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Global financial crisis & Nepal

SUJIT MUNDUL

The mayhem that the global financial / economic meltdown has caused to the western world is

no more a distant phenomenon for Nepal. The keen interest of our government, economists,

media, politicians, business community and public at large exhibits the pertinence of the subject

matter to us along with our western counterparts. At this juncture, perhaps the most crucial

concern for us would be its effects on Nepal. Would the Nepali economy be influenced by the

global crisis or will the winds of West pass through without a rustle? Before examining the

effects, it would only be pertinent to trace the origin of the predicament.

Crisis parentage

The most dominant trigger that initiated the crisis was the bursting of the US housing bubble due

to high default on substandard lending. For a number of years prior to the burst, people with low

credit rating and unstable income were advanced loans at sub prime rates encouraged by a long-

term trend of rising housing prices and a future opportunity of refinancing. The Federal Reserve

Board also basked in the bubble and refused to accept the aftermaths. It was thus initiated by US

financial institutions and nurtured by the Fed. The Federal National Mortgage Association

(Fannie Mae) and Federal Home Mortgage Corporation (Freddie Mac) fueled the fire for a long

time underwriting 80 percent of all toxic US mortgages that ultimately led to their bankruptcy.

Second, banks and financial institutions with overflowing debt component in their capital baseproudly prevailed in the US markets for a long time. Going further, the mortgages against loans

were securitized and converted into financial securities with a certain rate of interest. The

investment banks sold these complicated securities that were backed by highly risky debt, the

risks that even they were not aware of or which emerged in due time.

Third, most banks and financial institutions throughout the western world were convinced that

economic cycle was extinct and depression could only exist in the pages of history. They failed

to understand that longer the debt-fueled boom lasted and the greater the debt burden became,

the greater would be the carnage when the inevitable day of reckoning arrived.

Fourth, in a pursuit to earn more and more interest earnings, the banks, blinded by the profits,

went about in a spree of advancing loans to whoever was willing to take loans in times of market

boom. They felt that even if few of the borrowers defaulted, the volume of transactions and

subsequent refinancing would make them a neat profit in their overall position.

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Fifth, the alertness of ace rating agencies like Moodys and S & P can be viewed with skepticism

as they looked on while Collateralized Debt Obligations (CDOs) elevated the credit rating of

mortgages.

Lastly, amidst the cry for toughening regulations and empowering the regulators globally, the

manifold growth of US Credit Default Swap (CDS) market went unchecked. The arrangement ofcomplex derivatives remained unquestioned which intensified the magnitude of the crisis.

The Asian abode

Asia, at large, appears to be somewhat better protected than other parts of the world against a

slide into recession. It is believed that most Asian governments are in better financial condition

owing to their strong economic imperatives. Nevertheless, it is not decoupled from the global

economics (mainly western world and US). Major Asian stock markets have recorded a

significant drop in the recent past. Countries such as Taiwan, South Korea and Vietnam have

high dependence on exports. In China, weak exports orders combined with rising costs haveforced thousands of small factories to close in the countrys export zones. The woes of exporters

are felt throughout the region, which is tightly linked by trade in manufacturing parts and

machinery. Slower sales to US means reduced orders up and down the supply chain.

Insulated Nepal?

Apparently, the Nepali financial market does not seem to be directly impacted by the crisis due

to insignificant amount of foreign private capital inflows. However, Nepal has critical

dependence on other larger economies both in terms of imports and exports including

remittances. Therefore, the contagion effect of the global economies cannot be underestimated

under any circumstances. Deceleration in earning from exports and remittances would tend to

impair the countrys current account. Furthermore, the sustainability of speculative lending,

particularly in realty sector, is a matter of deep concern. In the absence of conscious efforts in

managing the economy, the crisis could gradually grapple the market. It would be apposite to

mention that the recent debacle in the commodity prices (steel, palm oil, plastics, etc) has

inflicted deep injuries to the corporates in Nepal. Although the magnitude of the financial loss is

a matter of conjecture, it should be treated as an important lesson for the market. The real

concern behind this episode is the effect on the financial system. Two questions quickly emerge:

Will the corporates be able to withstand the loss at ease? Will the drag effect be witnessed in the

books of the commercial banks?

To my estimation the following would be prone to the global ill effects:

Tourism: The tourism sector has started witnessing a slowdown as the number of tourists went

down by 16 percent in February this year against the same period last year. With the global woe

crafting a decrease in the expenditure muscle of these foreign tourists, the tourism sector of

Nepal is likely to witness a greater setback.

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Foreign aid: The development projects in Nepal are to a great extent dependent on foreign aids

and grants. In face of the crisis, concerns are there if some portion of such aids is likely to

shrivel.

Big budget projects and FDIs: International institutional investors are considerably hit by the

turmoil and so their investment in our country could be hindered, resulting in delays.

Exports: Less demand in the West for exportable products from Nepal.

Remittances: The flow of remittance has also started to decrease. In mid-November to mid-

December 2008, remittance income growth rate had stood at 67 percent. However, this growth

rate declined to 65 percent in mid-December 2008 to mid-January 2009 and 57 percent in mid-

February to mid-March 2009. It has been reported that the number of Nepali migrant workers

going for overseas employment has seen a contraction of 9.7 percent between mid-February and

mid March this year.

Against the backdrop of the foregoing, the government, regulators, commercial banks, financial

institutions and the constituent players would require to be vigilant and flexible for ensuring a

smooth pass-over.

Future outlook

The people closely following the financial developments over the past few months have

undoubtedly witnessed history. This upheaval has outshone all major events in the worlds

economic history. The Nepali financial market should consider this as a valuable learning

experience and make a collective and conscious effort to shield it against any similar situation.

Banks and financial institutions should adopt a disciplined management of capital and liquidityto avoid replicating the fate of the West. Regulators should ensure that commercial banks are

restrained from making over financing and speculative financing particularly in the commodity

and realty sectors. A conservative and prudent approach in lending should be implemented

without any compromise on financial disciplines.

(Writer is CEO, Standard Chartered Bank Nepal Ltd.)

Published on 2009-04-12 14:04:37 Republica