Global Financial Crisis
w Deep and long global economic recession looms for all countries with high unemployment, shrinking tax receipts, lower exports and trade, gyration in value of currencies, decreasing tourism income, reduced consumption levels - and the specter of depression
w Oil prices are in a steep fall, affecting the income of many oil-producing (developing) countries.
w All these pressures reduce the ability of governments in industrialized and developing countries alike to steer their economies; budget deficits are rising.
w Governments are forced to prune their budgets so as to reach as balanced a budget as possible, especially if they require IMF standby credits
w Moral hazard: Need for more equity in policy-making and allocation of public funds
w The global financial crisis has spread like wildfire across the world because one single model of globalization, i.e. liberalizing market economy without regard to diversity, different stages of development, needs etc. was pursued.
w The deliberate pushing aside of alternative models and approaches points to a moral and ethical deficiency, which policy-makers would have to account for.
The Consequences
w Developing countries, the most defenseless and often “innocent bystanders” - face a perfect storm and for them the crisis may translate into
w lower government budget allocations to social and productive sectors;
w More demand for official development assistance (ODA) and foreign direct investment (FDI) flows
w More demand for multilateral and NGO/ foundation funds
w For the private sector, this may translate into
w Lower economic growth
w Less trade with developing countries irrespective of trade barriers and custom levels
w Lower levels of FDI flows
w Less loans for investment and trade in developing countries
w Lack of interest in new public-private partnerships requiring private sector funding
w Overall, reduced confidence in market forces
The Multilateral Fallout
w Global “collisions” and contradictions arise; difficult to resolve - e.g., lower budget allocations by developing countries makes them look towards UN agencies which by themselves may be hit by lower budgets - or promote trade while credit dries up
w Doing more with less: demand by developing countries for assistance will increase while contributions to agencies are likely to decrease.
w Proximate causes
w Sub-prime lending
w Originate and distribute model
w Financial engineering, derivatives
w Credit rating agencies
w Tax regulations
w Large global imbalances
Financial Crisis: Differences between US/Europe and Pakistan
— What has not happened here
◦ No subprime lending
◦ No toxic derivatives
◦ No bank losses threatening capital
◦ No bank credit crunch
◦ No mistrust between banks
— Our Problems
◦ Reduction in capital flows
— Pressure on Balance of Payment
— Stock markets performance
— Monetary and liquidity impact
— Impact on MFs/NBFCs
— Reduction in flow from non-banks
— Perceptions of credit crunch
Issues and Challenges
Fiscal Policy
— Fiscal deficit in Pakistan
◦ Even before the recent setback: very high by international standards
◦ Contribute to the persistence of an interest rate differential with the rest of the world,
– constrains progress towards full capital account convertibility.
◦ Self imposed rule based fiscal correction needs to be consolidated and carried forward.
— Sustained interest rate differential also connected with the existence of a persistent inflation differential with the rest of the world.
◦ A key challenge is to further reduce inflation expectations toward international levels.
Monetary Policy
— A continuous need to adapt monetary management to the emerging needs of a fast growing and increasingly open economy.
— Financial deepening and increasing monetization.
◦ Expansion of monetary aggregates departs from their traditional relationship with real GDP growth.
◦ Task of monetary management: manage such growth without endangering price or financial stability.
— Further development of financial markets
— Large capital inflows in recent years
— Issues for monetary policy
◦ current account balance as a good guide to evaluation of the appropriate level of an exchange rate?
◦ to what extent should the capital account influence the exchange rate?
◦ implications of large current account deficits for the real economy?
— Optimal response to the large and volatile capital flows is based on
◦ sound macroeconomic policies
◦ prudent debt management
◦ exchange rate flexibility
◦ effective management of the capital account
◦ accumulation of appropriate levels of reserves as self-insurance and
◦ development of resilient domestic financial markets
◦ combination is country-specific; no “one size fits all”.
— Fundamentals to remain strong
◦ Financial sector robust
◦ Monetary policy – sufficient instruments, flexible
◦ Corporate sector not too leveraged – productivity gains
◦ Foreign direct investment buoyant
◦ Agriculture improving
◦ Growth domestically financed
◦ High growth rate
Approach to Manage Financial Stability
◦ Current account: Full, but gradual opening up
◦ Capital account and financial sector: More calibrated approach towards opening up.
– Equity flows encouraged;
– debt flows subject to ceilings and some end-use restrictions.
– Capital outflows: progressively liberalized.
◦ Financial sector, especially banks, subject to prudential regulation
◦ both liquidity and capital.
◦ prudential limits on banks’ inter-bank liabilities in relation to their net worth;
◦ asset-liability management guidelines take cognizance of both on and off balance sheet items
◦ Basel II framework: guidelines issued.
◦ Dynamic provisioning
◦ NBFCs: regulation and supervision tightened - to reduce regulatory arbitrage.
Lessons from the Crisis
— Avoid high volatility in monetary policy
— Appropriate response of monetary policy to asset prices
— Manage capital flow volatility
— Look for signs of over leveraging
— Active dynamic financial regulation
◦ Capital buffers, dynamic provisioning
◦ Look for regulatory arbitrage incentives/ possibilities