A MATTER OF LIFE AND DEBT...

A Matter of Life & Debt
Bishwambher Pyakuryal
.The year 2008 will be remembered as the first global financial crisis of the 21st century -- a once-in-a-lifetime crisis. Mortgage-backed securities and subprime borrowers in the US economy have been blamed for the current economic turmoil. Although high default rates and a sharp rise in delinquency have been held responsible for the havoc, the world still needs empirical evidence to correctly diagnose the matter.
In the United Kingdom, falling output has been blamed for the credit crunch, plummeting housing prices and rising energy costs. The way the British economy has contracted for the first time in 16 years indicates that the recession will inevitably continue, a period marked by a decline in trade and the economy, reduced profits for companies and closure of factories. It is almost certain that the economic downturn will last longer than expected. Usually, a recession lasts from six to 18 months if fiscal and monetary stimulus plans are put in place to offer loans at lower interest rates.
As mortgage-backed assets have lost their value, it is anticipated that banks and financial institutions in the world are likely to lose US$ 1 trillion from the credit crunch. There has been a dramatic decline in US housing prices for the first time since the 1930s. Big lenders are dangerously exposed to the high-risks loan markets.
The predicament is now spreading to emerging markets -- Russia, South Korea and Brazil. Some think a “hard landing” in the emerging markets may become the “second epicentre” of the global crisis. Not all banks are able to write off losses from bad loans. So there is a need for transparency to assess how bad the emergency is.
The causes and consequences of the global economic meltdown and potential corrective measures have become the priority agenda for discussion at global forums. The present crisis is the culmination of financial, exchange rate, business and human crises. The IMF's recommendations have brought disastrous results in many developing economies as they advocated premature capital liberalisation. As the world's most powerful financial markets are in chaos and symptoms of disintegration of the emerging economies have been noticed, many believe that the possibility of a global recession has been heightened. The IMF's special fund worth US$ 260 billion should be enough to rescue smaller nations. However, if the contagion spreads, the existing resources will be inadequate.
Argentina has nationalised 10 private pension funds by controlling almost US$ 30 billion worth of investments. In Brazil, government-owned institutions have been asked to purchase shares in private financial institutions. The Canadian government has earmarked US$ 21 billion for asset swaps. In Mexico, US$ 3.92 billion has been offered in loan guarantees for debt refinancing. Australia cut the interest rate by one percent and China by 0.27 percentage point. Japan, Malaysia, New Zealand, Singapore, South Korea and other countries have made immediate stimulus plans. Thanks to globalisation, not a single country has been left unaffected.
Nepal has a comfortable level of foreign currency reserves. Since the country's economy is integrated with India's, how badly Nepal will suffer depends on the performance of India's contingency plans. Instances of foreign institutional investors withdrawing foreign reserves from the Indian capital market have occurred. However, the recent rise in share values on the New York Stock Exchange presents a ray of hope. The Reserve Bank of India's standard regulation and meticulous supervision have been successful in maintaining capital adequacy requirements by prohibiting financial institutions from exceeding the given limits of exposure to the stock market.
In Nepal, the banking sector has made impressive progress. The interest rate spread is comparable to that in neighbouring countries. Banks are holding more funds than they are required to. The foreign exchange reserve presently stands at Rs. 177 billion, and the cash reserve of the commercial banks with Nepal Rastra Bank amounts to Rs. 24 billion.
Nepal is not directly connected to the troubled financial institutions abroad. From this perspective, there is no immediate threat to Nepal's financial regime. The closer the link, the grater the possibility of being affected. In terms of merchandise trade, about 80 percent of Nepal's readymade garments are exported to the US. Germany is the largest market for Nepal's carpets. This means that delayed financial recovery in these countries can have a negative impact on Nepal's export trade.
The crisis will also have a significant impact on the country's tourism sector. The US accounts for 5.9 percent and Europe for 25.7 percent of the total tourist arrivals in Nepal. Besides resulting in a fall in tourist arrivals, the credit crunch in these countries will certainly affect export trade, foreign investment and overseas development assistance.
Because of shrinking demand, there has been a massive slide in commodity prices on the global market. This translates into easy and cost effective access to industrial raw materials which can support the manufacturing sector and control inflation. The depreciation of the Nepali rupee against the US dollar should have a positive impact on exports, remittances and also tourism. But depreciation is also expected to increase the budget deficit by Rs. 1.9 billion in additional debt servicing burdens.
There is no record of the level of investments made by Nepali investors in India's capital markets with money borrowed from Nepal's financial institutions. India's share market index has declined by six thousand points between October 2007 and October 2008. The losers, if there are any, could default on repayments to Nepali banks.
Countries have different priorities. Victims of the global crisis are now working on limiting the damage than investigating its cause. In my opinion, Nepal's policymakers should now get ready to assess the loan portfolios of commercial banks. A rough estimate shows that real estate lending makes up about 10 percent of total lending. However, it is frightening to see that some banks with adequate liquidity have lent a significant portion of their money to real estate businesses. For example, the average loan exposure of the top three banks in terms of investment in real estate stands at almost 31 percent of their total lending volume. The authorities need to look into this seriously.
Remittances have increased by 42.5 percent this year and reached approximately Rs. 142 billion. It contributes 17.4 per cent of the GDP. The government should design and establish a special support fund to rescue overseas workers who could be displaced if there is a crisis in the countries where they are employed. This should be the approach in an inclusive democracy.
Posted on: 2008-11-04 01:13:02