Global Financial Crisis: A Catalyst for change in Global

Economic Paradigm

Professor B. P. SinghChairman

Delhi School of Professional Studies & Research

Formerly, Head & Dean Faculty of Commerce & Business

Delhi School of EconomicsUniversity of Delhi

Delhi

Agenda For Presentation• Anatomy of the Downturn : Cause and

Effect

• How it has been managed?

• Factors affecting Economic Supremacy of a Country

• Position of USA till 2008 and current predictions in the wake of current meltdown

• Changing outlook for 2009 – 10

Cont…• Global Financial Crisis: A Catalyst for

change in Global Economic Paradigm

• Cost of Bankruptcy

• Restructuring of the Economy: A Remedy

• Dimensions of Restructuring

• Acquisitions and Restructuring

• Policy Goals: What States Want From Restructuring

Anatomy of the downturnA closer look at the global ‘credit crunch’

The ‘credit crunch’ may have its roots in the US, but it’s now a global problem

The Rudd Government has moved to protect bank deposits for the next 3 years

Governments in Great Britain, Belgium, the Netherlands & even Iceland have been forced to bail out some of their biggest banks

Importantly, the Australian banking system, which is more regulated than that in the US, has held up very well

January 2008

March 2007

Anatomy of a downturna closer look at the global ‘credit crunch’

US Federal Reserve cutsinterest rates to 0.75% amidfears the US economy could fall into recession

JP Morgan buys US investment bank Bear Stearns in an ‘emergency’ rescue deal

US Federal Reserve provides US$200 billion to commercial banks in another bid to free up market liquidity in addition to $700 billion announced by US Govt. to rescue wall street.

Cont...

April 2008

International Monetary Fund warns losses related to the ‘credit crunch’ could top US$1 trillion

Cont...September 2008

7 September 2008: US government seizes control of mortgage lenders Fannie Mae and Freddie Mac15 September 2008: Lehman Brothers files for bankruptcy. Merrill Lynch is bought by Bank of America for US$50 billion16 September 2008: American International Group (AIG), the US’s biggest insurer, receives an US$85 billion loan from the US Federal Reserve to stave off bankruptcy28 September 2008: US bank, Washington Mutual, is seized by US regulators in the biggest US bank failure in history

Cont...September 2008

28 September 2008Britain, Belgium & the Netherlands are forced to bail out several major banks. US govt Announces US$700 billion plan to rescue Wall Street

US House of Representatives narrowly rejects the US$700 billion bailout plan by a vote of 228-205, sending global share markets tumbling29 September 2008Citigroup bids for US bank Wachovia in a deal backed by US authorities

30 September 2008$55 billion dollars is wiped off the Australian share market in a single day

One day later, the market recovers by more than 4%

Cont...

3 October 2008: After a second vote, the US House of Representatives passes the US$700 billion bailout plan6 - 10 October 2008: Concerns that bailout plan won’t prevent a global recession sends global shares sliding:

Japan -24.3%Europe -22.2%UK - 21.0%US -18.2%

Australia -15.6%

October 2008

The list of casualties kept growing….

In this way… it has been managed

Economic Supremacy of a Country depends upon its state in terms of Hard and Soft Power

In 2007 2020, 2030

Weight of US Economy on the Skids Since 2000

Source: IMF, World Economic Outlook DB, Oct, 2008

Growth Rate Predictions….

Source: IMF, World Economic Outlook, 2008

• Since the early 20th century, the US has been the top economic power in the world.- World’s largest consumer market• The US’s economic weight has fallen steadily since 2000.- 2000: 32% 2007: around 25%

• Global Economy is expected to slow down.- Despite a rise in productivity driven by technical innovation, global economic growth will slow overall due to aging population and shrinkage in economically active population

Position of USA till 2008

Predictions in the wake of Current Meltdown

• Emerging economies, including BRICs, are growing rapidly.- Average growth of 6.9% during 2002-2007 (Global economy grew 3.3%)- Weight of BRICs: 5.3% in 1992 12.8% in 2007

• Emerging countries will lead the global economic growth.- US: 2-3% growth (inflow of immigrants and productivity improvement)- Euro: 2-3% 1-2% growth (shrinking labor population)- Japan: 1-2% growth (rapidly aging population)- China: 6-7% growth 4-5% growth from 2020 (declining economically active population & slowing productivity growth)

Position of USA till 2008 (Cont…)

Predictions in the wake of Current Meltdown (Cont…)

• China showed especially fast growth.- Annual average growth of 10% since entering WTO in 2001- IMF predicts China will overtake Japan in 2010 to become the No. 2 economy

- India: 6-7% growth (growing population and productivity improvement) • As early as 2026, China may replace the US as the world’s largest economy.• India is expected to overtake Japan in 2023.• Economic weight of BRICs will continue to rise.- 16.1% in 2010 25.1% in 2020 31.7% in 2030

Position of USA till 2008 (Cont…)

Predictions in the wake of Current Meltdown (Cont…)

• US holds dominant position in all areas that create financial power; financial hub, center of financial assets & institutions.- US holds 56.1% of the world’s financial assets• 34% of bonds (as of 2006)• Stock market capitalization: 4.5 times that of Japan, the world’s second-largest market

• Financial power of Europe and emerging countries will strengthen.- Significant advancement expected in sovereign wealth funds and emerging countries

Position of USA till 2008 (Cont…)

Predictions in the wake of Current

Meltdown (Cont…)

- Among the world’s ten major banks, three are US banks- New York is the global financial hub

• Except for London, most other financial hubs specialize in narrow financial services

• Absolute financial power of the US will weaken but its superior status will continue.- In the wake of the financial crisis, the US financial industry will undergo a temporary contraction

Position of USA till 2008 (Cont…)

Predictions in the wake of Current Meltdown (Cont…)

• US maintains financial power based on its key currency status and advanced financial acumen.- US Dollar Recycling Mechanism• US’s current account deficit Increasing liquidity in countries with current account surplus Swelling foreign currency reserves of these countries Investment in the US

- US will continue to hold competitiveness thanks to large comprehensive financial groups

• Commercial banks & investment banks combined

Position of USA till 2008 (Cont…)

Predictions in the wake of Current

Meltdown (Cont…)

- US has quality workforce, core factor of financial industry • Financial crisis caused contraction in US investment banks.

• Financial power will be divided between the US and Europe.

• Impact of China’s rapidly growing financial power will be limited to Asia

Position of USA till 2008 (Cont…)

Predictions in the wake of Current Meltdown (Cont…)

Changing outlook for 2009

Source : “The Implications of the Global Financial Crisis for Low-Income Countries”, International Monetary Fund, March 2009.LICs = Low Income Countries (WEO: World Economic Outlook)

*

Cont….

Source : “The Implications of the Global Financial Crisis for Low-Income Countries”, International Monetary Fund, March 2009.LICs = Low Income Countries

Note : The Economic Power Index (EPI) represents scores based on the sum of comparative outlook in seven areas (US=100) – economic scale, key currency, financial power, resource-securing capability, science & technology, regional leadership, and global governance.

An Emerging Polarity in Global Structure by 2030Economic Power Index

Global Financial Crisis: A Catalyst for Change in Global Economic Paradigm

• The global financial crisis paved the way for China to shorten by more than two years, from the time necessary to catch up with industrialized countries, including the US.

– The US and Europe underwent “two lost years” due to the financial crisis and Japan for 4-5 years.( IMF,2008)

• Change in key currency and international monetary system

Cont.…• Emerging Polarity– The US maintains the largest clout in the world :

thanks to its defence and technological superiority.

– Once becomes politically integrated, Europe will emerge as a key force in international peace and mediation work on the back of its soft power and new values.

– Backed by its huge economic scale, China will likely play the role of the epicentre of Asia and emerging markets.

Cont…..

• The next 20 years (2010-2030) will be a period of transition in global economic order

– The US hegemony will gradually weaken

– Key variable in the shift of global economic order will be the emergence of BRIC countries, especially China.

Cont….

• The biggest uncertainty shall lay on how China and India will evolve in terms of their diplomatic relations in the future

– The most important variable in this relationship would depend upon how China’s political and economic systems will grow and take shape.

Cost of Bankruptcy…..Bankruptcy – Historical Vignettes • The penalty for declaring bankruptcy in Ancient

Rome was slavery or being cut to pieces. The choice was left to the creditor. By the Middle Ages, the treatment of insolvent debtors had softened considerably.

• In Northern Italy, bankrupt debtors hit their naked backsides against a rock three times before a jeering crowd and cried out, “I declare bankruptcy.”

• In French medieval cities, bankrupts were required to wear a green cap at all times, and anyone could throw stones at them.  

- Source: World Bank, Doing Business in 2004

Restructuring of the Economy : A Remedy

• To promote recovery in a crisis-affected economy, it is essential to link together a restructuring of the financial and the corporate sectors, a so-called rapid sequencing restructuring of the economy.

Dimensions of restructurings

• Asset restructuring

–Acquisitions

–Divestitures

–Spin offs

–Corporate downsizing

–Outsourcing

Cont….

• Restructuring ownership structure, leverage

–Exchange offers

–Share repurchases

–LBO (Leveraged buyouts)

– LCO’s (Leveraged cashouts)

Acquisitions and Restructuring

• Corporate Restructuring – Divestitures (sell-offs versus spin-offs)

• Spin-off Spin-off represents a pro-rata distribution of

shares of a subsidiary to shareholders. Occurs within the hierarchy. Terms and valuation of the assets are set

internally Parent stockholders create new board &

TMT. Parent can maintain ties with spun-off unit.

Cont…

Sell-off Sell-offs: Assets are sold to another

firm for cash and/or securities. Occurs outside the hierarchy. Value determined by market forces. Acquiring firm absorbs and governs

the sold-off assets as part of its hierarchy.

Which way is the best to Restructure……

is always based on the objectives of Restructuring…..

Policy Goals: What States Want From Restructuring 

• ENSURE OPPORTUNITY FOR RESIDENTIAL AND SMALL BUSINESS PARTICIPATION

• ENCOURAGE GROWTH OF EFFICIENT, COMPETITIVE GENERATION OF MARKET

• ACHIEVE BROAD CUSTOMER & NEW ALTERNATIVE SUPPLIER PARTICIPATION

Cont….

• ADDRESS TRANSITIONAL UNECONOMIC “STRANDED COSTS”

• RETAIN SYSTEM BENEFITS (RELIABILITY, LOW-INCOME ASSISTANCE, CONSERVATION & RENEWABLES)

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