Project Report

Global Financial crisis and its effects on Pakistan

1
 Group
Mavericks
Members
Asif Mumtaz Malik
Muhammad Mubeen Bahoo (Group Leader)
Osama Ehsan
Rana Shahzad Iqbal

Resource Person
Madam Zainab Dar

Subject
Development Economics

MBA 2 (A)

Bahria University, Islamabad

1
 Acknowledgement

We would like to sincerely thank Madam Zainab Dar who gave us guideline and taught about the
study which we have made.
We would also like to thank our fellows who participated and helped us to put our effort in the
study. The discussion made with personnel from planning commission Islamabad has made our
study authentic.
Their valuable comments and insights helped to improve the study enormously.

1
Table of Contents
Executive Summary

Project Report......................................................................................................................1

Global Financial crisis and its effects on PakistanGroup....................................................1

Group 2

Members..............................................................................................................................2

Acknowledgement........................................................................................................3

Introduction........................................................................................................................6

Topic Study.........................................................................................................................8

Research Objective............................................................................................................8

Our Methodology........................................................................................................9

How to Achieve.........................................................................................................11

Determinants....................................................................................................................11

Hypothesis........................................................................................................................14

Economic factors behind the Crisis in Pakistan...........................................................14

Techniques..............................................................................................................16

Appendices..........................................................................................................................i

References.........................................................................................................................iii

1
Executive Summary

The global financial Crisis in the whole world has come after the first recession in the world in
1930s. It has affected the poor areas of the world. People living under $2 per day have been
mainly affected. Pakistan has bad effects of this crisis. The poor people of the Pakistan got more
poor and unemployed.

We have carried out a study to find the relationship of the global financial crisis with the bad
condition of Pakistan. Pakistan got this adverse trend by the imports and exports. Pakistan was
totally depending on the imports and other countries raised the bill of imports. When we were
unable to buy these imports we got shortage of food due to unplanned budget. Both made the
situation more adverse. Unemployment and poverty took place when there were no resources
available to industry. The economic factors behind this issue were financial sector of Pakistan,
Capital Flows & Workers’ Remittances, Commodity Prices & Trade and External Financing.
Their determinants were; Impacts of the crisis on aggregate poverty, Impacts of the crisis on
growth and distributional impacts within countries. The determinants gave the clear picture of
the prior and current situation of the Pakistan. Techniques have been used to overcome the
situation. The mixed economy system has been followed by the other countries. Now
government is making intervention in the economy of these countries. The techniques to be
followed by the Pakistan are; give breaks in taxes, agricultural uplift, cash subsidies, easing the
monetary policy and increasing supporting programs for the labor intensive activities.

2
Introduction

What is Global Financial Crisis

The Global Financial Crisis has been called by leading economists the worst financial crisis since the one
related to the Great Depression of the 1930s1. It contributed to the failure of key businesses, declines in
consumer wealth estimated in the trillions of U.S. dollars, substantial financial commitments incurred by
governments, and a significant decline in economic activity. Many causes have been proposed, with
varying weight assigned by experts. Both market-based and regulatory solutions have been implemented
or are under consideration, while significant risks remain for the world economy.

The collapse of a global housing bubble, which peaked in the U.S. in 2006, caused the values of securities
tied to housing prices to plummet thereafter, damaging financial institutions globally. Questions regarding
bank solvency, declines in credit availability, and damaged investor confidence had an impact on global
stock markets, which suffered large losses during 2008. Economies worldwide slowed in late 2008 and
early 2009 as credit tightened and international trade declined. Critics argued that credit rating agencies
and investors failed to accurately price the risk involved with mortgage-related financial products, and
that governments did not adjust their regulatory practices to address 21st century financial markets.

Impact of the global financial crisis on the world’s poorest

As the financial crises started due to soft loaning policies of the Europe and later on they were
unable to recover those loans it has directly affected the poor countries by making their balance
of trade deficit. It has directly affected the poverty of those countries. The issue of global poverty
has many reasons at its back. The stock markets of the developed countries were crashed; banks
and financial markets got crashed. All the industrial countries were badly affected by this
downturn. It leads to the poverty by the way of unemployment. It is expected that, the crisis will
add 64 million people to the population living under $2 a day. It predicts that the global poverty
rate will fall from 42% to 39% in 2009, while the pre-crisis trajectory would have brought the
poverty rate down to 38%.

1 ( http://en.wikipedia.org/wiki/Financial_crises_of2007%E2%80%932009 )

2
Prior to the crisis, the incidence of poverty in the developing world had been on a trend decline.
The poverty rates of the developing world as a whole during 1981 to 2005 were $1.25 and $2.00
a day. In 2005 purchasing power parity (PPP) for consumption; the former line is the average of
the national poverty lines found in the poorest 15 countries and the latter line is the average for
the developing world as a whole. The trend rates of decline in the $1.25 per day poverty rate over
1981-2005 was 1% point per year, and only slightly lower (about 0.8% points per year) for the
$2 a day line.

This trend would have almost certainly continued in the absence of the crisis, given the expected
growth rates prior to the crisis (World Bank, 2008). To assess what impact the crisis is likely to
have on aggregate poverty we need to estimate the difference between the expected levels of
poverty.

Pakistan has been affected by the financial crises in terms of food price and oil prices; rest of the
disturbance was due to political instability.

2
Topic Study

Our topic of study is “Global Financial crises and its effects on Pakistan”. The reason to choose
this topic is that it has direct relationship with the poverty, unemployment, literacy and wealth
distribution.

Research Objective

Our research objective is to find out the effect of global financial crises of the world in Pakistan.
There are many views that Pakistan was not affected like other world. The financial institutions
of the world were manly affected due to their soft loaning policy. Their assumption was to
facilitate the people life. But situation got an unexpected trend. Peoples were facilitated but they
were unable to pay off their loans.

In Pakistan the loaning policy was not soft enough that everyone could get loan against given
terms and conditions. The factors were of political instability or economic recession? It raised
the question to be answered.

2
Our Methodology

After the study of factors which have lead to the down turn in Pakistan we build a relationship of
these factors with our variables that are poverty, unemployment, wealth distribution.
Due to the recession in the whole world the industry and the financial institutions were affected.
This effect decreased the exports of the countries. Industries were unable to produce more
because there was no cash available to the industries to produce more as there was no cash in
banks and in financial institutions, by this effect an ultimate downturn came in the stock markets
of these global economies and their investors lost everything. This was on behalf of the whole
world. Pakistan is an agrarian economy and was totally dependent on the imports from other
countries. Now other countries were already running short of cash and resources to produce
more, they increased the prices of the commodities which they were exporting. Pakistan has to
buy these commodities at a very high price even their own produce of agriculture “the wheat”
this created a demand for basics of life as a whole. On other hand Pakistan’s political instability
in 2007 and 2008 ignite the downturn more. Our exports started to decrease as there was no trade
on the side of imports, foreign reserves were utilized to fulfill the basics of life. Now both
imports and exports were out of reach. Pakistan became trade deficit due to the negative pressure
from imports and exports. The global financial crises raised the import bill. All the reasons gave
a very worse picture to the employment in Pakistan. Our textile industries to sugar industry all
were unable to produce their own products. Banks started to merge rather to provide the
employments to the people as they were becoming insolvent to their central banks. The effect on
our industry was same as in whole world, which is lack of cash and resources.
The complete picture leads to unemployment and unemployment to the poverty. Investors of
Pakistan invested in other countries and our economy got more down turn. Stock market indexes
came to a very low figure prior to the crises. The mass-scale unemployment came to the
economy.
Food crises came due to our own wrong decision of the export but it got more worsen when we
were in need of it. We imported it at greater price rather we exported it. The reason was financial
crises. People of rural areas who were producing for their own could only survive in this
condition. But the people who were under the poverty line were largely affected by this curse as
they were having no land of their own.
Here comes another aspect of nourishment in the sense of food and poverty due to the crises. The
nourishment of the peoples especially female has been affected indirectly. Due to poverty the

1
female has to survive on the less available food and cash for medicine. Infant child mortality did
not have any improvement and the goal of MGD was seemed to be farther. Mothers are unable to
give time to their children if we see as a whole. This factor has also leaded the child labor in our
industry because people have no money to educate their children.
The wealth distribution among the rich and poor seemed to be unjustified. People who were rich
became richer due to our false paradigm of trickledown effect applied by the government. In
other sense one can say that the time of trickle down was not came and the recession took place
and situation got more worsen. Now the person living under $1.25 has been increased.

How to Achieve

To achieve this we have made survey of the people views. After the survey we consulted internet to find
out the actual background of the problem. The supporting discussion with the personnel from of planning
commission of Islamabad was made. After all we have got a hook to hang our research.

2
Determinants

1. Impacts of the crisis on growth

The poverty impact of the crisis in a given country will depend on how it affects both average
consumption and the distribution of consumption relative to the mean. The World Bank has
made projections for average consumption at country level, which can be compared to the
Bank’s pre-crisis projections to assess the expected impact of the crisis. We use the World
Bank’s latest growth projections for 2009 and 2010 (as of mid-April 2009) as the “post-crisis”
growth rates while the counterfactual (pre-crisis) projections for those done by the Bank in
December 2007 for 2009 and 2010. We have used the growth projections for private
consumption per capita. Consumption is more appropriate than GDP for predicting the short-
term impacts on poverty, since the shock to GDP is unlikely to be passed on fully to
consumption in the short term.

The crisis is expected to sharply reduce growth in 2009. In December 2007, the Bank forecast a
growth rate of consumption per capita of 5.1% for 2009. (This is an expenditure-weighted mean
for the same set of countries for which we measure poverty using household surveys.) At the
time of writing (mid-April 2009), the expected growth rate in consumption per capita for 2009 is
0.7%. The expected growth is lower in 2010, with a pre-crisis rate (as projected in December
2007) of 4.4% versus 2.6% post-crisis.

2. Distributional impacts within countries

Past experience suggests that relative inequality falls about as often as it rises during aggregate
economic contractions, with zero change on average. This is in keeping with one of the stylized
facts to emerge from research on growth and distributional change, namely that economic growth
tends to be distribution neutral on average (Ferreira and Ravallion, 2009). So the most defensible
assumption for the present purpose is that the burden of the crisis will be more-or-less
proportional to initial income leaving relative inequality unchanged within a given country.

To test this assumption we have estimated the poverty rates across countries at each available
survey using the most recent prior survey and assuming distribution neutrality over the

1
intervening period. In other words, we compare the “actual” poverty rate calculated for a given
country at a given survey. There is a sign of underestimation at very high levels, though there are
only a few observations involved.) There is no significant difference in the means (the difference
in means is 0.05% points with a standard error of 0.28%). Statistically, one cannot reject the null
hypothesis that the predictions based on distribution neutrality are unbiased estimates of the
actual changes.

It is of interest to see how well the assumption performs if we concentrate solely on cases in
which the mean was falling over the period. Then we find a slight tendency for the distribution
neutrality assumption to underestimate poverty on average, suggesting that the actual changes in
distribution were poverty increasing in contracting economies. However, the underestimation is
not statistically significant; the mean difference is 0.43% points, with a standard error of 0.54%.

On applying the same tests to the $2 a day measures we again find that the distribution-neutrality
assumption tends to underestimate poverty on average, again suggesting a distributional shift
against the poor. For the full sample the difference was 1.07% points with a standard error of
0.35%, indicating that the difference is statistically significant in this case. However, this effect
vanished entirely when we confined attention to cases of a contracting mean; then the difference
dropped to 0.18% points with a standard error of 0.55%.

3. Impacts of the crisis on aggregate poverty

For each country, we project the distribution in levels forward to estimate the poverty impacts of
the crisis given the pre-crisis and post-crisis growth rates, keeping the relative distribution
unchanged from the latest available household survey. This is done at the country level, for each
of over 100 countries, allowing for different initial conditions. The country-level results are then
aggregated to obtain the overall impact.

Applying the country-specific growth projections to our survey-based data and aggregating, we
calculate that the crisis will add 53 million people to the 2009 count of the number of people
living below $1.25 a day and 64 million to the count of the number of people living under $2 a
day. Given current growth projections for 2010, there will be a further impact on poverty in that
year, with the cumulative impacts rising to an extra 73 million people living under $1.25 a day
and 91 million more under $2 a day by 2010.

2
Given current growth projections, the aggregate poverty rate is still expected to fall over time,
albeit at a slower pace. The same (post-crisis) growth projections imply that the aggregate $1.25
a day poverty rate will fall from 21% in the “pre-crisis” year of 2008 to 18% (1040 million
people) in 2009; the pre-crisis growth rate for 2009 would have instead brought the poverty rate
down to 17% (987 million). Using the $2 a day line, the poverty rate falls from 42% in 2008 to
39% (2,232 million) in 2009 under the lower expected growth rate, while the pre-crisis trajectory
would have brought the poverty rate down to 38% (2,169 million).

Impact of global financial crises on Pakistan

The severity as we discussed above, how it has affected poverty, growth, and distributions in the
whole world, in same way it has greatly affected the economy of Pakistan. There are different
views about the impact of the crises on Pakistan. Some peoples have said that the recession was
only in European countries and some has said that it has just affected the poverty, unemployment
and wealth distribution in Pakistan.

It is true that the main reason of the financial crises was due to the soft loans given by the
European countries and later on their recovery became impossible due to this banks were crashed
and stock markets along with them. But Pakistan has not suffered financial institutional crises; it
has been affected in terms of international relations.

By these crises the goals made by MDG (Millennium Development Goals) seemed to be far off.

The variables under our study are poverty, unemployment, wealth distribution and their related
aspects in terms of food and nourishment etc.

Hypothesis

After the study from determinants we build the hypothesis that recession came into Pakistan due
to the recession in the whole world but the trend was different. The political instability has just
ignited this issue.

1
Economic factors behind the Crisis in Pakistan

The developing nature of the financial sector has been a saving grace for the Pakistani economy.
Less developed linkages with international markets have meant that the direct impact of the
financial crisis has not been felt by the Pakistani financial sector. However; effects of the crisis
have been felt, even though in a limited manner, by the real sectors of the economy. The effects
of the global slowdown have been transmitted through the trade balance; with a slowdown in
global demand and fall in commodity prices having varying effects, the capital account; with a
significant reduction in private inflows to Pakistan. Following study about the factor will
describe the crises in Pakistan taken from report of State Bank of Pakistan 2 “Global Financial
Crisis: Impact on Pakistan and Policy Response

• Financial sector of Pakistan

The operating environment of the financial sector experienced significant deterioration in 2007
and 2008, due to a confluence of factors emanating from both the domestic and international
economic and financial developments. While the domestic environment was characterized by
weakening macroeconomic indicators and the uncertainty caused by the prolonged period of
political transition, the global financial crisis and the commodity price hike had a feedback
impact on the financial sector through the real sector of the economy. Pakistan, which remained
largely unscathed from a direct impact of the crisis, has been more concerned with issues relating
to monetary stability due to rising inflation since before the advent of the crisis. With a thriving
banking sector, increasingly resilient to a wide variety of shocks, increasing but still relatively
less correlation of domestic financial markets with global financial developments, a proactive
and vigilant regulatory environment, and most importantly, no direct exposure to securitized
instruments, risks to financial stability were largely contained and well managed as the crisis
unfolded and impacted the financial sectors in advanced economies.

• Capital Flows & Workers’ Remittances

A beleaguered international economic environment has held back Foreign Investment as it
posted a decline of 47.5 percent during the first ten months of 2008-09 compared to the

2 Report of Mohammed Mansoor Ali ,Director Economic Analysis Department, State Bank of
Pakistan on “ Global Financial Crisis: Impact on Pakistan and Policy Response” in July 2009

1
corresponding period of the previous year. Most of this decrease has come in the shape of an
outflow of private portfolio investment of US$ 1 billion. Investment from countries such as the
United States, United Kingdom, Singapore, and Hong Kong, which have been at the apex of the
international crisis, has dropped significantly. Some Asian economies have witnessed an
anticipated fall in workers’ remittances as unemployment grew in advanced host economies.
However, workers’ remittances to Pakistan remained vigorous and unaffected by the crisis,
totaling US$ 6.36 billion in July-April 2008-09 as against US$ 5.32 billion in the corresponding
period last year, thereby displaying a rise of 19.5 percent.

• Commodity Prices & Trade

An unprecedented hike in international commodity prices wreaked havoc on Pakistan’s external
sector during 2007-08, with the current account widening significantly. However, in the wake of
a reduction in global demand and the resultant decrease in commodity prices, the import bill has
reduced significantly, decreasing the current account deficit. A key loss to developing countries
during the current crisis has been a decrease in exports as demand from advanced economies
contracts. Pakistan has witnessed a slowdown in exports, but this reduction stands apart from that
witnessed by other Asian economies for two reasons. Firstly, the fall in exports is partly due to a
fall in domestic productivity and it is hard to distinguish between the impact of the crisis and
internal factors on exports. Secondly, the fall in imports has outpaced the fall in exports, having a
positive effect on the trade balance.

• External Financing
The global crisis has restricted Pakistan’s ability to tap international debt capital markets to raise
funds. An increasing cost of borrowing internationally, coupled with deterioration in the
country’s credit rating has ruled out issuance of government paper as a financing mechanism.
Pakistan’s presence in the international capital markets in 2008-09 was limited to the repayment
of Eurobond amounting to US$ 500 million made in February 2009 with no new issuance at the
backdrop of financial crisis engulfing the global markets.

2
Techniques

When the first global recession came in the world, it destroyed the whole economy of the world.
The reason of that recession was World War II. The studies made at that time does not apply on
our problem. The crisis which we are facing currently is due to free market system. There was no
government intervention in the economy. Now after the recession the mix system strategies are
now being applied. Now there is government intervention in the economy to support the
economy.
The crisis in the whole world has been cured by the bail out plans given by the government.
They have used Federal Reserve’s to cover-up. Although these strategies has not given the
instant recovery yet, it is expected that in few years the position of the markets will be stable and
on track. Pakistan has different criteria to survive in this critical situation as the effect was not
usual. The FGT (Foster, Greer, Thorback) indicators of headcount index, poverty gap index
poverty severity index/ squared poverty gap index tell us the clear gaps and state a true picture of
the situation. Figures are given in annexure 1.
1- Tax breaks will be given to the industry to produce the product. We have a problem of
energy crises but if we develop plans by keeping in mind our resources then the industry
crisis can be cured.
2- Agriculture sector needs a greater uplift. We are agrarian economy and we are not using
the resources of our agriculture. We have an ideal land for agriculture but we are not
utilizing it. Government has to empower the farmers so that they could produce more.
Once we have our own produce we will be good enough to overcome the problem of
hunger and malnutrition. People will not prefer migration towards cities if we will
develop the agriculture. The shortage of labor faced in the fields will be covered if the
agriculture will be given uplift. People will prefer to have cultivation on their lands.
3- Cash subsidies and food rationing programs regarding the monetary fiscal deficit will be
good in the procurement of stability.
4- Easing of the monetary policy and decreasing the rates of productive sector will be
helpful to tackle the problem faced by our country.
5- Increasing supporting programs for the labor intensive activities. It will help to fulfill the
need of employment. The wages paid to the poor keeps the poor always poor so if we will
start to overcome the poverty due to unemployment the half of the situation can easily be
handled.

1
6-

3
 Appendices

The reference table for crises effect in Pakistan.

Source: Economic Survey 2007-08, 2008-09, PSLM, Labor force Survey

Table 1 Impact of Global Financial Crisis on Macroeconomic Indicators Annex-I

Indicators 2006-07 2007-08 2008-09

GDP(MP) (US $ billions) 143.0 164.4 167.4

GDP growth rate 6.8 4.1 2.0

Sectoral growth rates:

Major crops 7.7 -6.4 7.7

Large-Scale Manufacturing (LSM) 8.7 4.0 -7.7

Wholesale & retail trade 5.8 5.3 3.1

Investment as % of GDP ( MP) 22.5 22.0 19.7

Private Investment as % of GDP (MP) 15.4 15.0 13.2

FDI (US $ billions) 5.1 5.4 3.7

FDI as % of GDP(MP) 3.6 3.3 2.2

Portfolio investment (US $ billions) 1.82 0.02 -0.51

Portfolio investment as % of GDP(MP) 1.27 0.01 -0.30

Foreign Savings (US $ billions) 7.4 14.2 9.0

Exports (US $ billions) 17.0 19.1 14.8

Imports (US $ billions) 30.5 40.0 28.9

Workers’ Remittances (US $ billions) 5.5 6.5 6.4

Money Supply (M2 growth rate) 19.3 15.3 4.6

Consumer Price Index (CPI Growth %) 7.8 12.0 22.3

Foreign Exchange Reserve (US $ Billions) 13.3 8.6 7.8

1
Foreign Loan/ Credits ($ Billions) 3.1 3.1 1.2

Fiscal deficit as % of GDP (MP) 4.3 7.6 4.3

Custom duty as % of GDP(MP) 1.5 1.5 1.3

Unemployment rate 6.2 5.2 5.2

Gini Coefficient 0.3 0.36

Poverty Head Count Index (%) 22.3 35

No of People living below Poverty line (million) 34.65 55.36

Source: Economic Survey 2007-08, 2008-09,

PSLM, Labor force Survey

Annual Plan 2008-09, 2009-10

References

(http://en.wikipedia.org/wiki/Financial_crises_of2007%E2%80%932009 )

(http://www.voxeu.org/index.php?q=node/3520 )

(http://www.defence.pk/forums/economy-development/17725-there-recession-pakistan.html )

On 10 December 2009 at 2:34pm.

Economic Survey 2007-08, 2008-09, PSLM, Labor force Survey

Report of Mohammed Mansoor Ali, Director Economic Analysis Department, State Bank of Pakistan
on “Global Financial Crisis: Impact on Pakistan and Policy Response” in July 2009

2
2