World financial crisis and challenges for Georgia

Davit Narmania – Doctor of Economics, Professor of Georgian Institute of Public Affairs (GIPA), Executive Director of Caucasian Institute for Economic and Social Research (CIESR)

Scientists and researchers of the economy name the following factors causing the crisis:

· Common circulation of economic developmet;
· High prices on raw materlias (inc. oil);
· Exhausting of the stock exchangs;
· Exhausting of credit market followed by US mortgage crisis;
· Application of new, unpracticed financial methods and instruments alike credit default swaps and other.
Common financial and banking crisis in USA has been preceded by high risk mortgage lending crisis in 2007 (subprime), in other words crediting persons with low income and negative credit history. After 20% landslide of the prices, American landholders grow poorer by 5 trillion dollars3. In October, 2008 American financier George Soros (George Soros, 1930) called the mortgage problem “mortgage soap bubble” and defined it as “stimulus mechanism for bursting the larger bubble”. HE prognosticated weakening (slump) of the US economy and high growth of Chineese economy. From his words, “While we were accumulating debts, they (Chineese) were saving and growing richer. After some time Chineese will own most part of the world, as they turn their dollar reserves and shares into real assets. This may cause redistribution of forces. As a result of sins commited by America in the last 25 years the power will be redistributed to Asia”4 .
Bernard Madoff (Bernard Lawrence Madoff, 1938) – former head of NASDAQ, is accused in misappropriation of 50 milliard US dollars by speculative scheme of his pyramide. In 1960 he founded private company Nernard L. Madoff Investment Securities LLC. He was the head of the company until FBI (Fedetral Beurou of Investigation) arrested him for financial machinations.
Crisis in construction and real estate sector has been automatically reflected in other fileds and by means of a chain reaction it has caused aggregate recession: the increase in the number of unemployed people, declining demand on construction materials, banking crisis and etc. Despite quick response of USA to crisis and its crisis managing so called Paulson’s plan (Henry Merritt Paulson, 1946, USA incumbent minister of finances), by that time the it has already spread in other fields and countries. In 2008, banks stopped lending the money for purchasing cars. Consequently, sales volume of auto giants like Opel, Daymler and Ford decreased and these companies cut the volume of car producing also.
Slump in stock exchange and crash of investment banks
In October, 2007 stock exchange market indexes riched its peak, followed by the slump: after 3 October, 2008 by the time when US Congress’s House of Representatives on the second hearing approved Paulson’s plan, S&P 500 Index dropped by 30%; Index MSCI World, which shows dinamics of developed country markets, slumped by 32,3%; MSCI Emerging Markets Index fell by 40,5%. In constrast to the drop of 2000-2002 ( which was caused by the crash of technological companies on stock exchange and was limited only to US markets) 2007-2008 years drop concerned every country. It was defined by the boom and next following crash in credit and domestic sectors and in raw materials’ sector lately. Initially there was a dip in the share price of western banks. Mining industry companies’ stocks of developing countries slumped after fast price reduction on oil. In 6-10 October of 2008 were the days of maximal slump of the indexes in US in the history: Dow Jones Industrial Average (DJIA) dropped to 7882, 51 and closed at 8451, 195. In October 2008, the slump of stock exchange for USA was record braking for the last 20 years, and all-time in the history of Japanese Market.
Financial times compared the 10 October of 2008, Friday, slump of stock exchange with 10 October of 1938: “Friday morning trade S&P 500 Index slump was almost identical to the slump of the year 1938, 10 October”6.
Bank Lehman Brothers declared bankruptcy. Together with it, four leading banks changed their current activities: Bear Stearns sold, Lehman Brothers bankrupted, Merrill Lynch sold, and Goldman Sachs and Morgan Stanley stopped their activity as investment banks, due to high risks and necessity of receiving support from Federal Reserve System.

Global financial crisis: Timeline of events7

2007:
– Liquidity crisis emerged on August 9, 2007.
– Northern Rock sought and received a liquidity support facility from the Bank of England on September 14, 2007.
– Record high US stock market on October 9, 2007 with Dow Jones Industrial Average (DJIA) at 14,164.
2008:
– January 2008 stock market volatility.
– On February 22, 2008 Northern Rock was taken into state ownership.
– Bear Stearns takeover in March 2008.
– Federal takeover of Fannie Mae and Freddie Mac.
– Global financial crisis of September-October 2008 beginning with the Bankruptcy of Lehman Brothers.
– Large losses in financial markets worldwide throughout September- October 2008.
– Emergency Economic Stabilization Act of 2008 was passed.
– The three major banks of Iceland were nationalized. Banks in several other countries were partially nationalized.
– October 24, Pre-Washington Summit held in Beijing between European Union and Asian states.
– October 26, IMF offered lines of credit to several states, including $16.5b to Ukraine, and sizable loans to Hungary and Pakistan.
– October 27, Hong Kong stock market crash with stocks falling another 13%.
– October 28, Hong Kong stocks rebound at 15%.
– October 29, Hungary received $25 billion rescue deal.
– November 20, US stock market Dow Jones Industrial Average (DJIA) 7,507.

Paulson’s Plan

US Finance Minister Henry Paulson, together with the representatives of FRS and Congress finished working on Emergency Economic Stabilization Act of 2008, which lately has been called Paulson’s plan8. The mentioned plan implied to make an appropriation in amount of 700 milliard US dollars in order to help banks. The special state corporation would purchase problem assets from banks. The plan included three main tasks: (1) Program of purchasing problem assets; (2) Tax benefits for business and population; (3) Encouragement of energy field. On 1st of October USA Senate accepted the plan, and on 3rd of October congress approved it. US president signed the plan on 5th of October and the formation of corporation has been started. Ed Forst was assigned as a head of the corporation (Edward C. Forst, 1961), former managing director of Goldman Sachs Group Inc. In 25th of November, 2008 it became clear that Federal Reserve system intended to invest in US banks 800 milliard US dollars, in order to stimulate consumer retail crediting. Declared program implied buyback of credit in amount of 600 milliard US dollars by Federal Reserve System, which were credited and guaranteed by Fannie Mae, Freddie Mac, Ginnie Mae hypothec agencies and consumer credits of federal banks.
Paulson’s plan caused discontent of part of the experts and congressmen. It concerned sources of means and such results of money emission that could cause US currency devaluation. From their point of view, instead of purchasing problematic assets from banks, it would be more effective to create hedge fund, which would insure against losses from these assets banks and other financial institutions. Besides that, according to research conducted by influential publishing “The Forbes”, Henry Paulson together with Bernard Medoff, founder of financial pyramid, were named as one of the first swindlers of 2008. The main subject to criticism is the fact that Paulson’s plan doesn’t imply monitoring of the means assigned by Federal Reserve System9.

Dow Jones Industrial Average – DJIA

Dow Jones Industrial Average Index is one of the main indicators of world financial crisis. The above mentioned index is one of the oldest working Industrial Indexes and it bears names of the founders – Charles Henry Dow, (1851-1902) and Edward David Jones, (1856-1920). Index was created in 1896 in order to analyze US stock market industrial components. The first index was published on May 26th of the same year. At present, thirty biggest and diversified companies participate in index formation process (Boeing Co., Chevron Corp., Coca-Cola Co., General Electric Co., General Motors Corp., JPMorgan Chase & Co., McDonald’s Corp., Microsoft Corp., Procter & Gamble Co. ect.). However, its word industrial bears only historical meaning and most of the companies participating in index formation have nothing in common with the industry10. As Dow Jones Index is the oldest in USA, it unifies leading companies. Financial crisis has started from USA, that’s why this index is the main indicator of financial crisis11. Initially Dow Jones Index was calculated by arithmetical mean of 12 member companies’ stock prices. In the list of the mentioned tvelwe companies only General Electric surirved up to now. Lately the number of the member companies increased up to 30. At present time, the old methodology index calculation is replaced by a newer one and it is calculated via scaled average: stock price is divided by divisor, which changes all the time when stock price varies. By means of this methodology index is invariable in case of inner stuctural changes of the stocks (stocks’ buy-sell activities inside the company). Dow Jones Index is calculated by the following formula:
DJIA=Óp/d, where Óp is total value of the stocks, and d – changes in the stocks’ price of index.
Crisis impact on Georgian economy and existing challenges
Coming out from the broadly developed international affairs, crisis initially started in USA rapidly spread all over the world, especially in the countries which have some economical relations with USA (incl. Georgia). Aa Georgian economy is the part of world economy, financial crisis had its negative affect on Georgian economy too. In terms of world financial crisis today Georgian has to face many challenges. Initiall results of the crisis in 2009 are already visible and its aggravation throughout the year is inevitable. We can sort out those fields and indicators in Georgia, which experience negative impact of financial crisis in the following way:
· Economical growth delay
Global financial crisis caused deceleration of the economy in every country. It especially decreased demand on luxuries , such as cars and other goods. This caused decrease in GDPs of world’s leading countries. Assets of the wealthy have decreased considarably and some of them even became bankrupted. Population started to spend with care. In the previous years the main factors defining economical growth in Georgia were private capital flows from abroad (direct foreign investments and bank credits) and permanent growth of budgetary funds12. Consequently decrease in foreign investments and bank credits impedes the economical growth in 2009. According to Georgian government prognsis before the world crisis nominal GDP would make up 21535,9 million Laris, but after rvealing crisis results government prognoses 21308,7 million Laris (decrease makes up 227,2 million Laris, that is 1,5% of early prognosed GDP). Real GDP was supposed to increase by 4,0%. However, at present time, after crisis rsluts show that its growth amounts to 2,5%. The same real GDP growth in 2008 will amount 2,5%, instead of supposed 8%13. Actual situation can be more pesimistic and it would only be possible to reach 2% growth by applying to financial sources from donors in order to ensure high aconomical activity.

· Decrease in Investments
Investments started to decrease in Georgia after August war events. At the current stage there is a trend of investment reduction caused by global financial crisis. This is also connected with exhausting of major units list offered for sale, nevertheless small units cannot lay a key role in this aspect. In 2008, Georgian received investments in amount of 2,17 milliard US dollars, according to government’s prognosis in 2009 Georia will manage to attract 1,7 milliard $ investments14. However, it’s enough to provide few example to understand that government is rather over-optimistic:
Ö After famous August events, and against the background of financial crisis Kazakh company “KazMunaiGaz” – refused to invest planned 1 milliard US dollars in Georgia. The company was planning to construct oil-refining factory in Batumi;
Ö American company “Clear Stream Holding” renounced declared investments in Georgia. Company purchased WiMAX frequency at 9 million 300 thousand dollars and was planning to build-up wireless internet service. According to company’s Georgian partners project is deranged and “Clear Stream” won’t pay the sum at the end of the November15.
The government’s plan of economical stimulation, that includes infrastructure investing, will arouse considerable percentage growth of total GDP consumtion and state purchasing. On the other hand investments start to decrease and this inequility leads us to even more challenges. Delays in the industry increase negative balance between export-import and accordingly the negative export rate raises.
· Decrease in budget receipts
As a rule, decrease in GDP and investment flow are the main factors of budget receipts reduction. In addition to this, key role is played by budgetary losses caused by the tax reduction (income tax rate reduction from 25% to 20%). Despite the ebow mentioned factors government expects growth of aggregate budget receipts. This expectation is quite optimistic and it exceeds previous year rate by 46,5 million Laris and amounts to 5510,2 million. On the background of considarabely decreased economic activities it is possible to expect budget receipt reduction.
· Banking system problems and international financial resources rise in the price
The lack of financial resourses of the banks became a worldwide challenge. In addition to this bankraptcy of the world’s giant banks, which were granting financial recources for many banks took its effect. Consequently, interest rates increased on banking resources and their availabillity declined. Most of Georgian banks were receiving financial resources from foreign countries and then lending out money at a higher rate of interest to Georgian clients. Because of interest rate lessening policy failure in USA, followed by the mass non-payments, still stable financial banks couldn’t apply such policy. This is the reason why we shouldn’t expect financial market rate decrease in the nearest future.
Only in 2008 banks started to land out money at a high rate of interest, and this was defined by international credit rate increase and high rate of real inflation in Georgia. Credit boom of the past years and inadequacy of deposits and credits terms was arousing banking risk strengthening16. If we take into consideration that Georgian banks mostly were lending out mortgage debts (to construction companies for real estate construction; and to corporate and physical bodies for purchasing of real estate), it became too risky to lend out money to construction sector. Due to trend of advance in prices, gradually populations buying ability is decreasing and fewer people apply to the banks to receive credit at high interest rate. Lots of construction companies are on the verge of bankruptcy or reducing their activity, which means that they also rarely apply banks for a credit. Owing to crisis in various fields, banking sphere became one of the most vulnerable fields in Georgia and is rather hard up. Consequently, banking system is in a tight box in this year, especially during first six months we should expect considerable changes in state of affairs.
· Price increase and consumption restraint
World financial crisis followed by price increase and therefore restraint of consumption (exceptions are oil, oil products and some other goods). This trend will continue in the nearest future too.
Nowadays, Georgian population’s basket of goods mostly consists of imported products. Inflation rate in our trade partner countries is quite high. High prices will be provoked by some measures taken by Georgian government, just like in 200817. As a result, we should expect high increase in prices and its rate will be much more than governments’ expected 7, 0%18.
· Growth of unemployment and poverty
Only after August well-known events, and lately during the period of financial crisis aggravation many employees lost their jobs. Because of reduced crediting in the banks especially suffered construction and car trading businesses. Actually construction activities were simply stopped. Due to problems in banking system, banks considerably reduced their credit portfolio. Hereupon, several thousands of employees lost their jobs in various banks and construction companies. Therefore, already high unemployment rate increased even more. In the recent years poverty was growing in Georgia continually. Only before August events and the start of global financial crisis, the number of people living below the minimum of subsistence level was more than a million. On the background of increased unemployment and high prices on consumer products, we should expect poverty level increase this year.
· Response to challenges
As we see, Georgia is facing considerable challenges caused by international financial crisis. In order to minimize the problem it is necessary to ensure immediate and corresponding response to them. Government’s anti crisis plan carries only declarative and it portrays always-changing presentation tabled on governmental sitting. Government should work out and elaborate actual anti crisis plan, discuss it with experts, donor organizations, and other interested parties. Afterwards it should be divided into active plans and monitored continually. Besides this, government’s analytical team should conduct analysis of international events, in order to face new challenges in 2009 prepared. Georgia should adapt to changes happening in international financial sector. Moreover, Georgian National Bank should play a key role in this. It should be strengthened institutionally and help to strengthen financial sector in Georgia.
Government should consider the problems as a whole and instead of taking spontaneous measures; it should start taking consecutive measures. Priorities must be clear and oriented on economical growth of the country. From a pure economical point of view, in this year conduct of any kind of elections and spending budgetary or other financial resources on it would be fatal for Georgian economy. It is necessary to spend money received from donor organizations systematically. Country’s government should remember that planned 4, 5 are not only a help and big part from it should be returned in few years and with corresponding interest rates.
owadays, all eyes are turned to world financial crisis and its negative aspects. Particular emphasis is placed on USA, as it is the originator of the world financial crisis. USA hypothecary market crisis was one of the main reasons of the world crisis. On the modern scientific language this crisis is called world bank and finance crisis, which took a start in the summer 2007 (July). However, the reasons that caused the crisis can be found in the earlier periods. In the summer 2007 the world’s leading financial indexes (Dow Jones, NASDAQ, DAX, S&P500, NIKKEI ecr.) started to slump1. USA and world financial system main index – Dow Jones slumped from 14200 points in July, 2007 to 7500 point in November 2008 (see below the more detailed description of the index). Fast-paced construction in USA up to 2007, with inadequate high prices, hugh volume of investments and use of improper methods of mortgage lending, caused gorging of USA real estate market and landslide of prices, followed by the solid loses for investors. The situation became complicated, because banks were lending out the mortgage credits at a low rate of interest and in most cases without participation. As a result, the mass non payment began that caused serious challenges for the banking sector. In addition to this, the unprecedented high prices on oil played its role that worked out 140 US dollars and more per barrel of oil in early July, 2008. Some of the experts believe that the second reason of crisis togather with mortgage crisis, was the artificially high prices on oil. This view is mostly presented by American experts, who do not wish to admit that the main reason is uncomprehending financial policy of US government’s economic team.
“The world financial crisis aggravation was caused by weak response of the government to the procceses”, declared Princton University professor researcher and Nobel Prize Laureate in 2008 Paul Krugman (Paul Robin Krugman, 1953). From his words, “The main reason of crisis aggravation is the weak response of the government on every stage that caused lost of trust and gave stimulus to crisis”