GLOBAL ECONOMIC CRISIS AND

ITS IMPACT ON BANGLADESH

M A TASLIM

Bangladesh Foreign trade Institute24th February 2009

Global Outlook

• Output in the advanced economies is expected to contract by 2% in 2009 (first annual contraction since WWII) with USA contracting by 1.6%, UK by 2.8%, Germany by 2.5%, Italy by 2.1% and France by 1.9%.

• Emerging economies growth will halve to 3.25%• Both India and China will be hard hit • World trade may contract by 2.8%• Bangladesh may not escape the global slump in

demand

GDP Growth

Growth of manf output and exports

-50

-40

-30

-20

-10

0

10

20

30

40

50

Industrial production Merchandise export value

Industrial output

PeriodUnited

States Canada Japan FranceGerman

y ItalyUnited

Kingdom

1998 .............................. 95.4 89.2 102.5 93.8 94.4 98.5 99.8

1999 .............................. 99.5 94.4 102.7 96 95.5 98.4 101.4

2000 .............................. 103.7 102.6 108.5 100 100.9 102.6 103.2

2001 .............................. 100.1 98.4 101.2 101.3 101.1 101.4 101.6

2002 .............................. 100 100 100 100 100 100 100

2003 .............................. 101.2 100.1 103 99.7 100.4 99.4 99.3

2004 .............................. 103.8 101.7 108 102 103.4 99.1 100.2

2005 .............................. 107.2 103.5 109.4 102.3 106.9 98.4 99.1

2006 .............................. 109.6 103.3 114.3 102.8 113.2 100.7 99.8

2007 .............................. 111.4 103.2 117.5 104.3 120.1 100.5 100.2

2008 p ............................. 109.4 .............. 113.6 .............. 120.2 .............. 97.2

2007: Nov r ................... 112.3 102.9 118.6 105 121.8 100 100.5

Dec r ................... 112.4 100 119.4 105.1 123 99.6 100.4

2008: Jan r ................... 112.6 100.6 118.7 105.4 123.7 100.7 100

Feb r ................... 112.3 100.1 120.6 105.7 123.8 100.4 100

Mar r ................... 112 98.8 116.5 104.4 123.7 100 99.7

Apr r ................... 111.4 99.5 116.3 105.6 124.4 100.7 99.7

May r .................. 111.2 99 119.6 102.4 121.9 98.7 98.7

June r ................. 111.3 99.1 117 101.6 122.3 98.8 98.4

July r .................. 111.2 100.3 118.5 102.8 120.5 97.8 97.9

Aug r ................... 109.8 98.8 114.3 102.3 124.1 98.2 97.1

Sept r .................. 105.2 98.6 115.5 101.6 119.9 95.1 96.7

Oct r .................... 107.1 98.1 111.9 97.8 117.7 93.1 95

Nov p ................... 105.7 96.4 102.4 95.5 113.1 91 92.7

Dec p ................... 103.6 .............. 92.6 .............. 107.6 .............. 91.1

Underlying Causes of the current recession

• The genesis of the current recession lies in the standard macro policies following the tech bubble burst and the steep decline in stock prices during 1999-00, which took the US economy into a recession

• The Fed responded by reducing the interest rate sharply.

• The Fed fund rate fell from 6.24%in 2000 to only 1.13% in 2003 and 1.35% in 2004, nearly 80% decline.

Interest Rates

Year Prime rate of banks Fed fund rate

1999 8.00 4.97

2000 9.23 6.24

2001 6.91 3.88

2002 4.67 1.67

2003 4.12 1.13

2004 4.34 1.35

2005 6.19 3.22

2006 7.96 4.97

2007 8.05 5.02

2008 5.09 1.92

2008

Nov 4.00 0.39

2009 Jan 3.25 0.15

2009 Feb 3.25 0.23

Underlying causes of the current recession I

• Low interest rate raised asset prices, particularly home prices. It made mortgage payments and refinancing of current mortgages easier increasing demand for housing. Supply increased to meet growing demand.

• Falling interest rates encouraged many to opt for adjustable rate mortgages (ARM)

• Between 1997 and 2006, American home prices increased by 124%

• Historically, US home prices tracked inflation, but during recent years home prices accelerated sharply

Underlying causes of the current recession

• Banks and mortgage institutions aggressively marketed home credit overlooking the risks.

• Subprime borrowers: borrowers who do not meet prime underwriting guidelines

• Subprime loans increased alarmingly:• The share of subprime mortgages to total originations

was 5% ($35 billion) in 1994, 9% in 1996,13% ($160 billion) in 1999, and 21% ($600 billion) in 2006

• The average difference in rates on mortgages of prime and subprime borrowers declined from 2.8% in 2001 to 1.3% in 2007 suggesting a sharp decline in risk premium

Underlying causes of the current recession

• A little-understood type of derivative assets flooded the financial market – mortgage backed securities and collateralised debt obligations, which later proved to be highly toxic

• Home mortgages were bundled and packaged by financial institutions into the same securities regardless of risks and sold to unsuspecting investors

• Foreign financial institutions also invested heavily in these securities exposing themselves to the vagaries of the US housing market

• The credit (default) risk that was traditionally retained by the issuing banks/mortgage institutions was distributed among ordinary investors

Underlying causes of the current recession

• Regulatory agencies and credit rating organizations failed to inform the investors about the risks,

• As long as the home prices were rising the risks were not evident or simply ignored

• The situation started changing dramatically when interest rates started rising from 2005 under fear of rising inflation.

Foreclosure

• Rising interest rates sharply increased mortgage payments. Many borrowers, especially the subprime borrowers, unable and/or unwilling to pay, became delinquent and faced foreclosure

• During 2007, 1.3 million homes were subject to foreclosure, up 79% from 2006.

Housing bubble burst• When finally the housing bubble burst (2005-06)

and home prices went on a free fall, the value of MBS also fell and more importantly became uncertain

• Institutions that had invested heavily in MBS suddenly found their asset value shrinking alarmingly

• Some had to take recourse to fire sell worsening the situation

• Subprime related losses and write-downs by financial institutions around the world exceeded half a trillion dollars by August 2008 and rising.

Bankruptcies

• Many financial institutions did not survive the fall out of the subprime crisis. They were bought out by other institutions or the government

• Famous names such as Northern Rock, Bear Stearns, Fannie Mae and Freddie Mac, Merrill Lynch, HBOS, Lehman Brothers, AIG, WaMu were among the early casualties

Bankruptcies

• Subprime mortgage defaults and foreclosures has caused more than 100 subprime mortgage lenders to fail or file for bankruptcy, including New Century Financial Corporation, the second biggest subprime lender of US.

• As a result prices in the $6.5 trillion mortgage backed securities market collapsed with flow on effects on other sectors.

Financial meltdown

• The losses and write-downs of financial institutions reduced credit flow to the economy

• The fear of toxic assets made banks and financial institutions unwilling to lend to one another

• Credit dried up• Sound business firms also fell victim of the credit crunch• The financial sector faced a meltdown that took the

economy on a downswing – the most severe since WWII• Many regard this to be a far bigger global threat than

terrorism

Government bailout

• US government responded to the crisis by passing the Emergency Economic Stabilization Act of 2008 that authorised the Treasury Secretary to spend up to $700 billion to inject capital into financial institutions by buying up distressed assets including MBS

• European and Asian nations followed suit.• Many financial institutions were partly or wholly

nationalised • The problem is far from over

Stock Market• The financial crisis also brought down the stock

market• Most stock market indices registered 40-50% fall• Net wealth of individuals and enterprises fell

accordingly• Falling wealth reduced consumer demand through

Pigou effect • Investment also fell reducing aggregate demand• The economy of major countries moved into a

recession• World output and trade started declining

S&P 500 INDEX

DOW JONES INDUS. AVG

NIKKEI 225

Commodity prices

• The emerging financial crisis led many investors to shift their fund to the commodities market including oil and food

• This caused massive increases in commodity prices since 2006

• Sharp increases in oil and food prices had a debilitating impact on the poorer countries – especially oil and food importing countries that include Bangladesh

• A large section of their population was pushed back into poverty due to falling real incomes

• The task of poverty alleviation became far more difficult• Real risks of social unrest

Demand slump caused slump in commodity prices

Economic Stimulus • Faced with a deep recession most nations adopted

their own economic stimulus plans• The newly installed Obama government received

Congressional approval for a $800 billion plus stimulus package that Obama expects will create about 4 million jobs – just about the increase in the number of unemployed since 2007.

• This is a fiscal package consisting of tax breaks and government spending in selected areas

• The main purpose is to stimulate aggregate demand

• Basically a Keynesian antidote to a recession

Protectionism

• Leaders around the world have spoken out against protectionist policies that could deepen the recession

• But worsening situation could make the demand for protection more strident on the street that could be capitalised by pseudo-nationalist elements

Protectionism

• There have been demonstrations against migrant workers in Europe

• There is little protection against the tendency to scapegoat migrant workers in Mid-East since the contracts are unilateral

• Labour export is likely to slow down

• Underlines the need for progress in Mode 4 negotiations in the WTO

Export pessimism

• Bangladesh has minimal direct exposure to the global financial market

• But it is connected via trade in goods and services

• Falling world trade will hurt the export industries• The latest indications point to rough time ahead• If export growth sputters, it will have flow on

effects on the economy• Jute and textile spinning units, leather and

ceramic industries have been already adversely affected

Economic Policies

• The government is yet to come up with a clear response

• BB needs to look at its monetary policy• With inflation falling toward 6%, the real interest

rate is too high for business investment – dual interest structure with lower rates for real investment in plants and machinery could be contemplated

• Need some stimulus for industries catering to the domestic market as well as the export industries

• Fiscal and monetary policies must complement each other

THANK YOU