
P
Pakistan’s Twin Deficits akistan’s financial crisis predates the Global Financial Crisis.
For the past several years, Pakistan has been running an unsustainable budgetary as well
as trade deficits. The Government of Pakistan, with expected revenues of around $20
billion, routinely spends some $26 billion a year thus incurring a budget deficit of over 7
percent 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. In 2007-08,
Pakistan’s balance of payment (BOP) crisis, as a consequence of $147 a barrel oil and a
spike in commodity prices, meant a frightful depletion of foreign exchange reserves
down to a less than 3-months import-cover. Inflation, in the meanwhile, shot up to over
24 percent and Pakistan stood caught in a vicious cycle of stagflation--economic
stagnation plus high inflation. Pakistan’s BOP crisis had come at a time when the entire
donor community including the U.S. and the Europeans were both engrossed in their own
subprime disasters. Pakistan, desperate for a bailout package, pleaded the U.S., begged
Saudi Arabia and urged China for a billion-dollar donation. The pleading, the begging
and the urging was to no avail. Finally, on 24 November 2008, the International
Monetary Fund (IMF), reportedly allured by the United States Department of Defense,
announced a 23-month, $7.6 billion, Stand-by Arrangement (SBA) of which the first
tranche of $3.1 billion was released. As a consequence, foreign exchange reserves
jumped from a low of $6 billion to over $9 billion.
P
Pakistan’s Banking Sector akistan’s banking sector is made up of 53 banks of which there
are 30 commercial banks, four specialized banks, six Islamic banks, seven development
financial institutions and six micro-finance banks. According to the State Bank of
Pakistan’s (SBP) Financial Stability Review 2007-08, “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 dual-headquartered 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.” As of end-
2008, data from the banking sector confirms a slowdown (after a multi-year growth
pattern). As of 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. In the meanwhile, the SBP has jacked up
economy-wide rates of interest (the 3-month treasury bill auction has seen a jump from
9.09 percent in January 2008 to 14 percent as of January 2009 and bank lending rates are
as high as 20 percent). Overall, Pakistan’s banking sector hasn’t been as prone to external
shocks as have been banks in Europe. To be certain, liquidity is tight but that has little to
do with the Global Financial Crisis and more to do with heavy government borrowing
from the banking sector and thus tight liquidity and the ‘crowding out’ of the private
sector.
CIRCULAR DEBT:
Circular Debt n 26 January 2009, Raja Pervaiz Ashraf, Minister for Water and Power,
told the Senate that the “federal government will settle half of the Rs400 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) and to
Independent Power Producers (IPPs). As a consequence, OMCs are unable to either
import oil or supply oil to IPPs. In return, IPPs are unable to generate electricity and
refineries are unable to open LC’s to import crude oil. According to BMA, a leading
financial services entity, “The circular debt problem is seriously impacting the operations
of the entire energy value chain. Due to low cash balances and liquidity as a result of the
debt problem, the companies have to resort to short term financing at high interest rates.
Refineries are having problems opening LC’s to import crude oil due to mounting
payables and receivables. The same can be said about the OMC sector including the fact
that financing costs in the entire energy sector have skyrocketed. IPP’s like HUBCO and
KAPCO are also having difficulty purchasing oil and continuing operations.”
KARACH ISTOCK EXCHANGE:

T
The Karachi Stock Exchange he Karachi Stock Exchange (KSE) is Pakistan’s largest and
the most liquid exchange. It was the “Best Performing Stock Market of the World for the
year 2002.”
As of the last trading day of December 2008, KSE had a total of 653 companies listed
with an accumulated market capitalization of Rs1.85 trillion ($23 billion). On 26
December 2007, KSE, as represented by the KSE-100 Index, closed at 14,814 points, its
highest close ever, with a market capitalization of Rs4.57 trillion ($58 billion). As of 23
January 2009, KSE-100 Index stood at 4,929 points with a market capitalization of
Rs1.58 trillion ($20 billion), a loss of over 65 percent from its highest point ever.
According to estimates of the State Bank of Pakistan (SBP), foreign investment into the
KSE stands at around $500 million. Other estimates put foreign investment at around 20
percent of the total free float. During calendar 2006 as well as 2007 foreign investors
were quite actively investing into KSE-listed securities. In September 2007, Standard &
Poor’s cut its outlook for Pakistan’s credit rating to “stable” from “positive” on concern
that “security was deteriorating.” On 5 November 2007, Moody’s Investors Service
announced that Pakistan’s credit rating had been placed “under review.”
Towards the end of 2007, the uncertainties of the upcoming general election, a troubling
macroeconomic scenario, an active insurgency in the Federally Administered Tribal
Areas (FATA), double-digit inflation, a ballooning trade deficit, an unsustainable
budgetary deficit and a worrying depletion in foreign currency reserves had all brought
dark, threatening clouds over the KSE.
IMF: PANACEA OR MORE PAIN:

O
IMF: Panacea or More Pain? n 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 deficit from around 7 percent of
GDP to 4.2 percent of GDP and an increase in 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. All this slowdown and all this additional
unemployment could very well bring Pakistanis out on to the streets—and that means a
full blown political crisis. There is no denying that we are in a terrible financial mess.
With the IMF in the equation the question now is if a serious, full blown political crisis
can somehow be averted (according to IMF’s own estimates the IMF package will
slowdown real GDP growth to 3 percent in 2008-09 and add an additional 2 to 3 million
to bottom-line unemployment)
COALITION SUPPORT FUND:

Coalition Support Fund oalition Support Fund (CSF) was created by the U.S. Congress
after 9/11 to reimburse key allied countries, particularly Pakistan and Jordan, for
providing assistance to the U.S. in the global war on terror. According to the Defense
Security Cooperation Agency (DSCA), “The Department of Defense programs for
supporting our coalition partners and building partner military capacity enable coalition
partners to participate in U.S. operations and conduct counterterrorist operations when
they otherwise lack the financial means to do so.” Under CSF, direct overt U.S. aid and
military reimbursements to Pakistan over FY2002-FY2009 (U.S. fiscal years) totaled
$11,998 million of which economic-related aid amounted to $3,129 million and security-
related aid amounted to $8,869 million. CSF has indeed been a source that filled
Pakistan’s ever-widening current account deficit. Under the new Obama Administration,
Pakistan had requested a reimbursement of $156 million but the United States unilaterally
deducted $54 million and reimbursed a total of $101 million.
CONCLUSION:
sharp spike in the international price of crude along with an unprecedented jump in
commodity prices were the two major external culprits behind Pakistan’s macroeconomic
imbalance. Oil has since come down from a high of $147 a barrel to under $40 a barrel
while commodity prices have experienced a drastic trimming. The two put together shall
provide long-needed relief to Pakistan’s trade account (and inflation). The other side of
the coin is that the world economy is slowing down like never before. Consider this:
America buys nearly 30 percent of Pakistan’s exports. America is our only major trading
partner with which we have a trade surplus. American investors account for nearly 30
percent of Foreign Direct Investment (FDI) into Pakistan. And, America is slowing down
like never before. The Global Financial Crisis and the accompanying global credit crunch
had a minor direct impact on Pakistan. But, Pakistan’s economy remains in the thickest of
woods. For FY 2008-09, Pakistan needs a colossal $13.4 billion foreign inflow of capital.
Of the $13.4 billion, IMF’s contribution is expected to be $4.7 billon and Pakistan still
needs to find other multilateral and bilateral donors to bridge the whopping gap.

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ARTICLE NO 1

GLOBAL FINANCIAL CRISIS:

Impact of Global Financial Crisis

Global Financial Crisis- A Timeline

a. Virtually no country, developing or industrial, has escaped

(1) Weaker export revenues;

a. Continue vigorous efforts and take whatever further actions

World Bank’s Global Monitoring Report-2009

Global Financial Crisis: Implications for South Asia

(a) Financial sector effects: South Asia is fortunate to have a broadly

Global Financial Crisis: Impact on Pakistan and Policy Response

The Impact of Recent Global Financial Crisis on the Financial

Global Economic Crisis and Poverty in Pakistan

The Impact of Recent Global Financial Crisis on the

Money markets: Domestic money markets have

GLOBAL FINANCIAL CRISIS: IMPLICATIONS FOR

Pakistan’s Economic Crisis

GF CRISIS AND ITS IMPACT ON PAK (REPORT)

IMPACT OF GF CRISIS AND ITS IMPACT ON PAK

PAKISTAN AND THE GLOBAL FINANCIAL CRISIS

PAKISTAN’S TWIN DEFICITS:

KARACH ISTOCK EXCHANGE:

IMF: PANACEA OR MORE PAIN:

COALITION SUPPORT FUND:

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