What it takes to get through the financial crisis

“We are not set for a Great Depression as we saw in the 1930s” was the message coming through at a recent PricewaterhouseCoopers SA panel discussion on the global financial crisis. “Things are significantly different this time round. Way back then, there were no stimulus packages from government, exchange rates were mostly fixed, there were no policies on monetary easing and no liquidity injections and we did not have the participation of an International Monetary Fund or a World Bank.”

PwC SA CEO-elect Suresh Kana says it does appear that governments are certainly doing whatever it takes to resolve the crisis. “They have decided not to go the route of purchasing the toxic assets in the system but are addressing global financial problems in many other ways – through part nationalization of banks through equity investments such as preference shares which help recapitalize these institutions, direct financial assistance to seriously affected companies, guaranteeing of lenders’ deposits, interbank lending guarantees, and monetary and fiscal action such as interest rate and tax cuts.

“We are already seeing a flutter of hope as the London Interbank Offered Rate (LIBOR) is coming down and various credit spreads above the relevant benchmarks are starting to narrow, but there is still a significant amount of work to be done. We need to see the recovery coming through into the real economy and for this to happen, asset prices such as housing must stop falling, the impact of lower interest rates must kick in and fiscal stimulus must take hold.”

The SA banking sector has proven to be exceptionally strong over this period but our current account deficit – probably the largest in the emerging market universe – makes us most in need of foreign fund inflows, and ideally of the capital rather than portfolio variety. As a highly dependent export nation, our vulnerability is reflected in our currency. “But our experts indicate that regrettably at this time, there is little or no chance of an immediate recovery. They point to the Emerging Market Bond Index spreads (difference between the rates offered by bonds in emerging markets and those in developed markets) and we are far worse than other emerging markets. Thankfully we do have a few shock absorbers we can rely on – being a very flexible currency and a small and contained government financing deficit” says Kana.

The situation does not look much better at overall economic levels and total credit extended has increased from 56% of GDP in 2002 to 82% in 2008. And along with this, the contribution of the financial services sector has soared out of all proportion. It comprised 1,2% of GDP in 1980 and now sits at 19,7% in 2008 as this sector has become more and more innovative and creative with its financial products.

The question now is how would the recovery look? “The economists point to many potential patterns for a recovery, and who really does know for certain. But the next 18 months will clearly be tough globally and in SA, but the foundations for this recovery are being laid.”

Kana says the view is that 2009 for SA should be a year that reflects a dramatic fall in inflation, because of our negative output gap, whereby actual output is less than full-capacity output, a condition which supports disinflationary conditions – and there will be much slower growth. Hopefully, early 2009 should see some very modest interest rate cuts.

Reflecting back on the events giving rise to the crisis, Kana says it becomes clear how the aggressive growth in subprime lending in the US and other developing markets and the endless search for ever higher yields, repackaged and on-sold in various forms, inevitably had to turn into one of asset value concerns, downgrades and defaults, leading to a loss of liquidity and ending up with the complete meltdown seen in the past few months. “This was compounded by years of current account surplus countries such as Russia, Saudi Arabia, Germany, Japan, China and Switzerland funding and/or supplying goods to the deficit countries such as SA, Spain, Italy, Australia, the UK and US. Supplies of cheap goods and services to these regions kept inflation low – but it could not go on indefinitely. This has now all collapsed into a situation described as one of no growth, extreme risk aversion, tight regulation, deleveraging and fear and panic.”

Kana says that hopefully we have all learned from these events, and particularly the financial services sector. “But perhaps not. A most poignant quote, already in 2005, comes from Andrew Hilton, head of the CSFI (Centre for the Study of Financial Innovation) in London.” Where is the next banking disaster coming from? ….there will be one – it is the nature of the beast.’”