Global Financial Crisis - - E MBYLLUR - Faqja

Global Financial Crisis:

Causes and Consequences

Dr. Prajapati TrivediSenior EconomistThe World Bank

Presentation Outline

• Meaning of Global Financial Crisis

• Causes • Consequences

– Saudi Arabia– India

Global Financial Crisis

• The global financial crisis of 2008 is the worst of its kind since the Great Depression

• Began with failures of large financial institutions in the United States

• Rapidly evolved into a global crisis resulting in a number of European bank failures

Meaning of Global Financial Crisis

• The term financial crisis is applied broadly to a variety of situations

• Usually, some financial institutions or assets suddenly lose a large part of their value– Banking Panics (and recessions)– Stock market crashes– Bursting of financial bubles– Currency crisis– Sovereign defaults

Banking Panics (and recessions)

• Commercial banks suffer a sudden rush of withdrawals by depositors, this is called a bank run– September 7, 2008:

• Two United States Government sponsored enterprises (GSEs), Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation), into conservatorship run by FHFA

– September 14, 2008• Lehman Brothers files for bankruptcy.• Sale of Merrill Lynch to Bank of America

– September 16, 2008• AIG faces severe liquidity crunch

• Financial institutions lost a large part of their value in coming days and weeks

Banking Panics (and recessions)

1 year ago RBS paid $100 billion for ABN Amro.

For this amount it could now buy:

Citibank $22.5 billion Morgan Stanley $10.5 billion Goldman Sachs $21 billionMerrill Lynch $12.3 billionDeutsche Bank $13 billion Barclays $12.7 billion

And still have $8 billion change......with which it would be able to pick up GM, Ford, Chrysler and the Honda F1 Team.

Speculative Bubbles and Crashes

• A bubble exists when the price of stock exceeds the value of the future income (such as interest or dividends) that would be received by owning it to maturity– Dutch tulip mania– Wall Street Crash of 1929– Japanese property bubble of the 1980s, – Crash of the dot-com bubble in 2000-2001, and now the – United States housing bubble.

Speculative Bubbles and Crashes

Causes

• Leveraged Investment• Asset-Liability Mismatch• Regulatory Failures• Fraud

– Medford

• Contangion• Œcopathy• Self-fulfilling Prophecy

Sub-prime Mortgage

Why History is Repeated?

• Schumpeterian Creative Destruction

• Regulatory Evolution• New markets• Nature of competition

Consequences

Readerscomments

All you need is cashThe increasingly desperate search for the stuff is changing

modern management?

Consequences for the Saudi Economy

• Government Investment • Consumer Demand• Private Sector Demand

Impact on the Demand Side of Development Process


Impact on the Supply Side of Development Process

• Capital Flows • Liquidity – working capital flows• Skilled Labor• Unskilled labor• Energy• Raw Materials

Impact of the crisis on the reform of the Saudi economy


• Government Investment – Long pipeline of funded Government projects– Funds from budget surpluses also committed for

projects

Hence neutral impact is expected in the medium term.



• Consumer Demand – No reason for Saudi consumption spending to

change.– Expatriate consumer spending may decrease as

some private sector projects may be postponedGiven that the Saudi economy was till recently

facing an excess demand situation, on balance this may be a positive factor.


Relationship between Individual Consumption and GDP

-200.00

0.00

200.00

400.00

600.00

800.00

1000.00

1969

A19

71A

1973

A19

75A

1977

A19

79A

1981

A19

83A

1985

A19

87A

1989

A19

91A

1993

A19

95A

1997

A19

99A

2001

A20

03A

Years

Saud

i Riy

als

Abroad

Clothes

Rent

Food

Furniture

Medical

Other

Entertainme

Transport

GDP


• Private sector Investment– Private sector investment in real estate sector

likely to be affected adversely. However, this may be a good outcome given that the Saudi real estate market was over-heated and was suffering from speculative fever.

– Private sector investment related to other aspects of population requirements not likely to be affected as the real purchasing power of Saudi consumer is not likely to be adversely affected.



• Capital Flows – There will be a slow-down of private capital flows (FDI)

as the financial crisis decreases the available pool of funds.

– However, from this smaller pool a much larger proportion of funds may be expected to come to Saudi Arabia. This is because of the large and stable buying power of Saudi consumers and Kingdom favorable business climate. According to the World Bank Saudi Arabia is ranked number 16 and is ahead of all countries in the Middle East.

• Impact likely to be neutral.



• Liquidity – Working capital flows – Like all other countries, Kingdom’s banks were also in

danger of a potential liquidity crisis resulting from losses on banks’ foreign investments.

– However, timely intervention by the Saudi government on October 16, 2008 eliminated this risk. The Supreme Economic Council asked SAMA to ensure sufficient liquidity for the Banks and guarantee the security of bank deposits.

• Impact likely to be neutral.



• Skilled labor – Given the global slow down and retrenchment in

OECD countries, the available pool of skilled workers will increase and there would be a downward pressure on their salaries. This would benefit Kingdom.

• Impact likely to be positive.



• Unskilled labor – Given the global slow down and retrenchment in

OECD countries, the available pool of un-skilled workers will also increase and there would be a downward pressure on their salaries. As one of the largest employers of expatriate labor force, this trend would benefit the Kingdom.




• Raw Materials – intermediate inputs – Global slow down will reduce the price of

commodities in general. Hence, the cost of construction materials (steel, copper, etc) will come down and benefit the Kingdom.




• Inflation – Globally inflation rates have started to come

down and that is also the case in Saudi Arabia.– This trend will be further supported by

strengthening of the dollar vis a vis other currencies.

• Hence, on balance, the financial crisis may be good for controlling inflation.

Affect on the welfare and quality of life of citizens


• Jobs – Saudi unemployment is not demand driven. Rather, it is a

structural problem. Hence, the dampening of demand is not likely to have any immediate negative impact.

– If Surplus projects are executed and other reform measures implemented, there may be a greater job creation for Saudis.

• Hence, on balance, the financial crisis may be neutral for jobs creation in the Kingdom.



• Travel Abroad – Stronger dollar (hence stronger Riyal) makes it

easier for the Saudis to travel abroad.• Hence, on balance, the financial crisis may

be good for citizens who want to travel abroad.



– There is a global trend towards accelerating reform agendas for dealing with the financial crisis in the short run as well as in the long-run. Kingdom will benefit from the experience of other countries and be able to upgrade its regulatory environment.

– The recent decrease in oil prices has once again brought the focus to the much needed reforms. Kingdom will now be able to work on a post-oil economy.

– The massive surpluses in the recent pasts ($70.6 billion in 2006 and $47.6 billion in 2007) have made it easier to make investment in these reforms.

• Hence, impact f the crisis likely to be positive.

Impact of the crisis on the reform of the Saudi economy

Please send comments to

Dr. Prajapati [email protected]

or

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Global Financial Crisis - - E MBYLLUR - Faqja

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