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Global recession and its impact on Pakistan economy Essay

Abstract

There has been speculation that American would lead global recession and it could impact the global economy. IMF also predicted that in 2008 global growth would fall from 4.9 percent to 4.0 percent. US economy suffered thousands of layoffs and the biggest retail sales dip on record. Strong economies as that of UK, Germany, France and the new emerging one’s like China and India also fell pray to this recession. Rising prices of oil and different commodities along with the credit crunch majorly contributed to the recent turmoil. The crisis of the sub-prime mortgage market also played its part. The impact of this slowdown on the developing countries might not be as severe on the developing countries as to the developed countries but still there would be spillovers.

So far Pakistan has escaped the recent economic turmoil emerging from Unites States and its main reason is that our economy is too week to shape in global matrix. Though Pakistan economy has not been affected up till now, the investors, driven by fear are taking there investment out. This is leading to the appreciation of a rupee as well as the depletion of foreign reserves which is causing further problems for Pakistan. Whether we are entering a recession or not is no more a question. The government must take proper fiscal measures for the short run and long run to overcome this slowdown and stabilize the economy. Keeping the check on the oil prices is the most important issue and should be carefully handled in the world politics.

Introduction

A slowdown or fall in the rate of economic growth; a recession is defined by the US National Bureau of Economic Research as a decline in gross domestic product in two successive quarters. A severe recession is called a depression. Recession is associated with falling levels of investment, rising unemployment, and (sometimes) falling prices. The economy goes through various periods of activities and these activities can be summarized in the business cycle. Its different phases define various characteristics in the economy. For example in the expansion phase, production along with employment, wages and business profits increase. During the contraction or recessionary phase, employment level in the economy falls, and production level, wages and business profits follow suit. A peak marks the end of the expansion phase, while a trough marks the end of the contraction phase and the beginning of the expansion phase.

The contraction phase of the business cycle marks many adverse effects on the economy amongst which the most important are unemployment, bankruptcies, unwillingness/inability of banks to lend money which leads to credit crunch, deflation, reduced sales which means reduced profits, foreclosures as recently seen in the American economy and stock market crash ( also widely debated nowadays ). The Great Depression that began in 1929, for example, was the most widespread depression in the 20th century. Slowdowns in the economy are a regular phenomenon, but the magnitude of the recent predicted depression is great.

The IMF estimates that global recessions seem to occur over a cycle lasting between 8 and 10 years. During what the IMF terms the past three global recessions of the last three decades, global per capita output growth was zero or negative. In January 2008, the IMF predicted that 2008 global growth would fall from 4.9 percent to 4.0 percent. There has been speculation about an American lead global recession and it could impact the global economy. Given the fact that today’s economies are interconnected it is likely that the repercussions of the recent slowdown would extend to all parts of the world. Although the impact on developing countries might not be as severe as it is on the first world they are nonetheless likely to feel the blow to some extent.

A Recession in Progress and its Impact

According to the IMF’s most recent World Economic Outlook, published on October 8th, the world economy is “entering a major downturn” in the face of “the most dangerous shock” to rich-country financial markets since the 1930s. Rising oil prices, commodity prices and one of the major causes of the recent turmoil, the crisis of the sub-prime mortgage market, which pushed up credit costs worldwide have contributed to a weakening global economy. Year 2008 witnessed unprecedented rise in commodity prices, especially oil price which touched the $147 a barrel mark in July. Oil prices severely affect the economy because it is an essential commodity which has it use from power generation to transportation. A rise in its price will certainly affect the price of those goods which are directly dependant on oil or indirectly (it may be involved in the production process). In an already weakened economy, rising business costs will discourage expansion, thus hampering growth.

Business might also shut down to escape exceptionally high costs. Unemployment and lower income levels will follow. The global economic slowdown, aggravated by the financial crisis initiated in U.S, will severely affect economies around the globe and emerging economies will find it hard to sustain their previous staggering growth rates. China’s growth rate will decline to 8% from 12% in 2009. Particularly noteworthy is to see why the financial crises in U.S. will have consequences around the world. In a highly globalised economy of today’s world a downturn in the financial capital of the world would drag others in a spiral down leading to a recession.

The recent Wall Street crisis has further deteriorated the economy. The pumping blood of today’s economies is credit. Credit crunch, which is the absence of credit, suffocates the economy by depriving business of finance and reduced consumer consumption. Banks are unwilling to lend which discourages investment. The net effect is a slowdown in growth which means fewer jobs and declining wages for the average man. As recently witnessed, governments have rushed to bailout their financial institutions.

In the face of Recession

The $700 billion bailout plan in U.S is the biggest package so far. Europe too is affected by the crisis has been forced to rescue its sinking financial sector. Banks such as Fortis and Glitnir were rescued by their respective governments. Why the U.S. financial crisis has such a major impact on the world economy can be determined by the fact that U.S. alone accounts for 28% of world GDP. In U.S. alone 159,000 people lost their jobs in a month following the crisis. Sales, e.g. of cars went down as consumers lost access to credit and consumer spending will fall further in other areas as well. Reduced spending would mean reduced jobs which would further push down the economy. Same is the case with other economies around the world. Britain and Germany experienced declining growth rates and Japan’s fell by 3%.

The hardest hit of all the nations will be the rich economies of the world whereas on the other hand emerging economies have shown resilience in the wake of the crisis. IMF expects the developing economies to grow at an average rate of 6.1% compared to their earlier impressive 8% rise in GDP. Exports for developing countries to first world countries will fall as income level over there decreases. This can be supported by the fact that several small scale businesses have shut down in China due to shortage of orders arriving from U.S. and other major economies. Markets are also being hit by faltering investors who are not willing to take risks. Analysts at Morgan Stanley estimate that capital flows to emerging economies could fall to $550 billion in 2009 from around $750 billion in 2007 and 2008. Such a sharp drop would hit economies that rely heavily on foreign finance: more than 80 developing countries are likely to run current-account deficits of more than 5% of GDP this year.

Impact on Pakistan

The world’s largest economies are showing signs of a slowdown, the New York Times reports. Japan, Germany, France, Italy, Spain, the UK, even famously fast-growing India and China are all taking a hit. Global growth overall will slow to 4.1% from 5% last year, the International Monetary Fund predicts. And definitely its spillovers will affect Pakistan economy too. The SBP’s First Quarterly Report issued last month said “the domestic economy is now more open and prone to external shocks than ever before”. The SBP governor has, however, reinforced the direction of monetary policy that she thinks is best suited to the economy in this scenario. The biggest challenge to the economic fundamentals is posed by increasing pace of inflation. State Bank said that so far Pakistan has escaped the recent economic turmoil emerging from US and engulfing the developed European economies. Much would depend on the nature and duration of the global crisis.

We have been able to escape the affect not because of some superior more efficient safeguards that we had but because we are too weak to figure in global financial matrix. Despite the fact the crisis hasn’t hurt the economy yet, the public, driven by fear, started withdrawing their deposits from banks, which made some banks fell prey to liquidity problems. The confidence of investors had decreased and there is a huge amount of capital outflow. As investors are taking out investment supply of rupee has increased and dollar has almost appreciated 30% against the rupee. As dollar has appreciated Pakistan imports have become expensive and the biggest benefit of falling oil prices is not availed by Pakistan because of this.

A matter of concern is the dismal state of the state bank’s foreign currency reserves which are down to $3 billion, which means Pakistan, would not be able to pay for its imports for long. The rate of growth of imports into rich countries is expected to slow sharply, leading to a cut in the rate of growth of exports by developing countries. Less exports for Pakistan means larger trade deficit, this has reached to the mark of 18.756 billion dollars in first 11 months of the current financial year. Because of this, business activity has been adversely affected in Pakistan. Unemployment and inflation has increased and the supply of goods and services has also been affected.

Due to the current world wide recession, the investors are actually on guard and don’t want to invest where there are doubts about the success of the investments. Therefore in country like Pakistan they are not willing to invest anymore. With the world wide collapse of the stock exchanges, the situation is not in favor of developing countries like Pakistan. So foreign direct investment has decreased and ultimately resulting in the decrease in the foreign reserves of Pakistan. They have hit six-year low and are depleting fast by $189 million, or 2.12 percent, in a week. Pakistan was also on the verge of getting declared as a default state and have just survived by borrowing loan from IMF which might stabilize the economy in the short run but in the long run it is discouraging for the business activities in the country and it would hamper the speed of the economic cycle. Due to the slowdown in the world economy “Friends of Pakistan” could not also help because they have their own economical crisis to deal with.

Response to the Crisis

Central Banks around the world have rushed to revise their policies, trying to absorb the shock of the recent set back. Whether we are entering a recession is no more a question. The need of the hour is to learn from this and devise policies to over come this and orientate the economy to a more resilient one. The major contributor to the problem has been the reckless borrowing by consumers and businesses alike. The total amount of household debt in U.S. alone amounts to a stunning $13.8 trillion in 2008. In strict economic terms, excessive leveraging has been a major contributor to the problem. In the short-run, governments must seek to stimulate the economy or at least dampen the stress of a slowdown. Fiscal measures such as deficit spending or tax cuts and monetary measures such as reduction in interest rates, to encourage investment and consumer spending, are standard procedures following a recession. Government spending such as infrastructural spending would create jobs hence boosting the economy. China, for example, has approved a stimulus package of $580 billion to stimulate the economy.

Germany will spend and cut taxes equaling to $29 billion. The rationale behind this is simple. Consumers and businesses are not spending enough to keep the economy moving at an acceptable pace. So the government plays its role by either encouraging them to do so by cutting taxes or by spending itself. Such fiscal measures were not popular in history. Economists believed that consumers would restrict spending to prepare for the tax increases. The notion that consumers are that rational has lost its credibility. Central Banks around the world have provided much needed liquidity to debt- stricken financial institutions and banks around the world are struggling to pull themselves out of the mess. This of course will take time. Monetary measures to help out would be hard this time. This is due to the fact that Central Banks affect the economy through its financial institutions which are, this time around, already facing desperate times.

Nonetheless, government interventions in the financial sector would help ease the prevailing fears. Preparing for the future requires long-term policies which might differ from the short-run ones. Building a more resistant financial sector is crucial. On the political front, a more diplomatic foreign policy would help keep oil prices at an acceptable rate. A war in the middle- east suppresses supply which pushes up the prices. Iran, which is on the agenda of U.S. congress, is one of the major suppliers of oil. A war there would escalate world oil prices. Supporters of passive policies will see current intervention by governments as less helpful.

They argue that loans taken from institution such as IMF put undesirable restrictions on economies which do more bad than good. Whereas on the other hand active policy adherents will see it as a much needed injection in the economy. Stimulating the economy in such hard times must be the top priority of governments because the markets cannot be left to function properly in a recession. Although ‘animal spirits’ plays its role throughout the various business phases, its effect is magnified in a recessionary period where people lose faith in the economy which only stresses the economy further down. Governments must restore the faith of people because it is “spending” at all levels that are needed to bring the economy back on its track.


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