What is going wrong with Sri Lanka, Pakistan and Turkey's Economy ? (International Economics)

 

WHY SRI-LANKA IS EXPERIENCING ECONOMIC CRISIS?

Sri Lankan economy has been facing with the shortages of the foreign exchange currently and the major reasons of the economic slowdown in Sri Lanka are:

1.     Tourism Industry has been affected badly by COVID and the Foreign Reserves depleted causing imports to rise

                                               

Ø  Tourism industry accounted for 10 percent share of GDP in Sri-Lanka prior COVID 19, but due to the pandemic tourism industry halted and the shocks are seen this time.

Ø  The earning from the foreign reserves dropped drastically from 7.5 Billion USD in Fiscal Year 2019 to 2.8 Billion USD in the end of July, 2020.

Ø  With shortage of Forex reserve to import goods (even for basic food supplies) the foreign currency had to be purchased and with this the domestic currency of Sri Lanka, Rupee depreciated by 8 percent.

 

2.      Mr. Rajapakshe's decision to ban chemical fertilizers on agricultural production and to make Sri Lanka 100 percent organic state in agro based production

 

Ø  According to the Food and Agriculture Organization – 2021, tea, rubber, coconut, and spices are the major agricultural exports of Sri Lanka and rice is the largest agricultural production in there. So the anti-chemical fertilizers law, Sri Lankan experts stated that the tea production was reduced in half and causing others crops also to reduce their respective production.

Ø  The traders in Sri Lanka are hoarding the essential food supplies and selling those food products at high prices. The army is authorized to seize food supplies from the traders and supplying it to consumers at fair prices.

Ø  Also the foreign exchange reserves are used for the purchase of the essential goods. Sri Lanka's central bank has been prohibiting the traders for exchanging more than Rs. 200 for an USD and stopped traders from entering into the forward currency contracts.

Ø  The government of Sri Lanka has refused to end its aggressive push for complete organic farming claiming that the short term pain of going into the organic system would be compensated by its long term benefits. It has also promised to supply farmers with the organic fertilizers as an alternative.

IS THE ACTION TAKEN BY SRI LANKAN GOVERNMENT IN RESPONSE OF THE CRISIS IS A GOOD STEP?

Ø  If we analyze the situation, the step taken by Sri Lankan's government to continue with the organic law is seen to increase the food prices even further because there would be the drastic drop in the production of the food products and also the shortages of food products (demand of the food products would be more than supply) would be there.

Ø  Also, in addition to this the decision by Sri Lanka's central bank to halt the forward contracts at the spot trading above 200 rupees to an USD also can affect in the essential supplies (for example: a food trader who wants to pay more than Rs. 200 for an USD to import the food product may be no longer to carry out the trade. And also without forward contracts which helps the traders mitigate the currency volatility onto professional speculators, many traders may be unwilling to import the essential food supplies.

 

 

 

WHY PAKISTAN IS FACING ECONOMIC CRISIS?

Presently the economic health of Pakistan is not up to the mark. The inflation is surging high over there. The current account deficit, deteriorating foreign exchange reserves and the currency depreciation have been the major cause of the crises.

The major causes have been the domestic and global factors of pandemic that is affecting the economy.

·         The foreign exchange reserve in Pakistan

According to the report published by State Bank of Pakistan on November 19. 2021 the Foreign exchange reserves stood USD 22.77 billion. Out of this, USD 16.25 billion has held by the central bank and the rest was with the commercial banks.

The reserves of the central bank declined by USD 691 million during the last week o9f November, 2021 due to the external debt repayments.

·         Economic Growth in Pakistan

The annual economic growth in Pakistan was 5.8 percent in the year 2018, but it decreased to 0.99 percent in the 2019, and further it decreased to 0.53 % in 2020. This led eventually to deplete in the current account. As it is evident that a persistent high deficit can cause to the excess supply of a country's currency in the foreign exchange market, which further leads to deplete the nation's currency.

·         BOP crisis and IMF bailout

Due to the BOP crisis because Pakistan was unable to finance its import bills or to service its external debt. Pakistan has been importing most of the items on the domestic consumption and this has increased the debt service obligations, which have made the situation even more worse. The current account of Pakistan deficits in September and October have been way larger than anticipated, reflecting both rising oil and commodity prices and improving the domestic demand. The burden of adjusting to these external pressures, as the central bank of Pakistan's monetary policy statement in November is noted that it has highly fallen into the rupee.

In the year 2019, Pakistan sought rescue from the IMF and it is reported in the last four decades Pakistan has 13 times bailed out by the IMF.

For the current period, it is reported that 750 million in IMF special drawing rights (around USD 1 billion) will be available to Pakistan, taking total disbursements to about USD 3 billion.

Also Pakistan is going to withdraw tax exemptions and subsidies, increase in levy on petroleum products, raise the power tariffs, and to audit USD 4.1 billion "extra funds" that is to be lent to Pakistan in April, 2020 due to the pandemic.

·         The Deal with Saudi Arabia

Pakistan undertook USD 3 billion loan from Saudi Arabia in November 27, 2021. The loan amount was agreed to keep in the Pakistan's central bank. In 2018 Pakistan had undertaken from S. Arabia USD 3 billion loan and out of which about USD 1 billion was disbursed.

It is also reported that Pakistan is about to get USD 7 billion from 3 other sources within the next 60 days, including the USD 3 billion in deposits from S. Arabia, a USD 1.2 billion Saudi Oil facility with deferred payments, a USD 800 million Islamic Development Bank oil facility. However, the ministry of Pakistan is stating that all of these would be enough to lessen the pressure on the import bills.

But, the loan from Saudi Arabia comes with a rigid interest rate of nearly around 4 percent can lead the situation to dilemma.

·         Inflation is Skyrocketing in Pakistan

In November, 2021 the inflation of Pakistan mounted to 11.5 percent from 9.2 in October. The prices of the food items such as fresh fruits, milk, and chicken increased to their highest levels. The regressive domestic policy in Pakistan focusing on " to systemically penalize the production of high value products by focusing support on wheat and sugarcane". As a result, Pakistan remains an importer of the horticultural products, dairy products despite having massive number of animals producing below potentials, and cotton to feed the domestic textile industry.

 

 

WHY IS TURKEY FACING ECONOMIC CRISIS?

 

Current Economic situation in Turkey

In Turkey, these days the price of medicine, milk, even toilet paper are soaring. The Petrol pumps have been almost closed due to the high prices of the petroleum products. The cost of living in Turkey has skyrocketed and the 25 percent of the youth have been unemployed. Turkey also has a huge debt and due to the losses in the value of the Turkish Lira, the situation has been even more worsened.

Cause of the Economic turmoil in Turkey

The causes of the situation are –

·         The president of Turkey Erdogan is quite rigid to lower down the interest rate and due to this the inflation in Turkey has reached to 21 percent currently. The president has threatened the central bank of Turkey to keep inflation in check and set the interest rate again.

 

·         The Turkish Lira on November 2020 was 7 to one Dollar ($) and currently in the month of November 2021 it has surged to 14.3 to one Dollar ($). The price of the imported goods keep on rising.

 

·         President Erdogan’s strategy to undertake expensive infrastructure projects enticed foreign investors and encouraged businesses and consumers to load up to a debt back in 2003 A.D. During the first decade of his reign Turkey was experiencing an economic miracle, however, Erdogan’s dream to ever expand led him to go towards the disaster and towards unsustainability. Rather than pulling back the borrowing for the ambitious projects still continued.

 

·         President Erdogan is also insisting that high interest rates cause inflation, even though it is low interest rates that put more money into circulation, encouraging people to borrow and spend more, and tend to increase price. This is the statement by Erdogan. But, in actual terms it is not true. He is continuously pushing the state bank of the Turkey to offer cheap loan to the households and businesses so that the borrowing can continue in Turkey.

 

Economists’ viewpoint on Erdogan’s rigidity and their solutions

Economists argue that by keeping the interest rate low consumers will be more eager to keep shopping and business will be more inclined to borrow, invest the amount in the economy and hire workers. He also stresses that if the Turkish Lira loses value against dollar Turkish exports will be simply cheaper and the foreign consumers will want to buy more. Economists say that this is theoretically true, but, when it comes to Turkish imports, it has high imports on the automobile parts, medicine, fertilizers, fuel, and other raw materials. And when the Turkish Lira depreciates even more further it is certain that those imports are going to cost high. This aspect is ignored by Erdogan.

To be refrain of the basic economic theory it has discouraged the foreign investors in Turkey as well.  Foreign investors were eager to provide loan to the Turkish businesses but now they are afraid of the currency depreciation. And eventually the low interest rate will lead to rise inflation even further.

Economists suggest that to solve the present context the interest rate should be risen for now so that the economy could be corrected. They suggest that the economy should not be looked by President Erdogan solely and his dogmatic beliefs should not interfere the functioning the economy (President used to say that the interest charge is against the Islamic law and violates the Islamic precepts). They also say that the suggestions from the foreign nations should be taken instead of blaming those for the price rise. 

 

Source: Analysts at Indian Express, The Hindu, New York Times, and Forbes.

Thank You

Aditya

Plz, laud with comments.

WHY THE FEDERAL RESERVE IS PLANNING TO RISE THE INTEREST RATE IN THE FUTURE ? (International Economics)

 

Why Fed is going to do so ?

The Federal Reserve is the central monetary authority to the largest economy of the world, the USA. After the pandemic of the COVID-19 almost all the countries experienced a slowdown in the economic growth and the USA being one of the largest economies, was not free from its impact. The general rule of Economics is that whenever the economy is alarmed to the situation of the crisis such as asset bubbles, hyperinflation, or any economic catastrophic crash downs, the central monetary authority (Fed in the USA and NRB is Nepal) tends to raise the interest rate so as to ensure the economic and financial stability. Doing this could help the economy move on its track.

Controlling the interest rate is one of the significant tools for which any central bank has privilege to deal with it. The governor (popularly known as the Chair) of the Federal Reserve, Jerome Powell on December 15, 2021 proclaimed to increase the Federal Funds Rate (also called as the Federal funds target rate) for the coming economic time. Powell seemed quite confident to set a target range for the federal funds rate through the meeting of the Federal open market committee. This rate would be the rate of reference or the base rate for the commercial banks to charge on their overnight loans. The average of the rates that banks negotiate for the overnight loans in the effective federal funds rate. This is seen to impact the other rates such as, the SOF rate and the prime rate.

Why do we bother if Fed raises the interest rate?

We must do it, because, as we know, this change in the interest rate by Fed can influence the interest rate throughout the global economy. It is a general rule of economics that when the interest rate in increased the cost of credit is also increased and it definitely impacts the entire economy. And the impact is assessed when every business tycoons and even people spend more of their money for the interest payments. Those who do not take the courage to pay such higher interest rate, they for sure, postpone their projects or their business undertakings and financing. This can lead people to save money for the higher interest payments. This eventually tends to decrease the supply of the money or the flow of credit in the economy and help curb the inflation. One of the reason behind Fed is doing this is also to control inflation in the future which is skyrocketing these days (6.8 percent – November, 2021).

Impacts into the various sectors and economic domain

The impacts of it on various sectors is resembled as –

·         Impact on Stock

According to the rule of thumb, higher market interest rate lays a negative impact on the stocks. The cost of doing business raises for the general people and business tycoons rises when the borrowing is very expensive. The higher value of costs and less growth of the businesses results in the low growth of the revenue and eventually the price of the stock declines. Some social psychologist proclaim that the rate surge can affect the market psychology and as far as the trading is concerned the traders can immediately sell the stocks to move towards the defensive investments. This can create distortions in the stock market indices.

·         The impact on the Bond

The market prices of the existing bonds decline quickly when the Fed announces the increase in the interest rate. This is generally because the new bonds will be soon coming into the market that will offer investors higher interest rate payments. For the reflection of the higher overall rate, the existing bond will decrease in price and that will eventually lead for the low interest rate payments attracts the investors even more. The economist Chan quotes that the inflation also degrades the actual face value of the bond, which seems to be the particular concern for the longer maturity debts.

·         Impact on the Saving Account and Deposits

The people with a saving account can be quite happy with the surge in the interest rate. Because in the USA the funds rate of the Fed is also a benchmark for a deposit account’s annual proceedings yields. Whenever the open market committee raises the rates banks increase the amount that people earn from the deposit accounts. The annual percentage yield that people earn on the savings accounts, checking accounts, certificate of deposit, and money market accounts also rises to the higher level. The online savings accounts are more reacting to the increase in the Fed rates due to the fierce competition for the online deposits among the online banks. However, the annual percentage yields by conventional bricks and mortar banks respond very slowly to the increase in the Fed rates.

·         Impact on the credit to the consumer

The consumer credits like personal loans, line of credit, credit card, respond more quickly to the increase in the Fed rates. The Fed rate is also more sensitive to the variable rate loans as the interest rate charge are in with the base with the federal funds rate.

Impact on Nepalese economy

The Nepalese economy is heavily reliant on the Indian Economy and the Chinese economy and relationship with the economy of the USA (only 1.2 percent of the total trade of Nepal with the world is in trade with USA), it is in a very small amount. However, major companies in the USA and their brands which are sold in Nepal are surely going to be affected by this. We can also say that it can affect the External Commercial Borrowings in Nepal from the USA. The research is yet to be done in detail regarding this.

 

Note: Please, laud with comments.

Thank You

Aditya Pokhrel

MBA, MA Economics, MPA (rng)

Asst. Director         

Nepal Rastra Bank (the central bank of Nepal)

 

References: Speech by the Chair, Jerome Powell – The Federal Reserve (2021)

                  Connell and Curry (2021) – Economists at Forbes