Global Financial Crisis : Impact on EAC Economies

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Global Financial Crisis Impact on EAC Economies

• A Presentation to the East African Business
  Council Workshop on the Global Financial Crisis.
• Arusha, Tanzania
• Njuguna Ndungu
• Governor,
• Central Bank of Kenya
• March 4, 2009

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What is the Global Financial Crisis all about?

• The genesis of the crisis can be traced to the
  availability of cheaper credit in the world
  financial system since 2000.
• The situation encouraged banks to undertake
  riskier projects. They were riskier because their
  true risks were not analyzed or appropriately
  priced.
• Specifically, mortgage lending to borrowers who
  in ordinary circumstances would not have been
  eligible for these facilities pushed up housing
  prices -sub prime mortgage
• While housing prices were on the rise,
  institutions could easily realize the underlying
  security.
• Further, institutions that originated the
  mortgages would securitize them i.e. issue
  mortgage backed securities that other
  institutions would then invest in.

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How has it manifested itself in the World?

• The housing bubble burst house prices declined
  in the United States and it became harder to
  realize mortgage securities.
• Financial institutions that invested in mortgage
  backed securities found themselves holding
  worthless assets.
• The crisis escalated against a backdrop of lack
  of trust between institutions as the exposures to
  these assets amongst the various institutions
  could not be ascertained.

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How has it manifested itself in the World? -cont

• This resulted in a credit and liquidity crunch as
  well as loss of customer confidence. The effects
  have spread to consumers who are uncertain about
  the future and firms which cannot access credit.
  At the household level, the households that
  acquired these mortgages have found themselves in
  negative net worth.
• The crisis The financial crisis led to a
  liquidity/ confidence crisis which led to an
  economic crisis hence economic recession.
• But what is disturbing is that we do not seem to
  be at the bottom- markets still jittery and
  falling. The guarantees and bailouts do not seem
  to have calmed the market or work as fast as
  anticipated

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What channels of effects on EAC?

• Two rounds of shocks
• First Round Effects Financial in nature
• Exchange rates Depreciation
• Rundown on international forex reserves
  (cushioning mechanisms on BOP reserves did
  their job)
• Short-term capital outflows (flight to saftey)
• Sell off at the Stock Market
• Second Round Effects economic in nature
• Slow international demand of commodity exports
• Decline in tourism
• Slow down in FDI and ODA
• Risk averse credit market
• De-globalization

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First Round Effects of GFC

• Exchange Rate depreciation since Sept 1, 2008
• Global dollar liquidity was driving general
  depreciation worldwide

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First Round Effects of GFC -cont

• Exchange rate fluctuations
• Pressure on currencies as a result of the global
  financial crisis as foreign investors fled to
  safety while consolidating their finances to
  meet their obligations abroad.
• The US dollar perceived by investors as a safe
  haven. During tough economic times, investors
  often flee foreign currencies and other risky
  assets for safe havens like the US dollar. The
  increased demand for the US dollar drives its
  price up relative to other currencies.
• In EAC countries - the market-determined exchange
  rate acted as an automatic stabilizer during this
  crisis.
• But there is a forex market as well as market
  misapprehension.

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First Round Effects Stockscont
Stock Market decline (From September 1, 2008)
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First Round Effects Stockscont
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First Round Effects Summary cont

• Official Foreign reserves have gone down, however
  banking sector forex reserves seems to be holding
  
• Official forex reserves seems to have mainly gone
  down due to revaluation.
• Since EA imports are not mainly in US dollars.
  Current forex levels can still purchase more
  imports
• Developing new measure. Trade weighted import
  cover
• Overall impact of First Round Effects
• No significant impact though relative price
  movements expected
• No general panic in East African markets
• Toxic assets in East African Countries None

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Second Round Effects Tourism

• Tourist arrivals have fallen significantly (a
  result of both political (early 2008) and Global
  Crisis (late 2008))

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Second Round Effects Exports

• Demand for Kenyan exports may decline.
• The recession in North America and Europe
  triggered by the credit crunch may reduce demand
  for Kenyan export goods
• This however depends on where the markets for
  Kenyan exports are and the price and income
  responsiveness of the goods being exported.
• Exports to the region (EAC, COMESA) will remain
  steady with minimal negative impact in the short
  run
• Exports to the Middle East and Asia will suffer
  minimal effects.
• Exports to North America and Europe might be
  affected but the size of negative shock will be
  dependent on the price and income responsiveness
  of goods being exported to these economies.
  Exports of essential commodities (vegetables, tea
  and coffee will be resilient).

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Second Round Effects Exports - cont
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Second Round Effects Exports - cont

• Exports to the region

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Second Round Effects ODA and FDI

• Donor Flows
• Are donor flows going to the affected? If Yes
  then
• What is the effect of reduced Aid flows to EA
  countries on (i) private consumption (ii)
  Government expenditure (iii) public investment?
• Countries who are more aid dependent will be hard
  hit? How will this affect exporting Countries in
  the region?
• FDI
• Which countries rely heavily on FDI?
• Where are the sources of FDI? Regional or OECD
  region? Will the region benefit from Chinese FDI ?

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Second Round Effects Risk Averseness

• Risk averseness during uncertainty
• Are banks restricting lending during the slowdown
  ?
• Are export sectors, tourism sector perceived to
  be risky by the banks ?
• Self fulfilling prophecy about economic prospects
  ? (A feeling on neighborhood effects)
• Are firms laying off workers ?

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Second Round Effects Risk Averse
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Second Round Effects Remittances

• Remittances they are pro-cyclical with domestic
  events and also depend on whether the recession
  will be protracted
• remittances are increasingly being viewed as an
  important source of finance for investment.
• It is difficult to judge the remittances
  currently compared with the previous years
  without having similar events (e.g. Kenya
  electioneering period in 2007 or Safaricom IPO).
• Falling commodity and oil prices and the rising
  US dollar have increased the purchasing power of
  remittances, allowing migrant workers to send
  less money home with similar impact.

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Risks and Opportunities EA region

• Risks
• Reduced foreign aid
• Reduced FDI
• Reduced Export earnings
• Trade Restriction (de-globalisation)
• Economic slowdown
• Opportunities
• Economic potential of the Region will continue to
  attract FDI
• EA as an investment destination (Arab and Chinese
  investors)
• The high interest rates may attract hot money,
  reduce pressure
• A need for good ratings from agencies give
  confidence for FDI

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Mitigations

• Can only intervene on local issues (rule out
  exchange rate interventions in FOREX market)
• Monetary stimuli ( Kenya already reduced CRR and
  CBR) to ease credit restriction
• Fiscal stimuli to be considered in June Budgets
• Shovel ready projects rural roads, laying of
  broadband cables, refurbishing schools and rural
  hospitals and dispensaries,
• Infrastructure Bonds to finance energy, water,
  roads etc
• Coordinated Bank Supervision

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Mitigations Measures the Government is Taking to
Contain the Situation

• Continue with the spending programs as approved
  by Parliament but giving higher priority to the
  much needed infrastructure investments (which
  will serve as a fiscal stimulus to the economy)
• Cutting costs of doing business (Mombasa Port
  24hrs, reduction of road blocks between Mombasa
  and Malaba etc government/private sector
  initiatives)
• Infrastructure bonds for investment and
  development. IB provides funds for infrastructure
  development that also stimulate savings and
  investment thus growth
• Improvements in productivity
• Reducing Infrastructure bottlenecks, lowers
  transactions costs to the private sector and
  enhances their profitability

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Mitigations Diaspora Bonds

• Investment Vehicles for Diaspora
• Diaspora bonds could give an opportunity to East
  Africans abroad who on average have a higher
  income than their home counterparts.
• Diaspora bonds are a way for tapping into the
  considerable wealth of East Africans abroad.
• East Africans in the Diaspora might have
  different risk perception of the home country
  than foreign investors.
• Having a credible Diaspora Association can be an
  attractive vehicle for investment and confidence.

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Investment

• The investment plans outlined in respective
  governments long term Visions will crowd in
  private investment.
• Massive investment in infrastructure (financed
  through the sovereign bonds and infrastructure
  bonds) will act as an economic stimulus to the
  economy.
• Perhaps the traditional donor lending and donor
  pre-conditions can be endogenised

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Growth Prospects for 2009

• Regional growth prospects for 2009, though
  predicated on how severe the recession in Europe
  and US will be, are better then many other parts
  of the World.
• Information available indicates that companies
  are building up inventory stocks, firms are
  importing machinery, transport equipment and
  intermediate goods.
• Portfolio and capital flows to emerging economies
  with macroeconomic stable environments will
  recover. Eastern Africa will be among those
  countries

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The Banking Sector

• The Central Bank of Kenya has enhanced its
  surveillance of banks especially on capital
  adequacy, liquidity risk management, forex
  exposure and market risks. These areas have been
  identified as possible conduits for global crisis
  to cause distress in financial institutions.
• The Central Bank has already stepped up its
  surveillance of banks foreign exchange exposure
  with daily reporting from October 2008. The daily
  return is an indicator as to the exposure levels
  which should consistently not exceed the
  stipulated 20 of core capital.
• Reforms to regulate and supervise investment
  banks

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Synergies

• Consolidate regional bank supervision
• Drive for higher forex reserves- 6 months import,
  step in the right direction (This will also
  provide investment opportunities)
• EA integration process essential
• Common markets
• Monetary Union
• Common capital markets
• Balance sheet of the Central Bank to be protected

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Role of Private Sector

• Keep economic activity going
• Sacrifice Take higher risks and accept lower
  returns.
• Minimise staff lay-off
• Infrastructure bond in Kenya- an avenue to invest
  retained earnings and create a cushion
• Communication
• Keep channels of communication with Government
  open
• Bur provide innovative and targeted advice for
  intervention.
• Innovations
• More emphasis- market place is where innovations
  take place (they have returns)
• Diversification of exports to cope with new
  challenges

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THANK YOU