The world economy is currently going through a serious financial disturbance that sparked off in the United States and has spread to Europe and the rest of the world. The crisis has already led to the collapse of powerful banks and firms as well as to recession in several countries, some consider such consequences as just the tip of the iceberg and that the worst is yet to come. This paper aims to study the current global financial crisis and its impact on Egypt. To do so, it first presents an overview of the causes and consequences of the current instability, followed by an assessment of the depth of the crisis and its implications on the Egyptian economy, the paper highlights the actions taken by the Egyptian government to cope with the effects of the crisis on the Egyptian economy.
The Nature of The Financial Crisis
The starting of the financial crisis
Spreading of financial crisis
Effect of The Crisis
The effect on USA
The effect on Europe
The Effect on Asia
The policies taken to overcome the financial crisis in different countries
The impact on the Egyptian economy
When did the crisis started to effect the Egyptian economy and which sector started first
Balance of payment
The polices undertaken to overcome the financial crisis in Egypt
Increase the government expenditure
Decrease custom duties and tariffs
Decrease taxes affecting investment
Increase expenditure on public good
Encourage Egyptian entrepreneurs
On the border of bankruptcy many giant investment banks and insurance companies around the globe are losing severely to the stock markets till there was no more liquid money available to finance business activities all due to the Financial Crisis, which is the most grave since the Great Depression in the 1930s.
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In 2008-2009, much of the industrialized world entered into a deep recession due to a financial crisis that had its origin in unprofessional lending practices involving the origination and distribution of mortgage debt in USA
Egypt was not far from this crisis, during the second half of 2008, the financial crises effects start to appear in the Egyptian economy in many fields. This global financial crisis led to slowdown the Egyptian economy due to the global economic recession; Economists expected a decline in the GDP growth rate during 2009, also trade will be affected badly.
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Due to the globalization; Egyptian stock market was affected by the decrease in price per share of the companies that participate in the Egyptian stock market, which affected the investors badly because of huge transactions of selling the shares by the foreign share holder
The Egyptian economists expected a decrease GDP, which lead to problem in financing of some projects. Due to the balance of payment deficit, the Government initiated broadcast tranquility in the hearts of investors, to clarify the steps of successful growth within the economic reform program in previous years. All this factors lead to some expectations; first a sharp decrease in Egyptian exports, foreign investments, Suez Canal and Tourism revenues.
The Egyptian government has taken some steps to face this crisis on the Egyptian economy, such as increasing the government expenditure by 15 billion LE, especially for financing new infrastructure projects. The Government also decreased the taxes and trade barriers to motivate local and foreign investors to invest in Egypt.
But what are the causes of this crisis? And when did it really start? What actions taken to withstand this crisis? How is it going to affect developing countries? We will try to clarify these issues in a simplified manner, by concentrating on Egypt as a developing country.
The global financial crisis
Economists started to anticipate a vigorous financial crisis that would strike the American economy during Ronald Regan presidency, who could be known as one of the prophets and defenders of capitalism, in which he avoided using the methods proposed by the Keynesian school of thought, replacing them with Von Hayek’s free market mechanism, by leaving everything to the market with minimum government intervention, and by saying everything we also include the banking sector, that had been imposed to intense forms of deregulation. (Foley, 2007)
Regan’s regime could be considered as the early development of this financial bubble that is erupting right now, after George W. Bush has accelerated it by promising his voters that he will fulfill the “American Dream” of owning a house, so he gave credit unions, investment banks, and other financial institutions the absolute freedom to give out loans at high rates, these loans had various names such as credit default swaps and subprime mortgages. (Lendman)
Subprime mortgages are new instruments in the financial sector that are manifested to make home ownership chances available to borrowers in the US, not following the traditional rules and regulations investment banks gave those subprime loans, that could also be known as Ninja loans, to borrowers that have; low incomes, no assets, no constant job, limited disposable incomes, and bad credit history. These subprime mortgages are not only considered risky because of the borrowers but also because they are set out on variable interest rates, which will make the monthly payments, paid by the borrowers to vary in monthly basis making it impossible for them to continue on paying their installments. (BLACKBURN)
Financial institutions were giving the credit of these subprime mortgages assuming that property prices shall not stop appreciating in its value. Putting in mind that some borrowers could fail to pay, the banks believed that generally the market would be in its favor. As the prices of housing market started to cool down, leaving the banks with greatly undervalued assets, due to the rising rates of the money market. The banks that issued these subprime mortgages initially, did not actually record them on their balance sheets, instead they packaged them with prime mortgages and a spectrum of other assets, into a mortgage baked security MBS, to be traded in the market. The setback was that assets with dissimilar risk profiles were sold together and on the other hand received an “AAA” grading, making them appealing to global investors especially Europeans, causing the crisis to spread out internationally. (BLACKBURN)
And when these subprime borrowers were no more able to repay their mortgages, the issuing institution “needed to finance the foreclosure with their own money, bringing the asset back on the balance sheet. This left many banks in a financially unviable situation, in a rather short, unmanageable timeframe. And, the fact that nobody knew how much more of those MBS would return on their balance sheets, banks effectively stopped lending to each other, drying up liquidity substantially, both in the US and in Europe.” (McGirr, 2008)
The United States GDP decreased at an annual rate of approximately 6 percent in the fourth quarter of 2008 and first quarter of 2009, versus activity in the year ago periods. The U.S. unemployment rate increased to 10.2% by October 2009, the highest rate since 1983 and roughly twice the pre crisis rate. The average hours per work week declined to 33, the lowest level since the government began collecting the data in 1964. (Gross Domestic Product (GDP) and Corporate Profits)
The European Union GDP decreased by 2.1% from the years 2007 to 2008, which in 2008 the GDP reached 0.9 %, the unemployment rate has increased from 7.2% to 8.5 % in the years from 2007 to 2009, the exports have increased from 1.33 trillion to 1.95 trillion dollars, and the imports have increased from 1.46 trillion to 1.69 trillion dollars, the inflation rate have increased from 1.8% to 3% from 2006 to 2008. (book)
Asia’s GDP decreased by 0.9% from the years 2008 to 2009, which in 2008 the GDP reached 7.6%, the unemployment rate has increased from 7.4%to 7.7%in the years from 2008 to 2009, and the exports have decreased from 49% to 35% of the GDP from the year 2007 to 2008, the imports have decreased from 40 % to 29% of the GDP from the year 2007 to 2008, the inflation rate have increased from 6% to 7.9% from the year 2007 to 2008. (Economics and Statistics)
Policy responses: in USA
To stabilize the financial system, more regulations from the central bank and control on banks, banks Competition should be eliminated like decrease interest rates to increase investment, decrease taxes, to increase investment and productivity and Increase government spending to increase aggregate demand, to increase production, to decrease unemployment. The Federal Reserve’s decreased the fed funds rates after January 1st in 2008. (Late 2000s recession)
President George bush proposed to the government to purchase up to $700 billion “troubled mortgage-related assets” from financial firms in hopes of improving confidence. The first half of the money was used to buy preferred stick in banks instead of troubled mortgage assets. (Late 2000s recession)
In January 2009, the American recovery and reinvestments act of 2009 signed by president Obama to provide a stimulus to the U.S. economy in the wake of the economic downturn.(Late 2000s recession)
The act includes federal tax cuts, expansion of unemployment benefits and domestic spending in education, healthcare and infrastructure. Also, tax cuts led to increase in investment and decrease in unemployment (expansionary fiscal policy).(Late 2000s recession)
The Federal Reserve’s facilitated lending to banks by lowering the discount rate to increase liquidity in banks. (Late 2000s recession)
Part of an effort to increase dollar liquidity around the world the fed coordinated with other central banks to land simultaneously financial institutions (banks) with it cannot lend directly.(Late 2000s recession)
Asia-pacific policy responses
On September 15th 2008, china cuts its interest rates for the first time since 2002 and Government spending plan to invest $586 billion in infrastructure and social welfare by the end of 2010. (Late 2000s recession)
The increase in investment will be in housing, rural infrastructure, health and education, environment, industry, tax cuts. Therefore unemployment will decrease and economic growth will increase and GDP will increase ( as its exports to Europe and USA decrease) so china decrease its interest rates to increase investment , to increase aggregate demand (Late 2000s recession)
Indonesia reduced its discounts rate at which commercial banks can borrow funds for the central bank, on the other hand the reserve bank of Australia injected $1.5 billion dollars into the banking system, meanwhile the reserve bank of India injected almost 1.3 billion, and bank of Japan pumped $29.3 billion in the financial system on the 16th of September 2008. (Late 2000s recession)
European policy responses:
From September, the European commission proposed a 200 billion Euros stimulus plan to be implemented at the European level by the countries and each country got its plan to increase money supply and liquidity. (Late 2000s recession)
The impact of the global financial crisis on the Egyptian economy
During the last two decades Egypt has implemented an economic reform program (ERSAP); this program targets to stabilize the Egyptian economy and achieving a high gross rate. The implementation of this program increased the gross rate to reach 5.9% in 1999/2000 compared to 1.9% in 1991/1992. (Ramadan, 2009)
Effects of The reform have started to appear strongly during the last five years, where the unemployment rate falls from 11.2 % in 2004/2005 to 8.4 % in 2007/2008. Also the foreign direct investment recorded 13.2 billion dollar which represent 81% of the GDP during 2007/2008 compared to 400 million dollar in 2003/2004 which represent 0.5% of the GDP. Egypt succeeded in implementing the right policies to achieve its target where the GDP in Egypt achieved a high growth rates during the last period amounted to 6.8%, 7.1% and 7.2% during the years 2005/2006, 2006/2007, 2007/2008. (Ramadan, 2009)
But during the second half of 2008, the financial crises effects started to appear in the Egyptian economy in many fields. This global financial crisis led to slowdown the Egyptian economy due to the global economic recession; Economists expected a decline in the GDP growth rate during 2009 to reach 4%. Also trade will be affected badly since 75% of Egyptian GDP is from trade divided as follows; about 32% of our exports go to the United States and 32.5% of imports come from United States and the European Union. Economists also expected a sharp decrease in foreign investment, where the two thirds of foreign investment in Egypt during the past two years were from America and Europe. (Abouhbaishe, 2008)
Ministry of Economic Development expects that the net losses resulting from the crisis will be more than 4 billion dollars during 2008/2009. While the most affected sectors will be the industrial sector. Due to the decrease in demand on the products, factories will reduce their production, which reduces the purchasing power of the per capita, leading to stagnation in the market. (Abouhbaishe, 2008)
Egyptian budget will be affected negatively due to several reasons during 2009. First the oil balance will decrease by one billion dollars because the oil prices fell from $ 147 per barrel to 39.5 dollars per barrel, second reason is the sharp decrease in remittances from Egyptians abroad by $ 600 million and the third reason is the decline in tourism revenues by more than 2 billion dollars, which negatively affected all economic activities associated with tourism (Construction – Furniture – food industries… etc). (Abouhbaishe, 2008)
The impact of financial crisis on the Egyptian banking system is limited for several reasons; The integration of the Egyptian financial sector in the global financial system is still limited and the Egyptian banking system did not strongly integrated into the global system. Also the central bank adopted the Egyptian plan for reforming the banking system during the period 2004-2008, which encouraged mergers to create strong banking entities. The controls established by the central bank of Egypt for crediting and lending value to ensure liquidity. Also the Bank’s investments in securities and in mortgage finance were limited, by a percentage not exceeding 5% of the total loan portfolio of the bank. (Abouhbaishe, 2008)
The Egyptian government has taken some steps to face this crisis on the Egyptian economy, such as increasing the government expenditure by 15 billion LE, especially for financing new infrastructure projects. The Government also decreased the taxes and trade barriers to motivate local and foreign investors to invest in Egypt. The central bank adopted some polices, which is strengthening of bank supervision, restructuring, and a cleanup of nonperforming loans to protect the financial system in Egypt. Although actions taken by the government to absorb the crises did not show any results, but this was the best way to take for a small developing country like Egypt. Finally Egypt still has some big economic problems that will continue to suffer from in the next several years. (Ramadan, 2009)