RECESSION CURVE

The mortgage crisis which erupted in the USA last summer eventually exploded, hitting the world economy with a financial crisis. The consequences led to a reduction in liquidity on the inter-bank market, weakened the capital of major banks and encouraged them to re-assess risks on a wide range of instruments. Today, the implications of the crisis have affected almost all economic segments in most countries of the world.

In mid-October, 15 EU countries adopted a joint plan to find ways out of the current situation and agreed to invest budget resources in problem banks until the end of 2009, thus acquiring their shares. It has yet to be determined how much will be involved. It is known that the Paris plan has been approved by the International Monetary Fund. To prevent other financial institutions from falling apart, European states have taken it upon themselves to guarantee inter-bank loans until 2009. It has also been stated that, under the framework agreement reached during the summit, the authorities will be investing funds in credit organizations, buying their privileged shares and thus injecting additional resources.

Only time will tell whether the plan can reverse the curve of global economic recession. However, according to IMF Managing Director Dominique Strauss-Kahn, considering the lessons of the crisis and the global nature of the world economy, it is necessary to change the world's entire financial architecture.

"What could have fallenapart, has"

This is how the current global economic situation has been described by well-known billionaire George Soros. "The crisis, which began with sub-standard mortgages, has spread to all credit bonds, endangered the existence of companies with primary and secondary insurance of municipal housing and mortgages and imperilled the whole multi-trillion market of credit swaps," he said. The last straw was the disruption of inter-bank credit, which is the foundation of the financial system. This came about because banks were compelled to withhold funds, while confidence in their partners disappeared. Central banks have had to inject gigantic amounts of money into the market and provide credit to an unprecedented number of financial institutions under an unprecedented broad selection of bonds. "As a result, the current crisis has become the most severe of the post-war period," Soros believes.

Economists from the United Nations Conference on Trade and Development had earlier drawn almost the same conclusions, albeit in slightly more reserved tones. According to them, the global financial crisis and the possibility of tighter monetary policies in a number of countries are harbingers of significant difficulties in store for the world economy in the remaining part of 2008 and in 2009.

The International Monetary Fund (IMF), for its part, has updated its forecast of the global losses incurred by financial institutions and banks, and caused by the unfolding crisis, from $945 billion to 1.4 trillion. In fact, $560 billion of these losses had already been registered by late September 2008.

The global crisis has also slowed down production around the world. According to projections, the global rate of growth will fall to 3.7 percent in 2008, which is 1 percent lower than in 2007. It is also expected that growth rate in 2009 will remain unchanged. The divergence of rates between developed countries and those with emerging markets will continue to widen. As a matter of fact, the growth rate of developed countries will fall to a level far below their potential.

Against this background the threat of deflation is increasing. The slump in the financial markets of the world, the prices of raw materials, as well as the toughening conditions for credit, are indicative of the fact that the period of falling prices is set to continue. "Although inflation is still a problem for many central banks, only a few months after prices of crude oil and food had reached their peak, there is a risk that the measures taken by different governments to support the economy will fail to have their desired effect, which will lead to a fall of prices in the real sector of the economy," the economists think.

Meanwhile, a more favourable forecast has been made recently with regard to developing countries, including Azerbaijan. The growth rate in such countries may remain at 6 per cent, due to the relatively stable dynamics of domestic demand in a number of major developing countries. The sustainability of countries with emerging markets, as well as developing ones, rests on such factors as their deepening integration into the global economy and the large-scale nature of the current boom in prices for stock exchange goods. This has promoted increased exports, direct foreign investment and domestic investment in countries exporting stock exchange commodities more than it did in previous booms.

The IMF, however, believes that the markets of developing countries, which earlier seemed to be unaffected by the crisis, have also suffered an impact of late. Many developing European economies were backed by credit from foreign banks or foreign investors, but now these resources are no longer available. And although foreign banks insist that they are ready to honour their commitments through representative offices in these countries, even if things are not too good in their own country, the crisis is likely to almost automatically restrict any expansion abroad. International analysts think that the future for most developing countries depends largely on the effect on prices of the raw materials they export. A forecast that prices will remain at a higher level than in the last 20 years is supported by several structural factors.

Light at the end of the tunnel

However, the opinion that the crisis is of a purely economic nature and is the consequence of mistakes on the mortgage market is not universally shared by analysts. There are too many political developments accompanying and entwined with the crisis hysteria: the US presidential election, the Georgia-Russian stand-off, etc. "This is an artificially constructed catastrophe and all the means of resolution are in our own hands" - this confession, which seems to be the only essentially correct one, was made recently by World Bank President Robert Zoellick after a meeting of the WB and IMF development committee. He said "the developments of September and October have shown that it is necessary to upgrade the markets for a new global economy" and make them "multi-faceted". Zoellick stressed that "it is now necessary to focus not only on the present crisis, but also on creating a new system so that such crises do not occur in the future".

The IMF believes from the experience of previous crises that the situation requires a coordinated and collective effort by the governments of all affected countries. At the same time, support for assets alone (like the recently approved US government's plan to purchase mortgage assets to the tune of $700 billion) would not be sufficient.

We recall that the USA has adopted a draft law on measures to stabilize the country's financial system. The project, totalling $700 billion, is intended to help banks avoid a shortage of funds and potential collapse. It is described as the largest-scale state intervention in the US economy since the great depression of the 1930s.

According to IMF estimates, world financial institutions now need to engage $674 billion in new capital but, in current circumstances, it is impossible to attract capital in the private sector. Thus it is worth considering the possibility of putting these institutions onto the state balance sheet. A third measure would be government action to support liquidity in the financial sector.

Economists from the United Nations Conference on Trade and Development recommend that diversification and industrial development be chosen as the most effective long-term strategy to reduce vulnerability to dramatic fluctuations in price. Such a transition requires greater investment in new production capacity (i.e. in the ability to manufacture more diverse and sophisticated products) and infrastructure.

At the same time, developing countries and those with an emerging market are facing the task of containing inflation and preparing for the risks of slower growth as a result of the economic recession in developed countries and pressure on financial markets. A number of countries may have to tighten their monetary policies further in order to keep inflation under control. In conditions of a flexible exchange rate regime, the growing value of currency usually provides valuable support here. Countries whose exchange rates are regulated strictly to the US dollar are better placed to take action, because rising rates of interest may stimulate greater inflows of capital. Tax, budgetary and financial policies may also play a useful role in preventing the "overheating" of the economy and related problems. Limitation on expenditure may help reduce domestic demand, reduce the need to tighten monetary policy and ease pressure from short-term capital inflow.

Azerbaijan not panicking yet

As far as Azerbaijan is concerned, there are no obvious consequences of the global economic crisis in evidence yet, though the government has had to slightly correct its plans on the introduction of new financial instruments and institutions. Thus, the global crediting crisis has killed off the last hopes of creating the conditions in 2008 for a debut release of Azerbaijani Eurobonds, and has considerably slowed down the establishment of private retirement funds.

Also observed is a certain level of influence on the banking sector. For instance, many commercial banks in the country have either suspended or restricted the issue of consumer credit, attributing their action to a problem of liquidity. While Azerbaijani Minister of Economic Development Heydar Babayev has acknowledged some impact of the crisis on Azerbaijan's banking sector due to a considerable rise in the value of resources brought from outside the republic, he noted at the same time that Azerbaijani banks have got used to such resources. "In essence, they did not have cheap financial sources before. I don't think that the global financial crisis can have any impact on the Azerbaijani economy, while the effects observed today are more of a psychological than financial nature," said Babayev.

In this light, the Azerbaijan Deposits Insurance Fund (ADIF), which began operations on 13 August 2007, does not deem it necessary to resort to an unplanned increase of insurance cover for the deposits of physical entities. "In this sense, the activity of banks is not risky. They have attracted outside borrowing only to the sum of 1.7 billion manats, which is considerably less than 20 per cent of their assets, which exceed 8 billion manats. If outside borrowing had exceeded 50 per cent of bank assets, it would have been worth considering an unplanned increase of insurance cover," the fund's executive director, Azad Cavadov, has said. He believes that additional stability to the market will come from the country's currency assets, which amount to 10 billion manats and budget funds amounting to 11 billion manats (Fineko).

Besides this, on 14 October the National Bank of Azerbaijan took a decision to reduce the refinancing rate from 15 to 12 per cent a year. The maximum threshold of the refinancing rate for inter-bank credit has been reduced from 20 to 17 per cent. Also, starting from 3 November, obligatory norms of reservation for banks on liabilities to residents in both national and foreign currencies will be reduced from 12 to 9 per cent, while obligatory norms of reservation on foreign liabilities will go from 5 to zero per cent. The National Bank statement says that the global crisis has not affected the basis of the Azerbaijani economy. Azerbaijan held over $17 billion in strategic currency reserves as of early October, while total external assets exceed liabilities by $9 billion. In other words, there is now no reason to panic.