Introduction

According to the International Monetary Fund the current crisis in the world’s financial markets is the worst in 75 years. Most significantly, it is the 21^st century’s first global financial crisis that is putting financial capitalism, ideologically, to its first acid test.

It is now threatening to derail the world’s economy into a major global slowdown with fears that it may result in a global recession and, then, depression resulting in falling GDP, investments and consumption coupled with inflation, mass unemployment and underemployment.

In short, times are uncertain, turbulent-- and dangerous due to the mass psychology of fear and anxiety arising from the hubris of consumerism and instant gratification in the background of the sustained, heavy private and public debts in the US. Dangerous because you have a hyper power, the United States of America, that is also the world’s greatest debtor: And it is in the throes of the global war on Islamic terrorism since 2001 with no end in sight.  

Economic pundits are divided as to the severity of the economic downturn. Ultra-Pessimists think that a global depression is likely. Pessimist think it will only be a recession: and Optimists think that it will be a slowdown only. However, amidst Optimists themselves opinion is divided as to the nature of the economic slowdown.

Will it be V shaped --- sharp drop with a quick sharp rise in say 1 year? Or U-shaped to involve a gradual slowdown with a slow turn around in say 2 years. Or will it be L-shaped --- slow decline with a prolonged period of slowdown as happened in Japan during the 1990s that lasted nearly10 years!

Causes of the Financial Crisis (FC)

The primary cause for the FC is the US sub-prime mortgage lending --- ‘sub-prime’ refers to lending to households who have high risks of default as a result of no previous exposure to housing credit, or having undergone bankruptcy in the past; or even not having sufficient and/or stable income to finance the long-term loan. In other words, they do not receive ‘prime market rates’ of interest for their loans. Total volume of sub-prime loans was estimated to be in the region of US $ 1.3 trillion in March 2007!

Maintaining a very low interest rates in the US in order to counter the 2001 recession, and massive inflow of foreign dollar holdings for many years, led to the US housing boom. In the process, many US lenders began to access sub-prime borrowers under two assumption: (a) that housing prices would continue to rise and hence refinance would be available to these borrowers, if need be, and that (b) to an American his home is his castle and he will, therefore, do anything to keep it intact: even to the extent of cutting other consumption expenditures to keep his hearth and home intact.

When, subsequently, the housing market crashed--- after its prolonged boom from 2002-06;  an  outcome of the financial innovation such as the hedge funds, derivatives, securitization and  collateralized debt obligations (CDOs), real estate asset values tumbled during 2006-07 resulting in household bankruptcy, foreclosures and decline in investments in that sector. Faced with the rise in the interest rate, sub-prime buyers found it well neigh impossible to obtain refinance given the unprecedented fall in housing prices to as low as 30% of the sales price.

With dramatic increase in defaults and foreclosures the sub-prime mortgage crisis was converted, in 2007, into a financial crisis as banks and financial institutions faced a grave liquidity crisis with the dramatic drop in cash flows and their own asset values. Banks and financial institutional found themselves with massive non performing assets: or simply put sheer bad loans.

So much so, banks and financial institutions refused to lend to other banks and financial institutions for fear of default.  Fear grew that the financial crisis may impact the real economy when pundits and politicians referred to the crisis as moving from “Wall Street to Main Street”. Thus intervention by the US government ensued to protect the real economy from a recession and mass unemployment by injecting $ 1.2 trillion into banks and financial institutions to prop up their liquidity so that they could start lending again.  

The real cause is something else:  lack of understanding of the full operational implications of the financial innovation wrapped up in an aura of the so-called ‘new economy’; lack of comprehension of the whole gamut of risks involved in these financial innovations, and lack of regulation to protect depositors from lax lending standards in the wake of spiraling graft and greed and an obsessive ideological belief that markets are, like democracy, self-regulating.

Usually innovations—in this case financial engineering but it could be technical, biological or product and organizational engineering---  lead to economic hubris to believing that ‘new rules of the game’ have to be written leaving regulators aghast and astounded, intellectually, while the stock market goes berserk with asset price escalation. Most are asked to believe that the world has changed. It’s only when the real economy surfaces as a problematic, as the asset prices crash and balance sheets show up for what they really are worth, that financial markets are awakened with a rude shock.

A shock wave so astounding and sever that the Us, the epicenter of the global financial architecture, is confronted with stark moral and ethical issues over the propriety and integrity of its regulatory agencies, surveillance agencies, credit rating agencies, accounting and audit agencies – perhaps its  business schools too.

Actions Taken By Governments to Deal With FC

The US government, first and foremost, chose to deal with the crisis unilaterally despite the feelings amongst internationalists that global problems call for global solutions. Seeing that it did not work --- and perhaps afraid that alternate financial models may arise that will weaken the US economic leadership --- President George W  Bush Jr hurriedly called for the meeting of the G7 along with the G 20 and the IMF  --- mostly emerging  global economic powers and also countries with huge dollar reserves such as the  OPEC nations--- “ to help the recovery from the brink of systemic breakdown” as said  by  IMF  Managing Director , Dominique Klaus-Kahn.

A pertinent question that deserves reflecting upon is this: it t is generally believed that in 1815 around 50% of the global wealth originated in Asia. This is likely to happen again before 2040 --even quicker if we include Russia and Turkey as Asian powers. Why should the Asian economies, therefore, keep on holding on to their 4 trillion plus US dollar reserves and/or lend these reserves to the US by buying cheap US treasury bills?

Is there not an opportunity cost to them for his practice?

Should they not use the massive reserves of Amercian (and European) foreign exchanges to invest in continental Asia to boost the Asian domestic demand through expansionary fiscal and monetary policies, right across the continent, to enhance pan-Asian connectivity, integration and modernization?

The underlying assumption for the above regional financial, fiscal and monetary strategy is that there needs to be an Asian Monetary Fund (AMF), propped up by the Asian Development Bank, that would allow each country to float local currency bonds, within due limits as determined by an independent pan-Asian Surveillance Agency, to make bilateral swaps for the surplus US dollars lying with the proposed AMF. 

Another highly pertinent issue is this: how proper was it, in this new age of globalization and when the West , for the West has been preaching privatization and market liberalization ad infinitum, since the 1970’s, to disallow Asian dollar and euro reserves to be used freely to buy out American, British and European banks and other strategic assets in distress by nationalization of their strategic enterprises ? 

Global Economic Impact and Impact on Nepal

The world economic growth fell from 5.0% that persisted from 2004-07 to just 3.5% in 2008. Some pundits fear a recession in US, Europe, and perhaps Japan and Korea.

Impact on Nepalese Economy: If Not Direct Definitely By Its Side Effects  

Nepal has not faced any direct impact, so far, from the global financial crisis. This is because its financial market is not open to short term portfolio investments from abroad. On the contrary, it has benefited from the drastic fall in global oil prices from $ 149 to $ 60 per barrel as the government was incurring huge losses adding to the fiscal deficit that was a high as Rs 10 billion at its peak --- nearly wiping out all of the surplus of internal revenue after meeting government’s regular expenditure!

External shocks weaken reform drives and underlying structural weaknesses are not addressed as they should. At this time even the  IMF is facing the external shock that hits at its very rationale with the collapse of the ‘Washington Consensus’ agreed to by and between the Group 7 nations. Thus one unforeseen impact could be the rolling back of the long-drawn financial and economic reforms’ agenda, which underscored Nepal’s move away from the proverbial Hindu rate of economic growth of just equal to the demographic growth. Beyond the Hindu growth rate was possible, all along the 1990’s, because of macro-economic stability, market liberalization particularly in finance and trade. Even during the civil war years, 2001-2006, macro-economic stability was systemically achieved by pursuing the agenda of reforms.  

Since the present Maoist-led government is not really committed to all round market reforms it is expected that foreign direct investment will decline in the wake of the global financial and economic crisis. The constant depreciation of the Nepali Rupee will make oil, fertilizer and other vital third country imports inflationary which may require adjustment to the customs duties and VAT causing further erosion of internal revenue.

As with all financial markets anywhere, weakening confidence by the private sector will cause loss of trust in the national economy and thus result in either massive outflow of capital or enhanced holding of Indian currency by Nepalese households.

With a fixed exchange regime with India, and given the phenomenal depreciation of the Nepali Rupee against the Dollar, much more imports will come from India at the cost of trade diversification. As a geo-political and geo-economic side effect,  a virtual ‘Indianization’ of the national economy may ensue to that equal to the unenviable position which existed prior to King Mahendra’s policy of trade diversification of 1965.

Europe’s economy is in recession even before America’s. Growth is expected to be 0.9% in 2009 and no more than 1.1% in 2010. This means that EU will find it hard to maintain its aid levels to Nepal and elsewhere posing a grave danger of an economic slowdown here in Nepal since so much of the capital investment is aid generated. This will also mean that poverty levels will rise as consumption levels and health status of the poor declines.

Tourism will also be affected worldwide. This time even more as the financial crisis and economic down turn is expected to be long lasting unlike in the past. One may expect long haul, inter-continental tourism to decline significantly given the financial distress being faced by the global aviation industry. Impact on tourism is expected to be indirect or a side effect depending on whether or not it faces a decline to India and Tibet. The ominous relations between HH Dalai Lama and China bodes ill for Tibet-bound transit tourists for Nepal. It should be underscored the high revenue yielding tourists are either India- or China-bound with Nepal as a stopover destination rather than a direct one.

Special effort needs to be made, therefore, to attract tourists from China and the SAARC nations with special package tours, which could include joint tourism packages with Bangladesh, Bhutan, India’s North East India and Uttar Khand; and not least Pakistan.

Exports will fall faster as competitiveness of Nepalese products is going be even lower as other countries producing similar goods face the downturn for their export to the industrial nations. Matters may be compounded if labour unrest and national bandhs are  not halted. Even if the volume of overseas’ export increases, earnings may decline due to depreciation of the Nepali Rupee.  Service earnings may, however, get a boost as there will be greater demand for offshore research and analysis to deal with the epidemic in loan defaults and delinquencies globally.

Remittances may not be affected as most migrant workers are in West Asia. Although Malaysia is facing threats of recession, nevertheless, Nepalese workers may not be affected as they are mostly in the service or tertiary sector. Should remittance be affected significantly (because of the depth of the recession in the industrial nations and its unfavourable impact on world oil prices for example) a balance of payment crisis will loom large in Nepal and national security and stability of the entire economy and polity will be gravely tested.

Geo-political side effect are going to be there, come what may, since this crises is also symbolic of the continental shifts in the global balance of power in favour of Asia as a new fulcrum of the emerging multi-polar world.  Nepal will be drawn closer to China with the transport and communication developments in the High Himalayas and the Tibetan Plateau.  Nepal will likely see much more foreign direct investment coming not just from China but also from West Asia, such as Qatar and Kuwait, if  it can foster political stability.  

Conclusions

Just because there are external shocks does not—and should or must not-- mean that nothing can be done internally. Time for forceful actions to deal with the crisis is now.

A National Action Plan for Crisis Management 2008-10 be designed by a think tank. Primarily, it should be a strategic management action plan that seeks to implement forcefully a special package programme and a set pf policy priorities institutionalized for the next 2 years. It should be designed to usher transformational leadership under the theme of public private partnership by drawing into the fray key economic ministries like agriculture, tourism, supplies, industry and finance, including Nepal Rastra Bank. The aim of the envisaged strategic management plan should be to design and coordinate counter measures to deal with the direct and indirect possible impacts of the global financial and economic crises on Nepal. 

Some general features may also include key elements like severe austerity measures; banning of all bandhs; guaranteeing uninterrupted flow of goods and services to markets; getting the public services to enhance their work hours and productivity to cope with the crisis especially meeting the need of the poor; deepening and broadening financial and economic reforms  like never before;  providing financial liquidity and better bank regulation and, not least, rehabilitating, promoting and developing entrepreneurs, to the maximum to create self-employment and reduce under-employment, be they informal cottage or pavement enterprises or small and medium enterprises

It is to be underscored  that great opportunities arise for import substitution activities during periods of world financial and economic crises. They can only be availed of, if the government and Nepal Rastra Bank innovate proactive micro-finance and related credit policies for cottage and SMEs. Getting national investment to a new high is a structural challenge. This is where the SMEs can be brought in to play a critical role.

Utmost policy and plan attention must be given to seeking national food security and self-sufficiency as a mater of national priority. The proposed Commission To Recommend Scientific Land Reforms should address this national issue as a major outcome to be sought.

The phenomenon of low investment level, low interest rate and rising bank profits must be explained. Is there more money in the national economy than what exists in the banking system? Most probably yes as can be gauged from the data on bank deposits and stock of money. This does not include the Indian currency being held by households.  One must also examine the phenomenon of the expansion of existing banks and other financial institutions compared to the entry of new banks; and seek to understand why existing banks do not grow in a speedier manner and diversify their products and service as one would expect them to with real competition.  

Vitally, the ability of Nepal to withstand the side effects of the current global financial and economic crises will fundamentally depend on the capacity of Ministry of Finance to generate the targeted internal revenue on a ‘war footing’.

It will surely be a historic achievement if the Finance Minster, Dr. Babu Ram Bhattarai, can raise the targeted revenue as, then, he will be the first Finance Minister that is in a position to have a fiscal policy that is truly development-oriented and not revenue-oriented. That was what amiss in the past as all finance ministers had to depend on imports and customs revenue even after VAT was implemented.

This year’s budgetary expenditure targets in the face of the people’s rising expectations, will be at grave risk should revenue targets not be met causing the budget to be, on the  contrary, an instrument of future conflict rather than peace and state transformation.

Laying hope on a few mega-projects, at times like these with so much uncertainty and unknowns, to have spillover effects on the macro-economy is a highly risky strategy. Rather than opting for a top-down approach, it is best to depend on what we already have, namely the many small and medium entrepreneurs across the length and breadth of the nation to spark economic growth and development from the bottom-up—from the very grassroots-- with myriads of small investments, innovations and initiatives that will eventually make great self-reliant waves in the macro-economy.

Finally, it must be underlined that nobody knows how long the global economic crisis will last. Old theories are unable to explain the new phenomena. Economic historians, who study the business cycles such as the Kondratieff-wave, think that what is happening is that, since the 1^st wave in 1771 (at the time of the Industrial Revolution) we are in the 5^th wave> That began in 1971 with the onslaught of the Information Communication Technology (ICT) revolution that ‘naturally’, after 50-54 years, tends to wane as a spent force leading to recessions and depressions until new innovations take root.

Such is the financial and economic knowledge–void that exists on the current financial and economic crises that large dose of pragmatism seems to be the best guide to weathering the storm.

Comments (18)

thank u sir for providing us such a valuable article which really help us in our studies.

Commented by kapila baral - December 13, 2009 @ 6:12 AM

thank you Prof Rana for such a useful information about nepalese economy. Such clear informations about are rarely found. Need to encourage such writer.

Commented by rachana - July 8, 2009 @ 3:07 AM

Marijuana should be legalized in NEPAL so, that people who are suffers from a disease like; cancer and AIDS have rights to access medical marijuana as well as use as a pain relief. In 1960s when hippy entered in ktm, at that time marijuana is legal. During 1973s policy change and marijuana is illegal. Nepal geographic is very good for hem product.

Commented by sujan - April 3, 2009 @ 5:37 AM

I think nepal will have to suffer alot if this crisis takes a L turn. Our budjet cant longlast without aids.And some symtoms have already be seen.Definately foreign aids gona decrease shaply.The journal needs to be well appreciated

Commented by kaushal tamang - March 27, 2009 @ 8:21 AM

it is areally good journal to present.it would help the coming generation.

Commented by victoreldred - March 12, 2009 @ 4:20 AM

This article is really analytical one. I enjoyed it and got insight into the Issue. Thank You Sir.

Commented by Bharat Singh Thapa - March 11, 2009 @ 3:29 AM

the write up really good. thanks to the author.

Commented by ajita singh - February 28, 2009 @ 2:23 PM

iam doing my MBA now i have been searching for what this crisis actually means,,today i got an perfect answer..thanks for the author for providing a lovely information

Commented by TEJA - February 12, 2009 @ 11:12 AM

very good analysis. but i want to know the current position of our ecomony in context to financial crisis? what is its impact, cause? and various measures please can you help me

Commented by anoushka - February 2, 2009 @ 11:27 AM

Very good analysis according to me. i expect some more articles in this topic from you.

Commented by Nawaraj Dahal - December 17, 2008 @ 2:32 AM

thanx for the real story of the world telling to neaplese.. but i hope this general idea nepali haru ko dimag ma chittai pugos and they can analyze in which condition our generation is heading. what backup and plans do we have..

Commented by pawan raj joshi - December 4, 2008 @ 6:22 AM

Arjun, as it appears in his comment, had slept in Mr. Rana's class. As I remember, Mr. Rana taught us how to be an objective observer."Obama has a big chunk of US Econimic giants behind him". I am wondering what is the basis of this assertion. Being a elected president of the rich country, does not mean he is back by "chunk of econimic giants.". At the same time he is not the president of Republic of Congo. He is a president of country where Wall street resides. He is elected in a country, Every country in this globe measures its well being in compare to the US currency. Mr. Rana's article was purly a economic analyis has nothing to do with presidential election of 08. It is the process of American political system which comes every four years.

Commented by manas - November 17, 2008 @ 3:54 PM

Comprehensiv article with intense view in each aspect of subject matter. I'v never read such a well bodyed article by any Nepali writer. But one thing is difficult to understand . U v written 'With a fixed exchange regime with India, and given the phenomenal depreciation of the Nepali Rupee against the Dollar, much more imports will come from India at the cost of trade diversification.' Could u plese elaborate it in a form of next article.

Commented by sujit mainali - November 17, 2008 @ 10:28 AM

i am been a student of Prof. Rana. He has very deep understanding of the world's economy, which he has wonderfully presented in this article. i am glad to be his student.

Commented by Keshab Bhattarai - November 15, 2008 @ 12:20 AM

I am really doubtful of large FDI coming from China or middle east. Chinese can produce everything inside China and there is no reason why they should come to nepal. Best potential for Nepal is tourism and quality educational institutions. Nepal can become international education hub. All this will be possible when Nepal stops playing dirty politics.

Commented by Rajendra Kumar - November 13, 2008 @ 12:07 PM

i am a studnet of Sir Rana. I really admire his analysis of the world economy. i have a point to make sir; Similar to the rise of Nazis in germany with the Jews being whipped-off, the rise of obama which happend in tandem with the fall of the world economy. Economic giants self created economic slowdon is liked to Obama's rise. Simialr to the German Businesmen who supported Hitler, Obama has a big chunk of US Econimic giants behind him. Obama is only a pawn of those giansts. u will see the econimic slowdown taking a V Shape and take its normal course

Commented by arjun - November 13, 2008 @ 9:09 AM

nepal ma pani yesta bidwan haru chan. i likes the long article by mr. rana.

Commented by puru rizal - November 13, 2008 @ 5:40 AM

very very nice artcile. hope to read more such artciles.thanka

Commented by ritu khadka - November 13, 2008 @ 3:23 AM

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