Falling growth levels in the US, Europe and the Middle East reflect incontrovertible evidence that these economies are reeling under a recession. It all began when the sub-prime mortgage crisis, triggered by mortgage delinquencies and foreclosures in the United States, hit the US financial market.
In layman's terms sub-prime lending can be defined as providing credit to borrowers deemed 'sub-prime' or those with (i) a heightened perceived risk of default, such as those who have a history of loan delinquency or default, (ii) those with a recorded bankruptcy, or (iii) those with limited debt experience. Speculation in residential real estate has also been acknowledged, as a factor in the collapse. During 2006, 22% of homes purchased were for investment purposes, with an additional 14% purchased as vacation homes.
In other words, a record level of nearly 40% of homes purchases were not intended as primary residences. Speculators left the market by end 2006 fuelling the crisis further. As home-owners in the US failed to pay their mortgages financial institutions were hurt by plunging asset values. This made the institutions reluctant to lend to other businesses and consumers leading to a credit crunch that stifled economic activity resulting in recession.
A number of casualties in the US financial market rocked the world namely Bear Stearns, Wachovia, Washington Mutual, Lehman Brothers, Merrill Lynch, American International Group, Fannie Mae and Freddie Mac. The failure of Bear Stearns, Lehman Brothers and Merrill Lynch (three of Wall Street's five largest investment banks) underscored the fact that the global financial system was indeed in much distress. In Europe, the financial institutions that caught the contagion included Britain's Northern Rock, Hypo Real Estate of Germany and Belgium's Fortis. And thence the contagion has spread to the rest of world.
The prescription for the recession has focused on increasing public sector expenditure, either through bail out packages sponsored by the government as in the case of the US or through increased private consumption by reducing VAT by 2.5 percentage points as in the case of the UK. The amount of additional money circulating in the economy would rise which would increase sales, lower stocks thereby once again fuelling the wheels of industry.
Pakistan however has remained unaffected by the global crisis. The reason is simple: we remain a largely cash based economy with little or no credit allocation to homeowners or small businesses. Thus the global recession has not impacted on our economy. Yet economists are forecasting a halving of the growth rate - from over 7 percent last fiscal year to around 3.5 percent this current fiscal year - a clear indication of a recession.
The reason for this can be attributed to economic mismanagement which ranges from the failure of the government to control its deficit to the rising circular debt of the oil sector that is further compromising the government's ability to provide an uninterrupted supply of electricity to the productive sectors. Thus energy shortfall is effectively negating the capacity of the industrial sector to increase output or the government to raise tax revenue, implicit with a rise in production.
But would Pakistan come out of the current economic impasse by next year? The International Monetary Fund is monitoring our macroeconomic indicators in an effort to ensure compliance by the government and it is therefore considered likely that the budget deficit would become sustainable by the end of next calendar year. The government also committed to the IMF to prepare a plan by end March 2009 to eliminate the inter-corporate circular debt which would include a time frame during which the respective entities will discharge their liabilities to each other. It remains to be seen whether, once the plan is prepared, the government would be able to enforce it.
The prescription for Pakistan therefore consists mainly of adhering to the action plan agreed with the IMF and through eliminating the circular inter-corporate debt that would go some way in ensuring adequate provision of electricity for the productive sectors. In addition law and order problems are also acting as a deterrent to productivity. The task is certainly challenging and one can only hope that the government will be able to meet them; however 2009 seems to be too optimistic for recovery - which is more likely by the end of 2010 if and only if the government continues its reform agenda.
