By:
Faith
L. Morlu
Abstract
The
world observed the deadliest financial crisis since the great depression of the
1930s in 2008. The signs of a financial crisis started becoming visible in the mid-2007
and early 2008 by the demise of stock markets, the failures of big financial
institutions in the United States and parts of Europe. Given that banks play a
key role in our modern market system due to globalization, the crisis quickly
swelled through the whole real economy,which turned a financial crisis of the
United States into a global economic crisis. The crisis affected many regions
of the world in different ways due to their diverse interaction with the United
States. In this paper, I examined the effect of the crisis in Africa more
precisely Ghana and South Africa. The impact was analyzed with regards to the
performance of Gross Domestic Product, Balance of Payments, Fiscal Deficits,
Net Investment Levels, Inflation indices and the Trade statistics of the both
countries.
1. The great recession of 2007
1.1 Background to the Crisis
The
years preceding 2007 are often been referred to by economists as the years of the Great Moderation, since these were
years advanced economies witnessed stable growth rate, and vast macroeconomic stability. In 2001 the US
Fed lowered the interest (The Fed fund rate) rate from 6.5% to a drooling 1.75%
(Singh, 2011). Thus creating a flood
of liquidity in the economy. Bankers and reckless borrowers who didn’t have a
permanent income or job came seeking credits due to the overflowing of cheap
money. These so-called subprime borrowers came for these loans with the minds
of achieving their dreams of owning a home. So, as subprime borrowers
increased, so did the prices of homes. This new development made Investment in questionable subprime mortgages seem like a new gold mine.
In
2003 the Fed brought interest rate down to 1%, thus leading to bankers
repackaging mortgages into Collateral Debt obligations (CDOs) and selling them
off. Subsequently leading to the development of a large subordinate market for
the distribution of subprime loans. And then the Security Exchange commission
of the US went on minimizing the Net Capital Requirement of the five big
investment banks in 2004. Thus making these investment banks to Leverage 30 or
40 times their original investments.
1.2 The Crisis
As
of June 2004, the Fed started immensely raising interest rates so much that by
June 2006 interest rates had peaked 5.25%.(IMF,
2009)This vastly increased in interest rates led to the start of borrowers defaulting
on their loans, causing a bad start of the year 2007 with so many subprime
lenders claiming bankruptcy. According to Singh (Singh, 2011), hedge funds and some financial firms held more than
1 trillion in securities that were backed by these failing subprime mortgages,making
the situation alarming enough to start a global financial crisis if more and
more borrowers kept defaulting.
August
2007 came with the clarity that the subprime crisis could not be solved single
handed by the US financial markets, and soon the crisis started spreading
beyond the borders of the US. Then came the freezing of the inter-bank markets,due
to the speculations among other banks. The Fed came into the situation by the
slashing of the Fed funds rate as well as the discount rate in an effort to
solve the problem, but the worst kept happening. The worst started by the filing of bankruptcy
by Lehman Brothers, followed by
collapsing of Indymac bank, the acquisition of Bear Stearns by JP Morgan
Chase, the selling of Merrill Lynch to Bank of America, and the US Federal
government controlling of Fannie Mae and Freddie Mac.
By
October 2008, the cross border spillover had deepened in many regions of the
world due to inter-linkage of markets and financial institutions with the high
correlation of risks. During which time the US Fed reduced the funds and discount
rates to 1% and 1.75%. Bigger economies Central Banks like China, England,
Canada, Switzerland, Sweden, and the European Central bank took measures to
help the global economy from further crashing by cutting down their rates. But
the cutting down of rates alone was insufficient to halt such extensive global
financial collapse.
2 The Impact of the crisis on Africa
2.1 Africa Before the Crisis
Granted
that Africa is indeed a diverse region and that, not necessarily all economies
have coped well. But prior to the 2007 recession, Africa economies were
generally flourishing, they grew at an average of approximately 6%, inflation
collapsed into a single digit level below 5%. This was before the food and fuel
price shock of 2008 (IMF, 2009).These
positive growth was attributed to the favorability of the external environment,
strong macroeconomic policies, the rise in commodity prices from 2002-2007, and
the massive inflows of grant/AIDS and debt reliefs from the international
community.
Figure
1.SSA
GDP and Exports growth in percentage before the Crisis
Source:
IMF data, Author’s accumulation
The
graph portrays that the region experience economic growth at an average of 6.5%
per year amid 2002 and 2007. The increase in the demand for Africa primary
commodities such as natural resources, particularly oil and minerals was a key
drive to the growth of the continent between these periods. This excess demand
was encouragedby the growth in industrialized countries and the rise of
emerging market economies
like china and India. Granted that
Africa growth during that period was driven by commodity boom, but many other
factors such as; increase in FDI, Net private capital flow, portfolio flows,
remittances, was anticipated to have expanded between the years.(UNCTAD, 2009) In many other African countries, there was an
increase in productivity and domestic demand in terms of telecommunications, as
the use of mobile phone and internet services grew from 2002-2008. All these
trends were aided by enhanced economic governance, fiscal restraint, efficient
banking policies, International debt relief programs, and the decline in the
number of civil war and insurgences made the continent quite striking for
foreign investments.
2.2 Impact of the Crisis on Africa
The
recession that started in the US financial markets was a bit slower in
affecting African economies, but it gradually did. Right after the fuel and
food price shock of 2008, the hard sustained economic gains that Africa had managed
to sustain over the years were at risk. Just as in other parts of the world,
Africa started experiencing the waves of the financial crisis in 2009. The
continent saw a great decrease in the demand of its export, decrease in
commodity prices, and the flow of remittances to the continent also started
declining. As the situation got at its height, International trade got more
costly, foreign direct investors got frightened leading to a fall in FDI, and a
tighter international investor and credit risk aversion led to the reversal of
portfolio flows. Even fragile states like Liberia, Guinea-Bissau and Burundi
whose social and political situation at the time were vulnerable, felt the
impact of the crisis due to their dependence on concessional financing. (Bourdin, 2009)
Figure 2. Percentage of SSA Real GDP, Exports, Imports and Current Account Balance\
Source:
IMF data, Author’s accumulation
Granting
that Africa is the least assimilated region in the world in terms of global
trade, but it was unable to drift away from the effect of the global economic
crisis. Despite the continent low contribution of approximately 2% to global
trade, but the majority of its economies depend on the exportof their primary
commodities for survival. Figure 2 shows a decline from 5.4% in 2008 to 1.3% in
2009 in the total real GDP of South Sahara Africa. Imports, which the continent
depends on heavily due to their poor production and manufacturing activities,
fell from 8% in 2008 to -4% in 2009 due to the decline in global productions.
Due to the continent exposure to industrialized economies, there was a decrease
in the demand for African exports leading to exports falling from 8% in 2007 to
-0.071% in 2008, and -5.6% in 2009.
The
IMF data indicates a general fall in Africa's economic growth by nearly4%percentage
in 2009.The mixture of poor export demand, the decline in private capital flows,worse
commodity prices, decrease in remittances, the cutting down in tourism
revenues, and fragile government revenues were all reasons that the continent
economic growth fell by close to four percentage in 2009. The continent
emerging markets or middleincome countries thatwere more assimilated into the global
markets were the hardest hit: with growth slipping by about 4.5% in 2009.But in
the normal course of events, disparities in economic growth across sub-Saharan
Africa areintenselyconnected with eccentricshocks which were also a reason for
the fall in the continent growth. What started with the decline of commodity
prices and in some countries affecting the wages ofthe workforce and even
farmers, quickly led to an exit for a total economic collapse and the
intensification of the class struggle.
1 3 Why Ghana and South Africa?
I
choose Ghana and South Africa because they are both growing economies and
emerging markets in Africa. And these economies with financially developed
markets were the first to feel the effects of the global financial crisis
because they were more assimilated into the global financial market by the
connection of capital flows, exchange rates and stock market investors. Given
that the first four economies that were hit by the crisis in Africa are;
Nigeria, South Africa, Ghana and Kenya, which led to capital flow reversals, a
fall in their equity markets, and exchange rate compression, I decided to analyze
the Ghanaian economy being from the west, and the South African economy being
from the South.
2 Ghana and the Global Financial
Crisis
3.1 Trends before the Crisis
There
have been a lot of changes in the Ghanaian economy since their independence
from the British in 1957. Their economy has gone through so many changes
ranging from the poor economic performance from the 1980s that was marked by
the coup and lack of market principles in the National economic policy. For the
most fact, before the economy started enjoying a period of strong economic
growth, they struggled with the issues of low productivity, high interest
rates, high and volatile prices, and high interest rates thus leading to a very
abnormal growth during those years.These issues lead to many difficulties such
as: limited access to International Credit, reduction in foreign direct
investment, declining exchange rate and International trade.
The
country came back on the track of unprecedented economic growth in the early
1990s, when they took up the multi-party, the neo-liberal project of the IMF
and World Bank, and constitutional rule. This return was marked by an increase
in the prices of the Ghanaian traditional products (Cocoa and Gold) compiled
with a series of market reforms which enable the environment for the growth of
the private sector. With the improvements in both the microeconomics and the
political conditions, the country has been standing firm on the grounds of a
solid economic performance over the past years.
Figure 3.
Ghana growth measure by the percentage change and real GDP and Inflation
Source: IMF data, Author’s accumulation
The
World Bank data show a growth rate of about 5% per year in the Ghanaian economy
over the last 20 years. Within the last few years, the country has been
pursuing a more outward trade policy that recognizes export as a key engine for
economic growth and prosperity. In figure 3, we see that the period after 2003
was a very spectacular one with a GDP growth rate averaging approximately 5.9%
from 2003 to 2007. The proper implementation of macroeconomics policies leads
to Inflation staying below an average of 15% throughout these years of boom.
The
government of Ghana principal objective from 2000 was to reduce its domestic
debts and stabilized the balance in terms of GDP performance. This objective
was realized from 2001-2005as gradual improvement was seen in the overall
performance of the budget balance. But as for fiscal deficits, it was very low
due to the new measure of improvement in revenue expansion, and economic
expansion.
But
with all the improved growth level in the Ghanaian economy, the Current Account
balance did speak an actual different story. Figure 4 indicates a current account deficit that kept growing from
2002 to 2007. Aneconomythat is being run on a current account deficit is due to
the increase in the value of imports of goods, investment, services, than that
of the value of exports. It is sometimes referred to as a trade deficit.
Figure
4.
Inflow of FDI as percentage of GDP and C/A balance as percentage of GDP
Source: IMF & ITC data, Author’s accumulation
And this was the case of Ghana during these years,
Ackah et al, in their 2009 paper reveals that during 2003-2007 imports
increased from $3232.8 million to $8073.57 million. While exports increase just
from $2562.4 million in 2003 to $4194.7 million in 2007. (Ackah et al, 2009)But the issue of low export during these years
cannot only be attributed to the economy huge dependence on primary
commodities. But I can argue that it was attributed to the economy’s heavy
dependence on a constricted range of primary commodities without
diversification, just like other African economies. I argue this because; Ghana
primary commodity in International trade that constitutes approximately 60% of
its exports is largely Cocoa and gold. See figure
5 below.
Figure 5.
Ghana Trade statistics, Imports and Exports as a percentage of GDP over the
years
Source: World’s Bank data, Author’s accumulation
3.2 The
impact of the Crisis
Due
to the country’s past 25 years of aggressive exports led industrialization, and
their enactment of the IMF and World Bank neoliberal policies, they became
significantly integrated into the global economy in terms of international
trade. So they were not spared from the external shocks of the crisis. Figure 5, shows an increase in
Inflation from in 2007 to 16.5% in 2008. This increase can be attributed on
account of the external shocks and the strong domestic demand. Just after a
brief fall, to single-digits in 2006, inflation gallopedin 2007–2008, which
reflected the impact of the global food and fuel price shocks, marking the
beginning of the global financial crisis late 2008. But the graph indicates
that by January-May 2009, inflation did stabilized a bit by 20% percent that is
it dropped from 16.5% in 2008 to 14.5% in 2009.
Figure
6.
Real GDP (annual % change), FDI Inflow (% of GDP), C/A balance (% of GDP)and
Inflation (Annual % change)
Source: IMF & ITC data, Author’s accumulation
The
graph also shows the shifts in the flow of FDI in the economy from 2008-2010.
FDI plays a key role in the Ghanaian economy, by means of capital flows as well
as employment generation. The decrease in FDI was due to the tension on global
capital, by the crisis. This led to a fall in FDI from 9.5% in 2008 to 9.1% in
2009 and it further fell to 7.9% in 2010 (percentage of GDP). The fall in FDI
can also be related to that of the decrease in aid/grants and remittances. As
many of the industrialized nations that grant aids were pressed by the crisis,
the number of aid flow into the economy rapidly decreased from 2007-2009. The
crisis also had an impact on exchange rates. The Ghanaian cedis started
depreciating against all other major currencies as of mid-2008.
As
the global financial crisis brought a fall in the prices of commodities due to
the fall in demand by international companies, the exports of concerned
countries began falling. The bank of Ghana reported a fall in the price of the
country’s main export which is gold in 2009. The price fell from $965.90 in
2008 to $803.91 in 2009. Gold wasn’t the only export that was affected; exports
such as cocoa and other commodity prices as well started declining during the
same period. While there were continuous
poor performance of exports during that period, Imports on the other hand was
increasing due to the export led strategy that made it to produce what was not
consumable and consume what was not produced in the economy. See figure 5.
1 Impact of the crisis on South
Africa
4.1 Trends
before the Crisis
South
Africa has been Africa’s wealthiest major economy for years, (until recently
Nigeria took over) has been a key player in the role of emerging market
economies that have helped transform the global economy over the years. The
South African growth trends started by their political transmission from the
Apartheid regime to the most peaceful political regime in Africa since early
1990s.An intense reformation of the economy did bear a successful fruit in the
form of macro-economic stability, flourishing exports and improvement in productivity
in capital and labor.This transmission came along with vibrant economic growth
that was sustained for almost a decade. The growth was due to the country’s
record of a sustained macroeconomic farsightedness that was added to a
supportive global environment. The country sustained a GDP growth at a stable
pace until the global financial crisis of 2008 and 2009. The sustained GDP
growth was also accompanied by the improvement in fiscal balances, leading to
the decrease in the government gross debts. Due to the sound policies
implemented, the collection of revenue quadrupled and the number of taxpayers
increased fivefold between 1996 and 2007. (World
Bank)
Figure 7.Real
GDP (annual % change), FDI Inflow (% of GDP), C/A balance (% of GDP)and
Inflation (Annual % change)
Figure
7 indicates the growth trend in South Africa from 2002 to 2007. As shown in
figure 7, South Africa's real GDP rose by 3.6% in 2002, 3.1% in 2003, 4.8% in
2004, 4.9% in 2005, 5.3% in 2006, which has been cited as the highest 1981 and
5% in 2007. This growth can be attributed to the effectiveness of thebold
macroeconomic reforms that have enhanced competitiveness, employment creation
and opening South Africa to the multilateral trading system. The country saw
its inflation rate going down from 5.8% in 2003 to 1.3% in 2004 but peak again
in 2005 to 3.3% which was due to the primary increase in food prices. All these trends were driven by household
consumption, private and public fixed investment on the demand side, financial
and business services, construction, and wholesale years and retail trade on
the supply side.
Figure 8.South
Africa Trade statistics, Imports and Exports as a percentage of GDP over the
Source:
World’s Bank data, Author’s accumulation
After
the country’s integration into the global economy, their trading statistics were
subjected to enormous changes as figure 8 rightly portrays. Exports and Imports
of South Africa started an actual boom from 2004 to 2008 given that exports
rose by 26% in 2004, 27% in 2005, 30% in 2006, 31% in 2007 and 36% in 2008.
Imports on the other hand, rose by 7% in 2004, 28% in 2005, 32% in 2006, 34% in
2007 and 30% in 2008. The change in the country’s volume of trade can be
ascribed to those reforms that were mainly concerned with at achieving greater
economic stability and liberalization. These reforms increased the country’s
productivity, favoring trade, and foreign capital flows as never before in the
economy.
4.2 Impact of the crisis on South
Africa
The
crisis made a severe impact on the South African economy, given that the
economy suffered its first recession in 2008/2009 since 17years of economic
growth and development. The year 2009 was marked as the largest slowdown in the
South African economy, and its impact was even larger than that experienced by
some industrialized and emerging economies.The financial crisis was said to
have been transmitted into the economy primarily via the financial markets,
tightening of bank lending standards and trade linkages due to their
integration into the world economy. In South Africa, the financial sector
experienced a failure of asset prices, intense increases in the cost of capital
along with a severe contraction in loaning. Millions became jobless in 2009 as
the result of the crisis. Besides the increase in unemployment, the effect of
the crisis was also seen through the increase in consumer demand and consumer
credit, the fall of imports and exports, and the sad story of net financial
inflows turning into net financial outflow thus resulting in share prices
dropping.
Figure
9.Real
GDP (annual % change), FDI Inflow (% of GDP), C/A balance (% of GDP)and
Inflation (Annual % change)
Source: IMF & ITC data, Author’s accumulation
Source: IMF & ITC data, Author’s accumulation
Figure
9, shows the impact of the crisis on the economy from 2008 to 2010. Real GDP
was seen to drop from 3% in 2008 to -2.1% in 2009. The fall in the real GDP in
2009 was a bit narrower as compared to other emerging markets. The fall was
quite lower because of the South African economy did not experience any major
bank failures or bankruptcy, and the OECD proclaimed this declined to be counterbalanced
by the strong growth in the construction industry and cheap oil prices during
that period. (OECD, 2010) The graph also
shows the impact of the crisis on the inflow of FDI in the economy. FDI fell
from 3.6% in 2008 to 2.7% in 2009 because of the decrease in the level of
confidence of investors. This decrease in the level of confidence of investors
led to foreign portfolio investment flows to other emerging countries to be reversed.
Additionally the impact of an unstable global capital market and a very poor
investment or banking environment placed a downward pressure on the volumes of
business and also had a negative effected on fee income. So investment income further
dropped due to the poor performance of the global equity markets. Subsequently,
the current account balance indicates a decrease in the trade deficit from
-7.4% in 2008 to -4.9% in 2009. Inflation, on the other hand, as portray by the
chart, fell from 11.5 in 2008 to 7.1 in 2009.
Just
as International trade jumped during the global crisis, South African exports
of goods (see figure 8 on pg. 11) and services fell sharply as a result.
According to Kershoff (2009:8-9), South Africa was hit really hard by the drop
in the international demand for vehicles and non-food commodities (industrial
raw materials) mainly because these items dominate the country’s exports. Figure
11 shows a fall in exports from 36% in 2008 to 27% in 2009, and imports also
fell from 39% in 2008 to 28 in 2009.
Another
significant impact on the South African economy was the increased in the rate
of Unemployment. The country had previously been suffering from the issue of
unemployment and this crisis, unemployment only added up and intensified the
existing regional economic inequalities. In mid-2009, South Africa labor force
statistics reveals that there were 7 of the 9 provinces that unemployment rate
had exceeded the national rate of 24.3%,
making it the highest in South Africa poorest provinces with a large rural
population.
1 Conclusion
With
Africa least integration into the global economy, it was hit hard by the global
economic crisis.The continent economic growth went from 5.2 percent in 2008 to
1.6 percent in 2009. Luckily, Africa responded by upholding those good policies
that had brought some level of growth in the past, and they continent started
recovering in 2010.Notwithstanding, with all the many challenges facing the
continent, ranging from an enormous infrastructure deficit,weak initial
conditions for the 2015 Millennium Development Goals,low agricultural
productivity, and a very poor governance,but Africa’s performance has recently
given us cause for optimism.
The
2008 financial crisis was more global than any other period of financial
turmoil since the great depression. The degree and severity of the crisis echoed
a combination of several factors, some of which are common to previous crises
and others are new.In previous financial havoc, the pre-crisis period, was
mainlyconsidered by the surging asset prices proving unsustainable, anextended
credit expansion that led to theincreasein debt, marked by the beginning of new
types of financial instruments and the failure of regulators to keep them up.
The
slowdown in economic activity that came as a result of thegreat recession of
2009, left Ghana and South Africa under immense pressure to build their economy
back to its pre-crisis level.Many Corporations were affected directly through
higher financing costs, as well as secondarily that is through the impact of
the crisis on their customers and, their balance sheets. Exports were under
pressure due to the decline in world trade, and many jobs were lost in some
industries, and in other industries the pressure onwages combined with the
costs of production remained high.Even though all financial criseshas
similarities with previous crises (Great depression, amongst others) in some features,
but the effects or the impact of the global financial crisis of 2009 remains
the worst ever experienced since the great depression and therefore it remains
significantly different.
2.
References:
1.
Ackah,
GodfredChales, Dorku, Bortei Ellen, and Aryeetey, Ernest “Global Financial Crisis Discussion Series: Ghana”, May 2009,
Overseas Development Institute 111 Westminster Bridge Road
3.
Otoo,
KwabenaNyarko, and Adjaye, Prince Asafu“The
effects of the Global economic and Financial crisis on the Ghanian economy and
Labour Market”, Labour Research and Policy institute November, 2009
4.
Paulo, Drummond and Gustavo
Ramirez,“Spillovers from the rest of the
World into Sub Sahara Countries”, IMF working paper 2009
7.
IMF “Regional Economic Outlook, Sub-Shara Africa; Staying the course”
October 2014
(Faith
L. Morlu is a Masters student at Jindal School of International Affairs)
