News From Telecom World

Current Global Financial Crisis: Likely impact on Bangladesh

Posted on: October 14, 2008

The stock price plunge and severe credit crunch we are watching today in global financial markets are byproducts of the developments in the US six years ago. In late 2001, fears of global terror attacks after 9/11 shook an already struggling US economy, one that was just beginning to come out of the recession induced by the bursting of the dotcom bubble of late 1990s.

In response, during 2001, the Federal Reserve, the US central bank, began cutting interest rates dramatically to encourage borrowing, which spurred both consumption and investment spending. As lower interest rates worked their way into the economy, the real estate market began to get itself into a frenzy. The number of homes sold and the prices they sold for increased dramatically, beginning in 2002. At the time, the rate on a 30-year fixed rate mortgage was at the lowest levels seen in nearly 40 years.

Subprime and similar mortgage originations in the US rose from less than 8 percent of all mortgages in 2003 to over 20 percent in 2006.

The crisis began with the bursting of the US housing bubble and high default rates on subprime and adjustable rate mortgages, beginning in approximately 2005-2006. For a number of years prior to that, declining lending standards, an increase in loan incentives such as easy initial terms, and a long-term trend of rising housing prices had encouraged borrowers to assume difficult mortgages in the belief they would be able to quickly refinance at more favourable terms.

However, once interest rates began to rise and housing prices started to drop in 2006-2007 in many parts of the US, refinancing became more difficult. Default and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and adjustable rate mortgage interest rates reset higher. Foreclosures accelerated in the United States in late 2006 and triggered a global financial crisis through 2007 and 2008.

Initially the companies affected were those directly involved in home construction and mortgage lending. Financial institutions, which had engaged in the securitisation of mortgages, fell prey subsequently. The rest is history.

The crisis is still unfolding. There remains great uncertainty as to the depth and severity of the crisis as well as its impact on the real sectors (so called main streets) in US and Europe. This makes it difficult to assess clearly how it will impact Bangladesh.

However, overall, there is absolutely no reason to panic. Bangladesh is relatively insulated from the financial side, but vulnerable to potential global economic slowdown, particularly in the US and EU. The foreign exchange reserves of Bangladesh Bank and commercial banks have limited exposure to the securities markets and banking system risk in the US and EU.

Foreign capital flows are largely in the form of concessional official lending. FDI and foreign portfolio investments are small. However, Bangladesh’s economy relies heavily on garment exports. This is where the main risk lies. Remittances may also be vulnerable. On the positive side, import payments may be favourably affected as a result of declining commodity prices, particularly oil and food.

The export sector is potentially the most vulnerable in Bangladesh since it depends heavily on US and EU economies. The readymade garment (RMG) industry accounts for over three quarters of export earnings and depends almost entirely on US and EU markets. There is growing concern that a deep and prolonged recession in the US and EU may reduce consumer spending significantly across the board, thus undermining the demand for Bangladeshi exports. BGMEA and BKMEA have indicated that growth in export orders was slow in the first quarter of Fy08. IMF has projected that income growth in Bangladesh’s export markets will decline from 1.5 percent in 2008 to 0.5 percent in 2009. If this happens, consumer spending will decline.

Although demand for Bangladesh’s exports is not too sensitive to income, export prices may decline and this could have significant effects on our export earnings even if export volumes remain largely unaffected.

There is unlikely to be any direct immediate impact on remittances. Remittances in Bangladesh proved to be resilient during previous financial crises in the world. The bulk (over 60 percent) of Bangladesh’s remittances come from the Middle East, and less than one-third come from the US, UK and Germany. Strong remittance growth (44 percent) has continued in the first quarter of FY09.

However, if a deep and protracted recession ensues in the US and EU, then the Middle-Eastern economies are likely to be adversely affected. Stock markets in important Middle-Eastern economies have already started to crash. Even if the current nearly $8 billion level of remittances is sustained, it would be challenging to maintain its growth momentum since 2001 if the world economy remains depressed for an extended period.

Official aid flows may take a hit. Governments in rich donor countries are doling out massive amounts to rescue their domestic financial institutions. They may look for savings from other sources to finance these bailouts. Foreign aid budget is relatively easy to cut since the foreign aid recipients do not count as their voters.

Import is probably the one channel through which Bangladesh may benefit. Import payments in August have reportedly been US$531 million lower than import payments in July. This decline in import payments is mainly due to the fall in prices of petroleum products, wheat and edible oil. Record high oil prices last year raised import payments to over US$20 billion in FY08, compared to slightly over US$15 billion in payments in FY07. The gains on account of reduced import payments can be sizable.

While mindful of the risks, early indications in FY09 are that the economy is on track to achieving the 6.5 percent growth projected by the government. Agricultural production outlook so far looks very good, export growth in July was exceptionally strong (71 percent), and service sector growth should maintain its recent growth trend.

Bangladesh’s remarkable resilience so far to this ongoing global financial crisis and slowing growth in high-income countries is in large part because of the country’s relative insulation from international capital markets and the negligible role played by foreign portfolio investors in the country. This resilience also derives from sound policy framework and macroeconomic fundamentals. However, investor psychology is much less insulated than the capital market itself, as demonstrated by the sudden increase in volatility in Dhaka and Chittagong Stock Exchanges last Sunday (October 12).

The overall financial leverage in Bangladesh is low. Unlike the global financials, Bangladesh’s banking system has no toxic derivative engagements. Barring a prolonged slowdown in the world economy leading to a drastic reduction in RMG exports, it is highly unlikely that the external shocks will increase the risk of asset quality problems or precipitate a credit crunch in Bangladesh. This is due to Bangladesh’s low level of external debt, robust international reserves, and limited direct exposure to the international financial system.

Low level of global integration shields Bangladesh from the global financial turmoil. However, Bangladesh is far from being completely insulated. Its heavy dependence on US and EU markets for merchandize exports is a real source of vulnerability as are remittances and foreign aid, though may be to a lesser extent. There is therefore no alternative to stronger policy vigilance and preparedness.

Policy makers have to make sure that markets do not panic by continuously providing evidence on the economy’s resilience in various sectors. They must proactively monitor the channels through which the global financial turmoil may start creeping into the Bangladesh economy and take appropriate mitigation measures.

Inflation has recently been the biggest macro policy challenge in Bangladesh. With the aggravation of the financial turmoil we have seen a sharp decline in global commodity prices. This makes the inflation battle a little easier for Bangladeshi policymakers. But new policy dilemmas are likely to emerge if export earnings begin to slow down and currencies of Bangladesh’s competitor countries depreciate. This will put exchange rate policy under pressure to maintain export competitiveness.

Market interventions aimed at depreciating the currency will dilute through declining international commodity prices to domestic prices and, consequently, undermine the objective of reducing inflation from its current double-digit level.

For Bangladesh a more momentous shock over the past couple of years has been the soaring price of commodities, which some have also blamed on financial speculation. The food-price spike in late 2007 and early 2008 caused havoc to the lives of the poor and middle-income groups. In response, the government extended its reach by increasing subsidies and expanding safety nets. FY09 budget has already built-in an expansionary stance to continue providing support to the poor so that they can afford to pay the high food prices.

If manufacturing is hit badly by recession in western economies, there will be fresh demand for further expansion of safety nets and increase in direct and indirect subsidies to exports. This will call for some more tough choices, accommodate these demands through increased domestic borrowing and/or restrain other spending if additional concessional financing cannot be mobilised from external sources.

Source: Daily Star

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