A currency crisis in the Caribbean by wuyunyi


									 Talking points for presentation at the ILO Conference: “The Global Financial
         Crisis: How did we get here and how do we move forward?”

Introduction: ›   Meeting at crucial juncture – G20 Meeting
              ›   Difference of Stakeholder Dialogue – not protest
              ›   Commend ILO for initiative

   •   There are two common features of all financial crises. The first is that they are
       preceded by the rise and fall of a bubble, defined as an unsustainable path of
       price increases in financial assets, commodities or real estate, or of capital
       inflows. Secondly, the rapid expansion of credit fuelled the bubble followed
       by sharp contraction in lending.

   •   The bubble was influenced by the surge of real estate prices in the United
       States fuelled by the sharp reduction of interest rates in that country in an
       effort by the Federal Reserve to combat the mild recession of 2001 prompted
       by the bursting of the 2001 Dot.com Bubble.

   •   As any bubble, when economic agents realised that real estate prices were
       totally overvalued, fear develops that this process will come to an end,
       therefore reduced demand for houses generated a self-fulfilling prophecy: as
       demand for real estate drops, its prices start to decline.

   •   In most countries this main vehicle for household savings, implied a hard
       negative blow to wealth which, in turn prompted the contraction of
       consumption and the increasing rate of defaults on mortgage debt.

   •    Highly leveraged financial institutions were faced with significant liquidity
       challenges. In turn, this generated problems for financial institutions that
       required bailouts, mergers and rescues.

   •   The financial crisis became systemic in the United States in September 2008
       and rapidly turned global.

   •   What lies behind this process is the massive use of mortgage-backed
       derivatives that were internationally traded. This meant the contamination of
       European and other foreign financial institutions balance sheets with “toxic”
       assets manufactured in the United States.

   •   Once real estate prices in the United States collapsed, there was a global
       solvency problem on the part of international banks.

   •   This initiated the credit crunch which, together with the negative wealth effect
       caused a spill-over of the financial crisis into the real sector.

   •   The resulting increase in unemployment further increased the default on not
       only mortgage debt, but also on consumption and credit card debt which
       exacerbated the solvency problems of financial institutions.
•   Figures released by the International Monetary Fund (IMF) in mid March
    point to a gloomier situation than previously expected. Indeed, these forecasts
    indicate a contraction of 0.6% for the world economy, with United States
    output dipping by 2.6%, the Euro Zone by 3.2%, Japan by 5%, the United
    Kingdom by 3.8% and Canada by 2%. Latin America would contract by 0.6%
    in 2009.

•   In this scenario, small open economies will suffer negative external shocks
    through a variety of channels, including trade, tourist arrivals, remittances,
    foreign direct investment (FDI) and external financing. The contraction in
    world demand would be felt by all Caribbean countries, particularly through
    reduced volumes of merchandise exports.

•   The intensity of the global recession varies from country to country, but will
    undoubtedly be felt throughout the region. According to ECLAC’s
    forthcoming Preliminary Overview of the Caribbean 2008-2009 (www.), the
    relative macroeconomic impact on the region would depend on, among other
    things, the twin deficits – i.e. fiscal and current account – and the level of
    public debt and of international reserves.

•   At the end of 2008, most Caribbean countries had unsustainable levels of
    public debt and not enough international reserves. As a rule of thumb, any
    public debt exceeding 40% of GDP can be deemed to be unsustainable.
    However, public debt in Barbados, Jamaica, Dominica, Grenada and Saint
    Kitts and Nevis are above 100% of GDP. Meanwhile, Belize, Guyana,
    Antigua and Barbuda, Saint Lucia and Saint Vincent and the Grenadines, have
    debt-to-GDP ratios above 70%. On the international reserves side, with the
    exception of Barbados, Guyana and Trinidad and Tobago, no other Caribbean
    country has more than 3.5 months of import cover.

•   But the worse part of the story comes when one looks at the current account
    side. As a simple average, ECCU countries recorded current account deficits
    of almost 35% of GDP in 2008, the main problem being their fixed exchange
    rate regimes.

•   As any household has to do, if it spends over income someone has to finance
    this gap. The natural candidates are savings and borrowing.

•   At the national level, savings are international reserves that are insufficient in
    most Caribbean countries. The other source of financing is borrowing from the
    rest of the world. But, given the magnitude of the current world crisis, this is
    not a readily available option.
Conclusions: ›    ECLAC’s views on the Way Forward:

(1) Informed, concerted policy actions are required on a regional basis –
      • Applaud the CARICOM Task Force Initiative.

(2) Several pre-existing conditions such as unsustainable levels of public sector
    debt and current account deficits could mean disastrous consequences for
    many Caribbean States and therefore require also concerted actions.

(3) We believe that an inclusive and consultative process will yield the best
    solutions to the crisis, for the Caribbean and by extension, globally.

(4) Among the possible solutions we see the need to broker a common
    understanding of support from the International Community/IFIs.

(5) Need for orderly relaxation of fixed exchange rate regimes in order to avoid a
    possible currency crisis in many CARICOM countries.

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