Question

Question 2

Financial crisis is an economic situation in which the economy of a country faces some unanticipated downturn or recession, price fluctuations, current account deficits and uncertainty on foreign sector. By the end of June 2018, Pakistan had a current account deficit of $18 billion, nearly a 45 percent increase from an account deficit of $12.4 billion in 2017. Exorbitant import and less-than-projected inflows (export revenues and remittances) have led to a current account deficit widening, with foreign currency reserves levels covering less than two months of imports—pushing Pakistan towards a difficult economic situation. Part of Pakistan’s financial crisis stems from the fact that 2018 was a poor year for emerging markets. Global monetary tightening, increased oil prices, and reduced investor confidence have negatively impacted the country’s already precarious economic situation. But the country’s deep structural problems and weak macroeconomic policies have further exposed the economy to an array of debt vulnerabilities. Pakistan has had an overvalued exchange rate, low interest rates, and subdued inflation over the last few years. This loose monetary policy has led to high domestic demand, with two-thirds of Pakistan’s economic growth stemming from domestic consumption. An overvalued exchange rate has led to a very high level of imports and low level of exports. Pakistan’s high fiscal deficit was accelerated even further in 2017 and 2018 because elections have historically caused spending to rise. Perhaps the greatest financial issues facing Pakistan are its pervasive tax evasion and chronically low level of domestic resource mobilization. Taxes in Pakistan comprise less than 10 percent of GDP, a far cry from the 35 percent of countries that are part of the Organization for Economic Co-operation and Development (OECD). Pakistan also suffers from impediments in the energy sector through frequent and widespread power outages that hurt its competitiveness. Required: A financial crisis occurs when information flows in financial markets experience a particularly large disruption, with the result that financial frictions and credit spreads increase sharply and financial markets stop functioning. i)- Comment and relate the above situation of Pakistan with the stages of financial crisis. ii)- What are Pakistan’s options to enhance financial stability and well-being?

Answer 1

A. There are different stages of financial crisis which would be depicted in case of Pakistan economy as follows-

stage one of the financial crisis is initiation of the financial crisis in which there is bad management of the finances by the the central banks of the economy and the central government of the economy is not able to collect the taxes and spend it on a efficient way into the economy so there would be continuous reporting of the fiscal deficit by these governments and they would be more inclined to borrow from the foreign banks as it can be seen in the cases of Pakistan.

Stage 2 could be related to the debt inflation where there would be a decrease in the overall domestic currency valuation of the economy in respect of the foreign currency and there would be continuous pressure on the government to pay upon its previous debt and it would be trying to generate new debt as well so this government will be trying to get into a spiral of debt payments and they would not be able to focus on to the economy and their currency depreciation is also leading to to loss in growth of the company as well as loss in the overall gross domestic product of the country.

Third stage of any financial crisis should be collapse of financial institution and contagion due to collapse of financial institution into the entire economy which can create the loss of job and which can also create the political interventions and shift in employment cycles as well as there can be a Chaos in the entire economy due to contagious financial system.

II. Pakistan option to enhance financial stability and well-being can be done through-

A. Efficient payments of its foreign debts.

B.proper management of its foreign reserve and proper management of monetary policy through Central Bank so that financial system could be control

C. There should be a focus on the overall growth of of the economy as well as there should also be an optimum focus on increase of employment

D. Major economic boosting is required in order to to establish a stable financial system

E. It will also help itself to regain its reputation by improvement of the financial domain and attraction of the foreign direct investment into the country.