Economic_Crisis

WELCOME ✓ Good evening ladies and Gentlemen. In another 45 minutes of time, we are going to conduct our presentation on Global Economic Crisis and its effects to Sri Lanka. ✓ Names of our syndicate members are shown on the screen. ✓ The Sequence of our presentation is as follows. SEQUENCE ✓ Introduction. ✓ Aim. ✓ What is an Economy. ✓ How it happened. ✓ Its effects to the Global Economy. ✓ Its effects to Sri Lanka. ✓ How Sri Lanka faced the economic crisis ✓ Conclusion. ✓ Recommendations. ✓ INTRODUCTION ✓ The whole world is facing the biggest economic crisis in its history at present, by making its financial and economic landscape upside down. ✓ The Global economic crisis prominently started with the failure of several major institutions of the United State. ✓ ✓ They are :- Wells Frago. Lehman Brothers. Bear Stearns JP Morgan Goldman Sachs Bank of America ✓ Now the crisis has spilled over to the Europe, Latin America, Asia and all over the world. ✓ SWITCH TO GRAPH- Impact of Finacial crisis-felt across the globe ✓ BACK ✓ ✓ Contd. The ongoing financial crisis has ✓ originated as a result of “subprime mortgage crisis” in mid 2007. ✓ SWITCH TO GRAPH Sub prime impact across the globe ✓ BACK ✓ The main reason was the bursting of US housing bubble and high default rates on “subprime mortgage” beginning 2006. ✓ SWITCH TO GRAPH Building up of the housing bubble ✓ BACK ✓ ✓ Contd. ✓ The economic crisis and its outcome can be explained using the theory of demand and supply. ✓ The price varies as a result of balance between product availability and demand. It affect directly to the global economic crisis. ✓ The “subprime mortgage” collapsed also affected to the prevailing economic crisis. ✓ The global economics crisis influences the whole world from east to west and its impact to the Sri Lanka as well. The Sri Lankan Government has taken ✓ immediate precautions to prevent any kind of large scale impact on the domestic economy arising from the international turmoil. ✓ ✓ AIM ✓ To analyze the global economic crisis and its effects to Sri Lanka. ✓ TRANSIT ✓ Let’s start with Basics ✓ ✓ What is Economy' Activities related to the production & distribution of goods and services in a particular geographic region with correct & effective use of the available resources. ✓ The Basic Economic Systems Market Economy ✓ Planned Economy Mixed Economy Market Economy In a market economy, national and state governments play a minor role. Instead of that, consumers and their buying decisions drive the economy. And basically it depends on the demand and supply in the market. Price mechanism is the decisive factor of the economy. ✓ Planned Economy In planned economy all major decisions related to the production, distribution, commodity and service prices are made by the government. Planned economy reacts slower to changes in consumer needs and fluctuating patterns of supply and demand. Mixed Economy A mixed economy combines elements of both the planned and the market economies in one cohesive system. This means that certain features from both market and planned economic systems are taken to form this type of economy. What is Global Economy The international network of individuals, businesses, governments, and multilateral organizations which collectively make production and consumption decisions. ✓ DIAGRAM Global Economy with International flows ✓ Advantage of Global Economy The global economy can reach the benefits of ✓ increasing economies of scale. With the opening up of the economy the Industrial sector has benefited with ✓ the attainment of cheap labor, capital and technology. ✓ Small companies also witness rapid growth owing to a wider customer base. Global economy has ✓ promoted international peace and cooperation. ✓ Disadvantages of Global Economy. The global economy has encouraged transportation on a wider scale for ✓ the free flow of goods and services across nations. This has, in turn, led to ✓ the emission of greenhouse gases. The global economy has also resulted in ✓ the loss of domestic jobs. The labour intensive industries of the developed countries find it profitable to shift to third world countries where wage rates are low. ✓ This leads to the displacement of labour in the developed countries. ✓ Further, it is difficult to formulate regulations and legislations that are undifferentiated across the globe. ✓ TRANSIT – Economy Crisis ✓ What is an Economic Crisis' ✓ Economics Crisis occurs as the result of negative changers of one or more basic variables. This variables can be changed by the political, Social or cultural decisions, such as heavy cost of war, unemployment, low prices and low levels of trade and investments. Further the present global economic crisis has been aggravated by the influence of prevailing political, social and cultural environment of the world. ✓ Then let see what basics Economics variables are ✓ Aggregate Demand. ✓ Aggregate Supply. ✓ Interest Rate. ✓ Consumption. ✓ Investment. ✓ Savings. ✓ Balance of Payment. ✓ Exchange Rate. ✓ ✓ Economics Crisis 2008 The present global economic crisis can be explained using demand and supply theory. ✓ The crisis began with the bursting of the United States housing bubble and high default rates on “Subprime” together with adjustable rate mortgage (ARM) beginning in approximately 2005-2006. The graph depicts how the price varies with supply and demand. This theory can be equally applied to the price of luxury homes in United States. As you see ladies and gentlemen ✓ The graph Starting 2006 Housing bubble busted ✓ Market Equilibrium - The graph [pic] Fig 01. Market Equilibrium Curve ✓ The Y axis denote the price of commodities. ✓ The X axis denote the quantity. ✓ The line intercept demand curve. ✓ The line intercept supply curve. The point is equilibrium. ✓ Economics Crisis 2008 (Continued) ✓ The prices of houses were increased due to the high demand of purchasing power in entire economy. As a result purchasing power of the economy increased leading to a high demand, which eventually made the prices of the luxury houses go up. ✓ Inreaes of prices due to high demand for houses - The graph The D1 line shows changes of Demand [pic] Fig 02. Shifting of demand curve when purchasing power increase. ✓ Economics Crisis 2008 (Continued) ✓ Further increase in loan incentives such as easy initial terms and along-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. The economic resources were used to build houses and the liquidity of the economics fell down. The price of houses decreased due to the expand in the supply of houses and the interest rates increased since the Banks and financial Institutions invested in this field. ✓ Decrease in prices due to over supply of houses - The graph The S1 and S2 lines shows Changes of supply [pic] Fig 03. Drop of prices in luxury houses in USA. ✓ USA refinance became more difficult, defaults and foreclosure activity increased dramatically as easy initials terms expired. ✓ Home price failed to go up as anticipated, And ✓ adjustable rate mortgages interest rates reset higher, foreclosures accelerated in the United States in late 2006. ✓ Economic crisis 2008 Contd ✓ trigged a global economic crisis through 2007 and 2008. During 2007, nearly 1.3 million US housing properties were subject to foreclosure activity, up to 79% from 2006. ✓ Since the investors asked banks to refund their money, the problem became overfull, because of decrease of the entire house demand; ✓ the Economy rapidly became a crisis. Also some of the US financial Institutions stated their collapse. ✓ The prices of houses rapidly decreased with the increase of supply without paying zero attention to the quantity of equilibrium demand. Therefore, banks and the Financial Institutions invested on the projects were unable to refinance. At the same time depositors were on the process of withdrawing their savings. Bankrupt was the ultimate result of the outcome. This is how we can analyze the global economic crisis theoretically. ✓ TRANSIT- HOW IT ORIGINATED ✓ CAUSES FOR THE GLOBAL ECONOMIC CRISIS ✓ Boom and Bust in the US Housing market ✓ Speculation ✓ High risk mortgage loans ✓ Securitization practices ✓ Inaccurate credit ratings ✓ US Government policies ✓ Policies of central banks ✓ Financial institution debt levels and incentives ✓ Boom and Bust in the US Housing Market ✓ The USA home ownership rate increased from 1994 to 2004. Sub-prime lending was a major contributor to this increase in home ownership rates and in the overall demand for housing, which drove prices higher. ✓ When housing prices increased, consumers started saving less and both borrowing and spending became high. This credit and house price explosion led to a building boom and eventually to a surplus of unsold homes. ✓ SWITCH TO GRAPH Housing Prices and income ✓ BACK ✓ U.S. housing prices reached its peak and began declining in mid-2006. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default. As more borrowers stop paying their mortgage payments, ✓ foreclosures and the supply of homes for sale increase. This places downward pressure on housing prices, which further lowers homeowners' equity. ✓ Boom and Bust (Contd) ✓ The decline in mortgage payments also reduced the value of mortgage-backed securities, which erodes the net worth and financial health of banks. ✓ Borrowers in this situation had an incentive to "walk away" from their mortgages and abandon their homes, even though doing so will damage their credit rating for a number of years. ✓ Increasing foreclosure rates encouraged further increase the inventory of houses offered for sale. House prices are expected to continue declining until this inventory of unsold homes declines to normal levels. ✓ ✓ Speculation ✓ Speculation in residential real estate has been a contributing factor. During 2005, a record level of ✓ nearly 40 percent of homes purchases were not intended as primary residences. ✓ Speculative borrowing that contribute to rise debt and an eventual collapse of asset values. ✓ High-risk mortgage loans and lending / borrowing practices ✓ Lenders began to offer more and more loans to higher-risk borrowers, including illegal immigrants. ✓ Sub prime mortgages amounted to $35 billion in 1994, $160 billion in 1999, and $600 billion in 2006. ✓ The combination of declining risk premium and credit standards is common to classic boom and bust credit cycles. ✓ ✓ Securitization practices ✓ Securitization, a form of structured finance, involves the pooling of financial assets, especially those for which there is no ready secondary market, such as mortgages, credit card receivables, student loans. The pooled assets serve as collateral for new financial assets issued by the entity owning the underlying assets. ✓ Securitization, combined with investor appetite for mortgage-backed securities (MBS), and the high ratings formerly granted to MBSs by rating agencies, meant that mortgages with a high risk of default could be originated almost at will, with the risk shifted from the mortgage issuer to investors at large. ✓ Securitization meant that issuers could repeatedly relend a given sum, greatly increasing their fee income. Since issuers no longer carried any default risk, they had every incentive to lower their underwriting standards to increase their loan volume and total profit. ✓ Inaccurate credit ratings ✓ Credit rating agencies are now under scrutiny for having given investment-grade ratings to CDOs and MBSs based on sub-prime mortgage loans. ✓ These high ratings were believed justified because of risk reducing practices, including over-collateralization, credit default insurance, and equity investors willing to bear the first losses. ✓ However, there are also indications that some involved in rating sub prime-related securities knew at the time that the rating process was faulty. ✓ US Government policies ✓ Both government actions and inactions have contributed to the crisis. ✓ Former President George W. Bush stated in September 2008: "Once this crisis is resolved, there will be time to update our financial regulatory structures. Our 21st century global economy remains regulated largely by outdated 20th century laws." ✓ Increasing home ownership was a goal of the Clinton and Bush administrations. The U.S. Department of Housing and Urban Development's (HUD) mortgage policies fueled the trend towards issuing risky loans. -heavy military expenditure owing to major confrontations with many countries further mounted the crisis. ✓ ✓ Policies of central banks ✓ Central banks managed monetary policy and may target the rate of inflation. They have some authority over commercial banks and possibly other financial institutions. ✓ They were less concerned with avoiding asset price bubbles, such as the housing bubble. ✓ Central banks had generally chosen to react after such bubbles burst so as to minimize collateral damage to the economy, rather than trying to prevent or stop the bubble itself. ✓ ✓ Financial institution debt levels and incentives ✓ Many financial institutions, investment banks in particular, issued large amounts of debt during 2004–2007. ✓ And invested the proceeds in mortgage-backed securities (MBS), essentially betting that house prices would continue to rise, and those households would continue to make their mortgage payments. Borrowing at a lower interest rate and investing the proceeds at a higher interest rate is a form of financial leverage. This strategy proved profitable during the housing boom, ✓ but resulted in large losses when house prices began to decline and mortgages began to default. ✓ TRANSIT- Its effects to the Global Economy ✓ Severe Damages to the Global Economy ✓ Depression of the global economy ✓ High tendency of investing for the housing which the cash flow of the European countries in the housing projects, ✓ the liquidity of the economy declined. Therefore aggregate demand contracted and led to an Economic Depression. ✓ SWITCH TO GRAPH ✓ Gross Investment & Gross Savings-Asia & USA. ✓ BACK ✓ Fluctuation of oil prices Just before the crisis due to that abnormal growth of some sectors of the western economy, ✓ consumption of oil increase leading to a gradual hike of oil price. As an immediate outcome of the Global Economy Crisis, ✓ SWITCH TO GRAPH ✓ Fluctuation of oil prices ✓ BACK ✓ purchasing power seemed to be reduced leading to the decline of the demand to the crude oil which of the same time tends to put down the price. ✓ ✓ Severe Damages (Contd) ✓ Increase the unemployment. As a constituency of the economy crisis ✓ the aggregate production rapidly declined as resulting increase of unemployment rate. ✓ SWITCH TO GRAPH World unemployment Rate ✓ BACK ✓ Dropping up of the Global economy market. ✓ Declining of both aggregate demand and supply coursed to a drop of global market. ✓ SWITCH TO GRAPH World trade growth decelerating rapidly ✓ BACK ✓ Fluctuation of the interest rate Interest rate was unable to be stabled ✓ as the financial market struggle severely. ✓ TRANSIT - Its effects to Sri Lanka ✓ Sri Lankan Economy The Sri Lankan economy has traditionally been ✓ based on agriculture, which now contributes less than 20% to the gross domestic product and employs about a third of the work force. ✓ The emphasis is on export crops such as tea, rubber, and coconuts Spices and coffee are also exported. Fruits and vegetables are grown for local use and consumption. Petroleum refining is important. ✓ Port construction, telecommunications, and offshore insurance and banking are also important industries. ✓ Remittances from Sri Lankan’s working abroad, mainly in the Middle East, contribute significantly to the economy. ✓ ✓ Sri Lankan Economy (Continued) ✓ Historically, industry centered chiefly around the processing of agricultural products. ✓ But textiles and garments are now Sri Lanka's biggest export. ✓ Sri Lanka has a persistent balance of trade problem, however, and the country is dependent on large amounts of foreign aid. Although coastal lagoons provide many sheltered harbours, only Sri Lanka lies on the main world shipping routes. The port of Colombo, on which most of the country's railroads converge, handles most of the foreign trade. Textile fabrics, mineral products, petroleum, foodstuffs, machinery, and transportation equipment are imported. The United States, India, and Great Britain are the largest trading partners. ✓ How it affected Sri Lankan Economy ✓ declining of the prices of commodities in the world market is obvious due to the world financial crisis. Reduction of oil prices and other commodity prices have made favorable effects on many economies. Sri Lankan economy does not heavily depend on foreign investment. Its impact is less, as our stock market does not function according to market principles due to the role of foreign capital in the financial sector of Sri Lanka is negligible. But there are some other adverse effects particularly on foreign trade of our country. In this regard it is important to look in to the direction of export and import trade structure of the economy. ✓ Textile and wearing apparel industry of our country is highly dependent on American and European market. The USA is the largest single market for Sri Lanka’s garment exports. ✓ Declining of the prices of agricultural commodities has already made adverse impact on our export earnings. As a country heavily dependent on tea exports the crisis might inflict some negative impact on our tea industry. Tea is the largest source of export earnings among agricultural commodities of the economy. It contributed to 13.2 percent of the total export earnings in 2007. ✓ By now the prices of tea have come down in the world market and it has already made serve impact on our small tea land holders. The risk of the world financial sector might also cause a reduction of foreign capital flows. Particularly the remittances of migrants in the Middle Eastern region are an important source of our foreign exchange and the remittances were estimated to have financed about 70 percent of the trade deficit in 2007. But with the reduction of oil prices we need to be very careful of the flow of remittances, as they are mainly sourced by oil producing countries such as Saudi Arabia, United Arab Emirates, Kuwait and Qatar. ✓ ✓ Impact on Sri Lankan Economy Fortunately, Sri Lanka has only ✓ a minor relationship with the foreign exchange market created less pressure on the local economy. Because of this reason, there will not be a significant direct impact on our economy. When examined the export sector of foreign trade, textiles & garments continue as the largest source of foreign capital in Sri Lanka. In addition, the shift of economic policy of the present government, ✓ which has given pride of place to the domestic economy, has also prevented any kind of large scale impact, arising from the international turmoil. For example, Sri Lanka’s “Api Wavamu – Rata Nagamu” policy has helped the - ✓ country to withstand against the world food crisis. This has been achieved in the midst on many countries, including Egypt, Haiti, Ivory Coast and Somalia, are having “Food Riots”. ✓ ✓ TRANSIT- HOW SRI LANKA FACED THE ECONOMIC CRISIS ✓ ✓ We have been resilient. ✓ Sri Lanka has been resilient against various external shocks in the face of ✓ Tsunami, ✓ Droughts, ✓ Floods, and ✓ Terrorism. ✓ Comparatively the new global financial shock has not affected us too adversely. ✓ Is it good luck' Or,did we do something right. ✓ That it is not only our good fortune that has enabled us to face the shocks. ✓ We have prepared our financial policies and practices carefully paying off. ✓ ✓ HOW SRI LANKA FACED THE ECONOMIC CRISIS ✓ The prudent policies we pursued have helped us to minimize the impact of external shocks, on the domestic financial system. ✓ The Central Bank has been vigilant in maintaining stable interest rates and exchange rate to protect the domestic economy and strengthen it. Our exchange rate was stable for over one year now. We have opened the ✓ Treasury Bill and Bond Markets to foreign investors with carefully placed limits, while creating a buffer to meet the threat of a sudden capital flight. ✓ ✓ HOW SRI LANKA FACED THE ECONOMIC CRISIS (Contd) ✓ The Central Bank has been highly concerned about the adverse implications that would arise due to any indisciplined lending by banks. We have been ✓ regularly examining our country’s financial relations with all our counterparties and financial institutions to anticipate any vulnerability. We have now been able to confirm that such relationships are very minimal and that we have suffered no damage. We are ✓ constantly acting to avoid any liquidity shortfall in the national financial system, and this has been in fact done recently through the partial relaxation of our very tight monetary policy. ✓ ✓ HOW SRI LANKA FACED THE ECONOMIC CRISIS (Contd) ✓ Increase the supply of liquidity to the market in the face of the global challenges. Such a measure is not unique to Sri Lanka. ✓ The Central Bank of Sri Lanka repeatedly requested from the commercial banks to take necessary measures to ensure safety. ✓ TRANSIT- CONCLUSION ✓ CONCLUSION ✓ The Economic Crisis, which has been spreading throughout the world for number of years, has come to its peak. Both major industries in the process of producing luxury vehicles and the small scale industries have come to a standstill. In order to cop up with this economic crisis, varied ✓ strategies are being applied by many countries though the effectiveness of those tactics proved to be in sufficient. The rescue package proposed by the ✓ former US President George W. Bush also failed as it was unable to address the co-issues of the Economic Crisis. ✓ Newly elected US President, Barrack Obama has come up with new set of proposals mainly focusing on liquidity of financial market in order to prevent the American economy further paralyzed. Both these solutions seem to be lacking the accuracy in terms of theoretical aspect of the economy. ✓ Conlusion (Contd) Whereas the recent trend in the Sri Lankan based on the ✓ increase of domestic production together with the measures taken to protect the local financial market have been able to stabilize the Sri Lankan economy in the midst of the Global Economic Crisis. In Sri Lankan economy with the project of ✓ “API WAWAMU RATA NAGAMU” and similar import substitute projects have been promoted successfully as preventive measures to this crisis. However the ✓ Global Economists have been unable to introduce effective economic solutions to the mounting global crisis. ✓ “Capitalism fails to bring about optimized solutions to certain economic issues born in global economy.”-Carl Marks ✓ ✓ TRANSIT- RECOMMENDATIONS ✓ Recommendations ✓ Expansions of the target markets for cater for the local exports. ✓ Diversification of exports instead of traditional domestic exports and enhancing the quality of the export products by introducing high technology. ✓ Discouraging imports except essential commodities to strengthen the foreign exchange. ✓ Promoting human capital targeting the foreign labour market. ✓ Enacting strict financial rules and regulations to safeguard the financial market from the racketeers. ✓ Close supervision activities in the financial market, which is vital in the market economy should be carried out by the Central Bank. ✓ Promoting Apparel industry through alternative global markets. ✓ Empowering the local manufacturers. ✓ Expand region wise production. ✓ ✓ Recommendations (Contd) ✓ Create Agro Exports Zones (AEZ) to energize the participation of villages to create an export oriented market. ✓ Increasing the foreign earnings of the apparel sector & tea exports. ✓ Removing unnecessary middlemen involved in the trade. 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