Jan 19 - 25, 2009

It was never meant to be happen again, but the world economy is now mired in the most severe financial crisis since the Great Depression. In little over a year, the mid-2007 sub-prime mortgage debacle in the United States of America has developed into a global financial crisis and started to move the global economy into a recession. Aggressive monetary policy action in the United States and massive liquidity injections by the central banks of the major developed countries were unable to avert this crisis. Several major financial institutions in US and Europe have failed, and stock market and commodity prices have collapsed and become highly volatile. Interbank lending in most developed countries has come to a virtual standstill, and the spread between the interest rate on interbank loans and treasury bills has surged to the highest level in decades. Retail businesses and industrial firms, both large and small, are finding it increasingly difficult to obtain credit as banks have become reluctant to lend, even to long-time customers. During end of 2008, the financial crisis escalated further with sharp falls on stock markets in both developed and emerging economies. Many countries experienced their worst ever weekly sell off in equity market.

Since the start of last quarter of 2008, Policy makers in the developed countries have come up with a number of more credible and internationally concerted emergency plans. Compared with the earlier piece-mail approach, which had failed to prevent the crisis from spreading, the latest plans are more comprehensive and better coordinated. The measures have reshaped the previously deregulated financial landscape; massive public funding was made available to recapitalize banks, which the government taking partial or full ownership of failed institutions and providing blanket guarantees on bank deposit and other financial assets in order to restore confidence in financial markets and stave off complete systemic failure. Governments in both developed and developing countries have started to put together fiscal and monetary stimulus packages in order to prevent the global financial crisis from turning into another Greta Depression.

Will this work?! It's hard to predict, but doing nothing would almost certainly have further aggravated the downside risks and more likely than no pushed the world economy into a deeper crisis. It should be appreciated, however, it will take time for most of these measures to take effect; the restoring of confidence among financial market agents and normalization of credit supplies will take months, if not years, if past crises can be seen as a guide. Furthermore, it typically takes some time before problems in financial markets are felt in the real economy. Consequently, it seems inevitable that the major economies will see significant economic contraction in the immediate period ahead and that recovery may not materialize any time soon, even if the bailout and stimulus package succeed. Moreover, the immediate fiscal costs of the emergency measures will be huge, and it is uncertain how much of these can eventually be recovered from market agents or through economic recovery. This poses an additional macroeconomic challenge.

Its is expected that the world gross product would be slow to a meager 1% in 2009, a sharp deceleration from 2.5% growth estimated for 2008 and well below the more robust growth in previous years. Also, income per capita for the world as a whole is expected to decline as a whole for 2009. This will be the case not only in the developed economies but also in many developing countries, where per capita income growth will be negative or well below what is needed to address poverty reduction. The vast majority of countries are experiencing a sharp reversal in the robust growth registered during last five years. This suggests a significant setback in the progress made in poverty reduction in many developing countries over the past few years. The prospects for the least developed nations, which generally did so well on average in last recent years, are deteriorating rapidly. Meanwhile, divergence in economic performance among the low-income countries remains greater than among the mainly middle-income countries in Asia or Latin America, although with the synchronized global downturn, growth divergences have narrowed somewhat from preceding years.

Looking ahead, the global growth recession is projected to cause both commodity prices and inflation to ease further, with oil prices averaging about $75 a barrel in 2009, and food and metal prices projected to decline by about 23% and 26% respectively, compared with their average levels in 2008. Nevertheless, these prices will remain well above the low levels of 1990s. At the same time, international trade is projected to decelerate sharply, with global export volumes falling by 2.1% in 2009. Export opportunities for developing countries will fade rapidly because of the recession I high-income countries and because export credits are dying up and export insurance has become more expensive.

Given this all, there is a strong need for reforms of the international financial system. Even in the most optimistic scenario, it will take time before confidence is restored in financial markets and recovery can take place. As immediate solutions are being worked out, it remains important to understand the systemic causes of the present crisis, which - in a nutshell - relate to weakness in global imbalances (current and capital account) and related systemic shortcomings in the international reserves system and the lack of an international lender of last resort. Understanding these deeper causes makes it clear that much more fundamental changes is needed to reform the international financial system in order to provide better safeguard for preventing recurrence of the present disaster and to create a framework for global economic governance in line with twenty-first century realities.