ARE WE IMMUNE FROM THE CURRENT FINANCIAL CRISIS?

For the past few months, international media has been following the developments in the global financial market and their effects on the “credit crunch” or the current financial crisis. However it’s only very recently that our media got aware of the crisis and started paying attention on the twists of the crisis. In the past week and in this week I had seen some reports on the crisis and its effects on our country, published on some news papers. They even went on quoting some prominent business people in Maldives, about what they think of the crisis and its effects on our country. Cabinet has also discussed about the issue in its last sitting.

Background of the crisis:

According to some financial analysts, the build up to the crisis rooted back to late 90s and early 2000s. The risky mortgages (usually referred as subprime mortgages in financial contexts) that made by US lenders in late 90s and mostly in early 2000s, and the subsequent securitization of those loans led to the crisis.

For various reasons, lenders were encouraged to make high volume of subprime or risky loans to individuals without sound proofs of credit worthiness. These individuals were only delighted to take up those offers with their unstable employment and income flows. Unfortunately the economic conditions in US got worsened, and through mid-2004 to mid-2006, US Federal Reserve increased the interest rate repeatedly causing those borrowers to default on their loan repayments.

When those borrowers defaulted on their loans, it wasn’t only the initial lenders who got in trouble. Through securitization, the initial lenders transferred those loans to other investors in the first place. Investment banks, hedge funds, wealthy individuals etc invested heavily in those loans (actually they invested in asset backed securities issued through securitization process but the return on those securities depend on the repayment of the loans). Some financial institutions invested a relatively large proportion of their funds in those securities. So the default of the borrowers put those investors on the verge of collapse.

Ultimately in August 2007, the crisis broke up with the collapse of a major US investment bank. From then we have been seeing the crisis continuing with surprising twists. In recent weeks it got worse than before and resulted many large financial institutions and hedge funds being bankrupt in various countries. Merely a financial crisis at the start has turned into a real economic crisis posing concerns over economic growth, employment etc. It’s for this reason we can’t shut our eyes on the crisis saying it’s a problem to be dealt with developed countries and international community.

Implications of the crisis for our country:

Unlike the developed countries, financial institutions in developing countries don’t seem to have a significant exposure to those “bad” securities. Hence our local bank and overseas banks in Maldives are safe to some extent. However the crisis has made it really difficult to get credit or funds in the international financial markets. So the banks in our country may suffer because of the limited or no funding from overseas to finance their lending activities. Apart from this I can’t see a direct impact of the crisis on our banks.

However we may have some serious indirect consequences which can send our economy into a slump. As I said before the crisis has taken a new twist causing real danger for economic growth and jobs in developed countries. Any slowdown or problems in the economies of our major tourist markets will be a problem for us. Europe and Japan being our major tourist markets can’t continue sending tourists to our country if their economies keep on deteriorating. So the current financial crisis can have potential negative effects on our tourism sector. Any Maldivian can imagine what will happen if the tourism sector performs badly or its income goes down.

Secondly any negative impact on our main donors like Japan will reduce the amount of foreign aids we get in the future. More than those foreign aids, the foreign direct investments (FDI flows) into our country may get reduced. This will be very harmful to our economy, especially in a time when we are badly in need of those FDI flows to undertake large projects which can potentially create many jobs. These FDIs are also important to maintain our foreign exchange reserves.

These are the main implications I can think of now, but as the crisis continues it may pose new threats and concerns to our economy. I think it’s high time that the government and tourism sector start thinking about this and plan how to tackle the problems. And this again highlights the danger of not having a diversified industrial base in our economy and depending too heavily on tourism sector.