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New CBMS Initiatives

New CBMS Initiative:Monitoring and Mitigating the Impact on Poverty of the Global Financial Economic Crisis

Background

The global economy is now threatened with a deep recession. The International Monetary Fund (2008) projected that the world GDP growth will slow down by at least 2.0 percentage points (from 5.0% to 3.0%) for 2008 and 2009. This would mean that global GDP per capita will also decrease. The World Bank (2008) also confirmed that the financial crisis is now considered a global economic crisis and is rapidly becoming an unemployment crisis. Given this, it is more likely that there will be a sharp decline in growth in 2009 through various channels. In the case of developing countries, the World Bank projected that growth would slow down to 4.5 percent in 2009 from 7.9 percent in 2007 (Brahmbhatt, 2008). The OECD projections highlighted the more dominant downside risks for 2009. Although widespread risks remain in 2010, there is a possibility of an earlier recovery since risks are more equally distributed (Schmidt-Hebbel, 2008).

Analyzing the current global financial crisis requires understanding of how it all started. One distinct feature of the current crisis is that it emanated from advanced economies rather than from bad policies in developing countries. The financial crisis of 2007-2008 or the “credit crisis” started in July 2007 when there was loss of confidence by investors in the value of securitized mortgages in the United States (US). This resulted in a liquidity crisis prompting a significant injection of capital into financial markets by the US Federal Reserves and the European Central Bank.

In September 2008, the crisis deepened when global stock markets fell and entered a period of high volatility. The failures of the large financial institutions in the United States evolved into a global financial crisis with several failures of European banks and decline in various stock indices, coupled with large reduction in the market value of equities (stock) and commodities globally. The crisis resulted to liquidity problems and de-leveraging of financial institutions which contributed further to liquidity crisis. It also resulted in rapid depreciation of currencies, rising dollar denominated debt liabilities and sudden credit tightening in developing countries; with capital flowing back to try to shore up damaged balanced sheets in the advanced countries. So far, China in particular, has halted the appreciation of the yuan.

After affecting several companies, mainly in the US, it also affected countries in Europe and in other regions spreading to other financial areas such as the stock markets and derivatives, equity and hedge funds, insurance and pension funds, public finance and foreign exchange. The countries which are reported to be currently in recession include Estonia, Latvia, Ireland, New Zealand, Japan, Hong Kong, Singapore, Italy and Germany. In addition, countries (including most developing countries) with the following characteristics are also expected to be at risk: (Velde, 2008)

  • with significant exports to crisis affected countries such as the USA and EU countries (either directly or indirectly)
  • exporting products whose prices are affected or products with high income elasticities
  • dependent on remittances
  • heavily dependent on foreign portfolio and FDI finance to address their current account problems
  • with sophisticated stock markets and banking sectors with weakly regulated markets for securities
  • with a high current account deficit with pressures on exchange rates and inflation rates
  • with high government deficits
  • dependent on tourism
  • dependent on aid

Although the global financial crisis originated in the US and spread to the European Union and some countries in Asia, the developing countries will not escape the adverse consequences. In particular, developing countries would be affected by the financial crisis in two possible ways: 1) through financial contagion and spillovers for stock and bond markets in emerging markets; and 2) economic downturn in developed countries. The latter may have significant impact on developing countries through the following channels: a) trade and trade prices; b) remittances; c) foreign direct investment (FDI) and equity investment; d) commercial lending; e) aid; and f) other official flows. Although the economic impact of the global financial crisis would vary across different countries, it is expected that, in general, there would be further pressures on current accounts and balance of payment. The crisis would also result to weaker export revenues, lower investment and GDP growth rates and loss of employment. In terms of social impact, the lower growth would translate into higher poverty and even slower progress toward the Millennium Development Goals (MDGs) (Velde, 2008). For most countries, it is important that the International Monetary Fund (IMF) provides more money and is trusted. It is important to try to reverse these capital outflows and the associated credit tightening. Only the very large reserve currency countries can do this. However, it is a different question as to how much they want to, given tradeoffs.