The Impact of Global Financial Turmoil on the Rmg Sector in Bangladesh

CHAPTER 1: INTRODUCTION- GENESIS AND SPREAD OF THE CRISIS

1.0 Introduction

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 favorable 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 world economy has changed spectacularly since September 2008. What began as a slump in the US housing sector is now a global crisis, spreading to both rich and poor economies. Many believe that this may go down in history as the worst crisis since the Great Depression of the 1930s wiping out almost 10 trillion US dollar worth of value from stock markets over the past months. The triggers of the present global financial crisis were in the US subprime mortgage market, the crumple of which engulfed the global financial markets leading to a painful recession of the world economy.

Global consequence of the crisis includes:

 Sharp rise in Unemployment in the US, Job loss in few other countries.

 Sharp fall in the stock market price around the globe, current stock prices are unable to explain the value of the companies.

 Panic also spread around to reduce property prices in some other countries.

 Extra caution in lending even with excess liquidity, depressed consumer demand.

1.1 Global Recession and Low Income Countries

Developing countries-at first sheltered from the worst elements of the turmoil-are now much more vulnerable, with dwindling capital flows, huge withdrawals of capital leading to losses in equity markets, and skyrocketing interest rates. It is no longer a question of 'whether' but 'when' and 'how' the ongoing financial crisis will affect developing and least developed countries. The effects will vary substantially across the globe depending on size and structure of the national economy, as well as level and nature of global integration. The full effects of financial crisis on developing countries have not yet been registered. Lack of real time data is a problem. The risks for low income countries vary, but all are potentially severe. Large external demand shocks will immediately have real economy impact as they can't be cushioned by internal demand. Unfavorable effects in Official Development Assistance (ODA) may accelerate economic slowdown in LDCs. World Bank projects the real GDP growth to slow down across all developing regions in 2009. Thus LDCs are likely to be affected significantly, given their trade relationships with the developed and developing countries. Progress towards MDGs faced setbacks over the last 2 years due to soaring food and fuel prices. Now the challenge for many LDCs who rely on exports is how to cope with falling demand for these exports and prevent mass unemployment. But unfortunately, the challenge of high inflation has yet to fade away in some regions.

If we compare the economic integration of Bangladesh, India and Pakistan with the rest of the world, we will find that in 2006 trade as percentage of GDP is highest in India (48.78%) followed by Bangladesh (44.22%) and Pakistan (38.61 %). Pakistan receives the highest FDI Inflow as percentage of GDP (3.37%) followed by India (1.19%) and Bangladesh (1.13). From the exchange rate side it as visible that Pakistan rupee has depreciated the most against the US dollar, followed by the Indian rupee while Bangladeshi Taka has remained relatively stable.

The IMF data and projections indicate that all the three countries are expected to experience some slowdown in GDP growth rates from the previous years. Bangladesh government expects over 6% growth for Bangladesh in FY 2008-09. Indian government forecasts growth to be between 7-8% for India. Pakistan's economy has grown by 7-8% over the past few years but most of this growth has taken place in sectors such as consumer financing. Real economy (agriculture, industry, mining, etc.) has not had much growth and impact on poverty reduction has been minimal at best. IMF projects high inflation of 23% and growth rate of only 3.5% for 2009. As previously mentioned, Pakistan rupee has depreciated significantly. This has adversely affected the country's ability to repay foreign debts. As a result, the foreign exchange reserves of the country have fallen so low that they hardly cover 9 weeks of imports. To avoid default, Pakistan has sought help from the IMF. A US $7.6 billion loan has been approved and the country is expecting about $500 million loan from China. Pakistan will immediately access US $3.1 billion of the loan under a 23-month facility, with the rest phased in. The slowdown of economic growth in India has been less rapid than in other more export dependent East Asian economies like Hong Kong, Singapore and Taiwan. GDP growth in the second quarter of the current fiscal year declined to about 8%, on the back of weakening investment. According to the Commerce Minister of India, the global meltdown in financial markets will impact demand in developed countries for Indian exports and the export target of $200 billion for the current financial year may be missed. Real estate and textile sectors are already facing a slump. Unrelated to the crisis, tourism and some related sectors may face short-term setbacks as a consequence of the tensions following the Mumbai terrorist attacks. Export growth in India slowed in the third quarter of FY08 from 33.7% year-on-year in July to 12.6% in September as demand from developed countries dropped dramatically. The government has foregone 31,000 crore rupee of revenue through reduction in taxes and duties, on account of fiscal measures to stimulate growth and fight