20304314 Global Financial Crisis 2007 and Its Impact of Pakistan s Economy

8/8/2019 20304314 Global Financial Crisis 2007 and Its Impact of Pakistan s Economy

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GLOBAL FINANCIAL CRISISIMPACTONTHEECONOMYOFPAKISTAN

INTRODUCTION:

Capitalism, 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 Americas 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).

Outside of the U.S., the Bank of China and Frances BNP Paribas were the first international

institutions to declare substantial losses 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. (Scribd, 2009)

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


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and could hurt income from remittances. Lower foreign capital flows and harder terms will reduce

domestic investment. Both will lower growth prospects. (Scribd, 2009)

Pakistan is another country in South Asia that has been severely affected by the financial

crisis. In fact, Pakistan seems to be one of the hardest hit. Its economy, already on the brink of

collapse, is destined for bankruptcy because fleeing foreign investors have caused a significant

depreciation in its currency, the rupee. Pakistan is also facing a serious liquidity crunch, with the

only solution being international support. Pakistan's request for Chinese support, however, has

been denied because of Pakistan's alleged involvement in terrorist activities in China's Muslim-

dominated areas. Saudi Arabia has refused to give Pakistan a financial concession on the oil trade,

as well. The only option for Pakistan is to approach the International Monetary Fund, which will set

highly stringent conditions for the nation. (Sidgel, 2009)

THE TERM FINANCIAL CRISIS:

The term financialcrisis is applied broadly to a variety of situations in which some financial

institutions or assets suddenly lose a large part of their value. Many financial crises are associated

with banking panics, and many recessions coincided with these panics. Other situations that are

often called financial crises include stock market crashes and the bursting of other financial

bubbles, currency crises, and sovereign defaults.

Many economists have offered theories about how financial crises develop and how they

could be prevented. There is little consensus, however, and financial crises are still a regular

occurrence around the world. (Wikipedia, 2009)

FINANCIAL CRISIS 2007-2009(RECENT)

The financial crisis of 20072009 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.

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. (Wikipedia, 2009)


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CAUSE OF THE CRISIS:

It is not yet clear whether we stand at the start of a long fiscal crisis or one that will pass

relatively quickly, like most other post-World War II recessions. The full extent will only become

obvious in the years to come. But if we want to avoid future deep financial meltdowns of this or

even greater magnitude, we must address the root causes which are summarized below: (Scribd,

2009)

y Credit boom and housing bubble: spread on credit instruments and the ratio of housing pricingin relation to its rental income.

o Fundamental mispricing in the capital markets risk premiums were too low and long-term volatility reflected a false belief that future short-term volatility would stay at its

current low. This is turn implied low credit spreads and inflated prices of risky assets.

One reason was the tremendous growth of capitalistic societies in China, India and

eastern bloc of Europe. There were fast-growing, investment and savings driven

nations. Hence, capital from the second set of countries poured into assets of the first

set, leading to excess liquidity, low volatility and low spreads.

As a result, massive shock to one of the asset market housing led to a wave of defaults

in the mortgage sector.

y Mistakes made by the Fed and other central banks keeping the federal funds rate too low fortoo long created both the credit bubble and housing bubble. In other words, with an artificially

low fed funds target, banks gorged themselves on cheap funding and made cheap loans

available.

o There has been great disparity in the quality and quantity of loansin the recent years. Interms of quantity, there was anincrease in low-ratedissuance ofshares rated B- or lower

from 2004 to 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.

oIn terms of quality, there was also a general increase in non documentation and

hig

h

loan-to-value subprime mortgages.

y Plus the failure to control poor underwriting standards in the mortgage markets no downpayment, no verification of income, assets, and jobs (calledNINJA noincome, jobs,orassets),

interest only mortgages, negative amortization, and teaser rates were widespread among


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subprime, near-prime and even prime mortgages. The Fed and other regulators generally

supportedthesefinancialinnovations.

o With defaults in interest payments and simultaneously in the ABSs, prices dropdrastically, leading to a huge loss of wealth causing severity of the crisis. (Scribd, 2009)

IMPLICATIONS TO THE USECONOMY

The US is going through the greatest financial crisis since the 1930s, as reported by

FianncialTimes.(Sameer Khatiwada)

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

Americas largest financial services entity, filed for bankruptcy. On September 16, American

International Group (AIG), one of Americas largest insurer, saw its market value dwindle by 95

percent (AIGs share fell to $1.25 from a 52-week high of $70). (Pakistan and the Global Financial

Crisis, 2009)

Notwithstanding, strenuous efforts by the US administration, including buying up of toxic

assets and recapitalization of financial institutions and stimulus packages the worlds largest, US, is

projected to contract by 2.9% till 2009 further down from the positive growth of 1.1 % in the

previous year. (State Bank of Pakistan, 2009) This has resulted in severe loss to not only financial

institutions but also the business and economic sector. Companies, including multinational that

invested in these Asset Backed Securities incurred huge losses as these investments were made

millions of Dollars. This resulted in a downward trend in growth. Companies, in order to reduce

costs started downsizing, cutting production and because no one was there to buy (or didnt have

the capability to), these losses tripled.

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 around the world was aware of the fact that a crisis is budding. The crisis rapidly

developed and spread into a global economic shock, resulting in a number of European bank


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failures, declines in various stock indexes, and large reductions in the market value of equitiesand

commodities. Moreover, the de-leveraging of financial institutions, as assets were sold to pay back

obligations that could not be refinanced in frozen credit markets, further accelerated the liquidity

crisis and caused a decrease in international trade.

EUROPE

The global financial 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. Leading

indicators of global economic activity, such as shipping rates, are declining at alarming rates.

(Sameer Khatiwada)

The $10 trillion mortgage market went into a state of severe turmoil. Outside of the U.S., the

Bank of China and Frances BNP Paribas were the first international institutions to declare

substantial losses 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. (Pakistan and the Global

Financial Crisis, 2009)

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 economies are expected to contract by 3.8% in 2009.

(State Bank of Pakistan, 2009)

Countries relying on trade as a primary mean of boosting economic growth saw trade

volumes disappear as contractions starts in trading partners.

Growth in world trade volume fell to 3.3% in 2008, as compared to 7.2% in 2007, and is

expected to contract substantially by 11% till the end of 2009. (State Bank of Pakistan, 2009)

AFRICA

Growth performances vary considerable among developed and developing countries. As for

Africa, IMF World Economic Outlook


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prices has reduced the surplus petrodollar, which is now having impact on the development

projects. (The News, 2009)

Financial system as the backbone of economy and that was why the financial crunch

brought the economy down affecting US, UK, Japan, India, Asiaall going down with decline in

economic growth.(Dawn News, 2009)

THE CRISIS ENTERING EMERGING ECONOMIES

Initially the view was that the financial crisis that began in the US and then spread to

Europe would not seriously affect the economies of the developing countries. Most developing

countries were not closely linked to the global financial system based in the US. However, very soon

it became clear that developing countries including Pakistan would be affected by the global

financial crisis. Developed countries have been worst hit but so have developing countries like

Pakistan. (Zubair, 2009)

The new growth power houses in china and India are experiencing worst kind of slowdown

in economic growth mainly because of the sub-prime meltdown in the US and the ensuing financial

and credit crunch around the world. (State Bank of Pakistan, 2009)

The global financial crisis is hitting emerging economies 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 South Asian economies are already limping from the adverse effects of the huge terms

of trade shock 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. (World Bank, 2008)


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Exports from developing countries are projected to contract by 6.4% during the same

period and developing economies started experiencing substantial slowdown in growth in 2008,

with real GDP growing at 6.1% as compared to robust growth of 8.3% in 2007. Growth in these

countries is projected to slowdown further to 1.6% in 2009. (State Bank of Pakistan, 2009)

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. (World Bank, 2008)

South Asia constituting a belt of emerging economies, 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.

(World Bank, 2008)

The financial crisis that has spanned the globe has had an especially strong impact in

countries beset by political uncertainty. Analysts say weak governments saddled with poorly

performing economies are more vulnerable to social unrest and armed insurgency.

The 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. The policy option of full pass-through of

fuel and fertilizer prices to consumers is not politically viable, although further reduction in 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. (Dawn

News, 2008)

According to analysts, Pakistan is one of the most prominent examples of a nation where

economic pressures are feeding unrest and threatening a wobbly government. (Thomas, 2009)

The trickle-down effect of this crisis has gone from the developed to the less developed

parts of the world. Pakistan is no exception; the combined effects of a global food, fuel and financial


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crisis took quite a toll on the economy as the current account balance and fiscal deficits increased,

inflation surged and growth slowed. (Garewal, 2009)

In emerging economies, the slowdown manifested itself through various channels like

volatility in the financial markets led to a flight of capital. Emerging economies have already seenthe spreads on sovereign and corporate debt widening, and a retreat in equity prices as a result of

the global crunch. East Asian tigers Malaysia, Thailand, Korea, Philippines, and Singapore all are

prospective candidates for posting negative growth. The effects of adverse developments at global

level have been felt unevenly and countries with weaker macroeconomic fundamental, however,

are taking a bigger hit. The impact of the meltdown might be compensated to some extent through

boosting local demand. But vigilance by the policy-makers around the developing countries is

needed to lessen the severity of downside risks posed to current crisis. (State Bank of Pakistan,

2009)

Over the medium term, there is substantial scope for domestic resource mobilization through the

tax system that will play a key role in regaining the growth momentum. All South Asian countries

can benefit from it. (Dawn News, 2008)

THEFINANCIALCRISISANDPAKISTAN

The world is thus engulfed in a new hydra-headed crisis, with three essential components:

food, fuel and finance. The three components have different geographical origins and their effect ondifferent segments of the globe and their inhabitants is highly uneven. But the transmission of these

crises 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.

Pakistan is affected by all the three components of the mega-crisis in varying degrees. But its

economic managers have always tried to deal with such crises individually, rather than as a whole,

and in an ad hoc, rather than a systematic manner. (Naseem, 2008)

Pakistans 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


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deficit in excess of $15 billion a year and a current account deficit of over $1 billion a month. In

2007-08, Pakistans balance of payment (BOP) crisis, as a consequence of $147 a barrel oil and a

spike in commodity price, 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. (Scribd,

2009)

High fiscal and current account deficits, rapid inflation, low reserves, a weak currency and a

declining economy have put Pakistan in a very difficult situation. (Dawn News, 2008)

Pakistan is going through a critical phase at this juncture. 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 Pakistanis have declined over the years in terms of

value. Pakistan is one of the most prominent examples of a nation where economic pressures are

feeding unrest. According to some observers, Taliban can take advantage of the bad economic

conditions of the country. Shuja Nawaz, director of the South Asia Center at the Atlantic Council

argues that Well, I dont know if theyre paying much attention to the economic news, but the

Taliban know only that when the government is unable to deliver services, and when there is

unhappiness among the general population because food prices have gone up tremendously,gasoline is not available, electricity shortages are rampant, that it is much easier to convince the

people that the Taliban have the solution rather than the government,. (Garewal, 2009)

Pakistan now has the lowest credit rating in the developing world. According to John

Chambers, managing director with Standard & Poor, only Seychelles has a lower rating and it has

already defaulted on its debt. None of these developments are related to the financial problems

faced by the industrial countries. In fact, there will be positive short-term impact on Pakistan of the

current economic turmoil in the developed world. Pakistans external account situation is the result

in part of the large increase in the import bill. This happened because of the unrelenting increase in

the prices of oil and several agricultural commodities imported by the country. Both food and

energy price indices continued to increase through 2007-08; with the oil price increase outpacing

the increase in the price rises of internationally traded agricultural products. The financial crisis

has suddenly reversed these trends. The price of oil has declined by 50 percent in a couple of


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governance have given rise to greater radicalization. Growth has stalled in Pakistan, while prices of

food and fuel are up. Inflation, while down slightly from last year, still hovers at around 20 percent.

Shuja Nawaz, director of the South Asia Center at the Atlantic Council, says such ingredients are a

classic recipe for radicalization.

The impact of any financial implosion would certainly compound the countrys political

crisis which is already being intensified by US demands for the Pakistani army to step up its war on

Islamist militias along the border with Afghanistan. Its support for the bogus war on terror has

been transformed into an argument for financial aid. As a Pakistani official explained to the New

York Times: A selling point to us even has been, if the economy really collapses this is going to

mean civil strife and strikes, and put the war on terror in jeopardy.

A top secret National Intelligence Estimate (NIE) drafted by US intelligence agencies andleaked to the media last week, summed up the situation in Pakistan as no money, no energy, no

government. According to McClatchy newspapers, the NIE warned that the government was facing

an accelerating economic crisis that includes food and energy shortages, escalating fuel costs, a

sinking currency and a massive flight of foreign capital accelerated by an escalating insurgency.

(Michael F. Martin, 2009)

SECTORAL IMPACTOFTHECRISISINPAKISTAN

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 the Overseas Development Institute, UK, the

economic, financial as well as social impacts could include:

o Weaker export revenueso Further pressure on current accounts and Balance of Payments (BOP)o Lower investment and growth rateso Lost employmento Lower growth translating into povertyo More crime, weaker health systems and even more difficulties meeting the

Millennium Development Goals


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In Pakistan, the sectors that are most severely hit could include financial, business and

social. A prcis 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. (Velde, 2008)

External Sector Impact

The countrys macroeconomic environment is affected by intensification of war on terror

and deepening of the global financial crisis which penetrated into the domestic economy through a

route of substantial decline in Pakistans exports and a visible drop in foreign direct inflows.

Although contraction in export receipts is more than compensated by massive import compression

emanating from global crash of crude oil and commodity prices, the external sector vulnerabilities

remain a threat. Pakistans economy continues to remain exposed to the vagaries of international

developments as well as internal security environment. (State Bank of Pakistan, 2009)

When people stop borrowing, and start saving to pay off debt, it acts like a shrink in money

supply. Thus goods and services get cheaper, and money (in this case USD because worldwide debt

is mostly in denominated in USD) get more valuable compared to other things. Economies that

depend on exports are also effected because others such as US and Europe start importing less.

EXPORTSThe financial crisis made countries realize that they dont 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 customer, the U.S. didnt have the capacity to pay for exports. As a result, the

export sector of Pakistan was badly hit. Its major exports included textiles, surgical instruments,

sport goods etc. The recent Economic Survey of Pakistan 2008-2009 reports, exports started to

faceheatofglobalfinancialcrisissince November2008 andthecontractionofworldoverdemandhas

exacerbated export contraction. The exports witnessed negativegrowth of 2.6percent declining

from $ 16.4billionlastyearto $ 16.0 billionin July-April2008-09.(State Bank of Pakistan, 2009)

IMPORTS


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The surge in global energy and commodity prices coupled with poor agricultural production in

Pakistan over the past two years had played havoc to the countrys import expenditure. However,

the recent lowering of these prices did provide some relief to the countrys trade deficit.

Imports registered a negative growth of 9.8 percent in July-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. Import compression

measures coupled with massive fall in international oil prices have started paying dividends. (State

Bank of Pakistan, 2009)

As a result, the continued decrease in exports, is, after three years, was outstripped by the

decrease in import bill which improved the trade deficit by 12.3% in the year 2009

Financial Sector Impact

FOREIGN EXCHANGEPakistans exchange reserves declined markedly throughout 2008. The State Bank of Pakistans

holdings of foreign exchange reserves fell from $14.2 billion at the end of October 2007 to $3.4

billion at the end of October 2008. (Michael F. Martin, 2009)

Exchange rateafter remaining stable for more than 4 years, lost significant value against the US

dollar and depreciated by 21% during MarchDecember 2008. Most of the depreciation of rupee

against dollar was recorded in post November 2007 owing to combination of factors like political

uncertainty, trade related outflows and speculative activities. This was another implication of the

financial crisis that also contributed to a massive increase in the inflation rate of the country, hence,

lowering the living standards even more.

However, with 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 around Rs.80-82 per dollar.


BANKING SECTOR


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State Bank of Pakistans (SBP) Financial Stability Review 2007-08 reports that, Pakistans

banking sector has remained remarkably strong and resilient, despitefacingpressures emanating

from weakening macroeconomic environment since late2007. (Pakistan and the Global Financial

Crisis, 2009)

According to Fitch Ratings, the international credit rating agency dual headquartered in New

York and London, the Pakistanibankingsystemhas,overthe lastdecade,graduallyevolvedfroma

weak state-owned system to a slightly healthier and activeprivate sector driven system. (Scribd,

2009)

But 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, Pakistans banking

sector hasnt 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. (Pakistan and the Global Financial Crisis, 2009)

Market analyst Muhammad Suhail told the Los Angeles Times last week: The global crisis has

really added 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 rose to high levels ranging from 32 to 40

percent, despite the injection of 54 billion rupees into the financial system by the central bank.

(Michael F. Martin, 2009)

CIRCULAR DEBTOn 26 January 2009, Raja Pervaiz Ashraf, Minister for Water and Power, told the Senate that the

federalgovernmentwillsettlehalfofthe Rs400 billioncirculardebtbytheendofJanuary.

Circular debt arises when the Government of Pakistan owesand 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


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to generate electricity and refineries are unable to open LCs to import crude oil. According to BMA,

a leading financial services entity, Thecirculardebtproblemisseriouslyimpactingtheoperationsof

theentireenergyvaluechain. Duetolowcashbalancesandliquidityasaresultofthedebtproblem,

the companies have to resort to short termfinancing at high interest rates. Refineries are having

problemsopening LCstoimportcrudeoilduetomountingpayablesandreceivables. Thesamecanbe

said about the OMC sector including thefact thatfinancing costs in the entire energy sector have

skyrocketed. IPPs like HUBCO and KAPCO are alsohaving difficultypurchasing oil and continuing

operations.(Pakistan and the Global Financial Crisis, 2009)

STOCK MARKETThe Karachi Stock Exchange (KSE) is Pakistans 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 & Poors cut its outlook for Pakistans credit rating to

stable from positive on concern that security was deteriorating. On 5 November 2007,

Moodys Investors Service announced that Pakistans 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. (State


Thought much of this precipitous decline is related to equity market which has fallen by

over 62% (as on December 2008) since touching its peak in April 2008. While issues related to the

macroeconomic scenario and shaky political environment fuelled anxiety among investors

community and contributed to a fall in value, a dearth of adequate corporate governance measures


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aggravated the situation. Supplementing the extensive weakness was the diminishing foreign

interest in the equity markets of Pakistan. (State Bank of Pakistan, 2009)

The Daily Times warned on October 14: The recent decline in the Pakistan stock market

suggests that the bubble has burst and experts fear that this is likely to spread to the real estatemarket, which like the stock market is irrationally overpriced. (Garewal, 2009)

EXTERNAL AND FISCAL BALANCEPakistan has been facing balance of payments (BOP) pressures from expansionary fiscal and

monetary policies; the terms of trade shocks accelerated the deterioration. 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. 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. However, this rate

witnessed a rare development in the beginning of the year 2009; it shrank by 23.5%. (State Bank of

Pakistan, 2009)

Current account deficit shrank to $ 8.5 billion as against $ 11.2 billion last year. In the month of

February 2009, the current account witnessed a surplus which is a rare development in Pakistan

economy. This was first monthly surplus since June 2007. It turned to deficit in March and April

2009. (State Bank of Pakistan, 2009)


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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.

(World Bank, 2008)

FISCAL BALANCEThe severity of the macroeconomic imbalances in the last fiscal year once again reinforces

the importance of fiscal prudence for sustainable economic growth. The overhang from 2007-08

continued to haunt adjustment efforts. The fiscal consolidation efforts faced headwinds like

deteriorating security environment, domestic political uncertainties along with the deepening of

the global financial crisis and overall depressed macroeconomic environment. The unanticipated

persistence of inflationary pressures on the economy kept fiscal policy options limited. The

shrinking revenues constrict governments ability to pursue counter cyclical policy. (State Bank of

Pakistan, 2009)

The fiscal deficit widened most for Pakistan, rising from 2.4 percent of GDP in 2004 to 7.4

percent in 2008. (World Bank, 2008)

There has been 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 annual GDP.The fiscal improvement in 2008-09 has largely based on reduction of oil subsidies and a slash on

development spending. Going forward Pakistan needs a substantial increase in resource base to

augment its development efforts and fiscal consolidation efforts has to come from enhanced

revenue base because we have already exhausted options for expenditure cuts. Pakistans future


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economic development crucially hinges upon additional resource mobilization and for this end

extending the tax base to unexplored sectors is very crucial. (State Bank of Pakistan, 2009)

INFLATIONAs inflationary pressures across the globe continue to dissipate, sparking deflationary concerns

in even some countries like Thailand and India which shared pain of galloping inflation with

Pakistan a few months ago, Pakistan still faces high double-digit inflation. Although all the price

indices like the CPI including core inflation have shown a downward trend in recent months, the

decline has been subject to stiff downward rigidity. The month on month increase in food and

nonfood inflation in the last three months (February- April) has been especially disappointing.

Going forward the government has to rationalize electricity tariff which will be inflationary in

nature.

Rising food and fuel prices have been a major source of inflationary pressure in South Asian

countries especially Pakistan. In Pakistan, food prices made 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. (World Bank, 2008)

This year core inflation rose to 18% from the 14.7% last year. This year inflation

accelerated at rapid pace mainly because of food prices which increased as result of high prices of

widely consumable items such wheat, wheat flour, sugar and meat etc, owing to their supply

shortage. Other major factors that effected domestic prices include phasing out of subsidies on

petroleum products, upward revision of support prices of wheat by above 50 percent thus pushing

up the retail prices of wheat and wheat flour across the country. (State Bank of Pakistan, 2009)


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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 prosperous and that business activity flourishes. But the global credit crunch

and liquidity problems of many transnational corporations have already led to net capital outflows

from emerging markets, halting new investment projects. Finally, banks in many emerging market

economies are vulnerable to a global liquidity crunch due to short-term international financing

exposure and risky lending practices. Put otherwise, new waves of crises in emerging market

economies appear rather unavoidable, much more so in countries that have not built up sufficientinternational reserves or have not run fiscal surpluses, Pakistan, is an example of which.

With fast depleting international reserves there is growing fear that the country may be

forced into defaulting on its foreign obligations. It was because of the fear that on October 6,

StandardandPoorsand Moodys, two of the worlds largest rating agencies, downgraded Pakistani

bonds. This has created a panic and investors have begin to fear whether Pakistan will be able to

pay them back. (Garewal, 2009)

TEXTILE SECTORPakistan Textile Industry is facing an uncertain environment. Following few factors, increasein

inputcostofminimumwageby 50percent,increasinginterestrates,non-guaranteedenergysupplies,

lack of R&D and reduction in cotton production, put a negative impact on the industrys

competitiveness internationally. Because of the entire situation the companies are downsizing,


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Social Sector Impacts

Every dilemma that enters the society has its social costs that the country has to bear. With

Pakistan, a country already with a high rate of unemployment or semi-employment and poverty the

financial crunch only worsened the situation.

POVERTY AND UNEMPLOYMENTFood prices have a significant bearing on poverty incidence. A review of price trends of

essential items during 2007-08 indicates that the major portion of food inflation during this period

stemmed from hike in the prices consumed by the poor household 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. (State Bank of Pakistan, 2009)

The government estimates that about 25 percent of the population of 169 million is living below

the poverty line of $1 a day, but other sources put the figure far higher. An Oxfam report released

this month estimated that the number of poor in the country has risen from 60 to 77 million

because of food inflation. It found that the poorest 20 percent spent 50 to 58 percent of their

income just to buy cereals. (Garewal, 2009)

The Report of a UN Inter Agency Assessment Mission fielded during June-July 2008 found

that food security in Pakistan in 2007-08 had significantly worsened as a result of food price hike.

The total number of households falling into this category was estimated to be seven million

households or about 45 million people in 2008. The survey further indicates that more than 40

percent of households reported no change in income in 2008 since last year. Forty five percent of

the population working as employees witnessed decrease in their real wages. The Report shows an

increase in the share of severely food insecure population, from 23 percent in 2005-06 to 28

percent in 2008. The main findings indicate that the high food prices are undermining poverty

reduction gains, as food expenditures comprise a large share of the poors total expenditures and

food price hike has severely eroded poor household purchasing power. The Task Force on Food

Security based on the World Bank estimates of head count ratio of 29.2 percent in 2004-05 poverty

estimated that poverty head count increased to 33.8 percent in 2007-08 and 36.1 percent in 2008

09 or about 62 million people in 2008-09 were below the poverty line.


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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, notwithstanding

the benefits of a strong agriculture recovery. The onset of the global financial crisis suggests a

significant slowdown in South Asias growth prospects for 2009-1O. The slowdown will be

particularly notable for Pakistan. Pakistans economy is already facing difficulties; the financial

crisis will aggravate it. (World Bank, 2008)

In attempting to weather the storm, Pakistan has some significant advantages, including a

fairly diversified economy. Three million citizens working abroad send home about $6.5 billion in

annual remittances. Very few bank assets are tied up in mortgages. The government has begun to

move away from subsidies that are a drag on the economy. (State Bank of Pakistan, 2009)

Moreover, many foreign banks are optimistic about investing in Pakistan. A recent example

is UKs second largest bank Barclays which started its operations on Pakistan last year. Pakistani

banking industry has huge potential to grow and we will grow with this potential, said Vinit

Chandra, Chief Executive Global Retail and Commercial Banking Emerging Markets. Barclays Bank

sees Pakistan as one of the best performers in the wake of the global financial crisis which sunk

many global banks in the US and European countries. I think Pakistan banking industry is the hero

as the industry has surplus liquidity while not a single bank failed here, he said. He said banks are


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cautious over lending because of rising high non-performing loans (NPLs) and slow economic

growth. He said global crisis impacted Pakistan also but the impact was much lesser than the

disastrous impacts on other countries.

Even two per cent economic growth is not the worst performance if we see the growth ofeconomies on other part of the planet, he said. This is because Pakistan is a domestically-driven

economy which received less negative impact of global crisis and recession. (Iqbal, 2009)

STEPS TAKEN TO TACKLE THE SITUATION

INTERNATIONALLY

Since the start of the global financial crisis, various governments have taken extraordinary

measures to pull out of recession. These include stimulus packages by governments, lowering of

discount rates by central banks, bringing in new regulations to ensure risks are taken care of,

buying of shares of private enterprises by the state, etc. The concept of the free-market economy as

the world had known for several decades has been shattered. (Zubair, 2009)

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 and

the Global Financial Crisis, 2009)

An unprecedented global economic crisis demands unprecedented initiatives to restore

growth. The World Bank Group is helping with the financial rescue but believes that we must

remain focused on the human rescue for the many millions left behind. The Bank is calling for

developed countries to pledge the equivalent of 0.7 percent of their stimulus packages, or as much

as they can in additional money, to a global vulnerability fund to help developing countries, which

can't afford bailouts and deficits. (Iqbal, 2009)

International Crisis Group senior vice-president Mark Schneider says non-military aid

should be an integral part of the U.S. counterinsurgency strategy against al-Qaida and Taliban

fighters taking sanctuary inside Pakistan's border areas.


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"The fundamental objective of the counterinsurgency strategy when you're working with a

government is to strengthen that government's capability to broaden its legitimacy. And it

broadens its legitimacy by governing, extending services, creating jobs, providing economic

opportunity for the population, and providing some kind of, as I said, citizen security and rule of

law," he said. (Thomas, 2009)

Moreover, U.S. Senator, John Kerry has indicated that he and Senator Richard Lugar, will

soon introduce our Enhanced Partnership with Pakistan legislation. The legislation is expected to

be similar to the Enhanced Partnership with Pakistan Act of 2008 which will be designed to

improve the economic situation in Pakistan.

Pakistan has already received nearly $12 billion in aid from the United States since 2001,

the bulk of it for counterterrorism. It obtained a $7.6 billion loan from the International MonetaryFund and is to be seeking an additional $4.5 billion. (Thomas, 2009)

NATIONALLY

Pakistan is facing difficulties in financing its current and fiscal account deficit in the current

year. The State Bank of Pakistan has made its intentions very clear through monetary policy

statement that it is not going to be the financer of the deficit anymore. The privatization is not the

right proposition in the given circumstances. The National Savings is not the right choice because of

its poor organizational structure and product development. The government could tap this source

only through inflating interest rates and that would be disastrous to the financial sector. National

Saving schemes are mobilizing their deposits from the pool of investors willing to spare resources

for the longer term and any preferential treatment may be detrimental for other competing

counterparts like commercial banks. (Dawn News, 2008)

Foreign ministers of Pakistan's major donors agreed on Friday to form a partnership with

Islamabad "to develop a comprehensive and coordinated approach to the security, development,

and political needs of the border".

At the beginning of the current fiscal year (2008-2009), Pakistans economy was confronted

with four major challenges which posed threat to Pakistans recovery and socio-economic growth

including


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i. Regaining macroeconomic stabilityii. Poverty reduction

iii. Fiscal retrenchment andiv. Weakness in the external account. (State Bank of Pakistan, 2009)

In order to ensure that macroeconomic difficulties do not further slowdown the pace of job

creation and adversely affect poverty reduction, the government has recently reached an

agreement with IMF for a US $ 7.6 billion package.

For the first time, IMF has accepted Pakistans homegrown proposals/programs which have

two main objectives:

(i) to restore the confidence of domestic and external investors by addressingmacroeconomic imbalances through a tightening of fiscal and monetary policies until

visible signs of demand curtailment; and

(ii) to protect the poor and preserve social stability through well-targeted and adequatelyfunded social safety nets. The governments new broad-based program for economic

stabilization was mainly focused on rationalization of expenditures, removal of

unproductive subsidies to reduce the burden on the budget; significant cuts in

expenditures to reduce budgetary deficit and a tight monetary policy to fight inflation.

The government adopted the following measures to address the above challenges:

a) Strong adjustments in the petroleum prices were undertaken to reduce the budget deficit;b) Significant cuts were made in the expenditures to curtail aggregate demand;c) Tight monetary policy was followed by the State Bank of Pakistan to contain inflationary spiral;d) Electricity tariffs were periodically adjusted to rationalize energy prices;e) Government adopted a Nine-Point Program for economic and social recovery encompassing the

following elements:

i. Macroeconomic Stability and Real Sector Growthii. Protecting the Poor and the Vulnerable

iii. Increasing Productivity and Value Addition in Agricultureiv. Integrated Energy Development Programv. Making Industry Internationally Competitive

vi. Human Capital Developmentvii. Removing Infrastructure Bottlenecks through Public Private Partnerships (PPPs)


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viii. Capital and Finance for Developmentix. Governance for a Just and Fair System

f) Prioritized the scarce government expenditures available for development-related programs;g) Directed immediate support to the most vulnerable groups through the Benazir Income

Support Programme (BISP). These are small (Rs.1000 per month per family) cash grants

channeled through women to help satisfy the most fundamental needs of vulnerable

households. Currently reaching 3.5 million poor households, the scope of the programme is

expected to expand to 7.0 million households in 2009-10;

h) Implemented improved and transparent targeting of Benazir Income Support Programme(BISP) and other programmes aimed at the poor and the vulnerable groups.

i) Intensified public-private partnerships with the objective of making private investments,including foreign investors, the most important funding source for economic development; and

j) Reinforced the importance of sound governance, managerial and systemic mechanisms toensure that investments in the social sector are cost-effective and aimed at output-oriented

service delivery. (State Bank of Pakistan, 2009)

Pakistans stabilization programme is supported by the Stand-By Arrangement (SBA) with the

IMF approved on November 24, 2008. The SBA envisaged a significant tightening of fiscal and

monetary policies to bring down inflation and strengthen the external position adopting several

structural measures in the fiscal and financial sectors including strengthening of the social safety

net. In addition, to stabilize the macroeconomic situation, the Programme aimed at addressing

some of Pakistans long standing economic problems. In particular, it called for a comprehensive tax

reform to raise budgetary revenue and phase out the electricity subsidies to create greater fiscal

space for public investment and social spending. Initial developments in the economy since the

implementation of the Programme have been positive:

The exchange rate has broadly stabilized enabling the State Bank of Pakistan (SBP) to buyforeign exchange on a net basis.

SBP reserves have strengthened from US$ 3.5 billion at end October 2008 to US$ 7.1 billionon end March 2009.

T-Bill auctions have been consistently oversubscribed with wide participation of banksenabling the government to retire some of its debt to the SBP

Headline Consumer Price Index (CPI) inflation is estimated to have declined from 25.3percent in August 2008 to 17.2 percent in April 2009.

The overall fiscal deficit is estimated to have been restricted to 4.3 percent in 2008-09.


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POVERTYREDUCTIONPoverty Reduction Strategy (PRSP)

The government is conscious of the cost being imposed on poor families from the sharp

escalation in food prices. Many of these needs are strongly linked and need to be addressed

holistically unless health services are improved, the incidence of ill health will continue to rise;

unless educational retention is improved, children will never be able to exit from poverty because

they will be concentrated in low-return employment or remain unemployable. It is, therefore,

important to address primary needs via social protection, while simultaneously focusing on the

mechanisms that ensure that the exit from absolute poverty is permanent for the majority of the

vulnerable and a large proportion of the chronically poor. The national Poverty Reduction Strategy

covers the three-year PRSP-II period of 2008-09 2010-11 while also providing a framework for

thinking well beyond this timeframe and is, therefore, to be viewed as an approach to a long-term

national economic strategy that has its main focus on reduction of poverty.

BenazirIncome SupportProgramme (BISP)

The sharp rise in international oil and food prices last year and the global financial crisis not

only adversely impacted the macroeconomic indicators in Pakistan but also increased the number

of the poorest of the poor. Recognizing the urgent need to protect the poor and the vulnerable, the

Government of Pakistan (GoP) launched the Benazir Income Support Programme (BISP) in 2008 asits main social safety net programme. This programme would serve as a platform to provide cash

transfers to the vulnerable identified on the basis of a poverty scorecard and would be backed by an

exit strategy. This strategy includes imparting training to one member of each vulnerable family to

sustain itself. The Programme also envisages a workfare initiative through social mobilization. BISP

intends to cover 3.4 million families or 22.75 million people in the current year. In the next year, the

government intends to at least double the allocation for BISP to cover 7 million families. (Thomas,

2009)

INFLATIONTo contain inflation within desirable limits, the government took various measures such as

government expenditure through stringent fiscal discipline, supply augment arrangements through

imports and smooth distribution network of essential commodities. Throughout the year, the

Economic Coordination Committee (ECC) keep a constant watch over prices and supply of essential


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commodities in their fortnightly meetings And come up with recommendations to improve supply.


MONEYAND CREDITIn the light of continued inflationary buildup and increasing pressures in the foreign exchange

market, the SBP announced a package of monetary measures on May 21, 2008 that included;

i. An increase of 150 bps in discount rate to 12 percent;ii. An increase of 100 bps in CRR and SLR to 9 percent and 19 percent, respectively for

banking institutions

iii. Introduction of a margin requirement for the opening of letter of credit for imports(excludingfoodandoil) of 35 percent, and

iv. Establishment of a floor of 5 percent on the rate of return on profit and loss sharing andsaving accounts.

Following a slight reversal in the mounting inflation, the SBP announced a decline of 100 bps on

April 20, 2009. SBPs tight monetary policy and rationalization of fiscal subsidies and expenditure

controls are the key factors that contributed a reasonable progress towards macroeconomic

stability. Although the fiscal and external current account deficit reduced during the last year, still it

remains high along with the risk of slippages. (State Bank of Pakistan, 2009)

CHALLENGESAND RECOMMENDATIONS

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. However, with the following policy recommendations, middle-income countries

can also decrease the impact of the financial crunch in the long run. There is a need to act, even if it

requires questioning conventional wisdom in such central aspects as the role of the state and the

market in post-crisis conditions.


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o Further reduction of the gap between domestic and international prices and bettertargeting of open-ended subsidies are possible options especially in Pakistan which faces

the largest macroeconomic imbalances.

o Tightening of demand and hence compression in imports, especially in countries likePakistan and Sri Lanka. 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.

o Domestic resource mobilization in the medium-term through the tax system that will play akey 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.

o Better expenditure management is also a medium-term option for reconciling stabilizationwith growth objectives.

o Refocusing policy attention to the next phase of structural and institutional reforms willalso help growth to recover. (World Bank, 2008) Going forward the government has to

pursue aggressive trade diplomacy to augment its access to external markets, beside ignite

its efforts to diversify exports to optimal exploitation of export potential. (State Bank of

Pakistan, 2009)

o The government can overcome the financial crisis and repair the economy by providingproper incentives and infusing confidence into resident as well as overseas Pakistanis

o Pakistanis living abroad should be encouraged to invest in Pakistan by redressing theirgenuine reservations and providing them with a level playing field. Overseas Pakistanis

have the potential to change the economic outlook of the country. 2

Dr. Hafiz A. Pasha, in a conference in the Pakistan Societyof Development Economist, said that

short time ago, the foreign exchange reserves of Pakistan sharply declined, currency was

depreciating, high inflation, high trade deficit and Pakistan was almost near to bankruptcy. The

panel of economists prepared completely independent report. The report looked at the short-term

macro economic framework, social protection strategy and development strategy and institutional

framework for development. Dr Ishrat Husain, former Governor State Bank of Pakistan while

chairing the session on Global Financial Crisis organized said:


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o Pakistan has to pursue active monetary and fiscal policies to deal with the globalfinancial crisis which is affecting our economy,

Moreover, there should be:

o Mobilization of domestic resources rather than depending too much on external sourcesand foreign debt. This will lead to debt un-sustainability.

o Institutions should be developed for capacity building. There must be coordination inthe monetary policy and fiscal policy coordination, trade and exchange rate policy and

the policy on social protection.

o The service sector tax and excise duty be increasedAnalysts think it is a dilemma that Pakistan moved too fast on the trade liberalization, she

should retreat on trade liberalization. The reduction in tariff over the time led to the import

consumption society and this is not sustainable for long time. (Garewal, 2009)

o Maximize efficiency by being clear about short-run and long-run objectives andcorresponding regulatory tools.

o Reward more those institutions that performed well relative to those that do not.o Increase coordination among global central banks and worldwide financial stability

regulators (Viral V. Acharya, 2009)

o Reforms in the regulatory framework to include tighter scrutiny and check over theperformance and working of all financial as well as non-financial institutions

o Encourage investors to do more saving and less consumption of incomeo Expansion of public investment which will indirectly improve consumers

confidence, to the extent that there is significant job creation involved. Investment

by the government in creating a social safety net can also have a favorable impact on

consumers attitudes. If consumers feel more protected when facing catastrophic

circumstances regarding health, the loss of a job, extreme poverty, social security,

and so on, they will be induced to have more of a propensity to spend and less to

keep precautionary savings.

o Incorporate knowledge. Moving toward a knowledge- based economy willincreasingly become a necessary condition for any export- led strategy to be really

successful that is, to consistently increase productivity and improve the

economys competitiveness.


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In the globalized economy, and more so as a consequence of the current crisis, the

challenge of how to persuade society to seriously make this turn toward high-

quality education, research and development, joint private- public partnerships to

develop innovative visions of the future, and the like is becoming one of the key

strategic issues for middle- income economies.

Much explaining and persuading will be required for a multi-layered program of reforms to

be undertaken and accepted by the general public. The changes required in the quality of the labor

force, in the way labor markets operate in order to increase productivity, and in the new

institutions required to provide economic security to those changing or losing jobs are all essential

to accelerate the transition toward a knowledge- based economy. Implementing these reforms

again represents a major challenge for governments and policy makers. (Viral V. Acharya, 2009)

But the long run advantages once the reforms and the requisite supporting institutions are in placeare huge. These reforms serve as a cushion for a countrys economy in distressed times.

CONCLUSIONAND REMARKS

In the context of the current economic and financial crisis, one advantage of what is now

happening in public discussion is that there are fewer I know it all or The markets will fix it

approaches. Fewer economists are telling policy makers We told you so. Instead, the shared

sentiment for both politicians and decision makers and regulators is How could we not have seen

what was coming?

Much explaining and persuading will be required for a multilayered program of reforms to be

undertaken and accepted by the general public.

Essentially, a new conventional wisdom will need to emerge encompassing six main points:

o Markets will work better if there is more regulation, not less.o What is produced and traded should be more in accord with the needed new, high-

quality jobs.

o Labor and education reforms should be undertaken. To be successful, these will need tobe supported by a wide spectrum of political opinion. (Viral V. Acharya, 2009)

o Time will be needed to gradually expand coverage in basic social services until allparticipants in the labor force, both so- called insiders and outsiders, are included.


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o The only way to introduce flexibility in the labor market will be to point towardguaranteed universal social security, health care, and unemployment insurance

coverage for workers with different types of employment contracts.

o All these changes will require additional resources, and some countries have more of amargin to increase tax revenues than others. For those with little margin, innovative

formulas relying on a mix of public revenues, targeted household savings, and solidarity

funds should be tried, as some countries in Latin America and Europe are

experimenting with.

Nevertheless, Pakistans economy still faces pressures from uncertain security

environment, higher inflation driven by spike in food prices, the acute power shortages, and

bewildering stock market, perceptible contraction in the large-scale manufacturing and slowdown

in services sector; lower than anticipated inflows and growing absolute financing requirements.

Abatement of inflationary pressure remained oblivious and prices depicted stubbornness. The

current slowdown is substantially different from the deceleration of the 1990s or early 2000s. The

aggressive monetary tightening posture of the

SBP has witnessed a reversal in the last monetary policy statement by notional downward

adjustment of policy rate in April 2009 to ensure that stubbornness of monetary policy might not

hemorrhage the economic activity. The recent monetary policy has tried to strike a balance

between sustaining the growth momentum and containing the inflation in stabilization mode. (State


The International Monetary Fund has recently argued for reforms in middle- income

countries that include four main components (IMF 2009b):

1. systemic regulation, meaning that all financial institutions must be incorporated in aninclusive supervisory framework not only banks but also insurance companies,

investment funds, mutual funds, and other companies operating with mortgages,

derivatives, and so on;

2. consolidated supervision, referring to financial conglomerates, international banks,regional banks, and other related financial institutions, which should be supervised not only

at the national level but also in coordination with regulators in the advanced economies;

3. an avoidance of the procyclical nature of capital requirements, and of provisions requiredfrom banks and other financial institutions, which should be increased during boom years

so as to be better able to deal with nonperforming loans in downswings; and


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4. supervision by central banks of the price of assets, to anticipate and regulate when systemicrisk emerges. (Viral V. Acharya, 2009)

This rather detailed description of changes suggested by none other than the guardian of

orthodoxy and good financial behavior, the International Monetary Fund, serves the purpose of

calling attention to the enormous challenge that is the political economy of regulatory reform. And

this can be illustrated even more clearly by quoting from the editorial page in a recent issue of the

Economist, referring to the difficulties of changing regulation: Financiers tend to gain the

advantage over their overseers. They are better paid, better qualified and more influential than the

regulators. Legislators are easily seduced by booms and lobbies. Voters are ignorant and bored by

regulation. It would be hard to find a more accurate description of the difficulties that must be

faced when one attempts to undertake a systemic overhaul of regulatory frameworks, either in

advanced or middle- income economies. (Michael F. Martin, 2009)

Sharp spike in the international price of crude along with an unprecedented jump in

commodity prices were the two major external culprits behind Pakistans 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 Pakistans 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 Pakistans 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, Pakistans 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, IMFs

contribution is expected to be $4.7 billon and Pakistan still needs to find other multilateral and

bilateral donors to bridge the whopping gap. (Pakistan and the Global Financial Crisis, 2009)

Pakistani Prime Minister Yousuf Raza Gilani has said that Pakistan wants "trade not aid."

But Mark Schneider says Pakistan needs both to survive.

"What you really need is trade and aid because trade doesn't do anything with respect to

building a police force or training judges or training teachers. That comes about from government

services. And so you need both aid to help strengthen those government agencies, and you need

trade to permit the expansion of an economy," he said.


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Some analysts believe the combination of insurgency and ineffectual governance may

prompt the military to step back into the political arena again, as it has done for more than half of

Pakistan's nearly 62-year history.1

As David Blair, a well-known diplomatic editor said, President Asif Ali Zardari needs a mere6 billion to avoid defaulting on his debts and stave off the immediate threat of bankruptcy. This

sum is only 0.3 per cent of the amount now devoted to saving the global financial system.

For the amount that Britain is prepared to spend to salvage its banks - 500 billion -

Pakistan could be rescued no less than 83 times over. Since the terrorist attacks on September 11,

America has given Pakistan 5 billion of aid. This is barely one per cent of the 458 billion that

Washington may be forced to spend on saving Wall Street.

Bereft of oil and possessing little natural wealth, Pakistan has suffered decades of economic

failure and stagnation. Ten years ago, it came within a whisker of formally defaulting on its debts

and declaring itself bankrupt. So the country's leaders have become perennial seekers of bailouts.

Yet for once, the stigma attached to being an international beggar has entirely disappeared.

Today, almost every government is besieged by formerly well-heeled beggars - and most are

seeking far larger sums than Pakistan with its 165 million people.

In this time of crisis, saving a valued ally has never seemed so cheap. (Blair, 2008)

The meltdown of the American financial system is also believed by the experts to have a few

lessons for Pakistan to learn. First, we immediately need to strength regulations of the markets to

stave off any big crisis that we cant afford to have. Second, the government should help the capital

market to restore investor confidence in our economy.

In fact, I believe that there may be positive short-term impact on Pakistan of the current

economic turmoil in the developed world. Pakistans external account situation is the result in part

of the large increase in the import bill. This happened because of the unrelenting increase in the

prices of oil and several agricultural commodities imported by the country. Both food and energy

price indices continued to increase through 2007-08, with the oil price increase outpacing the

increase in the price rises of internationally traded agricultural products. The financial crisis has

suddenly reversed these trends. The price of oil has declined by 50 per cent in a couple of months


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while the prices of traded food crops have registered significant drops. This should provide

Pakistan with some relief and stop the rapid hemorrhaging in its foreign exchange reserves. The

structure of the Pakistani economy and the structure of its financial system will protect the country

from feeling the full impact of the financial crisis in America and Europe. Pakistan is poorly

integrated with the global economy. This means that the shocks being felt in developed countries

will not be felt to any great extent in Pakistan. It will be spared the consequences of the unraveling

in many parts of the western financial structure. It now appears that the financial crises that have

gripped America and Europe will also affect the real economies of these countries. Most experts

now believe that America and Europe at this time stand at the threshold of deep recessions. The

first signs of these have already begun to appear. In September, America lost 160,000 jobs; it is

expected that by the end of the year there will be a reduction of one million jobs in the United

States. Job losses result in declines in spending.

Consumer spending is the main engine of growth in the United States. If it declines

significantly, the economy will go into recession. That is likely to happen. Once an economy is in

recession, there is a negative impact on imports. We will see a fairly large reduction in the American

imports. Of the developing world, the country that will be affected most severely will be China

which depends on exports to the United States to drive its trade oriented economy. The affect on

China will be felt by a number of countries in its neighborhood who have become important

suppliers of parts and components to the rapidly transforming Chinese production system. While

China has a large trade surplus with the United States, it has begun to run trade deficits with many

East Asian countries. Trade, in other words, will transmit to many developing countries the shocks

of the current financial crisis in the western world. Here again, Pakistan is likely to be protected by

the underdeveloped status of its trading sector. While the United States is Pakistans single largest

trading partner, a recession in America will not have a significant impact on either the quantum or

value of exports. Most of these are in textiles which, as the economists suggest, are not highly

dependent on incomes. Even though Pakistan may escape the immediate negative consequence of

the turmoil in the West, there will be long-term consequences. One of them is the possible impact

on remittances from the United States. Over the years the US has become the single most important

source of remittances for Pakistan, a good part of which originates not with the Pakistani workers

of which there are not too many in America but from the professionals whose incomes will suffer if

the US goes into a long and deep recession. What has become the single largest source of external

finance for Pakistan may come under pressure.


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The government needs to gain investors confidence and sustain development expenditure,

particularly for infrastructure and education. Without these actions, it will be very difficult for

Pakistan to attract foreign investment.

The regulations put in place by the State Bank of Pakistan over the last many years havehelped Pakistan emerge out of this crisis relatively unscathed. No financial institution collapsed,

unlike the banks in the US and Europe, and the government did not need to step in to buy shares of

failing institutions. We did have a high percentage of write-offs in Pakistan but nothing compared to

amounts that were written off in the US and Europe.

The economy has been on a rollercoaster ride ever since the country gained independence

more than six decades ago. At this time it is going through one of its periodic downturns. This one is

more severe than many experienced in the past. The reason is not hard to understand.

The country is passing through a perfect storm; dealing simultaneously with a number of

crises. All of these are not related to economics; some have their origin in politics, some in the

structure of the society and some in the rise of Islamic extremism.

Given the ongoing struggle with Islamic extremists in which Pakistan now has taken a

decisive position, the country will manage to receive a significant infusion of capital. This will come

mostly from official sources and will go largely to the government in support of the budget and of

the various programmes and policies favoured by the donors.

Private capital flows needed by the entrepreneurial classes will only become available when

the country becomes an attractive destination for the investors. For that to happen, the government

will need to do a great deal of hard work. Some of this is needed to make the economy more

competitive.

the latest report issued by the Islamabad-based Competitive Support Fund to point out the

numerous weaknesses in the current structure of the economy. These had resulted in Pakistanslipping by nine places in the ranking of the countries on the competitive scale by the World

Economic Forum. These weaknesses need to be removed in order to place the economy on a higher

plane of growth and development.


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One way of doing this is to bring to the economy the capacity to innovate. This is largely absent at

the moment although, as the report points out, there are inherent advantages present which

include a very young population. The median age of Pakistans population is 18.2 years which

means that tens of millions of young people are entering the workforce every year. Properly

equipped with education and appropriate skills, they could lend enormous dynamism to the

economy. Left alone to their devices they will only swell the ranks of the disgruntled.

The other advantage Pakistan has is the capacity to adapt new technologies and new ways of doing

things when conditions are right. This was amply demonstrated in the late sixties and the early

seventies when the farming community in particular the medium sized farmers quickly adopted

the technology associated with high-yielding seeds developed in Mexico (wheat) and rice (the

Philippines).

The importance economists have begun to place on innovation as a driver of growth and

development is of relatively recent vintage. Development economics began its life as a separate

discipline by suggesting that by the transfer of low productivity labour from the countryside to

industry and modern commerce personal incomes would increase, markets would expand, and new

opportunities would beco

20304314 Global Financial Crisis 2007 and Its Impact of Pakistan s Economy

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