Crisis parentage
The most dominant trigger that initiated the crisis was the bursting of the US housing bubble due to high default on substandard lending. For a number of years prior to the burst, people with low credit rating and unstable income were advanced loans at sub prime rates encouraged by a long-term trend of rising housing prices and a future opportunity of refinancing. The Federal Reserve Board also basked in the bubble and refused to accept the aftermaths. It was thus initiated by US financial institutions and nurtured by the Fed. The Federal National Mortgage Association (Fannie Mae) and Federal Home Mortgage Corporation (Freddie Mac) fueled the fire for a long time underwriting 80 percent of all toxic US mortgages that ultimately led to their bankruptcy.
Second, banks and financial institutions with overflowing debt component in their capital base proudly prevailed in the US markets for a long time. Going further, the mortgages against loans were securitized and converted into financial securities with a certain rate of interest. The investment banks sold these complicated securities that were backed by highly risky debt, the risks that even they were not aware of or which emerged in due time.
Third, most banks and financial institutions throughout the western world were convinced that economic cycle was extinct and depression could only exist in the pages of history. They failed to understand that longer the debt-fueled boom lasted and the greater the debt burden became, the greater would be the carnage when the inevitable day of reckoning arrived.
Fourth, in a pursuit to earn more and more interest earnings, the banks, blinded by the profits, went about in a spree of advancing loans to whoever was willing to take loans in times of market boom. They felt that even if few of the borrowers defaulted, the volume of transactions and subsequent refinancing would make them a neat profit in their overall position.
Fifth, the alertness of ace rating agencies like Moody’s and S & P can be viewed with skepticism as they looked on while Collateralized Debt Obligations (CDOs) elevated the credit rating of mortgages.
Lastly, amidst the cry for toughening regulations and empowering the regulators globally, the manifold growth of US Credit Default Swap (CDS) market went unchecked. The arrangement of complex derivatives remained unquestioned which intensified the magnitude of the crisis.
The Asian abode
Asia, at large, appears to be somewhat better protected than other parts of the world against a slide into recession. It is believed that most Asian governments are in better financial condition owing to their strong economic imperatives. Nevertheless, it is not decoupled from the global economics (mainly western world and US). Major Asian stock markets have recorded a significant drop in the recent past. Countries such as Taiwan, South Korea and Vietnam have high dependence on exports. In China, weak exports orders combined with rising costs have forced thousands of small factories to close in the country’s export zones. The woes of exporters are felt throughout the region, which is tightly linked by trade in manufacturing parts and machinery. Slower sales to US means reduced orders up and down the supply chain.
Insulated Nepal?
Apparently, the Nepali financial market does not seem to be directly impacted by the crisis due to insignificant amount of foreign private capital inflows. However, Nepal has critical dependence on other larger economies both in terms of imports and exports including remittances. Therefore, the contagion effect of the global economies cannot be underestimated under any circumstances. Deceleration in earning from exports and remittances would tend to impair the country’s current account. Furthermore, the sustainability of speculative lending, particularly in realty sector, is a matter of deep concern. In the absence of conscious efforts in managing the economy, the crisis could gradually grapple the market. It would be apposite to mention that the recent debacle in the commodity prices (steel, palm oil, plastics, etc) has inflicted deep injuries to the corporates in Nepal. Although the magnitude of the financial loss is a matter of conjecture, it should be treated as an important lesson for the market. The real concern behind this episode is the effect on the financial system. Two questions quickly emerge: Will the corporates be able to withstand the loss at ease? Will the drag effect be witnessed in the books of the commercial banks?
To my estimation the following would be prone to the global ill effects:
Tourism: The tourism sector has started witnessing a slowdown as the number of tourists went down by 16 percent in February this year against the same period last year. With the global woe crafting a decrease in the expenditure muscle of these foreign tourists, the tourism sector of Nepal is likely to witness a greater setback.
Foreign aid: The development projects in Nepal are to a great extent dependent on foreign aids and grants. In face of the crisis, concerns are there if some portion of such aids is likely to shrivel.
Big budget projects and FDIs: International institutional investors are considerably hit by the turmoil and so their investment in our country could be hindered, resulting in delays.
Exports: Less demand in the West for exportable products from Nepal.
Remittances: The flow of remittance has also started to decrease. In mid-November to mid-December 2008, remittance income growth rate had stood at 67 percent. However, this growth rate declined to 65 percent in mid-December 2008 to mid-January 2009 and 57 percent in mid-February to mid-March 2009. It has been reported that the number of Nepali migrant workers going for overseas employment has seen a contraction of 9.7 percent between mid-February and mid March this year.
Against the backdrop of the foregoing, the government, regulators, commercial banks, financial institutions and the constituent players would require to be vigilant and flexible for ensuring a smooth pass-over.
Future outlook
The people closely following the financial developments over the past few months have undoubtedly witnessed history. This upheaval has outshone all major events in the world’s economic history. The Nepali financial market should consider this as a valuable learning experience and make a collective and conscious effort to shield it against any similar situation. Banks and financial institutions should adopt a disciplined management of capital and liquidity to avoid replicating the fate of the West. Regulators should ensure that commercial banks are restrained from making over financing and speculative financing particularly in the commodity and realty sectors. A conservative and prudent approach in lending should be implemented without any compromise on financial disciplines.
(Writer is CEO, Standard Chartered Bank Nepal Ltd.)
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