Despite the continued efforts of the central banks around the globe the global liquidity crisis is on the rise and getting worse. Some say, it is fall of US economic imperialism. Others term it resultant of greed and open market mechanism.
It has become hot topic in ongoing presidential candidate's debates in the USA. USA, Britain, France, Italy, Japan, China, Germany, and many countries of Latin American are worried about the global economic meltdown due to persistence global liquidity crisis.
They are all trying to seeking a common strategy to combat with this economic/financial situation. Emerging market countries are turning to the International Monetary Fund to help shore up confidence in their financial systems strained by a global credit crunch. Hungary, Ukraine, Serbia and Iceland all signalled to the IMF.
It has started blame game and India, Brazil and South Africa slammed rich nations for ongoing global liquidity crisis.
It has already caused large drops in many international stock markets/equity markets and our stock exchanges are not any exemption.
The Sub prime mortgage crisis ($588 billion loss till September 30), the 2000s energy crisis, an inability to secure loans led to the September 15, 2008 decision by Lehman Brothers Holdings, Inc. to file for bankruptcy, the buyout of Merrill Lynch by Bank of America, and concerns over the American International Group (AIG) ending in that company's bailout by the Federal Reserve System on September 16 are supposed to be some of the main reasons in large stock market crashes, prompting large infusions of cash by central banks around the world.
Diversified & integrated efforts/policies
According to the Economist, London, China cut its interest rate for the first time since 2002. Indonesia reduced its overnight repo rate, at which commercial banks can borrow overnight funds from the central bank, by two percentage points to 10.25 per cent.
The Reserve Bank of Australia injected nearly $1.5 billion into the banking system, nearly three times as much as the market's estimated requirement. The Reserve Bank of India added almost $1.32 billion, through a refinance operation; it's biggest in at least a month In Taiwan, the central bank on September 16, 2008 said it would cut its required reserve ratios for the first time in eight years.
The central bank added $3.59 billion into the foreign-currency inter-bank market the same day. Bank of Japan pumped $29.3 billion into the financial system on September 17, 2008 and the Reserve Bank of Australia added $3.45 billion the same day. The European Central Bank injected $99.8 billion in a one-day money-market auction.
The Bank of England pumped in $36 billion. Altogether, central banks throughout the world added more than $200 billion from the beginning of the week to September 17. On September 29, 2008 the Belgian, Luxembourg and Dutch authorities partially nationalised Fortis. The German government bailed out Hypo.
Formation of global liquidity
According to IMF, derivatives account for 75 per cent of global liquidity which is 802 per cent of global GDP. The scrutinised debt is 13 per cent of liquidity which is 142 per cent of world GDP. Then broad money supply, at 11 per cent and 122 per cent, and finally central banks at 10 per cent of global GDP and just 1 per cent of liquidity. (see table)
Global equity markets
All major global equity benchmark indices are under great stress. It hit a 52-week low on September 29-30, 2008, due to global credit/liquidity crisis, which has slowed down the world economy.
The global stock market value plunged to $42.21 trillion on September 30, 2008, from a high of $62.57 trillion on October 31, 2007, losing almost $20.36 trillion in market capitalisation.
The value of the US equity market has dropped by $5.13 trillion (26.94 per cent) to $13.92 trillion, while the United Kingdom's market cap plunged by $1.49 trillion from its high to $2.72 trillion. France witnessed value erosion of $ 1.11 trillion, while Germany's market value dropped by $773 billion from its 52-week high during the period.
Asian stocks fell the most from their 52-week high, witnessing value erosion of $6.35 trillion, compared with the decline in the US and European markets. Among the Asian markets, the Indian market was the worst hit, registering a 51 per cent drop ($914 billion) in its market capitalisation from $1.81 trillion on January 10 to $894 billion on September 30 this year.
The federal reserve efforts
The central bank of the USA has recently restarted its efforts to ease the global credit squeeze. It requested other central banks to pump hundreds of billions of dollars of liquidity into stressed financial markets.
A new auction program for commercial banks and brokerages, which will be able to swap thinly traded mortgage securities and other collateral for safer Treasury obligations, has been announced. The Fed also said it has authorised increases in its existing temporary reciprocal currency arrangements or swap lines with the European Central Bank and the Swiss National Bank.
The Fed will provide up to 30 billion dollars to the ECN and six billion to the SNB, representing increases of 10 and two billion dollars, respectively. The move is coordinated with the ECB and SNB along with the Bank of Canada and Bank of England. The central banks around the globe are announcing specific measures to deal with the liquidity crunch in the global system.
It is hope that the new lending auction is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally.
SBP's policy initiatives
The SBP reduced the Cash Reserve Requirement (CRR) by 200 basis points in two phases in order to ease the current liquidity squeeze and provide a relief to banks. It is expected that overall Rs61 billion will be released into the banking system. The banks are facing huge liquidity shortage for the last few days and during last week, the overnight call rate also reached to 40-48 per cent due to the rising demand by the banks.
The SBP has also taken strict notice of the unwarranted recent increase in overnight call rates and has advised banks to act prudently in sharing the liquidity in the system to ensure call rates are reflective of the fundamentals in the money market.
Integrated policies
(a) Proper and complete documentation of economy. A good percentage of available liquidity is not deposited in the formal financial sector due to the existence of huge black market/informal sector in the country which should be streamlined.
(b) Rationalisation to government borrowing from the central bank and commercial banks.
(c) Reduction in banking spread which is highest in Pakistan in order to attract more domestic savings.
(d) Stabilisation of macro-economic conditions and upgrading of Pakistan's credit ratings.
Insurance industry
According to Pakistan Credit Rating Agency (PACRA) due to ongoing global financial crisis pressure is mounting even on the insurance sector, which may impact its growth prospects, profitability and liquidity, undermining its overall financial strength.
The ongoing international financial crisis would bring domestic insurance sector under pressure. It now faces major challenges arising from various socio-economic risks, including stock market turbulence, rising trend in the interest rates, widening fiscal and trade imbalances, and worsening security conditions.
Concluding remarks
It is obvious that domestic banking industry is strong enough to observe the recent liquidity church shocks. Some individual banks having very high advance to deposit ratio may be facing difficulties; but by and large the big network banks, as well as middle tier banks are not facing difficulties. Sincere efforts are needed to restore the confidence of local and international investors to invest in the country. Prudent banking practice is essential.
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