Many economists consider the financial crisis of 2007/2008, also known as the Global Financial Crisis of 2008 the worst financial crisis since, the Great Depression of the 1930s. It resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. The direct impact of the global financial crisis on developing countries including Pakistan has been limited due to non-integration of the domestic financial sector with the global financial sector (IMF, March 2009). However, the crisis has set in motion global recession which has not spared the low income countries.
How the recession affects an economy depends, among other things, on the state of the economic fundamentals of the country when the recession sets in. Economies with sound macroeconomic indicators will be able to face the recession with expansionary policies. However, countries with poor macroeconomic indicators at the onset of the recession can follow the expansionary policies only at the cost triggering a crisis of greater proportion.
The global recession has posed policymakers around the world with unprecedented challenges. Severely damaged financial sectors seemed immune to most responses, while fiscal stimuli and other policy tools have, at best, been sluggish to establish some stability in economies dealing with the spill over of the financial crisis into other sectors and a general economic slowdown. In a little over a year, what started off as a sub-prime crisis in US mortgage and housing markets, has amplified to a global economic downturn of an extraordinary scale, bringing to an end four years of booming economic growth across the world.
In developed economies, strains in the financial sector, a drying up of credit, and an increasing amount of risk aversion in the face of limited information about potential losses, led to the closing of many credit lines and the evaporation of financing mechanisms. Commodity producing sectors in these economies were hard hit by these events, resulting in a general economic deceleration rather than a crisis limited to the financial sector.
In emerging economies, the slowdown manifested itself through various channels. Volatility in financial markets led to a flight of capital. Furthermore, access to external financing became all but impossible and spreads on bonds widened to record levels. Countries relying on trade as a primary means of boosting economic growth saw trade volumes disappear as trading partners in the rest of the world struggled to deal with the slowdown in their domestic economies.
The global financial crisis is impacting the real and social sectors of developing countries through multiple channels. The linkages between developed and developing economies have deepened as well as broadened over the past two decades in the wake of intensifying globalization.
As the slump in the global economy prevailed, the Pakistan’s economy witnessed a period of significant instability and a deterioration of most macroeconomic indicators. The timing of the crisis, and Pakistan’s response to domestic developments might seem contradictory to a layman. As governments around the world lowered interest rates and implemented expansionary fiscal measures to revitalize their economies, Pakistan underwent a phase of fiscal tightening, and a stringent monetary stance with discount rates remaining relatively high for most of the period (discount rates remained at 15 percent till April 2009). Fiscal, Monetary, and External debt policies of Pakistan have primarily been driven by the underlying need to resurrect significant macroeconomic imbalances in the domestic economy, rather than as a response to the financial crisis and global economic slowdown. The financial sector of the economy is still in its developing stages with limited, albeit growing, linkages with global markets. As a result,...
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