Liquidity crisis, dwindling reserves and falling rupee
By Aftab Ahmad

According to an opinion expressed by the international credit rating agency Moody’s, developing economies of Asia Pacific faced little difficulty in dealing with the effects of the global financial crisis, mainly because their banking sector was generally not integrated with the international banking system. However, in the event of a global recession or a serious economic downturn, the Asian economies would not remain unaffected, particularly those which depend heavily on their exports to the industrialised nations for their economic growth.

The global financial crisis, as is well-known, had been the outcome of the situation arising out of the sub-prime mortgage crisis and the resulting credit crunch. The financial crisis in the US had spread overseas to Europe as the European banks had active business relations with the banks in US. However, since the banks in the developing Asian countries including Pakistan had not purchased the credit instruments relating to the sub-prime mortgage from the US or European banks, they had remained generally unscathed from the effects of the global financial crisis.

Still, the global financial crisis had created a panic situation in many Asian countries including Pakistan. The situation had led to all sorts of rumours in the country and massive withdrawals had been made by depositors from their bank accounts. In the circumstances, the State Bank of Pakistan (SBP) had been forced to take immediate action to improve the liquidity of the banks, including reduction in the banks cash reserve requirement (CRR). After the measures taken by the SBP, the situation in the banking sector had become generally satisfactory.

However, other sectors of the economy are still facing the problem of liquidity. According to a report appearing in the media recently, a sum of Rs.20 billion was expected to be injected in the Karachi Stock Exchange (KSE) to improve its liquidity and its performance (presently, the floor is frozen at 9,188 since August 08. According to another report, the trade sector is, also, facing the liquidity problem since the retailers have reportedly reduced their purchases from the wholesalers and been making only partial payment for the goods.

Above all that, the external sector has been facing a cash crunch for quite some time. While exports earnings had been moving slowly and were well below imports, the portfolio investment has nearly vanished due to freezing of the floor, also a source of foreign exchange income – has come to a stand still. As a result, the foreign exchange reserves has declined from $16 billion to less than $7 billion and the exchange rate deteriorated from Rs.62 to a US dollar in January 2008 to over Rs.81 to a dollar, at present. As a result, the country has been forced to approach the IMF for a balance of payment (BOP) support.

Nevertheless, Pakistan is not the only country to face such a situation. India, also, took action to improve liquidity in its banking sector. Its stock market has declined by nearly 50 per cent. Also, its foreign exchange sources had dried up in 2007-08. Portfolio investment and DFI had staged a nosedive in India in recent months. As a result, the Indian rupee depreciated by nearly 25 per cent, that is, from Rs.39 to a US dollar to Rs49 to a US dollar during the last couple of months. Luckily, India had foreign exchange reserves of over $300 billion and it could resort to market intervention to prevent its currency from a free fall. However, its foreign exchange reserves have now gone down to $280 billion.

Unfortunately, after the liquidity problem resulting from the global financial crisis, the threat of a global recession is now looming over the horizon. In the event of the global recession becoming a reality, exports from developing countries to the industrialised nations such as the US and EU would be greatly reduced. DFI and economic assistance from developed nations would, also, be adversely affected. As a result, industrial production in developing countries such as Pakistan may decline, which may lead to increase in unemployment and poverty in the coming months.

According to a recent international Press report, the US Gross Domestic Product (GDP) recorded a negative growth of 0.3 per cent in the July-September, 2008 quarter. Consumer spending, which constitutes nearly 66 per cent of the US GDP, went down by 3.1 per cent during the aforesaid quarter. Many economists in the US reportedly believe that US economy will continue to contract in the coming weeks and months and thus the classic definition of a recession – two straight quarters of negative growth – would be met very soon.

According to the aforesaid report, unemployment in the US which stands at 6.1 per cent at present could hit 8 per cent or more next year. The consumer spending was thus likely to go down further, hard-hitting the US GDP growth. In the third quarter of the current year, the consumers had reportedly cut back on purchases of cars, furniture, household appliances and clothing etc. In addition to the consumers, businesses cut back sharply on the purchase of equipment and software in the third quarter.

The economies of the European Union and Japan are, also, reportedly in distress, following the global financial crisis and economic downturn in the US. Governments in the aforesaid countries had to pour billions of dollars into their financial sector to improve liquidity and make their banking sector viable. Their stock markets have been in doldrums and their economic growth has slowed down. It is feared that in the event of a full-fledged recession in the US, the economic growth in the EU and Japan might shrink further and slide into recession.

Even the economy of China, which is known for its fastest GDP growth for decades, is reported to be feeling pinch of the situation arising out of the global financial crisis and global economic slowdown. According to a report published in the International Herald Tribune, dated October 16, exporters of nearly every product in China are running into trouble as demand slows down in the US and Western Europe. Most of the suppliers are upset due to the global financial crisis and call it a disaster. A large number of workers in the export-related industries have reportedly lost their jobs.

According to the aforesaid report, China’s own GDP growth has slowed down from about 12 per cent until last year to an estimated 8-9 per cent, at present. The Shanghai share market has reportedly lost two-third of its value during the last one year, while the Hang Seng index in Hong Kong dipped by nearly half, during the same period.

The question is what Pakistan should do, under the circumstances explained in the preceding paragraphs, in order to stay afloat and keep its economy moving. In the first instance, we desperately need the IMF bailout package to avert the perception of default in the short and medium term. Besides, the IMF package would also help the government in correcting the macro-economic imbalances through a well-thought reform programme.

Secondly, there is a need to diversify the export items as well as the export markets in order to keep our exports growing in a scenario marked by a global economic downturn. At the same time, it would be necessary to cut the import of non-essential items – all such items the country could live without. This would be important in order to bridge the massive export-import gap of about $21 billion and bring down the trade and current account deficit to a sustainable level.

Thirdly, the government may persuade China to invest in the country’s export-oriented manufacturing sector, in order to boost the country’s export earnings. At the same time, China may also be invited to invest in Thar coal and the energy sector to help the government in overcoming the current energy crisis.