Motivation
2008 global financial crisis played a major role in the collapse of the banking industry in US which also led to a financial collapse in a lot of other countries, plunging the world economy into a recession. The primary reason for the crisis was attributed to “high risk, complex financial products; undisclosed conflicts of interest; the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street” [1] The failure of the banks in US had ripple effect in all corners of the world. While major countries from Europe, Asia and Africa such as Germany, UK, Japan, South Africa’s economy shrunk or grew at a much slower pace. Small countries like Iceland, Hungary, Latvia, Ireland were on the verge of collapse.
While studying about the situation in Iceland we observed a unique trend whereby they refused to bailout the banks. The government reduced interest rates (4.25% in 2011) to meet the governments’ low inflation target & took a loan of 2.1bn USD from IMF and 2.5bn USD from neighbouring countries which aided them in their quest to curb the devaluation of their currency. Another fact that motivated us to study Iceland in detail was the fact that they started paying instalments in loan to IMF before schedule [12].
Many steps were taken by governments of different countries in the aftermath of the crisis and the aim of this project is to study and understand how these measures have helped uplift the respective economies post-financial crisis. The idea for this project was conceptualized when we started out to discuss one country and how they handled the crisis. But then the curiosity about what other economies have done during these past eight years to revive their economy motivated us to choose this topic.
Context
We have narrowed down our focus on the economies of Iceland, Ireland, South Africa and Pakistan and would be studying the steps taken by these countries during the course of the project.
While researching various countries that were affected by the 2008 financial crisis, we shortlisted these countries based on the following reasons.
1. Iceland: Quick Recovery, unconventional methods adopted by the government to revive economy
2. Pakistan: To understand how an economy with not so strong macroeconomic indicators (high fuel and food prices) and high dependency on exports to US and Europe survived the crisis
3. Ireland: The financial crisis exasperated the impending housing crisis in Ireland [7]
4. South Africa: To understand the failure of South Africa’s homegrown structural adjustment program, Growth, Employment, and Redistribution program (GEAR) policies to weather the crisis.
Icelandic Financial Crisis
In 2001, banks in Iceland were privatized, which led to easy access to international financial markets. The 3 major banks in Iceland (Kaupthing, Landsbanki and Glitnir) expanded all over the world and they financed their expansion via interbank lending markets and short term external debt (deposits from outside Iceland). They offered higher interest rates in Netherlands and UK. When the financial crisis of 2008 hit, the risk perception of Icelandic banks increased, the creditors started demanding repayment and the banks could not get fresh loans. The total outstanding debt of the three banks was 9.5 trillion Krona, 7 times the GDP of Iceland and their built up assets were worth 14.4 trillion Krona, 11 times the GDP of Iceland. Due to the massive size of the financial economy of Iceland, the Central Bank was unable to offer loans to the banks. Moreover, Icelandic households had taken debt in foreign currency (213% of the disposable income) as it had lower interest rate [10]. When investors started converting their Icelandic assets into foreign currencies, it led to fall in value of the Icelandic currency. As Icelanders were earning interest in Krona, they were unable to repay their debt taken in foreign currency.
Pakistan Financial Crisis
Pakistan being an underdeveloped country with political instability and dependent on western countries for exports and imports, had to face the adverse effects global financial crisis. Pakistan primarily exports textiles and apparel to the USA and European countries and imports machinery for western countries and petroleum products from the Middle East. The financial crisis in USA led a decrease in global demand, leading to drop in the exports made by Pakistan which consequently resulted in a lower GDP and foreign exchange reserves[8]. The political instability in Pakistan also increased the risk perception about investments, which led a huge capital drain. From the imports perspective, the import bills soared primarily because of drop in exchange rates due to poor foreign exchange reserves and increase in cost of imports. This led to a reduction in productivity, ultimately resulting in inflation and un employment.
Ireland Financial Crisis
The Ireland economy was seen as one of the top among the European countries in its economic achievements. Ireland saw a period of high economic growth rate, low unemployment and budget surpluses. The country underwent a major economic crash which involved a full-scale banking crisis, housing market collapse and soaring unemployment levels. All of this was this majorly due to the Great Recession of 2008. The major banks of Ireland had increased international bond borrowings to approximately €100 billion (over half of Ireland’s GDP) in 2007 from €16 billion in 2003. Irish house prices had become increasingly overvalued in the years leading up to 2007 [7,12]. The Ireland housing environment was increasingly becoming gloomy in the late 2007s and economic downturn further exacerbated the situation
South African Financial Crisis
South Africa, one of the fastest developing countries in the world had to experience the heat of global economic crisis in 2008. Its economy had weathered the late 1990’s late Asian economic crisis which was mainly due to homegrown GEAR policies. During 2008, the South African economy was primarily dependent upon the export of precious metals (gold and diamond) to countries like China, US and the Middle East [3]. It was facing a severe increase in inflation rates, which had increased the mining labor and production costs. With the onset of economic crisis, the demand for precious metals melted down in USA and China leading to a drop in exports. Since the South African GDP is highly dependent on exports (33%), the drop in exports lead to a cut down in productivity of prominent miners leading to a further boom in inflation
Methodology
We would be studying and evaluating the core reason of the financial crisis in each of the economies. Further, we would understand and evaluate the measures taken by these countries to revive the economies. The various measures taken would be evaluated on their effectiveness over the eight-year period. We would do regression analysis on various parameters of the economic health (like GDP, inflation and employment rate) of these countries for evaluation of the remedial measures.
Time frame of study: 2008-2015
Macroeconomic Parameters:
• GDP
• Inflation
• Unemployment rate
• Exchange rate
• Investment