Global Financial Crisis Page |1

Global Financial Crisis

What is crisis?
Crisis is an unstable situation of extreme danger or difficulty.

What is Financial Crisis?

The term financial crisis is applied broadly to a variety of situations in which some financial
institutions or assets suddenly lose a large part of their value.

A financial crisis is a situation when money demand quickly rises relative to money supply.
Until a few decades ago, a financial crisis was equivalent to a banking crisis. Today it may
also take the form of a currency crisis. Many economists have come up with theories on
how a financial crisis develops and how it could be prevented. There is, however, no
consensus and financial crises are still a regular phenomenon. A stock market crash is an
example of a financial crisis.

The Historical Prospective

Worldwide, the Great Depression started in 1929 and ended between the late 1930s or
early 1940s for different countries. As the largest and most important economic depression
in modern history, it is now a benchmark for how far the world's economy can fall. The
Great Depression originated in the United States starting with the stock market crash on
October 29, 1929, is known as Black Tuesday. The end of the depression in the U.S. is
associated with the onset of the war economy of World War II, beginning around 1939.
The depression had devastating effects in the developed and developing countries.
International trade was deeply affected, as were personal incomes, tax revenues, prices, and
profits. Cities all around the world were hit hard, especially those dependent on heavy
industry.
Construction virtually halted in many countries. Farming and rural areas suffered as crop
prices fell by 40 to 60 percent. Facing plummeting (drop sharply) demand with few
alternative sources of jobs, areas dependent on primary industries, such as farming, mining
and logging, suffered the most.
However, even shortly after the Wall Street Crash of 1929, optimism persisted; John D.
Rockefeller said that "these are days when many are discouraged. In the 93 years of my life,
depressions have come and gone. Prosperity has always returned and will again." Most
countries set up relief programs, and suffered political upheavals (violent disturbance),
pushing them to the left or right. [1]

Forecast of the Crisis

Besides many other studies by international financial institutions (IFIs), a Deloitte Research
Study titled Global Economic Outlook 2007 (Is a crisis imminent or are things better than we
thought?) predicted the crisis in these words, “The US invests far more than it saves (its
current account deficit) and the rest of the world saves far more than it invests (a current
account surplus). This is the big imbalance in the global economy. It involves a massive flow
of capital to the US from the rest of the world. The magnitude of this transfer is
1
http://ipripak.org/journal/winter2010/Article5.pdf
Global Financial Crisis Page |2

unprecedented in recent history and probably cannot be sustained indefinitely. Therefore,

when it ends, it could have a destabilizing effect on the global economy, if only because of
the shifting of gears.” [2] The international financial system has failed to deliver on two
accounts; (i) preventing instability and crises and (ii) transferring resources from richer to
poorer economies. [3]

Trends Leading to the Crisis

The following are some trends which somehow predicted the arrival of crisis.

 High Commodity Prices

In 2008, the prices of many commodities, notably oil and food, rose so high as to
cause genuine economic damage. In January 2008, oil prices surpassed $100 a barrel
for the first time, the first of many price milestones passed that year. By July the
price of oil reached as high as $147 a barrel although prices fell soon after.
 Trade
In mid-October 2008, the Baltic Dry Index, a measure of shipping volume, fell by 50
per cent in one week, as the credit crunch made it difficult for exporters to obtain
letters of credit.
 Inflation
In February 2008, Reuters (London based International News Agency) reported that
global inflation was at historic levels, and that domestic inflation was at 10 to 20 year
highs for many nations. "Excess money supply around the globe, a surge in growth
supported by easy monetary policy in Asia, speculation in commodities, agricultural
failure, the rising cost of imports from China and rising demand of food and
commodities in the fast growing emerging markets," have been named as possible
reasons for the inflation. In mid-2008, IMF data indicated that inflation was highest
in the oil-exporting countries and developing Asia on account of the rise in oil and
food prices.
 Unemployment
The International Labor Organization predicts that at least 20 million jobs are likely
to be lost by the end of 2009 due to the crisis - mostly in "construction, real estate,
financial services, and the auto sector" - bringing world unemployment above 200
million for the first time.

Global Financial Crisis of 2007-Present

The financial crisis of 2007–present is a crisis triggered by a liquidity crisis in the United
States banking system. It has resulted in the collapse of large financial institutions, the
bailout of banks by national governments and downturns in stock markets around the
world. In many areas, the housing market has also suffered, resulting in numerous evictions,
foreclosures and prolonged vacancies. It is considered by many economists to be the worst
financial crisis since the Great Depression of the 1930s. [4]

2
“Global Economic Outlook 2007: Is a Crisis Imminent, or Are Things Better Than we Thought?”, A Deloitte Research Study,
http://www.deloitte.com/assets/Dcom-Global/Local%20Assets/Documents/dtt_GlobEcon07_091506.pdf
3
Jayati Ghosh, “Global Inequity Must End,” Daily Times (Islamabad), October 26, 2008
4
http://www.reuters.com/article/idUS193520+27-Feb-2009+BW20090227
Global Financial Crisis Page |3

It contributed to the failure of key businesses, declines in consumer wealth estimated in the
trillions of U.S. dollars, substantial financial commitments incurred by governments, and a
significant decline in economic activity.

Some Major Companies Failures in Global Crisis

 New Century Financial Corporation

 Lehman Brothers
 Charter Communications
 Allco Finance Group
 General Motors
 American Freedom Mortgage
 American Home Mortgage
 Bernard L. Madoff Investment Securities LLC

Different Dimensions of Global Financial Crisis

 Subprime Mortgage Crisis

 Energy Crisis
 Automotive Industry Crisis

Subprime Mortgage Crisis

Subprime Mortgage:
A subprime mortgage is a type of loan granted to individuals with poor credit histories, who,
as a result of their deficient credit ratings, would not be able to qualify for conventional
mortgages. Because subprime borrowers present a higher risk for lenders, subprime
mortgages charge interest rates above the prime lending rate.
There are several different kinds of subprime mortgage structures available. The most
common is the adjustable rate mortgage (ARM), which initially charges a fixed interest rate,
and then converts to a floating rate based on an index such as LIBOR, plus a margin.

Subprime Mortgage Crisis:

The subprime mortgage crisis is an ongoing real estate crisis and financial crisis triggered by
a dramatic rise in mortgage delinquencies and foreclosures in the United States, with major
adverse consequences for banks and financial markets around the globe.
Approximately 80% of U.S. mortgages issued in recent years to subprime borrowers were
adjustable-rate mortgages. After U.S. house prices peaked in mid-2006 and began their
steep decline thereafter, refinancing became more difficult. As adjustable-rate mortgages
began to reset at higher rates, mortgage delinquencies soared. Securities backed with
subprime mortgages, widely held by financial firms, lost most of their value. The result has
been a large decline in the capital of many banks and U.S. government sponsored
enterprises, tightening credit around the world.
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Causes for Mortgage Crisis:

1. Boom and Bust in Housing Market

Low interest rates and large inflows of foreign funds created easy credit conditions for a
number of years prior to the crisis, fueling a housing market boom and encouraging debt-
financed consumption. The USA home ownership rate increased from 64% in 1994 (about
where it had been since 1980) to an all-time high of 69.2% in 2004. Subprime lending was a
major contributor to this increase in home ownership rates and in the overall demand for
housing, which drove prices higher.

2. Homeowner Speculation
Speculative borrowing in residential real estate has been cited as a contributing factor to the
subprime mortgage crisis. During 2006, 22% of homes purchased (1.65 million units) were
for investment purposes, with an additional 14% (1.07 million units) purchased as vacation
homes. During 2005, these figures were 28% and 12%, respectively. In other words, a record
level of nearly 40% of homes purchases were not intended as primary residences.

3. High-risk mortgage loans and lending/borrowing practices

In the years before the crisis, the behavior of lenders changed dramatically. Lenders offered
more and more loans to higher-risk borrowers, including illegal immigrants. Subprime
mortgages amounted to $35 billion (5% of total originations) in 1994, 9% in 1996, $160
billion (13%) in 1999, and $600 billion (20%) in 2006.

4. Securitization practices
The traditional mortgage model involved a bank originating a loan to the
borrower/homeowner and retaining the credit (default) risk. With the advent of
securitization, the traditional model has given way to the "originate to distribute" model, in
which banks essentially sell the mortgages and distribute credit risk to investors through
mortgage-backed securities. Securitization meant that those issuing mortgages were no
longer required to hold them to maturity. By selling the mortgages to investors, the
originating banks replenished their funds, enabling them to issue more loans and generating
transaction fees.

5. Inaccurate credit ratings

Credit rating agencies are now under scrutiny for having given investment-grade ratings to
MBSs (Mortgage Backed Securities) based on risky subprime mortgage loans. These high
ratings enabled these MBS to be sold to investors, thereby financing the housing boom.
These ratings were believed justified because of risk reducing practices, such as credit
default insurance and equity investors willing to bear the first losses. However, there are
also indications that some involved in rating subprime-related securities knew at the time
that the rating process was faulty.

6. Other Causes
 Government policies
 Policies of central banks
 Financial institution debt levels and incentives
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 Credit default swaps

Automotive industry crisis of 2008–2010

The automotive industry crisis of 2008–2010 was a part of a global financial downturn. The
crisis affected European and Asian automobile manufacturers, but it was primarily felt in the
American automobile manufacturing industry. The downturn also affected Canada by virtue
of the Automotive Products Trade Agreement.
The automotive industry was weakened by a substantial increase in the prices of automotive
fuels linked to the 2003-2008 energy crisis which discouraged purchases of sport utility
vehicles (SUVs) and pickup trucks which have low fuel economy. The popularity and
relatively high profit margins of these vehicles had encouraged the American "Big Three"
automakers, General Motors, Ford, and Chrysler to make them their primary focus. With
fewer fuel-efficient models to offer to consumers, sales began to slide. By 2008, the
situation had turned critical as the credit crunch placed pressure on the prices of raw
materials.
Car companies from Asia, Europe, North America, and elsewhere have implemented
creative marketing strategies to entice reluctant consumers as most experienced double-
digit percentage declines in sales. Major manufacturers, including the Big Three and Toyota
offered substantial discounts across their lineups. The Big Three faced criticism for their
lineups, which were seen to be irresponsible in light of rising fuel prices. North American
consumers turned to higher-quality and more fuel-efficient product of Japanese and
European automakers. However, many of the vehicles perceived to be foreign were actually
"transplants," foreign cars manufactured or assembled in the United States, at lower cost
than true imports.

Energy Crisis 2003-2008

From the mid-1980s to September 2003, the inflation-adjusted price of a barrel of crude oil
on NYMEX was generally under $25/barrel. During 2003, the price rose above $30, reached
$60 by August 11, 2005, and peaked at $147.30 in July 2008. Commentators attributed
these price increases to many factors, including reports from the United States Department
of Energy and others showing a decline in petroleum reserves, worries over peak oil, Middle
East tension, and oil price speculation.

Possible causes for Energy Crisis

Demand
World crude oil demand grew an average of 1.76% per year from 1994 to 2006, with a high
of 3.4% in 2003-2004. World demand for oil is projected to increase 37% over 2006 levels by
2030, according to the 2007 U.S. Energy Information Administration's (EIA) annual report.

Supply
An important contributor to price increases has been the slowdown in oil supply growth,
which has continued since oil production surpassed new discoveries in 1980. The fact that
global oil production will decline at some point, leading to lower supply is the main long-
term fundamental cause of rising prices. Although there is contention about the exact time
Global Financial Crisis Page |6

at which global production will peak, there are now very few parties who do not
acknowledge that the concept of a production peak is valid. However, before the record oil
prices of 2008, some commentators argued that global warming awareness and new energy
sources would limit demand before the effects of supply could, suggesting that reserve
depletion would be a non-issue.

Investment Demand
Investment demand for oil occurs when investors purchase futures contracts to buy a
commodity at a set price for future delivery. "Speculators are not buying any actual crude. ...
When the contracts mature, they either settle them with a cash payment or sell them on to
genuine consumers."

Monetary Inflation and Value of Dollar

Oil is quoted and traded in US Dollars. Therefore by definition the price or value of oil
fluctuates based on investors' assessment of the value of oil and US Dollars. This has led to
concern among some economists that the principal earned from the sale of oil may lose
value in the long run if the U.S. dollar loses real value. Some analysts believe that as much as
$25 of the June 2008 prices around $140 were due to dollar devaluation.

The Effects of Oil Crisis

Political scientist George Friedman has postulated that if high prices for oil and food persist,
they will define the fourth distinct geopolitical regime since the end of World War II, the
previous three being the Cold War, the 1989-2001 period in which economic globalization
was primary, and the post-9/11 "war on terror".
In addition to high oil prices, from year 2000 volatility in the price of oil has increased
notably and this volatility has been suggested to be a factor in the ongoing financial crisis
which began in 2008.

How can we avoid Oil Crisis in future?

Attempts to mitigate the impacts of oil price increases include:
 Increasing the supply of petroleum
 Finding substitutes for petroleum
 Decreasing the demand for petroleum
 Attempting to reduce the impact of rising prices on petroleum consumers

Global Crisis and Pakistan

The global recession has posed policymakers around the world with unprecedented
challenges. Severely damaged financial sectors seemed immune to most responses, while
fiscal stimuli and other policy tools have, at best, been sluggish to establish some stability in
economies dealing with the spill-over of the financial crisis into other sectors and a general
economic slowdown. In a little over a year, what started off as a sub-prime crisis in US
mortgage and housing markets, has amplified to a global economic downturn of an
extraordinary scale, bringing to an end four years of booming economic growth across the
world.
Global Financial Crisis Page |7

In developed economies, strains in the financial sector, a drying up of credit, and an

increasing amount of risk aversion in the face of limited information about potential losses,
led to the closing of many credit lines and the evaporation of financing mechanisms.
Commodity producing sectors in these economies were hard hit by these events, resulting in
a general economic deceleration rather than a crisis limited to the financial sector.

In emerging economies, the slowdown manifested itself through various channels. Volatility
in financial markets led to a flight of capital. Furthermore, access to external financing
became all but impossible and spreads on bonds widened to record levels. Countries relying
on trade as a primary means of boosting economic growth saw trade volumes disappear as
trading partners in the rest of the world struggled to deal with the slowdown in their
domestic economies. The global financial crisis is impacting the real and social sectors of
developing countries through multiple channels. The linkages between developed and
developing economies have deepened as well as broadened over the past two decades in
the wake of intensifying globalization.

As the slump in the global economy prevailed, the Pakistan’s economy witnessed a period of
significant instability and a deterioration of most macroeconomic indicators. The timing of
the crisis, and Pakistan’s response to domestic developments might seem contradictory to a
layman. As governments around the world lowered interest rates and implemented
expansionary fiscal measures to revitalize their economies, Pakistan underwent a phase of
fiscal tightening, and a stringent monetary stance with discount rates remaining relatively
high for most of the period (discount rates remained at 15 percent till April 2009). Fiscal,
Monetary, and External debt policies of Pakistan have primarily been driven by the
underlying need to resurrect significant macroeconomic imbalances in the domestic
economy, rather than as a response to the financial crisis and global economic slowdown.
The financial sector of the economy is still in its developing stages with limited, albeit
growing, linkages with global markets. As a result, Pakistan has been relatively well-
insulated against the contagion in international financial markets. It is remarkable to note
that Pakistan is among a handful of countries with a positive rate of growth, and among a
very few with the lowest decline in real GDP growth as compared to other countries
affected by the global financial crisis.

Impact of Global Crisis

The developing nature of the financial sector has been a saving grace for the Pakistani
economy. Less developed linkages with international markets have meant that the direct
impact of the financial crisis has not been felt by the Pakistani financial sector. However;
effects of the crisis have been felt, even though in a limited manner, by the real sectors of
the economy. The effects of the global slowdown have been transmitted through the trade
balance; with a slowdown in global demand and fall in commodity prices having varying
effects, the capital account; with a significant reduction in private inflows to Pakistan.

Financial Sector: The operating environment of the financial sector experienced significant
deterioration in 2007 and 2008, due to a confluence of factors emanating from both the
domestic and international economic and financial developments. While the domestic
Global Financial Crisis Page |8

environment was characterized by weakening macroeconomic indicators and the

uncertainty caused by the prolonged period of political transition, the global financial crisis
and the commodity price hike had a feedback impact on the financial sector through the
real sector of the economy. Pakistan, which remained largely unscathed from a direct
impact of the crisis, has been more concerned with issues relating to monetary stability due
to rising inflation since before the advent of the crisis. With a thriving banking sector,
increasingly resilient to a wide variety of shocks, increasing but still relatively less correlation
of domestic financial markets with global financial developments, a proactive and vigilant
regulatory environment, and most importantly, no direct exposure to securitized
instruments, risks to financial stability were largely contained and well managed as the crisis
unfolded and impacted the financial sectors in advanced economies.

Capital Flows & Workers’ Remittances: A beleaguered international economic environment

has held back Foreign Investment as it posted a decline of 47.5 percent during the first ten
months of 2008-09 compared to the corresponding period of the previous year. Most of this
decrease has come in the shape of an outflow of private portfolio investment of US$ 1
billion. Investment from countries such as the United States, United Kingdom, Singapore,
and Hong Kong, which have been at the apex of the international crisis, has dropped
significantly. Some Asian economies have witnessed an anticipated fall in workers’
remittances as unemployment grew in advanced host economies. However, workers’
remittances to Pakistan remained vigorous and unaffected by the crisis, totaling US$ 6.36
billion in July-April 2008-09 as against US$ 5.32 billion in the corresponding period last year,
thereby displaying a rise of 19.5 percent.

Commodity Prices & Trade: An unprecedented hike in international commodity prices

wreaked havoc on Pakistan’s external sector during 2007-08, with the current account
widening significantly. However, in the wake of a reduction in global demand and the
resultant decrease in commodity prices, the import bill has reduced significantly, decreasing
the current account deficit. A key loss to developing countries during the current crisis has
been a decrease in exports as demand from advanced economies contracts. Pakistan has
witnessed a slowdown in exports, but this reduction stands apart from that witnessed by
other Asian economies for two reasons. Firstly, the fall in exports is partly due to a fall in
domestic productivity and it is hard to distinguish between the impact of the crisis and
internal factors on exports. Secondly, the fall in imports has outpaced the fall in exports,
having a positive effect on the trade balance.

External Financing: The global crisis has restricted Pakistan’s ability to tap international debt
capital markets to raise funds. An increasing cost of borrowing internationally, coupled with
deterioration in the country’s credit rating has ruled out issuance of government paper as a
financing mechanism. Pakistan’s presence in the international capital markets in 2008-09
was limited to the repayment of Eurobond amounting to US$ 500 million made in February
2009 with no new issuance at the backdrop of financial crisis engulfing the global markets. [5]

5
http://www.unescap.org/pdd/calendar/strengthening_responses/papers/Pakistan_monetary_Ali.pdf
Global Financial Crisis Page |9

Is there a recession in Pakistan?

The global recession has not hit us exactly the same way or for the same reasons as it seems
to have entangled the rest of the world, or so we are told by economic analysts. Some argue
that recession has not hit Pakistan at all and the current economic impasse can be
attributed entirely to mismanagement of our economic managers.

According to recently released statistics, there is ample evidence to suggest that

manufacturing output is on the decline - one major indicator of recession. Pakistani
manufacturing sector accounted for 25.9 percent of Gross Domestic Product in 2006-07. Or,
in other words, about a quarter of our total GDP was sourced to the manufacturing sector.
However, interestingly, in 2007-08 manufacturing accounted for 25.9 percent of GDP in
comparison to the previous year's (2005-06) 26.1 percent.

Analysts who may allege that this decline, however insignificant, may well portend the start
of a recession must note that there was a higher decline between 2004-05 and 2005-06:
from 26.3 to 25.9 percent of GDP. These years were hailed by the then government of
Pervez Mushrarraf as high growth years and high growth is not compatible with a recession.
A closer look at the ingredients of manufacturing may provide some answers.

Manufacturing, as calculated by the Economic Advisor's Wing and contained in the annual
publication titled Economic Survey, constitutes five sub-heads. First, mining and quarrying,
which registered a constant contribution to GDP in 2006-07 and 2007-08: 2.5 percent. Large
scale manufacturing declined from 13.4 percent to 13.3 percent of GDP between the two
years, while small scale manufacturing rose from 4.3 to 4.4 percent. Construction remained
constant at 1.3 percent, in spite of ongoing construction work for the quake affected
families, while distribution of gas and electricity rose from 2.5 to 2.7 percent.

Considering the charges of blatant manipulation of statistics during the Shaukat Aziz era
these statistics too are suspect to some extent. This is particularly relevant as government
involvement in the manufacturing sector is considerable. There is evidence to suggest that
public sector manufacturing - inclusive of military as well as civilian government
involvement in the manufacturing sector - constitutes a significant portion of the total
manufacturing sector.

In 1991 public sector accounted for about 40 percent of total manufacturing value added
and absorbed around 48 percent of gross fixed investment. The total value of public sector
industrial output in 1991 was 36 billion rupees (in constant 1988 fiscal year prices), but
pretax profits were only 1.3 billion rupees, reflecting the inefficiencies and overstaffing
prevalent in these enterprises.

To improve the efficiency and competitiveness of public sector firms and end federal
subsidies for their losses, the government launched a privatization programmed in 1991.
Majority control in nearly all public-sector enterprises was to be auctioned off to private
investors, and foreign investors were rendered eligible buyers. In March 1992, twenty units
were privatized, but by 1993 only about 30 percent of the government's target number of
 Global Financial Crisis Page |
10

firms had been sold because some of the enterprises were unattractive for private investors.
In 1994, the government led by Benazir Bhutto, rhetorically committed to continuing the
policy of privatization, backed down in the face of stiff resistance from the powerful public
sector employee unions.

The Musharraf era was marked by privatization of 166 units (January 1991 to February
2007). The take of the federal government from this was 475 billion rupees, a hefty 8.9
billion dollars. According to the Economic Survey between July 2007 and February 2008 - the
last months of the dying Musharraf regime - UBL's divestment of 25 percent shares through
a GDR fetched 650 million dollars, hailed as the biggest book builder in Pakistan's history.
Thus as a result of sustained efforts to privatize large-scale parastatal units the public sector
continues to account for a significant proportion of industry even today. Be that as it may it
is evident that the manufacturing sector did not decline significantly as a percentage of GDP.

This situation is likely to change dramatically during the current year. The energy shortage is
having major implications for industrial output; in addition the expected increase in
electricity rates by April, revealed by the Special Advisor to the Prime Minister on Finance,
will raise the cost of manufacturing still further and there is evidence to suggest that part of
the inflationary pressures can be sourced to the inadequacy of electricity supply to the
industrial sector.

This is endemic to Pakistan and therefore a decline in output raising fears of an onset of a
recession cannot be attributed either to the global financial crisis or indeed the heavy
subsidization of oil and products by the previous government; but to the failure to supply
electricity, a critical input, to the manufacturing and farm sector. It is precisely for this
reason that the International Monetary Fund (IMF) recommends even tighter fiscal and
monetary policy measures in the months to come, recommendations that are the reverse of
the usual prescriptions for recession, as a means to check inflationary pressures sourced to
too few goods being produced domestically chasing too much money that was generated
because of a burgeoning budget deficit.

Growth rate - a measure of an economy in recession or not - declined in 2007-08, and is

expected to decline further in the current fiscal year. However it is still expected to be over
3 percent - a growth rate that would be the envy of countries in the throes of the recession.
All through the 1990s growth rates were very high.

The past government insisted that this was due to their investment friendly policies;
however the fact that aid began to flow in the aftermath of 9/11 at unprecedented levels
was perhaps a more critical ingredient of the growth rates achieved during the Musharraf
era. The growth targets for the current year as well as in the following year are not high, i.e.
under 3.5 percent; however, this growth rate is sufficiently significant to conclude that
recession is unlikely in this country.

To conclude, our malaise is basic: an infrastructure base grossly inadequate to sustain even
the existing output potential, a government heavily involved in manufacturing and
contributing heavily to inefficiencies in the sector which, in turn, also reduces the tax
 Global Financial Crisis Page |
11

revenue that can be realized from the manufacturing sector, and constant state intervention
in pricing of commodities which is leading to artificial shortages and higher black market
prices. At the same time the country is losing its battle with respect to providing education
and health care facilities with the bulk of the annual budget allocated for servicing past
debts, defense and non-development expenditure. The fault, as Caesar said to Brutus, is not
in our stars or global recession but in ourselves that we remain a prisoner to
underdevelopment. [6]

Was there any effect of Global crisis on Pakistan?

Pakistan has severe economic problems of its own not connected with the financial turmoil
in the US and Western Europe. With fast depleting international reserves there is a growing
fear that the country may be forced into defaulting on its foreign obligations. It was because
of this fear that on October 6, both Standard & Poor and Moody’s, two of the world’s largest
rating agencies, downgraded Pakistani bonds. One such bond will run out of its term early
next year and the investors have begun to fear whether Pakistan will be able to pay them
back.
Pakistan now has the lowest credit rating in the developing world. According to John
Chambers, managing director with Standard & Poor, “only Seychelles has a lower rating and
it has already defaulted on its debt”. None of these developments are related to the
financial problems faced by the industrial countries. In fact, I believe that there will be
positive short-term impact on Pakistan of the current economic turmoil in the developed
world. Let me explain. Pakistan’s external account situation is the result in part of the large
increase in the import bill. This happened because of the unrelenting increase in the prices
of oil and several agricultural commodities imported by the country. Both food and energy
price indices continued to increase through 2007-08; with the oil price increase outpacing
the increase in the price rises of internationally traded agricultural products. The financial
crisis has suddenly reversed these trends. The price of oil has declined by 50 percent in a
couple of months while the prices of traded food crops have registered significant drops.
This should provide Pakistan with some relief and stop the rapid haemorrhaging in its
foreign exchange reserves.

The structure of Pakistani economy and its financial system will protect the country from
the full impact of the financial crisis in America and Europe. Pakistan is poorly integrated
with the global economy. It will be spared the consequences of the unraveling in many
parts of the western financial structure.

Pakistan is likely to be protected by the underdeveloped status of its trading sector. While
the United States is Pakistan’s single largest trading partner, a recession in America will not
have a significant impact on either the quantum or value of exports. Most of these are in
textiles which, as the economist suggest, are not highly dependent on incomes.
Even though Pakistan may escape the immediate negative consequence of the turmoil in
the West, there will be long-term consequences. One of them is the possible impact on
remittances from the United States. Over the years the US has become the single most
important source of remittances for Pakistan, a good part of which originates not with the

6
http://www.defence.pk/forums/economy-development/17725-there-recession-pakistan.html
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12

Pakistani workers of which there are not too many in America, but from the professionals
whose incomes will suffer if the US goes into a long and deep recession. What has become
the single largest source of external finance for Pakistan may come under pressure.
The main conclusion drawn from this analysis is that the policy makers in Pakistan must
make an effort to understand the nature of the economic and financial crisis in the West
and adopt the policies that will prepare it for both the short and the long-term.

“The concluding words are that the Global Financial Crisis might have not any
direct impact on Pakistan but it’s gradually slowing down the strong economies
of the world. Specifically USA because they are major business partners with
Pakistan and slump in their economy will ultimately have an indirect impact on
Pakistani economy.”