Impact of the Global Financial Crisis on Developing Economies - Philippines - Case Study Example

Impact of the global financial crisis on developing economies – Philippines Name Course code Instructor Date Introduction In September 2008, an American bank with global investments called Lehman Brothers was publicly declared insolvent, after it file for bankruptcy protection. The incident heralded subsequent bankruptcies and takeovers of other banks and financial institutions across Europe and the United States, and to small extent Australia (Yap et al. 2009; Brown & Davis 2009). This sent significant shocks across the global financial system, including in the thriving economies in East Asia. The spread of the financial crisis can be explained by the Contagion theory, which suggests a situation where the collapse of currency in one country triggers financial or economic crisis to happen in other countries (Kogid et al. 2009). Consequently, many other Asian economies like Singapore, Japan, Malaysia, Philippines, and Hong Kong witnessed significant economic downturn (Yap et al. 2009). At this point in time, the financial crisis, which has origins in the United States subprime mortgage market spiralled into a global recession. In respect to the Philippines, the Philippine banks had initially tended to have relatively conservative attitude, which should have contributed to marginal effects of the crisis on the economy but this was not the case. Indeed, when compared to other East Asian economies, the economic growth of Philippines has been slow, following the crisis (Yap 2009; Yap et al. 2009). This essay argues that while Philippines had at the onset of the 2008-2009 financial crisis withstood the global financial unrest better than most economies in East Asia because of its conservative policies, the situation had some risks on the country’s asset markets, financial sector, foreign exchange market, real sector and macroeconomic balance. The effects of the crisis on Philippines’ asset markets The financial crisis slowed foreign investment into Philippines by leading to significant capital outflows. The financial crisis triggered virtual freeze in liquidity across the financial markets in the United States and Europe, which led to the setback of capital flows to the developing countries – among them Philippines (Yap et al. 2009). The direct effect of the liquidity squeeze on international capital markets included increased price of risk, greater levels of volatility of the exchange rate volatility, and declined equity prices. In the case of Philippine, the stock market could have recorded minimal effects of the global financial crisis but this was not the case. Despite this, the exchange rate also showed volatility as the national currency depreciated by up to 16.6% in November 2008 against the United States dollar. The exchange rate movements, as a result, affected the profitability of exporters instead of the demand for the exports (Yap et al. 2009). The Philippine equity market also faced significant pressure during the 2008financial crisis relative to the declining global economic outlook. Indeed, the uncertainties surrounding the financial crisis and the associated decline of the global economy led to increased risk aversion, leading the foreign and domestic investors to release their holdings of stocks. Consequently, the stock market faced a declined capacity to raise fresh capital in 2008 in Philippines. Indeed, after the Lehman Brothers collapsed, the Philippine Stock Exchange Index (PSEi) also plummeted significantly in September 2008 extending further to around 48.3 percent at the end of 2008. The decline was in reflection of the movement of equity prices globally, following the heightened risk aversion and uncertainty. The financial crisis slowed investment in Philippines, as investors in the country stock market became more cautious during the crisis (Yap et al. 2009). Still, the exporters’ profitability had an effect on their employment decisions and investment decisions. In turn, this led to employee layoffs, particular in foreign-owned firms, and minimal investment by the foreign firms. The exchange rate movements also had effects on the inclination to import, the level of protecting import-substituting industries, as well as the value of Philippine’s national currency (peso) relative to the remittances from overseas (Guinigundo 2009). Effects on Philippine’s financial sector The initial effects of the global financial crisis on asset markets put pressure on the developing countries’ financial markets, including that of Philippines. The economies with high involvement of foreign investors, and which depended significantly on short-term foreign currency funding, as well as those that operated an external current account deficit reported significant effects. Examples of economies in East Asia mostly affected included Indonesia and Korea, as they witnessed harsh foreign currency liquidity shortages, which led to sharp decline in their national currency rates (Yap et al. 2009). However, for an economy with low involvement of foreign investors, and which depends less on short-term foreign currency funding, did not report significant effects. In fact, towards the end of 2008, the banks in Philippines continued to report comparatively high rates of return on assets and equity, despite failing to experience rise in impaired assets (Guinigundo 2009). The performance reflected marginal exposure of the banks in Philippine to the noxious structured mortgage products that pervaded the international market. Another reason for this is that the Philippine businesses focused on the domestic market, which means that their profitability of Philippine remained comparatively high in 2008 (Yap et al. 2009). Effects on Philippines foreign exchange market The Philippine currency weakened further against the US dollar at the onset of the financial crisis. Indeed, the currencies of the major East Asian emerging markets, including in China and Hong Kong, had suffered significant decline against the US dollar. The resultant significant capital outflows by foreign investors put pressure on the foreign exchange market (Goldstein & Xie 2010). This reflected the increase in demand for dollar liquidity consistent with the massive capital outflows that happened in Philippines in 2008 (Guinigundo 2009). Indeed, it is estimated that averagely, the volume of transactions in the foreign exchange market increased significantly between September and October 2008 (from roughly $ 777 million to $876.2 million in that order) after the Lehman Brothers was declared bankrupt. This suggested an increase in pressure on the dollar liquidity in the foreign exchange market during the start of the crisis (Yap et al. 2009). Consequently, the Philippine currency weakened further against the US dollar at the onset of the financial crisis, even as there was an increased risk aversion because of market uncertainty after the infectious impacts of the US financial disorder and its subsequent effects on the global economy. Effects of crisis on Philippines real sector The Philippine economy slowed down in 2008 particularly due to a sharp rise in inflation. An additional factor was the significant decline in fixed investment, construction activities, and personal consumption expenditures. The investment in public construction had also declined by nearly 0.4 percent in 2008. It has been observed that the effects of the crisis manifested themselves during the fourth quarter of 2008 and deeper into 2009. The manufacturing sector also experienced 29.2 percent decline in exports in the period (Yap et al. 2009). Similar decline in exports was noted in its Asian trade partners like China. This slowed both countries’ export-led economic growth (Kyophilavong 2012; Cudia 2012). A possible explanation for this is the decrease in consumption due to inflation (Yap et al. 2009). An additional effect was the turnaround in the service sector, as it was spared the harsh consequences of economic downturns. Still, the coordinated recession in the world’s major economies, as well as the global credit squeeze continued to unfavourably affect the Philippines exports, FDI, and domestic private investment. For instance, the share of the country’s exports to the United States declined to 16% in 2008 from 34% in 1998 (Yap et al. 2009). The effects on macroeconomic balance The global financial crisis also had effects on the Philippine macroeconomic balances. In 2009, the national government’s fiscal deficit was expected to expand to 3.2 percent of the GDP, although the targeted amount was 0.5 percent in July 2008 before the crisis (Yap et al. 2009). An explanation for this was that there were expectations that the deficit would expand, and that the Government was rather indisposed to reduce expenditures during a period when the economy was steadily slowing down. The government later expanded the budget by 15% in 2009 compared to a 6 percent in 2002, while seeking measures that could address the adverse impacts of the crisis. In addition to the requisite government expenditure needed to resolve the crisis, the Philippine Government had to contend with weak revenues. Hence, the ratio of the taxes to the GDP remained low. For these reasons, the fiscal deficit reached more than P111.8 billion in a record four in 2009 in comparison to the P25.8 billion in 2008 (Yap et al. 2009). Furthermore, because of Philippines’ trade structure, the sharp decline in imports corresponded with the fall in exports. Additionally, the private sector flows in the country’s external account decreased, hence contributing to deterioration in its capital and financial account. This led further to decline in the stock prices and the national currency (Yap 2009). Conclusion While Philippines had at the onset of the 2008-2009 financial crisis withstood the global financial unrest better than most economies in East Asia because of its conservative policies, the situation had some risks. The financial crisis slowed foreign investment into Philippines by leading to significant capital outflows. It also slowed exports. In turn, low exporter profitability led to employee layoffs, particularly in foreign-owned firms, and minimal investment by the foreign firms. The exchange rate movements also had effects on the inclination to import, the level of protecting import-substituting industries, as well as the value of Philippine’s national currency relative to the remittances from overseas. The crisis slowed investment in Philippines, as investors in the country stock market became more cautious during the crisis. Consequently, the Philippine currency weakened further against the US dollar at the onset of the financial crisis, even as there was an increased risk aversion because of market uncertainty after the infectious impacts of the US financial disorder and its subsequent effects on the global economy. The crisis also led to inflation, which slowed Philippine economic growth, leading to a decline in fixed investment, construction activities, and personal consumption expenditures. The global financial crisis also had effects on the Philippine macroeconomic balances. However, since the Philippine economy has low involvement of foreign investors, and depends less on short-term foreign currency funding, its financial and banking sector did not report significant effects. In fact, towards the end of 2008, the banks in Philippines continued to report comparatively high rates of return on assets and equity, despite failing to experience rise in impaired assets. 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