The Current Global Financial Crisis and Its Impacts on the OIC Countries Dr. Murat Yulek

Organization Background Current Crises Case in Point: 1929 Case in Point: UK, Now Case in Point: USA, Now Threats, Opportunities and Strategic Choices for OIC Countries

Background World Economy: Post-2001 period characterized by Relatively high growth rates –Generally across the board with exception of some countries such as in Europe Increasing fuel, metal and subsequently other noncommodity prices Rapid increase in credit and generally low interest rates (the latter especially until mid-2004 in the USA) Increasing asset prices –Financial assets: Stock exchange indices & market capitalizations –Non-financial assets: Residential, commercial and industrial property

Background Rapid expansion of credit, unethical banking practices and weaknesses in regulation and monitoring of banks fed bubbles in housing markets, notably in the US and the UK Artificially increased housing prices fed by the credit boom started a vicious circle of inflated bank balance sheets, increased funding of banks as their housing loans were recycled back to them through securitization in the secondary markets Banks’ asset quality in the US worsened when temporarily increased policy rates by the US Fed between mid-2004 and mid 2006 led to repayment difficulties in low quality housing credits (subprime)

Current Crises Banking sector crises in western economies –Investment banks closed down in the USA –Significant pressure on commercial banks including bank runs and close downs Collapsing and volatile stock exchanges Serious slowdown in western economies –Growing unemployment –Lower domestic absorption (consumption and investment)

Post Crises Episode: What is Next? Western Economies: Significant crises resolution costs already underway –Serious budgetary consequences Negative Wealth Effects coupled with lower confidence will lead to maintained contraction in consumption & investment and hence imports Fall in production may feed into downward income generation spiral

Case in point: 1929 Crises For some European economies, it took more than six years to recover from the 1929 depression imported from the USA Source: OECD

Immediate effects of Current Crises Case in Point: The UK Unemployment increased by 164,000 between May and August 2008; almost a 10 percent rise from 1.63 million Most hard hit is London where number of jobless looking for jobs increased by 42 percent in September 2008 Some estimates put 1.5 million additional unemployment generated by end-2010 leading to an unemployment rate of 10 percent from current 5.7 percent.

Immediate effects of current crises Case in Point: USA Slowdown in GDP –Current 2008 projection 1.6 % (down from 2.8 % projection in April 2007) – 2009 projection: 0.06 % –Consumer confidence lowest since 1978 October 2008 UMich consumer sentiment index: 57.5 from 70.3 in September Construction activity much worse: Q208 new constructions starts are 40 % less than post 9/11 (Q401)

Immediate effects of current crises Case in Point: USA Slowdown in GDP (Continued) –Housing market in shambles Case-Schiller Index back to 2004 levels Construction activity much worse: Q208 new constructions starts are 40 % less than post 9/11 (Q401)

Financial crises and the OIC Countries While the crises is being weathered, strategic directions for post-crises episode should be developed

Financial crises and the OIC Countries Opportunities Threats Strategic Directions

OIC Countries: Threats from the crises Slow down in western economies will lead to lower imports from OIC countries Some commodities exported by OIC countries may suffer lower prices –Non-diversified exporters may be exposed to risk OIC based sovereign wealth funds will flow to the USA and Europe to chase cheap assets

OIC Countries: Opportunities from the crises Many OIC countries Do not have high exposure to financial crises in their own homes Have good fiscal positions A number of OIC countries have significant amount of liquid capital accumulated over the last few years They also still have significant amounts of oil wealth Valued even at USD 50 / barrel, Middle Eastern proven oil reserves stand at a value of USD 38 trillion

OIC Countries: Strategic Directions in the Post Crises Episode Strong policy coordination needed among OIC countries Bad example from US and EU: coordination problems and sluggish and ad hoc responses to crises in the USA and Europe have further deteriorated the situation Some East European countries such as Hungary and Ukraine has started talks with the IMF  Introduction of a macroeconomic safety network among OIC countries may be needed to reduce possible fall outs of the crises on weaker members  Policy coordination among central banks, ministers of finance and banking regulators is essential

OIC Countries: Strategic Directions in the Post Crises Episode Strong policy coordination needed among OIC countries (continued)  Strengthened Intra-OIC Trade and investment flows will prove more valuable during the global slowdown following the current crises  Sovereign wealth funds from OIC countries should direct more capital to OIC countries where returns are relatively higher and their capital can be put at use for the development of the member countries

OIC Countries: Strategic Directions in the Post Crises Episode Strong policy coordination needed among OIC countries (continued)  There will be a new round of reengineering of the international and national financial architectures  OIC countries can play a role in proposing more role for profit sharing mechanisms that are less prone to crises