Ramifications of the global financial turmoil
Tuesday, 11 November 2008
Abul Maal A Muhith
THE oil-rich countries will surely be affected severely by the financial debacle in the developed countries as they have substantial control over assets of many financial institutions and business enterprises in those countries. They will also be adversely hurt by fall in crude oil prices. The depression in those countries may be comparatively deeper. And this has ramifications for remittances and manpower export for the poorer countries.
How the trade scenario plays out will also have serious implications for the developing countries where growth gets a big boost from expanding exports. Of the $1.7 trillion imports of USA a year about $600 billion or one third is imported from the developing countries. China and Mexico are its second and third sources of imports after Canada. Of its exports of a trillion dollar about 40% flows to developing countries and here also Mexico and China are second and fourth markets. USA may be forced to cut imports to balance its trade and that will have adverse impact on the economies of many countries. A system of trade financing even in the short-run may soften the impact to a considerable extent.
A word about the existence of the large international public sector is very relevant. This time we have the UN and all its associated agencies and organs as also the powerful IMF, WTO and World Bank as against the only toothless League of Nations and the International Labour Organization of the 1930s. One of the objectives of the Bretton Woods trio (World Bank, International Monetary Fund and the aborted International Trade Organization) was to have a world without want and fear and ensure peace and prosperity for all. They deliberated on how to avoid depression by short-term financing of trade deficits, how to facilitate flow of capital and growth in investment everywhere and how to stabilize commodity prices to save people from swings of shortages and abundance and from changes between uneconomic and unaffordable prices.
International public sector is now a crowded field. Beside the United Nations and its regional social and economic Commissions there are many organs and sector agencies and, of course, the mighty IMF, World Bank and the World Trade Organization. The performance of this international public sector has been of no significance in predicting and forestalling the crisis. Could they play a role in reducing the depth and breadth of the recession? So far there is very little evidence of their activism mainly because the Treasury and the Central Banks of the industrialized Seven have taken all the initiatives. But the trio can be empowered to arrest the decline in the flow of capital to weak economies, in financing trade and thus regulating competitive devaluation and trade protectionism and essentially in lending a voice to the weak and the deprived.
Bangladesh situation and what to do
Let us look at Bangladesh and try to assess as to what can be the impact of the melt-down. Bangladesh now is a small economy of $ 68 billion. 22% of its wealth emanates from agriculture but it employs 50% of the labour force. Services generate half of GDP and employs 35% of labour force. Manufacturing yields 17% of GDP and accounts for 10% of employment. Unemployment and under-employment account for 40% of a labour force of 70 million. 45% of population is poor and 20% is absolute poor. International trade accounts for 40% of the GDP; imports are worth $ 16 billion and exports are $ 12 billion only. Remittance is a big source of foreign exchange earnings, about $ 6 billion or 10% of GDP and it is growing fast. Foreign currency reserves are over $ 5 billion and it is not threatened by Bank failures. The current annual real growth of the economy is around 6% and the rate of inflation is at about two digits. The growth is largely dependent on growth of export and especially of knit wears and woven garments. The growth potential of rural and agriculture sector is high. The level of domestic credit is about 50 % of GDP. Public expenditure is about 16% of GDP and public investment is less than 6% only.
Its exports are threatened as nearly 85% of it goes to developed countries. Even remittances, which are largely from developing countries (over 65%) may decline because of possible hard times in the Gulf. Most of the imports (over 75%), however, are from developing and oil-exporting countries. We import a great deal now from developing countries and both India and China sell a lot to us. So any deceleration in these countries as well will affect us perhaps favourably. Well, one of the benefits of the crisis may be that world prices will stabilize at a much lower level since high prices of food items and crude oil had reached unsustainable levels.
The country is likely to gain from decline in import prices. In the garments sector Bangladesh supplies the cheaper quality of products but the expectation that its demand may not be very adversely affected is misplaced. What is more likely is that a decline in the growth rate of exports will take place. The surplus of wage earners abroad for remittances may fall short and manpower import by oil-producing countries may stagnate and thus growth in remittances may be adversely affected. Bangladesh receives foreign aid of about $1.5 billion a year all on grant or concessional terms. Its debt servicing, including IMF transactions, is about equal to the receipt of aid. The inflow of direct foreign investment is rather low, around $500 million a year and the outflow is a little less only. It is quite possible that investment, which is at 24% of GDP, may fall short and the growth rate of the economy may suffer.
The country needs to carefully ensure dynamism in domestic demand and hence an expansionary stance must be meticulously followed. How to arrest any decline in employment rate and how to continue investment in productive sectors will be the big challenges. Recently current expenditures have been increasing at a fast pace and some measure of austerity will be desirable there. There is a culture of default on bank credit in Bangladesh and a recent tendency of aggressive banking may have halted the improvement in that culture. The nation has to be very vigilant there. External exposure of Bangladesh Banks is essentially limited to trade transactions and rare cases of syndication of industrial or business loans. Some of the banks do assist the process of the flow of remittances. Foreign investment in the stock exchange after the collapse of 1996 is just nominal. The financial sector as a whole including the stock exchange is not likely to be affected by Bank failures abroad. But in a competitive world the banks and financial institutions in their mid-term planning should seriously consider mergers.
The big question is what will be the architecture of the new order? How is the housing collapse that periodically happens in USA going to be met? How much of mortgage should generate secondary loans? What impact will the crisis have on industrial production which has already taken a back seat leaving the place of honour to services sector? How is service provision likely to change? How will US habit of reliance on credit and consumerism be changed? How much of US double deficits should be considered safe and how much of it should be financed by the savings of others? How far will the idea of a world currency move forward? It looks obvious that the faith in self-correcting mechanism of the private sector was rather too stretched. The relaxation in regulations actually has nurtured greed and fraud. A balance, therefore, is needed in state intervention vis-a-vis market freedom. But a new order will be a matter of the medium term, say five years or more. In the meantime we have to survive and arrest decline in economic activities.
To us the most pressing question is how should Bangladesh handle the crisis? First of all, we should not be unduly complacent that the storm will be over and we shall escape with little bruises. We should instead be prepared for a down-turn in exports, remittances and investment. We have no reason to panic but we must develop our capacity for quick appreciation of developments as well as for quick response to such developments. We need to improve our management of the economy and handling of the macro environment in particular. We should appreciate that the level of our integration in the global economy is very high despite our status as a least developed country. We should set up a Task Force in the Ministry of Finance with high level representation from the Central Bank, the Planning Commission, the Banking sector, the non-banking Financial sector, the Export and Import trade sectors and the Academia and Research sector. The leadership of the Task Force must be political representing both the government and the opposition.
The first job of the Task Force is information gathering and analysis of developments across the globe on a daily basis. Thereafter, it has to consider both short and long term measures to meet the crisis.
Some of the measures that must be considered may be the following:
* In order to protect the growth of the economy an expansionary monetary policy should be adhered to.
* Every effort must be made to maintain and expand domestic demand. The easiest scope for that lies in emphasis on rural sector development, where major items of importance are agriculture, infrastructure and energy.
* Export promotion measures should be readily adjusted and export should be provided all assistance.
* A measure of austerity should be introduced in the current expenditure of the public sector with a view to save resources for investment.
* Initiatives for manpower export should be kept up at a high gear and urgent steps should be taken to train the exportable manpower, as needed.
* Investment in rural and agriculture sectors should be given the highest priority.
* The next item of priority should be development of the infrastructure and especially energy development and power supply.
* Adjustment in public expenditure may be considered to spare investible resources for quick return and slow down long-gestation investment.
* In order to arrest any lag in investment the best efforts should be made to absorb available foreign assistance and improve the investment friendly environment for Direct Foreign Investment.
* The price situation should be under careful observation and market intervention, if required, must be speedily made. The main actors in this operation should be Finance, Commerce, Food and Transport ministries. The expansionary economic stance should take note of the price situation.
* The interest rate policy should be under review and as soon as a break on inflation is noticed there should be lowering of interest rate.
* Exchange rate should be under regular review and steps where necessary should be taken with minimum lag to adjust it with reference to the performance in the countries of the currency basket.
The writer is a former finance minister of the government of Bangladesh.
THE oil-rich countries will surely be affected severely by the financial debacle in the developed countries as they have substantial control over assets of many financial institutions and business enterprises in those countries. They will also be adversely hurt by fall in crude oil prices. The depression in those countries may be comparatively deeper. And this has ramifications for remittances and manpower export for the poorer countries.
How the trade scenario plays out will also have serious implications for the developing countries where growth gets a big boost from expanding exports. Of the $1.7 trillion imports of USA a year about $600 billion or one third is imported from the developing countries. China and Mexico are its second and third sources of imports after Canada. Of its exports of a trillion dollar about 40% flows to developing countries and here also Mexico and China are second and fourth markets. USA may be forced to cut imports to balance its trade and that will have adverse impact on the economies of many countries. A system of trade financing even in the short-run may soften the impact to a considerable extent.
A word about the existence of the large international public sector is very relevant. This time we have the UN and all its associated agencies and organs as also the powerful IMF, WTO and World Bank as against the only toothless League of Nations and the International Labour Organization of the 1930s. One of the objectives of the Bretton Woods trio (World Bank, International Monetary Fund and the aborted International Trade Organization) was to have a world without want and fear and ensure peace and prosperity for all. They deliberated on how to avoid depression by short-term financing of trade deficits, how to facilitate flow of capital and growth in investment everywhere and how to stabilize commodity prices to save people from swings of shortages and abundance and from changes between uneconomic and unaffordable prices.
International public sector is now a crowded field. Beside the United Nations and its regional social and economic Commissions there are many organs and sector agencies and, of course, the mighty IMF, World Bank and the World Trade Organization. The performance of this international public sector has been of no significance in predicting and forestalling the crisis. Could they play a role in reducing the depth and breadth of the recession? So far there is very little evidence of their activism mainly because the Treasury and the Central Banks of the industrialized Seven have taken all the initiatives. But the trio can be empowered to arrest the decline in the flow of capital to weak economies, in financing trade and thus regulating competitive devaluation and trade protectionism and essentially in lending a voice to the weak and the deprived.
Bangladesh situation and what to do
Let us look at Bangladesh and try to assess as to what can be the impact of the melt-down. Bangladesh now is a small economy of $ 68 billion. 22% of its wealth emanates from agriculture but it employs 50% of the labour force. Services generate half of GDP and employs 35% of labour force. Manufacturing yields 17% of GDP and accounts for 10% of employment. Unemployment and under-employment account for 40% of a labour force of 70 million. 45% of population is poor and 20% is absolute poor. International trade accounts for 40% of the GDP; imports are worth $ 16 billion and exports are $ 12 billion only. Remittance is a big source of foreign exchange earnings, about $ 6 billion or 10% of GDP and it is growing fast. Foreign currency reserves are over $ 5 billion and it is not threatened by Bank failures. The current annual real growth of the economy is around 6% and the rate of inflation is at about two digits. The growth is largely dependent on growth of export and especially of knit wears and woven garments. The growth potential of rural and agriculture sector is high. The level of domestic credit is about 50 % of GDP. Public expenditure is about 16% of GDP and public investment is less than 6% only.
Its exports are threatened as nearly 85% of it goes to developed countries. Even remittances, which are largely from developing countries (over 65%) may decline because of possible hard times in the Gulf. Most of the imports (over 75%), however, are from developing and oil-exporting countries. We import a great deal now from developing countries and both India and China sell a lot to us. So any deceleration in these countries as well will affect us perhaps favourably. Well, one of the benefits of the crisis may be that world prices will stabilize at a much lower level since high prices of food items and crude oil had reached unsustainable levels.
The country is likely to gain from decline in import prices. In the garments sector Bangladesh supplies the cheaper quality of products but the expectation that its demand may not be very adversely affected is misplaced. What is more likely is that a decline in the growth rate of exports will take place. The surplus of wage earners abroad for remittances may fall short and manpower import by oil-producing countries may stagnate and thus growth in remittances may be adversely affected. Bangladesh receives foreign aid of about $1.5 billion a year all on grant or concessional terms. Its debt servicing, including IMF transactions, is about equal to the receipt of aid. The inflow of direct foreign investment is rather low, around $500 million a year and the outflow is a little less only. It is quite possible that investment, which is at 24% of GDP, may fall short and the growth rate of the economy may suffer.
The country needs to carefully ensure dynamism in domestic demand and hence an expansionary stance must be meticulously followed. How to arrest any decline in employment rate and how to continue investment in productive sectors will be the big challenges. Recently current expenditures have been increasing at a fast pace and some measure of austerity will be desirable there. There is a culture of default on bank credit in Bangladesh and a recent tendency of aggressive banking may have halted the improvement in that culture. The nation has to be very vigilant there. External exposure of Bangladesh Banks is essentially limited to trade transactions and rare cases of syndication of industrial or business loans. Some of the banks do assist the process of the flow of remittances. Foreign investment in the stock exchange after the collapse of 1996 is just nominal. The financial sector as a whole including the stock exchange is not likely to be affected by Bank failures abroad. But in a competitive world the banks and financial institutions in their mid-term planning should seriously consider mergers.
The big question is what will be the architecture of the new order? How is the housing collapse that periodically happens in USA going to be met? How much of mortgage should generate secondary loans? What impact will the crisis have on industrial production which has already taken a back seat leaving the place of honour to services sector? How is service provision likely to change? How will US habit of reliance on credit and consumerism be changed? How much of US double deficits should be considered safe and how much of it should be financed by the savings of others? How far will the idea of a world currency move forward? It looks obvious that the faith in self-correcting mechanism of the private sector was rather too stretched. The relaxation in regulations actually has nurtured greed and fraud. A balance, therefore, is needed in state intervention vis-a-vis market freedom. But a new order will be a matter of the medium term, say five years or more. In the meantime we have to survive and arrest decline in economic activities.
To us the most pressing question is how should Bangladesh handle the crisis? First of all, we should not be unduly complacent that the storm will be over and we shall escape with little bruises. We should instead be prepared for a down-turn in exports, remittances and investment. We have no reason to panic but we must develop our capacity for quick appreciation of developments as well as for quick response to such developments. We need to improve our management of the economy and handling of the macro environment in particular. We should appreciate that the level of our integration in the global economy is very high despite our status as a least developed country. We should set up a Task Force in the Ministry of Finance with high level representation from the Central Bank, the Planning Commission, the Banking sector, the non-banking Financial sector, the Export and Import trade sectors and the Academia and Research sector. The leadership of the Task Force must be political representing both the government and the opposition.
The first job of the Task Force is information gathering and analysis of developments across the globe on a daily basis. Thereafter, it has to consider both short and long term measures to meet the crisis.
Some of the measures that must be considered may be the following:
* In order to protect the growth of the economy an expansionary monetary policy should be adhered to.
* Every effort must be made to maintain and expand domestic demand. The easiest scope for that lies in emphasis on rural sector development, where major items of importance are agriculture, infrastructure and energy.
* Export promotion measures should be readily adjusted and export should be provided all assistance.
* A measure of austerity should be introduced in the current expenditure of the public sector with a view to save resources for investment.
* Initiatives for manpower export should be kept up at a high gear and urgent steps should be taken to train the exportable manpower, as needed.
* Investment in rural and agriculture sectors should be given the highest priority.
* The next item of priority should be development of the infrastructure and especially energy development and power supply.
* Adjustment in public expenditure may be considered to spare investible resources for quick return and slow down long-gestation investment.
* In order to arrest any lag in investment the best efforts should be made to absorb available foreign assistance and improve the investment friendly environment for Direct Foreign Investment.
* The price situation should be under careful observation and market intervention, if required, must be speedily made. The main actors in this operation should be Finance, Commerce, Food and Transport ministries. The expansionary economic stance should take note of the price situation.
* The interest rate policy should be under review and as soon as a break on inflation is noticed there should be lowering of interest rate.
* Exchange rate should be under regular review and steps where necessary should be taken with minimum lag to adjust it with reference to the performance in the countries of the currency basket.
The writer is a former finance minister of the government of Bangladesh.