Since September 2008, the World has been gripped by a financial crisis that has overshadowed the two earlier crises: food and fuel. While the first two crises were caused by the persistent rise in cost of oil and food for months, the financial crisis was caused by unsafe exposure of financial institutions to loans that were not well assessed.
The financial crisis has been latent and was just a matter of time following the creation (about four years ago) of abundant liquidity and low interest rate by the US Federal Reserve. In response to this excessive liquidity, banks packaged loans for all sorts of people including those with bad credit records. This created a bubble in the credit markets and the real estate. Financial Institutions borrowed short and lend long.
An obvious inducement for this lending is the high interest rate. The first sign of default emerged when financial services innovators repackaged and securitised these loans and hit exchanges with it. When real estate prices began to fall, the number of defaulters increased. This resulted in the collapse of sub-prime lending (a type of loan that is offered at rate above prime to individuals who do not qualify for prime rate loans).
Though other credit market segments (prime mortgage loans, commercial real estate, leverage loan) also could have been the precipitator, sub-prime collapse was a contagion on them. The attendant results of this scenario are the spiraling problems now called the global financial crisis.
What started as a downturn in the
Surprisingly however, African leaders have stood aloof and behaved as if the continent is immune to the crisis. According to World Bank, the GDP growth projection in developing economies for 2009 is now likely to be 4.5% instead of the earlier projection of 6.4% . This shows the possibility of the crisis being contagious. Whether the African economy has the capacity and character to absorb the crisis is far from obvious.
Of course there is hardly any domestic mortgage market in
This is the experience in
The above trend is noticeable already in capital markets around
In early December 2008, ASI had declined from 66,271 to below 33,025, representing $89.2b and $50.3b in market capitalization respectively. This represents almost a 50% decline. Though this free-fall in ASI predates the crisis, the crisis further accentuated the loss of confidence which have made many capital market investors to exit, even in loss.
Perhaps, the long-term effect is the meltdown impact on African exports in terms of production, employment and revenue accruable. African economy being monolithic and largely dependent on extractive resources is a sure bet to suffer. Prices of nature-sourced resources are dwindling amidst decreasing demand. Oil prices, for instance, have plunged below $40 and are still falling, from a record $147 months ago.
The Organization of the Petroleum Exporting Countries (OPEC) has cut output by 1.5 million barrels per day. This has happened at a time when there were cuts in production in countries like
In Platinum market, Lonmin Plc, a major player in
As developed countries’ economies experience recession, loans and grants, which form a sizable chunk of developing world national budgets, will fall. Also, there will be a fall in remittances which have over the years become an important source of foreign exchange earnings for African countries. Receipts on tourism will reduce.
Several African countries are experiencing macroeconomic imbalance. This raises palpable fears of this crisis ending in human tragedy. High food and oil prices have pushed an estimated 100 million people into extreme poverty. More are being added to this number as growth rates decline. If this crisis is not timely addressed, less and less money will be available for education, health and other services.
The concern on how safe
Recently, it has dipped further to $55.254billion and there are no signs that this downward slope will stop soon. Amidst official denials that the global recession would not affect Nigerian economy, the local currency (Naira) has continued its free-fall in foreign exchange market.
In view of declining crude oil prices, several governments (particularly oil producing countries) might resort to raising all forms of taxes in order to meet the shortfall in revenue. This will be counterproductive in the longer term, as it will lead to more tax evasion rather than the increase in fund being envisaged.
One lesson learnt is for business managers to play less with financial innovation in which the associated risk is not well assessed. Growth aspirations should commensurate with organizational ability. Any defaulting board or management should pay for the risk. This is why they were highly remunerated in the first place.
Government rushing-in with aid to underwrite for mismanaged businesses creates incentives for mismanagement elsewhere. If this continues, such a government will crash under its weight. Direct state assistance in such matters does two things. First, it uses taxpayer’s money to correct the private mistake of some. This disincentivises both the management and the shareholders of better-managed firms. Secondly, it creates an impression that some firms are ‘too big to fail’, and will be bailed out by government. This apart from undermining innovativeness reduces the pressure to raise fresh capital.
It is economic folly for
Direct government intervention will create bigger problems in the longer term. The downward trend in the
An economy grows when entrepreneurs innovatively respond to market signals. Governments will do well by removing prohibitive taxes and regulations that distort this signals.
By Olusegun Sotola
Sotola is a Research Fellow with the Initiative for Public Policy Analysis, a public policy think-tank based in