mmediate impacts of the crisis
Global Development Finance 2009: Crisis impacts
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What began in the summer of 2007 as an extended period of financial turmoil caused by the losses in the U.S. subprime mortgage market, erupted into a full-blown and global financial crisis in mid-September 2008, precipitated by the failure of the investment bank, Lehman Brothers. The realization that such a key player in the international financial system could fail shook the confidence of bankers, investors, and households alike and reverberated rapidly throughout the global economy. The initial loss of confidence in the financial system provoked a liquidity crunch in the interbank market (these events and their implications for financial flows to developing countries are discussed in further detail in chapter 2). Banks became extremely reluctant to lend to one another, and liquidity dried up rapidly, causing spreads between the interest rates banks charge each other (LIBOR, or the London Interbank Offer Rate for overnight funds) and what they expect to pay central banks (the overnight index swap rate) to jump to unprecedented levels (see first figure shown here). Uncertainty about the future and fears that the crisis could provoke a deep recession or even depression skyrocketed, evidenced, for example, by some 4,500 stories about the financial crisis and its potential negative effects appearing in major English-language print media in September 2008 (see second figure shown here). The sudden drying up of liquidity and increased uncertainty also yielded a change in the pricing of risk throughout the global economy. Interest rate spreads on riskier assets, including the bonds of firms in developing- and high-income countries, and, to a lesser extent sovereign states, increased substantially (see third figure shown here). Increased risk aversion, a reassessment of growth prospects, and the need for firms and investors in high-income countries to strengthen their balance sheets resulted in a large-scale repatriation of capital from developing countries. As a consequence, stock markets the world over lost between 40 and 60 percent of their dollar values—the currencies of almost every country in the world depreciated against the U.S. dollar—implying a massive loss in global wealth.( see 4th figure shown here). Successive interventions by authorities in both high-income Europe and North America (including substantial efforts by the Federal Reserve in the United States to intermediate directly between banks) have helped restore short-term liquidity. As of end-May 2009, interbank spreads are down some 350 basis points since September 2008 in the case of the United States and by 200 basis points in the Euro Area. This, plus the fact that there have been no additional failures of major financial institutions or significant currency crises, has brought about a near-stabilization and even improvement in financial conditions over the period since March 2009. Spreads on developing-country bonds have narrowed (see fifth figure shown here), with the market now distinguishing better between the risks posed by different countries. At the same time, stock market valuations are regaining ground in a number of countries. Still, conditions continue to be tight and markets nervous. Interbank spreads remain above historical levels, and the IMF estimates that only a third of all financial sector losses have been booked at this stage (IMF 2009b). Similarly, developing-country spreads remain high, and, even though the base rates against which these spreads are calculated have declined in response to the post-crisis relaxation of monetary policy in high-income countries, yields and borrowing costs for developing-country firms have increased substantially—doubling in some cases—with potentially important effects on debt sustainability and the profitability of future investment (see below). . http://web.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTDECPROSPECTS/EXTGBLPROSPECTSAPRIL/0,,contentMDK:20370624~menuPK:659161~pagePK:2470434~piPK:4977459~theSitePK:659149,00.html

A protracted recession Global Development Finance 2009: Risks Available in: Français, Español, 中文 Given the severity of the downturn, its synchronized nature, and the weakened state of the world’s major financial institutions, there is much more than the usual level of uncertainty surrounding future prospects. As the recent outbreak of a novel form of influenza in Mexico serves to remind us (see Potential economic impacts of the A H1N1 flu outbreak), the world’s economy is at a particularly vulnerable juncture, where an event that might otherwise have carried relatively minor economic consequences could have a much broader impact. Not all of the uncertainty concerns the possibility of slower growth, although the economic and human costs of a deeper or more protracted recession are most troubling. One upside scenario concerns the possibility that private sector confidence and the financial sector respond more robustly and more quickly than is assumed in the baseline. Under such circumstances, the fiscal and monetary stimulus already in place could provoke a more rapid recovery than anticipated, which could rekindle inflationary pressures. In this scenario, the authorities would be forced to respond with a relatively quick tightening of policy measures that could induce a second round of below-potential growth toward the end of the projection period. The main downside risk to the outlook is that the confidence and wealth effects of the financial crisis are much more persistent than in the baseline, and that the consolidation efforts of banks constrain lending more durably. In this scenario, second-round effects intensify—including rising unemployment and the bankruptcy of firms that might have survived a milder recession and unemployment. Instead of recovering somewhat during 2010, global investment could decline by another 5.5 percent, with the sharpest contractions in those countries experiencing the most marked reversals in capital flows and in investor confidence. In this scenario, the projected rebound in private consumption would be much weaker due to slower income growth and higher savings, notably, in high- and middle-income countries where households have more discretionary income with which to maneuver. As a result, instead of rebounding as in the baseline, global trade would continue to decline, intensifying the pressures on the most vulnerable middle-income countries (those with current-account deficits in excess of 10 percent of GDP). In the protracted recession scenario reported in table 1.10, this causes severe currency crises characterized by sharp exchange-rate depreciations and even more significant reductions in domestic spending in many economies. Overall, this scenario implies that the fall in world output in 2009 would be deeper than in the baseline because the recovery expected in the second half fails to emerge. Output would stagnate in 2010, before rebounding by 3 percent in 2011. World trade volumes would fall a further 4.7 percent in 2010, bringing global trade volumes almost 17 percent below 2008 levels. In this scenario, GDP in developing countries would register a very modest 2.0 percent increase in 2010, with the bulk of the weaker performance concentrated in Europe and Central Asia, where GDP is projected to decline by an additional 1.5 percent. Not all countries in the region would be affected equally, and several (such as Latvia, Lithuania, and the Russian Federation) are projected, even in this downside scenario, to experience stronger growth than in 2009. Table 1.10 A protracted recession (percentage change from previous year, except interest rates and oil price) 2007 2008e 2009f 2010f 2011f Global Conditions World trade volume 7.5 3.7 -11.9 -4.7 5.8 Real GDP growth e World 3.8 1.9 -3.6 -0.4 3.0 Memo item: World (PPP weights) f 5.0 3.0 -2.4 0.2 3.8 High income 2.6 0.7 -4.8 -1.2 2.2 OECD Countries 2.5 0.6 -4.8 -1.2 2.1 Euro Area 2.7 0.6 -5.3 -2.8 1.7 Non-OECD countries 5.6 2.4 -5.8 -1.2 4.2 Developing countries 8.1 5.9 0.5 2.0 5.5 East Asia and Pacific 11.4 8.0 4.2 3.9 7.5 Europe and Central Asia 6.9 4.0 -5.8 -1.5 3.0 Latin America and Caribbean 5.8 4.2 -2.7 0.2 3.1 Middle East and N. Africa 5.4 6.0 3.0 3.4 4.5 South Asia 8.4 6.1 4.0 4.7 7.6 Sub-Saharan Africa 6.2 4.8 0.2 0.6 5.3 Memorandum items Developing countries excluding transition countries 8.2 5.9 1.2 2.4 5.7 excluding China and India 6.1 4.5 -2.2 0.3 3.7 Source: World Bank. Note: PPP = purchasing power parity; e = estimate; f= forecast. a. GDP in 2000 constant dollars; 2000 prices and market exchange rates. b. GDP measured at 2000 PPP weights. next page Permanent URL for this page: http://go.worldbank.org/N6GGDYE8V0

Exchange rates and inflation
Global Development Finance 2009
The intensification of the financial crisis in September 2008 inspired a significant reversal in capital flows, away from developing countries and toward high-income countries, notably the United States. The need to repatriate liquid assets to cover losses elsewhere and an increase in home bias on the part of global investors, caused the currencies of almost all developing economies to depreciate against the U.S. dollar. The collapse in commodity prices also played a role in exchange-rate depreciation for developing commodity exporters, such as Argentina, Brazil, and the Russian Federation, and also for high-income commodity exporters such as Australia and Canada. In the immediate aftermath of the crisis, only a few currencies appreciated or held their ground against the dollar, among them the Chinese renminbi and the currencies of several oil exporters that are pegged to the dollar. Many developing countries depreciated by 20 percent or more, but the extent of depreciation was much less severe in real effective terms—because most currencies depreciated against the dollar simultaneously.7 The depreciation of developing countries’ currencies has meant that the local currency price of many commodities fell much less sharply than the dollar price of these commodities. For example, the Brazilian price of internationally traded wheat and oil fell by 12 and 25 percent, respectively, between July 2008 and February 2009, contrasted with a drop of 25 percent and 65 percent in dollar terms. In addition, the depreciations have increased the local currency cost of servicing dollar-denominated debt. While depreciation will improve the competitiveness of affected countries, the extent to which this can be translated into increased exports will be diminished by the depressed state of world demand. 7 The real effective exchange rate is an index of a country’s exchange rate with that of its key trade partners (weighted by export and import shares) and corrected for inflation differentials. next page

Most developing country currencies depreciated sharply against the majors Percentage change, year-on-year Sources: World Bank and International Monetary Fund. Note: USD/LCU: Exchange rate expressed as dollars per local unit (an increase implies appreciation of the local currency); REER: the real effective exchange rate (increase implies an appreciation of the local currency in real terms versus all countries).

Outlook summary

Global Development Finance 2009: Outlook summary

The financial crisis that erupted in September 2008—following more than a year of financial turmoil—has become a global crisis for the real economy. Economic activity in high-income and developing countries alike fell abruptly in the final quarter of 2008 and in the first quarter of 2009. Unemployment is on the rise, and poverty is set to increase in developing economies, bringing with it a substantial deterioration in conditions for the world’s poor and most vulnerable. The outbreak of the financial crisis provoked a broad liquidation of investments, substantial loss in wealth worldwide, a tightening of lending conditions, and a widespread increase in uncertainty. Higher borrowing costs and tighter credit conditions, coupled with the increase in uncertainty provoked a global flight to quality, caused firms to cut back on investment expenditures, and households to delay purchases of big-ticket items. This rapid increase in precautionary saving led to a sharp decline in global investment, production, trade, and gross domestic product (GDP) during the fourth quarter of 2008, a trend that continued in the first quarter of 2009. The sharpest declines in economic activity were concentrated among countries specialized in the production of durable and investment goods and in countries with serious pre-existing macroeconomic vulnerabilities. This suddenly very weak international environment accelerated the fall in commodity prices that began in mid-2008. By end-May 2009, oil prices were down 60 percent from their peak and non-oil commodity prices, including internationally traded food commodities, were off 35 percent. Lower food and fuel prices have cushioned the poverty impact of reduced activity to a degree and helped to reduce the pressure on the current accounts of oil-importing developing countries, even as they reduced surpluses among developing oil-exporters by as much as 17 percent of GDP. Policy reactions to the crisis have been swift and, although not always well coordinated, have so far succeeded in preventing a broader failure among financial institutions, and thereby avoided a much more severe collapse in production. In the absence of public-sector assistance, the massive losses suffered by investment banks and other institutions would have forced commercial banks to sharply reduce lending—forcing firms to cut back on investment and production even more forcefully. Instead, bank lending continued to grow until very recently, although much less rapidly than in the past. These policy measures have not been costless. Fiscal balances in 2009 are expected to deteriorate by about 3 percent of GDP in high-income countries, and by about 4.4 percent of GDP in developing countries. Longer term, increased high-income country indebtedness may raise borrowing costs, potentially crowding out developing-country private and public-sector borrowers. The drop in economic activity, combined with much weaker capital flows to developing countries, is placing a large number of low- and middle-income countries under serious financial strain. Many countries are having difficulty generating sufficient foreign currency from exports or borrowing to cover import demand. Overall, borrowing needs for developing countries are expected to exceed net capital inflows by between $350 billion and $635 billion (see chapter 3). Many countries are meeting this financing gap by drawing down on the international currency reserves they built up during good times. However, the sustainability of this strategy is uncertain. Since September 2008, 16 countries have consumed 20 percent or more of their foreign reserves, and the current stock of reserves covers less than 4 months of imports in 18 countries. The challenges of widening current-account deficits and deteriorating fiscal positions are most acute in the Europe and Central Asia region, partly because the recession is expected to be deepest there, but also because many countries entered the crisis period with double-digit current-account deficits (as a share of GDP) and/or elevated government debt. If, as appears likely, financing is not fully forthcoming for these economies, heavy compression of domestic demand and exchange-rate depreciation will be required to restore internal and external balances. Despite the rapid decline in GDP in high-income countries during the first quarter of 2009, a number of indicators point to the beginnings of an economic recovery. Stabilizing and even recovering stock markets, modest improvements in exports in some countries, a recovery in consumer demand and the still-to-come demand-boosting effects of discretionary fiscal stimulus measures are among the factors pointing to the beginning of recovery. High frequency indicators vary distinctly by country at the moment, however, with data for the United States and China more suggestive of economic revival than those for western Europe and other developing regions. Moreover, several factors point to continued weakness. Unemployment continues to rise throughout the world, housing prices in many countries are still falling (adding to negative wealth effects), bank balance sheets are fragile, and much more consolidation and recapitalization required. As a result, the timing and strength of the eventual recovery in the global economy remain highly uncertain. Indeed, many countries are facing growing pressure on their currencies and banking sectors. Already several high-and middle-income developing countries have entered into special borrowing agreements with the International Monetary Fund (IMF) to prevent deteriorating external and fiscal positions from getting out of hand. The baseline scenario presented in this edition of Global Development Finance depicts a much more subdued recovery than during a normal recession, partly because this downturn follows a financial crisis—which tends to be deeper and longer-lasting than normal ones—and partly because today’s downturn has affected virtually the entire world, precluding the more typical scenario where recovery from a more geographically isolated downturn is at least partly achieved by exporting to healthier and more rapidly growing countries. In this scenario, global GDP, after falling by a record 2.9 percent in 2009, recovers by a modest 2.0 percent in 2010 and by 3.2 percent in 2011 (table 1.1). Banking sector consolidation, continuing negative wealth effects, elevated unemployment rates, and risk aversion are expected to weigh on demand throughout the forecast period. Among developing countries, growth rates are higher (given stronger underlying productivity and population growth) but remain similarly subdued at 1.2, 4.4, and 5.7 percent, respectively, over 2009 through 2011. Given the output losses already absorbed—and because GDP only reaches its potential growth rate by 2011—the output gap (or the difference between actual GDP and its potential), unemployment, and disinflationary pressures are projected to build over 2009 to 2011. A more robust recovery is possible, fueled by the substantial fiscal, monetary, and sectoral initiatives that have been put into place. So too is a much weaker outcome. In the latter scenario, the drag of the financial sector on economic growth, which is a key feature of the baseline, is projected to be more intense, while even weaker confidence impedes recovery in discretionary investment and consumer spending—leading to still slower growth. Moreover, pressure on current accounts, exacerbated by a weaker recovery, could force a number of countries (notably, several in Europe and Central Asia) into a much less orderly process of adjustment, characterized by substantial currency depreciation and painful cuts in domestic demand. http://web.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTDECPROSPECTS/EXTGBLPROSPECTSAPRIL/0,,contentMDK:20370063~menuPK:659159~pagePK:2470434~piPK:4977459~theSitePK:659149,00.html

Economic Terms

Deflation

A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.
Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals. To counter deflation, the Federal Reserve (the Fed) can use monetary policy to increase the money supply and deliberately induce rising prices, causing inflation. Rising prices provide an essential lubricant for any sustained recovery because businesses increase profits and take some of the depressive pressures off wages and debtors of every kind.

Disinflation

A slowing of the rate at which prices increase. Typically, this occurs during a recession as sales drop and retailers are not able to pass on higher prices to customers.
Disinflation is not to be confused with deflation, where prices actually drop.

Economic Cycle

The natural fluctuation of the economy between periods of expansion (growth) and contraction (recession). Factors such as gross domestic product (GDP), interest rates, levels of employment and consumer spending can help to determine the current stage of the economic cycle.
An economy is deemed to be in the expansion stage of the economic cycle when gross domestic product (GDP) is rapidly increasing. During times of expansion, investors seek to purchase companies in technology, capital goods and basic energy. During times of contraction, investors will look to purchase companies such as utilities, financials and healthcare.

Inflation

The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.

As inflation rises, every dollar will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then a $1 pack of gum will cost $1.02 in a year. Most countries' central banks will try to sustain an inflation rate of 2-3%.

Philips Curve

An economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship. According to the Phillips curve, the lower an economy's rate of unemployment, the more rapidly wages paid to labor increase in that economy.
The theory states that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment. However, the original concept has been somewhat disproven empirically due to the occurrence of stagflation in the 1970s, when there were high levels of both inflation and unemployment.

Stagflation

A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation.

Stagflation occurs when the economy isn't growing but prices are, which is not a good situation for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries. For these countries, including the U.S., stagnation increased the inflationary effects.

Source: http://www.investopedia.com/terms/s/stagflation.asp
15-10-2008

Predicting Forex Market

Five Keys to Predicting Forex Market Movements

To profit from the fascinating world of international trade, you must have a firm grip on the key factors that affect a currency's value. When making our trades, we analyze five key factors. In order of importance, they are:

Interest Rates
Economic Growth
Geo-Politics
Trade and Capital Flows
Merger and Acquisition Activity

If you can predict how each of these factors affect your currency trades, you have the foundation to make serious returns.

Source:
http://www.bkforexadvisor.com/freereport/report_index.aspx
15-10-2008