Global Financial Fall-out: Assessing Impact on Nepalese economy

1. The current financial crisis is “Once-in-a-lifetime crisis”. It will be remembered as first global financial crisis of 21st century. This crisis is the mixture of financial, currency (exchange rate), business, and finally a family crisis.

2. The first global economic crisis in modern capitalism broke out in 1857 and in the midst of suspicion that capitalism would no longer recover; this crisis was overcome by 1858, in less than a year.

3. In USA it is subprime loan and in UK, fall in output has been blamed on the credit crunch. There has been a dramatic decline in the US house prices for the first time since the 1930s. Big lenders are dangerously exposed to the high risk loans market.

4. The reason, mortgage-backed securities became the priority business in the United States in the past was because of very simple reason:

a. Consider the information given by the US Census Bureau. A person who bought a new home in January 1996 for $155,000 could reasonably expect to make a profit of $100,000 when selling in August 2006. Unfortunately, this prospect is now bleak because of credit crunch.

b. A safe mortgage is a maximum of 3 times the buyer’s yearly income, but mortgages have been 5 to 10 times incomes in the last few years, which have eliminated the current prospect of housing market.

5. As mortgage-backed assets have lost their value, it is anticipated that banks and financial institutions in the world are likely to lose $2.8 trillion from the credit crunch. The crisis is now spreading to emerging markets-Russia, South Korea and Brazil indicating the possibility of “second epicenter” of the global crisis.

6. The level of contraction of the economy realized after many decades indicates that inevitability of the continuation of recession. If contagion spreads, today’s capital adequacy will be meaningless tomorrow.

7. There were some common trends globally, some of which can even be seen in nepal’s case. For example, in many countries, foreign investors withdrew portfolio investment. This made impact in domestic and foreign capital market. The countries realized the reduction in foreign exchange reserve. There was a liquidity crunch in the domestic market, which created problem in accessing credit. This situation badly affected share market and real estate. This was the initial problem of financial crisis.

8. Usually a recession lasts from six to eighteen months only if the fiscal and monetary stimulus plan is put in place to offer cheap rates to borrow money. It will continue otherwise.

9. Coming to India, as crisis is likely to stay longer, the impact on India will also be stronger than expected. India already has experienced a knock-on effect. As Nepali rupee is pegged with India and 64% of the total trade deficit remains with India, Nepal will also have an indirect impact. The indicator of the impact both in India and Nepal is the sharp fluctuation in the capital market and devaluation of rupees.

10. With the fall in the interest rate in india, there was a moderation in growth. Nepal is in a unique situation in the sense that inflation rate is increasing and growth declining. CBS reports, the manufacturing production index declined by 1.4 percent in 2007/08 compared to a growth of 2.6 percent in the previous year. The challenge Nepal faces is to balance between inflation and growth.

11. a) China may pose additional threat in the global economy since more than 40 percent of industries in China are loss making units, as a result of which the banking sector has been accumulating Non-Performing assets. The financial infrastructure keeps crumbling and new globalization pride is frighteningly unstable.

b) Although China has a foreign exchange reserve of $2 trillion, it cannot be protected because of the dramatic fall in global demand. Since 1990s, household consumption as a share of China’s GDP has fallen from approximately half of 25 percent.

12. As world’s most powerful financial markets are in turmoil and symptoms for the crack down of emerging economies have been noticed, many believe, there is a greater possibility of global recession. IMF’s special fund worth US $ 260 plus additional $100 billion could have been enough to rescue smaller nations, but if contagion spreads, existing resources will be inadequate.

13. The government in Argentina has nationalized country’s 10 private pension funds. In Brazil, the government-owned institutions are asked to purchase shares in private financial institutions. The Canadian government has earmarked US$ 21 billion asset-swaps. In Mexico US$3.92 billion is offered in loan guarantees for debit refinancing. Australia cut interest rate by one percent. Japan, Malaysia, New Zealand. Singapore, South Korea, etc have immediate stimulus plan. It indicates at whatever degree, the globalization will not leave a single country unaffected.

14. Nepal has a comfortable level of foreign currency. From a level of Rs 165.1 billion in mid-July 2007, the foreign exchange reserve has increased by 28.8 percent by reaching the level of Rs 212.6 billion in mid-July 2008. The decline in the aggregate demand in the real sector and weakening consumer spending is a sign to justify the vulnerability of such reserve. To cushion the impact of the economic meltdown, the government should initiate contingency plan.

15. There are causes in India to withdraw foreign reserves by foreign investors from the capital market. However, a ray of hope is the current revival of rising share value in New York Stock Exchange and its impact in Japan and other Asian countries. The Reserve Bank of India’s standard regulation and meticulous supervision has been successful to maintain capital adequacy requirements by limiting the financial institutions to exceed given limits of exposure to stock markets. The role of Nepal Rastra Bank should therefore be more significant for timely and implementable regulations.

16. In Nepal, there is an impressive development of banking sector. Interest rate spread is comparable with the regional neighbors. Banks are holding more funds than they are required to. The foreign exchange reserve at present is Rs 177 billion and the cash reserve of the commercial banks with the Nepal Rastra bank is Rs. 31 billion.

17. Nepal does not have direct link with the troubled financial institutions abroad. From this perspective we do not see immediate threat in Nepal’s financial regime. The greater the integration, the higher is the possibility of being victimized by speculative factors.

18. In terms of merchandise trade, about 80 percent of Nepal’s readymade garments find their share in the USA and Germany happens to be one of the largest markets for Nepal’s carpet. This means delayed financial recovery in these countries can have a negative impact on Nepal’s export trade.

19. The crisis will also have a significant impact in country’s tourism sector. Out of the total tourist arrivals in Nepal, USA represents 5.9 percent and Europeons counstitute 25.7 percent. Besides the decline in tourist arrival, the credit crunch in these countries will certainly have some impact on Nepal’s export trade, foreign investment in Nepal and overseas development assistance for Nepal.

20. As demand is shrinking, there is a massive decline in commodity price in global market. This means there is an easy and cost effective access to industrial raw materials, which can support manufacturing sectors and control inflation. A plan therefore, needs to be developed without any delay in accessing priority-based industries and other related construction works.

21. The depreciation of Nepali currency against US dollar should have positive impact on export, remittances and also tourism. Since manufacturing sector is contracting and export is declining, it is difficult to realize export gains from currency depreciation. But currency depreciation on the other hand, is expected to increase budget deficit by Rs. 1.9 billion as an additional burden to dept servicing.

22. No homework has been done to investigate the level of investments made by Nepali entrepreneurs in India’s capital market with their money borrowed from Nepal’s financial institutions. India’s share market index has declined by 6,000 points between October 2007 and October 2008. The victims, if there are any, could become defaulters in Nepal’s banks.

23. Rough estimate shows, on an average, out of the total loan, the percentage share of real-estate lending stands at about 10 percent. However, it is scare to note that the average loan exposure of top three banks in terms of investment in real estate stands at almost 31 percent of their total lending volume. The policy makers in Nepal should now get ready to assess loan portfolio of the commercial banks. As we know, not all the banks are able to write off the losses from bad loans, therefore, there is a need for transparency to assess how bad the crisis may become in the future.

24. The remittance has increased by 42.5 percent this year reaching approximately to Rs. 142 billion. The worker’s remittances soared by 80.7 percent in the first three month of 2008/09 compared to a growth of 17.2 percent in the corresponding period of the previous year. Remittances contribute 17.4 percent of the GDP.

25. Out of the total 241104 remittance earners from Nepal during the last FY 2007/08, Qatar, ranked first and Malaysia, UAE, Saudi Arabia ranked top three. Malaysia has early symptom to get contagion effect but rest are at the moment fine. Therefore, no immediate threat is seen in the remittance front. In case there is a crisis, the government should design and establish a special support fund to rescue overseas workers who might be displaced.

26. There is a threat that prospective foreign investors who would be interested to invest in Nepal by taking loans from troubled financial institutions may now back out. A special task force should be constituted to inform the investors about Nepal’s financial sector health and government’s rescue program, in case trouble arises. At the domestic front, the policy on the existing capital adequacy should be to access credit to productive sectors, exports and small and medium enterprises.

27. Finally, the world should chose between the “intrusive-regulation” and “market-led code of conduct”. To facilitate the existence and viability of new global economy, it is the common interest of every nation, rich and poor to safeguard globally integrated financial system.

(This is based on the lecture given by Dr Bishwambher Pyakuryal at Kathmandu College of management on December 7, 2008)