Attaction of foreign inflows in East Asia
RUSSIAN STATE PEDAGOGICAL UNIVERSITY
BY HERZEN
Economic faculty
Department of applied economy
Course work on theme:
ATTACTION OF FOREIGN INFLOWS IN EAST
ASIA
Student of the third course
_________________
Superviser of studies,
Candidate of economic science,
Senior lecturer
Linkov Alexei Yakovlevich
St. Petersburg
2000 y.
Plan
1.
Integration,
globalization and economic openness- basical principles in attraction of
capital inflows
2.
Macroeconomic
considerations
3.
Private
investment:
a)
Commercial banks
b)
Foreign direct
portfolio investment
4.
Problems of
official investment and managing foreign assets liabilities
5.
Positive benefits
from capital inflows
International economic organizations
(IEOs), such as the World Bank, the World Trade Organization (WTO), and the
International Monetary Fund (IMF), have bun promoting economic openness and
integration, centered on free trade and capital flows. as not a complement but
a substitute for national development strategy.
Investment efforts in South
Korea and Taiwan were underwritten by active government strategy, including
subsidies, promotion, tax incentives, socialization of risk, and establishment
of public enterprises. Singapore’s economic growth was also predicated on a
high investment strategy implemented by the government, even though Singapore
relied relatively more on foreign investors than the other East Asian countries
did.
Regionalism is likely to
remain an important factor in global economic relations in the foreseeable
future, as countries continue to strive for greater access to foreign markets
and for solutions to economic problems and disputes that in many cases might be
resolved only through regional cooperation.
Managing large and perhaps
variable capital inflows- or, more aptly, managing the economy in such a manner
as to effectively and productively absorb these flows- is a major challenge for
East Asian countries. Each country has embarked in its own financial markets,
following initiatives in trade liberalization. Until recently, the bulk of
capital inflows in East Asia has been FDI and project- related lending, both
official and private. At the relativly lower levels of a decade ago, these
flows could be readily accomodated. The overall impact of foreign investment on
growth and exports has been very positive. As the capital flows have increased,
they have created macroeconomic pressures on exchange rates, domestic
absorption, investment policies, and the capacities of domestic capital
markets. The more recent expansion of portfolio investment implies much more
integration into global capital markets and a corresponding increase in
exposure to international market discipline- refferred to by some as market-
conditionality- that will circumscribe policy options and limit the range of
possible deviation from global norms on a number of variables.
The increased complexity of
these poses serious policy challenges to authorities, whose primary objective
is to promote real sector growth in economies in which the industrial and
financial sectors are still rapidly evolving.
Achieving sustainable,
rapid growth with open capital accounts and active capital markets my will be
more difficult than was true with the more closed financial structures that
used to be the norm in East Asia. Indeed, concern about losing control of
domestic policy contributed to some governments reluctance to liberalize their
financial sector and capital accounts in the past, and contributes to their
willingness to stop the process if they see it getting out of hand. However,
capital controls are becoming more porous, the pressures to liberalize
stronger, and the benefits from more open financial sectors more compelling
Government preferences and market forces are liberalization. East Asian
countries can continue their rapid growth only if they achieve the efficiency
gains that result from further liberalization. Furthermore, less distorted
markets provide fewer opportunities, for sent-seeking behavior and resource
misallocation caused by price and other market distortions.
As capital, domestic and
foreign, to seek the highest rate of return in only market. Investment levels
in countries that offer strong growth potential can be augmented by flows of
foreign saving. At the same time, sophisticated investors have expanded
opportunities to seek short-term gain from exploiting market imperfections,
implicit guarantees, and price fluctuations.
These latter activities and
the extent to which they influence other portfolio investments are more
worrisome because of their volatility and their potential impact on long-term
policy. They may or may not be responding to fundamentals. Theoretically,
speculation and arbitrage are believed to contribute to efficient markets and
to impose few net costs overall. Market forces represented by these speculative
flows have generally, but not always, created pressures toward needed
corrections, either of fundamental policy unbalances or of unwarranted implicit
guarantees or distortions.
However, short-term traders
can exert a great deal of influence on specific markets as specific times, with
can work against government policy objectives. It is argued that short-term
traders would do this only if policies were wrongheaded, but in practice market
forces make no judgments as to the inherent value of a policy- only as to
whether a profit can be made from expected market movements. Market agents have
been known to err and overshoot (although policymakers probably anticipate or
perceive more errors than are likely to occur). Nevertheless, it is not
generally wise policy to try to resist market pressures on the theory that they
may be wrong. They are not often wrong, and resistance can be expensive, since
today private international markets can mobilize vastly larger sums than even
industrial country governments. When market forces do err or overshoot, they
correct themselves usually quickly enough to avoid much lasting harm. In fact,
quick policy reaction when the market is applying pressure in response to some
perceives profit opportunity often sends a signal that large gains are unlikely
and mitigates the flow, whereas digging in against market trends may set up an
easy win for speculators at the government’s expense. Moreover, where policy
failures contribute to market pressures, resistance to adjustment can be vary
expensive. The burden is on governments to manage their economies so that easy
arbitrage opportunities are not readily available and official policies or
actions do not give rise to implicit guarantees or other distortions that
markets can exploit to the detriment of public objectives. Consistent application
of sound policy and clear direction goes a ling way toward reducing the
likelihood of overreaction by markets. In addition, policymakers can blunt
short-term flows that pose dangers to the economy through a variety of
instruments that reduce speculative short-term gains.
Governments should
naturally exercise caution in opening financial markets to international flows.
Liberalization needs to be predicated on (a) developing an appropriate
regulatory framework and supervisory system, (b) ensuring that the resulting
incentives promote prudent behavior, and (c) adopting a macroeconomic policy
structure that is consistent with open financial flows. Policies need to
promote both domestic and international equilibrium, be flexible enough to
respond to disturbances from the capital markets, and include safety features
to activate in periods of crisis. Even with such precautions, the world is a
highly uncertain and unpredictable place. There can be no assurances against
unforeseen crises, even with the best of policies. This is part of the price of
open market economies. The point is not to stifle an the economy in order to
avoid crises but to ensure that the economy is sufficiently flexible and robust
to weather the crises and continue to develop and liberalize despite such
interruptions.
The basic the theoretical
framework for analyzing the impact of external capital flows derives from the
pioneering work done by Flemming (1962) and Mundell (1963) on open- economy
stabilization policies. Their relatively simple models have been revised as the
issues addressed have become more complex. Policy guidelines have become more
complicated and much more dependent on a host of other factors that affect
economic activity, including expectations, which can be hard to pin down. The
theory provides a useful backdrop and guide for appropriate policy responses,
but practical policymaking requires a thorough understanding of the
characteristics of the economy in question, the exact nature of the capital
flows, and the range of available policy options and tradeoffs. East Asian
policymakers have been adept at pursuing reform until difficulties arise, then
slowing or even backtracking a bit to reassess and make corrections before
moving ahead once more. This pragmatism has proved its worth, as these
countries have generally avoided major crises.
The basic theoretical
models were initially developed to study the relative effects of monetary and
fiscal policies in achieving domestic stabilization. Impacts on the external
equilibrium were viewed as results and perhaps as constrains. Critical to the
analysis if the exchange regime- fixed or floating- and the openness of the
capital account (or the degree of substitutability between domestic and
financial capital assets).
Under most conditions, the
models indicate, that given a fixed nominal exchange rate regime, fiscal policy
is relatively more powerful than monetary policy in affecting domestic output.
Expansionary fiscal policy increases demand for domestic goods but also tends
to raise interest rates as additional public borrowing is required. Higher
interest rates attract more foreign capital, increasing reserves. The increase
in domestic resources to that sector. The current account balance deteriorates,
partly absorbing the increased capital flows. Real currency appreciation occurs
as domestic prices rise, even though the nominal rate if fixed.
Conversely, monetary policy
has a greater effect on the external account. Raising domestic interest rates
attracts foreign capital and builds reserves, the amount depending on the
substitutability of foreign and domestic assets. Attempts to stimulate domestic
demand by lowering interest rates are diluted, as capital flows overseas to
seek higher rates there, reducing any effect on domestic demand. The more
substitutable foreign and domestic assets are, the less the interest rate
change required for a given effect. Increased substitutability of assets leads
to other problems, however. Where governments try to constrain domestic demand
by raising interest rates, capital flows in, to benefit the higher rates, and
counteracts the restraint. If sterilization is attempted- if, for example,
governments sell bonds (tending to further increase domestic interest rates) to
absorb the increase in the money supply associated with the influx overwhelm
the authorities’ ability to continue to issue bonds to purchase foreign
exchange. In such circumstance, it is hand to prevent a real currency
appreciation.
For an economy dependent on
export growth, as most East Asian countries are, the dangers of expansionary
fiscal policy, combined with monetary constraint to keep inflation under
control, are evident. East Asian countries generally adopt more conservative
fiscal stances than Latin American countries.
Under a floating-rate
regime, the additional exchange rate flexibility dampens some of these effects,
but at the cost of loss of control over the nominal exchange rate. Fiscal
policy becomes relatively lass effective in influencing domestic output. The
increase in demand from expansion leads to an appreciation of the nominal (and,
consequently, the real) exchange rate, increased imports and lower exports, and
less demanded for money and bonds.
Interest rates rise, but
less than in the fixed-rate case, and the floating rate keeps the external
accounts in balance. The increase in capital inflows offsets the higher current
account deficit. Under most reasonable assumptions, output rises, but less than
under a fixed exchange rate for a given increase in expenditures. By contrast,
monetary policy can have a more compelling effect. An expansionary action, such
as open market purchase of domestic bonds, increases output through the effects
of money supply on demand. It also leads to a depreciation, which shifts
resources to the tradable sector and decreases the current account deficit,
offsetting the outflow of capital brought about by the more perfect
substitutability of assets, although the interest rate change will be smaller.
These models can also be
used in reverse to examine the effects of a change in external variables on the
domestic economy. What are the implications when we look at the effect on
domestic policy of increases in foreign capital inflows? For a regime with a
fixed nominal exchange rate, an increase in foreign inflows tends to reduce the
domestic interest rate and increase domestic demand. This, in turn, leads to an
increase in domestic prices that will bring about a real appreciation through
higher domestic inflation. Reserves tend to accumulate, although by less than
the capital inflows, as the current account also deteriorates.
Monetary policy action to absorb the capital inflows through, for example,
open-market sales of bonds (sterilized intervention) could offset the impact on
demand. But such an action would tend to increase interest rates, which could
well attract more capital inflow. It is not likely to be effective in the long
term if there are practical limits on how many bonds can be issued, and it
could be costly (because of negative carry on the reserves accumulated). The
more substitutability there is between domestic and foreign assets, the less
variance is possible between domestic and foreign interest rates before
increase in the domestic interest rate become self-defeating. Fiscal contraction
would offset the increase in demand and perhaps allow a reduction in interest
rates, which would diminish the attraction of domestic assets to foreign
investors. A fiscal response would take longer to orchestrate than a monetary
response, however, become public budgets are hard to cut in the short run.
Under a floating-rate
regime, a foreign capital inflow leads directly to an appreciation of the
nominal and real exchange rates. The impact on output depends on the relative
strengths of the increase in demand resulting from the capital inflow and the
reduction in demand for domestic output because of the appreciation, but an
increase in output is likely. If the exchange rate is allowed to adjust, the
real appreciation attributable to the capital inflow has less effect on the
domestic economy. Prices may rise, and interest rates may fall. However, for
export-oriented economies a sustained appreciation may pose serious long-term
problems for the export sector. Many fear that appreciation would cause significant
loss of exports and eventually overall growth, as markets are lost to
lower-cost competitors. Depending on the relative strengths of different
effects, the expansion of domestic demand could be counteracted by either
tighter fiscal policy or monetary contraction, offsetting some of the
appreciation. The former still raises the same questions about the speed of
response; the latter may raise interest rates enough to attract more foreign
inflows, exacerbating the initial problem. Furthermore, exchange rate
appreciation induced by capital inflows will increase the yield to foreign
investors as measured in their own currencies, which may extend the capital
inflows, particularly short-term, yield-sensitive flows. The ability of
floating exchange rates to insulate an economy from external influences depends
on the authorities’ willingness to accept exchange rate movements determined,
in part, by foreign investment demand. A floating-rate regime also depends on
the flexibility of domestic prices and wages and on adequate factor mobility to
be effective. The prevailing fixed or managed exchange rate regimes in East
Asia and most other countries indicate a marked reluctance to accept the
implications of fully floating exchange rates.
Even at this simple level,
the models illustrate several important points. The degree of openness of the
capital account and the substitutability of foreign and domestic assets have an
important bearing not only on financial sector policies but also on real sector
policies. Financial flows can have tremendous effects on the real economy – for
example, on interest and exchange rates and, through those variables, on
output, employment, and trade . The more open an economy and he more
integrated into world capital markets, the harder it is for the country to
maintain interest rates that deviate significantly from world rates or an
exchange rate that is far out of line with what markets believe to be proper.
The market’s views on these rates are driven by many short-and medium-term considerations
and, particularly for interest rates by forces in the major financial markets.
Market pressures on a given country’s capital markets reflect a great deal more
than just the fundamentals of a particular country. Countries cannot afford to
have key policy variables that are inconsistent with global trends. Thus the
capital account’s openness exposes the economy to pressures that may complicate
achievement of the country’s long-term real sector objectives, and
stabilization issues must be more finely balanced against growth objectives.
Integration into capital markets has its price.
To be more realistic in
these models, one can admit leakage’s and other factor- such as unemployed
resources, market imperfections, and expectations- that may mintage or enhance
the basic impacts described above. Introducing greater sophistication increases
the complexity and number of variables that must be considered in reaching any
conclusion, but it does not make reaching a conclusion any easier. In fact, the
results can be less determinant. The amount of unemployment in the economy
affects the extent to which changes in aggregate demand move output or prices.
In developing economies with limited factor mobility among sectors, the
question of unemployed resources may have to be considered on a sectoral as
well as an aggregate level, or by skill level. Depending on the particular
model used, the inclusion of expectation function private investors will apply
to any government action or nonaction. In some cases, where governments have
announced a commitment to protect exchange rates or fix interest rates,
guesswork is reduced for the market, but possibly at the cost of offering
privat speculative investors a largely covered bet. In other cases it is much
harder to predict whether a policy course outlined by a government will be seen
as credible. In factor in a policy’s effectiveness. The history of government
commitment and the market’s estimation of the resources the government has
available to defend a position figure into this equation. Although models
provide useful general guidance and help frame the issues, their implementation
must be tempered by an analysis of the features of practical considerations.
The basic dilemma stems
from the role of the exchange rate (nominal for-term transactions and real for
long-term decisions) in equilibrating both goods and capital markets as they
become more open. Heretofore, developing countries in East Asia and elsewhere
have been able to use the level and movement of the exchange rate to effect the
goods market almost exclusively. East Asian countries have often used nominal
deprecations to maintain stable or slightly falling real exchange rates and so
promote exports.
As capital markets open
capital flows can create pressures to appreciate the real or nominal exchange
rate against targets directed toward the goods market. Attempts to maintain a
rate satisfactory for the goods market without adjusting other policy
instruments can lead to disruptive capital flows. Either the exchange rate
target has to be modified, or other policy instruments must be adjusted. Using
the exchange rate as a “nominal anchor” to help combat inflation adds to the
burden and can be effective only where fiscal and monetary policies are closely
coordinated in support of that objective. In countries with less developed
financial sectors, the choice and range of instruments are limited.
As the theoretical models
have become richer and more complex, so have the range and complexity world.
Most of the stabilization models deal with money and simple bonds as assets and
include little, if any, explicit analysis of risk- except as the degree of
substitutability of domestic and foreign assets may be taken as a partial proxy
for differing risk. The models do not look at the differential impacts of
different types of capital flow can be quite different. Policymakers need to
look at the characteristics of the instruments involves in capital movements in
both a short-term and a medium-term perspective to help formulate policy.
Commercial bank borrowing
provides resources that are essentially untied. Where the capital flow is
directly linked to a specific project, its impact will be in the capital goods
markets. It will probably have a high import content, witch will absorb a portion
of the increase in demand from the capital inflow and ease pressure to
appreciate the exchange rate or raise domestic prices. However, because these
flows are flexible, they can readily be used to finance budget shortfalls of
the government or of enterprises, perhaps delaying necessary fundamental
adjustment, as often happened leading up to the debt crisis of the 1980s. In
that case they increase aggregate demand and are more likely to lead to
inflationary pressure and exchange rate appreciation. Because of its fixed
term, the stock of this form of capital is not likely to be volatile. However,
flows can stop abruptly, leading to economic stresses, particulary where
borrowers have come to rely on foreign flows and have allowed domestic savings
to decline. Excessive dependence on commercial bank flows can be risky because
there are few built-in hedges to protect the borrower against exchange and
interest rate fluctuations. Furthermore, repayment schedules are fixed in
foreign exchange, and provision must be made to service this debt on schedule,
regardless of the state of the economy of then project financed.
Foreign direct investment
initially affects the market for real assets through purchases of new capital
goods and construction services for plant constructions and sales of firms to
foreign investors, or, in the case of privatization’s and sales of firms to
foreign investors, through purchases of existing plant and equipment. Direct
investors may even encourage incremental national saving and investment, either
from local partners or from bank borrowing. FDI in new plant increases the
aggregate demand for investment goods, and frequently of other goods as well.
Higher demand for imports eases the pressure of capital inflow on the domestic,
reduces reserve accumulation, and relieves pressure on the exchange rate. Most
FDI in East Asia has been of this productive type, and its impact has been
manageable. When FDI is in a protected industry, as has occurred in some cases,
the profits it earns may not come from real (as opposed to accounting) value
added. This form of FDI is least beneficial, as it exploits local marker
imperfections to the advantage of the foreign investor and may not increase
domestic value added or measured or wealth measured in world prices. The
eventual repatriation of capital and profits could reduce the host real income
and wealth.
FDI attracted by
privatization programs is not as likely to result in much new investment.
(Depending on the terms of sale, the new owner may be required to undertake a
certain amount of new investment or renovate existing equipment). When an
existing domestic asset is sold, there is no direct increase in the capital
stock, although the productivity of the existing capital should increase. FDI
received is available for whatever purpose the seller chooses, including
reducing an external gap, lowering taxes, or sustaining other current
expenditures. The effect depends other current expenditures. The effect depends
on what the seller (the government, in the case of privatization, or a private,
in the case of a private asset sale to foreign interests) does with the
proceeds: reduce other debt (which might ease pressure in the banking system),
invest in another project (which would increase investment, as discussed
above), or spend on other goods, primary consumption (which would increase
aggregate demand and perhaps imports, with no increase in output capacity). To
the extent that capital inflows support increased imports without a
corresponding increase in investment, domestic saving are reduced.
FDI lows are as sustainable
as the underlying attraction- stable policies and profitable opportunities. To
the extent that an economy’s growth depends on a sustained inflow of FDI- for
the level of investment, for technology and skill transfer, or for supporting
an export strategy- the importance of maintaining those conditions is evident.
Although FDI is not readily reversible, sharp drops on new flows can have
repercussions if countries depend on it for future export growth. Similarly, to
the extent that countries have increased resources derived from the foreign
investment, a reduction in those flows will require perhaps difficult
adjustments on the consumption front.
No contractual repayments
are associates with FDI. Investors expect a return on their investment-
generally a higher rate of return that on loans and bonds because of the higher
risks and opportunity costs involved. Malaysia, which has been the beneficiary
of substantial FDI, has grown rapidly: an estimated one- third of its current
account receipts is now claimed by service payments on FDI. When FDI flows are
sustained over a long period, foreigners inevitably came to own a substantial
portion of the country’s capital stock in the sectors that attracted FDI. This
prospect is not viewed with as much concern as it once was FDI is not likely to
be volatile: once invested, the real asset is not going to more, although
changes in ownership are possible. Eventually, a foreign investor may want to
sell to a local partner or divest onto a local stock market, and the host
country needs to be prepared for a repatriation of capital. In times of stress,
however, investor may well find ways to get their capital out quickly. Many
investors set as a target the recouping of their outlays (which are usually
less than total project cost) within two or three years, through repatriated)
profits.
Composition of Net
Private Capital Flows (in billions of 1985 U.S. dollars)
FPI potentially has a much
wider range of effects, depending on the type of instrument and how it is used.
It can occur through securities placed in foreign or domestic markets,
including short-term funds and demand deposits. (The relation of these two
instruments to physical investment may be limited; they may be much more a
function of financial variables). Although many of its impacts can be similar
to those of bank loans and FDI, portfolio investment can also have a much
greater effect on domestic capital markets and interest rates. Whereas direct
investment regimes, portfolio flows raise issues of financial and capital
market regimes and their management. Portfolio investment touches more on
issues of disclosure, accounting, and auditing that does direct investment.
When portfolio investment
takes the form of an external placement (bond or equity) and the funds are used
to finance new investment, the effects are in the real sector, as discussed for
FDI. If the funds are used for other purposes, the result depends on those
purposes. Paying down debt might ease pressure in the banking sector or build
reserves. If the inflow is subsequently invested in domestic capital markets or
deposited in banks, the money supply and domestic credit expand. Demand for
assets, including real estate, would probably increase, with effects similar to
those of foreign investment in local markets (discussed below). If the funds
are used for consumption, pressure on domestic output could increase, leading
to a rise in prices. These uses are likely to put more upward pressure on the
exchange rate and downward pressure on interest rates, as the prices of
nontradables and domestic assets are bid up. This is true whether the
government or the private sector carries out the initial borrowing or stock
issue. Offshore placement do not give rise to volatility concerns in the
issuing country’s market. Subsequent trading in the asset occurs in the foreign
market and does not result in further capital movements, other than normal
repayments, into or out of the borrowing country. Sustained access to foreign
markets if another matter; if depends on the market’s continued positive
assessment of the borrower, the liquidity of the borrower’s paper, and the
borrower’s compliance with market rules. If circumstances lead to price
volatility in foreign markets, new placements will be inhibited.
In some East Asian
countries (Indonesia, Korea, and Thailand) domestic banks have been major
issuers of bonds into external markets. Since 1990, 40 percent of placements
have been by financial institutions, with banks accounting for 27 percent.
Large banks obviously have better credit rating than many of their clients and
are thus able to raise funds less expensively. This is a legitimate
intermediation function and has opened financing opportunities to many domestic
firms that would otherwise have had less access to funds. For the ultimate
borrower, lower interest rates, not foreign exchange rates, are typically the
critical factor. For the intermediating banks, the spreads and volumes are
attractive, and the operations help establish the bank’s international
presence. These actions, however, pose two risks. First, there may be a relative
decrease in the effectiveness of monetary police, since in the effectiveness of
monetary policy, since the financial system can miligate or offset government
attempts to expand or contract credit by modulating its foreign borrowing for
domestic clients. When foreign interest rates are lower than domestic rates,
borrowers will be tempted to seek more funds abroad, which may undermine
domestic policies of monetary restraint. Second, banks (especially public or
quasi-public banks) may be borrowing abroad with the implicit or explicit
expectation of a government quartette. They may not take full account of the
exchange risk and may face interest risks as well, since they are
intermediating across currencies and between short-term liabilities and
long-term assets. These risks are likely to be passed on to the government,
should they adversely affect the banks. The recently reported instance of
BAPINDO, a troubled Indonesian bank that borrowed internatinally, seems to have
involved an implicit guarantee, as that bank would not have been able to borrow
on its own account. More generally, central banks may be forces to intervene to
protect the banking sector with official reserves if there are major
disruptions of commercial banks’ capacity to refinance abroad. For some large
borrowers, domestic markets may not yet be deep enough to absorb the size and
other requirements of their financing needs, so that these enterprises must
turn to international markets.
FPI in domestic markets is
a different matter. The bulk of this inflow has been in equities, as investors
have been seeking high yields, mostly through appreciation. These flows
purchase existing portfolio assets and sometimes new issues. To the extent that
the new issues fund new investment, the effects would be quite similar would be
owned by the domestic issuer rather than the foreign investor. New issues may
also be used to recapitalize existing operations. Here the effect would be
through the banking system and the rest of the domestic financial market, where
debt would be retired by the new equity-generated flows. Although this could
ease pressure on the banking system, it would tend to lower interest rates and
increase domestic liquidity. That, in turn, would increase aggregate demand and
create more pressure on the exchange rate than if the funds had been invested
in new equipment with a high import content.
The bulk of equity
investment has been into existing stocks in East Asian markets, driving up the
prices of equity. the cost of capital drops for those floating new issues, but
there are for also strong wealth effects on existing asset holders- as their
wealth increases, consumption is likely to go up as well. This will tend to
raise domestic prices and appreciate the currency in real terms, Whether these
foreign equity, investments increase physical investment depends on the
behavior of the other asset holders- those who sold to foreign investors and
those whose assets appreciated. If they invest in new projects, physical
investment will also increase, otherwise, it will not. It is more likely that
domestic savings will fall when there are large portfolio investment flows than
when the flows take the form of FDI. In Latin America, which has experienced
more portfolio inflows decline, rather than physical investment to increase. In
the past East Asia has avoided this result, partly because its overall policy
regime has favored investment, partly because of the greater degree of
sterilization it has been able to achieve, and partly because the share of portfolio
investment has been smaller. Portfolio flows are a very recent phenomenon, and
it is still to soon to measure many of their effects in East Asia.
It is particularly
worrisome when large private capital flows move into commercial real estate.
Experience in many countries, both industrial and developing, indicates the
ease with which speculative bubbles can develop in real estate during an
investment boom. Asset inflation in this sector can generate very high rates of
return- much higher than are available from investment in manufacturing- over a
few years. But such rates are not sustainable. When the bottom falls out, as it
inevitably does, there are frequently severe repercussions on the banking
sector, since domestic banks are usually major financiers of the real estate,
and governments often end up bailing out the financial sector. Indonesia faced
this problem in 1993; Thailand saw carliev bouts of these bubbles; and they are
not unknown in other countries, including the United States and Japan.
The sustainability of flows
into stock markets is a complex matter. To the extent that the flows depend on
continued high gains, mostly appreciation, one could wonder whether the high of
return of 1992-93 will resume after the 1994 correction. Even in the best of
circumstances, one would expect some flow reversals, in addition to normal
volatility. Unfortunately, the best of circumstances rarely occurs, and the
Mexican episode of December 1994 has precipitated outflows in many emerging
markets as fund managers have bailed out everywhere. It is hard not to view
this as herd behavior with a tinge of panic, but it caused a 3 percent
devaluation in Thailand and more than doubled short-term interest rates there.
Other East Asian markets have also suffered outflows as international investors
have generally reduced their exposure in emerging markets. However, giver the
long-term growth potential of the East Asian economies and the indications of a
longer-term stock adjustment process, there is reason to except that such
reactions will be temporary set backs in a persistent trend toward a lager
share of sound emerging market stocks in global portfolios. The spectacular
yields witnessed recently may not be sustainable, but the East Asian countries
should offer high rates of return over the long term and should continue to
attract investment.
A number of countries in
East Asia and elsewhere have begun attracting foreign portfolio investors into
their own fixed-income markets ,purchasing, instruments in local currency. In
this case the foreign bondholder takes the exchange risk, for which he expects
added compensation. It is encouraging that these economies are becoming
attractive enough, and their exchange management is considered stable enough,
to attract investment in local currency securities. For obvious reasons,
interest tends to be in bank deposits, in shorter maturities, and in guaranteed
instruments of government or their agencies.
To the extent that
short-term capital flows exceed working balances, trade financing, or bridge
activities to long-term investment, they are most likely the result of
relatively high interest rates not offset by an expected devolution. For the
most part, these flows are seeking high short-term rates of return and reflect
cash management or speculative decisions rather than long-term investment
decisions rather than long-term investment decisions. But like long-term flows,
they tend to lower domestic interest rates and appreciate the exchange rate.
They are likely to expand bank reserves and lead to more credit expansion,
although on a potentially more volatile base. To the extend that a government
is trying to restrain domestic demand with high interest rates, the inflow
would undermine its policy. These flows may not directly influence long-term
savings and investment, but they may do so.
The World Bank and
investment bankers regularly provide advice to developing countries on asset
and liability management. But that advice often is non optimal or simply wrong.
Although many tactical tools for active risk management in developing countries
have been developed in the past decade, a framework for developing a strategy
that incorporates country-specific factors has lagged far behind.
For example, in case when
the Federal Reserve Bank (the “Fed”) last September arranged a $3.6 billion
bailout of Long Term Capital Management (LTCM)- a Connecticut- based hedge
fund- critics of the US financial establishment cries foul. The bailout
contrasted strikingly with IMF treatment of indebted firms in Asia. When
indebted businesses in Asia were unable to replay foreign loads, US and IMF
officials insisted that they be forced to close and their assets sold off to
creditors. Bailing out ailing businesses with endless lines of bank credit was,
US officials claimed, the essence of “crony capitalism” and the cause of all
Asia’s problems “Reducing expectations of bailouts, ” declared the IMF, must be
step number one in restructuring Asia’s financial markets.
To Japanese officials, the
LTCM bailout was a clear case of the US “ignoring its own principles”.
Representative Bruce Vento (Democrat, Minnesota), in a Congressional
investigation of the LTCM bailout, said that “there seem to be two rules, a
double standard.” But this view is incorrect. Where bailouts are concerned,
there is only one standard. Whether in Korea, Thailand, Connecticut or Brazil,
US- and IMF- organized bailouts conform, to the same quiding principle:
whatever happens, whoever is at fault, the wealth of Western credits must be
protected and enhanced.
Until 1997, Western
creditors were bullish on Asia and “emerging markets” generally. They poured
billions into stocks, banks and businesses in Thailand, Indonesia, Korea,
expecting mega-returns and a piece of the action as the former “Third World” embraced
freemarket capitalism. Beginning in 1997, though, Western investors began to
worry that they might have over-lent. They pulled out of Thailand first,
selling baht for dollars; as the baht’s value collapsed, worry turned to panic.
Soon, international financial operators were selling won, ringgit, rupiah and
rubles in an effort to cut potential losses and get their funds safety back to
Europe and the US. In the ensuing capital flight, Asian stock prices plunged
and the value of Asian currencies collapsed. Local businesses that had taken
out dollar payments to Western creditors.
For a time, local
governments tries to stave off default by lending their reserves of foreign
currency to indebted firms. South Korea used up some $30 billion in this way.
But this money soon ran out. Western banks refused to make new loans or roll
over old debts. Asian businesses defaulted, cutting output and laying off
workers. As the economies worsened, panic intensified. Asian currencies lost 35
to 85 per cent of their foreign- exchange value, driving up prices on imported
goods and pushing down the standard of living. Businesses large and small were
driven to bankruptcy by the sudden drying up of credit; within a year, millions
of workers had lost jobs while prices of basic foodstuffs soared.
As the crisis unfolded, IMF
officials flew to Asia to arrange a bailout, agreeing ultimately to loan $120
billion to Thailand, Indonesia and South Korea. When announcing these loans,
the press used terms like “emergency assistance” and “international rescue
package,” leading the casual reader to presume that the money will be spent on
food for the hungry, or aid to the jobless. In float, the money is used to
“help” countries pay bank their debts to international banks and brokerage houses.
Which international banks and brokerage house? The same ones who made
speculative loans in the first place, then panicked and brought about the
collapse of the Asian economies. The IMF rescue packages are intended only to
rescue the Western creditors.
The industry has also been
working overtime to squelch defensive government action against their
speculative attacks. At a recent conference in New York City, economist Jagdish
Bhagwati noted that the IMF and the US Government, despite repeated crises and
heavy criticism have intensities pressures on countries to lift exchange
controls. The IMF recently proposed changing its Articles of Agreement so as to
require countries to permit even more freedom for financial speculations.
Echoing this sentiment, US Treasury official Lawrence Summers decried efforts
by Malaysia, Hong Kong and other to curb foreign lending, calling capital
controls “a catastrophe” and urging countries to “open up to foreign financial
service” providers, and all the competition, capital and expertise they bring
with them.
Critics of IMF and US
policy have, of course, noted that the combination of free flowing capital and
bailout funds are a boon to banks other creditors. Such IMF critics as
financier George Soros and Harvard’s Jeffrey Sachs complain that the game of
international speculation and bailout played by the Western financial
establishment- in which hot money rushes into a country, then pulls out,
leaving behind a wrecked economy to be cleaned up by local governments and G7
taxpayers- is a menace to world economic stability. For the Western financial
establishment, however, the bailouts are not the real prize. Nor are the
devastated economies of Asia an unfortunate side-effect of a financial scamp.
They are the while point of the game. Asia’s bankrupt businesses, insolvent
banks and jobless millions are the spoils of what economist Michel Chossudovsky
aptly calls “financial warfare”. The gains to be won from these financial
hit-and-runs are immense. There are, first of all, the foreign- exchange
reserves of the target countries. Countries accumulate currency reserves by
running trade surpluses, often after year upon year of selling more abroad than
they purchase. These surpluses are accumulated at great cost to the working
populations, who labor hard to produce goods, destined to be consumed by foreigners.
In 1997-1998, Asian countries spent nearly $100 billion in accumulated
reserves trying- vainly as it turned out- to prevent devaluation. Brazil, the
latest country to fall, spent $36 billion defending the real against
speculators. Thus, in little over a year, did the Western financial elite
confiscate $136 billion of hard-won wealth from the emerging markets.
Next, there are the
bargains to be had once the target country’s currency has collapsed and its
firms are strapped for cash. Year of effort, for example, by the Korean elite
to keep businesses firmly under control of state-supported conglomerates called
chaebols were undone in a matter of months. By early 1998, as the IMF
negotiated the terms of surrender, Citigroup, Goldman Sachs and other firms
were snatching up ownership of Asian banks and industries. With currencies down
15-60 per cent and stock prices down 40-60 per cent, Asia is today a bargain-
hunter’s paradise. Nor are assets the only bargains to be had. As a direct
result of the destruction wrought by global financial interests, the prices of
basic commodities have plummeted over the past year. Oil. Copper, steel,
lumber, paper pulp, pork, coffee, rice can now be bought up by Western firms
dirt cheap, an important key to the continued profitability of US industry.
Then there is the higher
tribune that countries, once in debt peonage to Western creditors, must pay on
both old and new loans. South Korea, for example, under the terms of the IMF
bailout, will pay interest on foreign loans that is 25-30 per cent higher that
rates on comparable international loans- this despite the fact that the loans
have been guaranteed by the Korean Government. Since the crisis began,
international lenders have doubled or tripled the interest rates they charge on
emerging- market debt. What is such usurious interest cripples the economy and
drives the country into default? Well ,then they will become wards of the IMF,
lender of last resort.
Next, there are the people
themselves, engulfed in debt, impoverished and committed by their governments
to can endless course of domestic austerity and debt crisis of the 1980s, the
Asian crisis has resulted in millions of newly unemployed, whose desperation
will pull wages down world-wide. Like the debt crisis of the 1980s, the Asian
crisis will turn entire countries into export platforms, where human labor is
transformed into the foreign exchange needed to repay Asia’s $600 billion debt.
In just this past year, Thai rice exports rose by 75 per cent, while Korea has
managed to boost its exports and accumulate $41 billion in reserves for debt
service. These figures, notes the World Bank, indicate that people in Asia “are
working harder and eating less”.
Finally there are the
governments themselves, the ultimate prizes to be won. It is no accident that
conditions imposed by the IMF, with their emphasis on altering state
employment, welfare and pension systems, their insistence on reforming the
legal and political systems of the target countries, entail a major loss of national
sovereignty. Through IMF negotiations, national governments are transformed
into local enforcement agents of transnational corporations and banks. IMF
officials are quick to point out that the usurped governments often were not
paragons of democracy and virtue. This of course is true. But the motives of
the IMF are themselves profoundly undemocratic, intended to seize sovereignty
and fix the rules of the game and to protect and expand, at all cost the wealth
of the international financial elite.
Deposit Banks’ Foreign Assets
|
All countries
|
1990
|
1991
|
1992
|
1993
|
1994
|
1995(I)
|
6,793.4
|
6,753.5
|
6,780.4
|
7,239.0
|
7,907.9
|
8,568.9
|
Developing countries
|
1,672.47
|
1,710.26
|
1,721.40
|
1,821.60
|
2,030.93
|
2,098.60
|
Asia
|
868.69
|
884.06
|
891.33
|
928.57
|
1,068.13
|
1,135.63
|
Deposit Banks’ Foreign Liabilities
|
All countries
|
1990
|
1991
|
1992
|
1993
|
1994
|
1995(I)
|
7,137.0
|
6,994.7
|
6,945.9
|
7,099.6
|
8,047.7
|
8,689.8
|
Developing countries
|
1,681.28
|
1,703.69
|
1,735.69
|
1,859.19
|
2,105.00
|
2,200.18
|
Asia
|
838.28
|
861.37
|
869.10
|
929.69
|
1,093.74
|
1,181.70
|
How a market develops,
including the orderly introduction of new instruments, is an important element
of managing capital flows. In a broader since, the kinds of instruments
available and favored (by the tax structure or by other regulations) in a
market and the extent of foreign ownership allowed may also have an effect on
the allocation of investment in the real sector. For example, in markets in
which bonds are readily available or pension funds are impotent buyers, more
capital is likely to be available for long- gestating projects.
Two conclusions emerge from
this analysis. First, capital flows are inherently neither good nor bad. They
have a great potential to be either, depending on how productively they are
used or on whether they are allowed to distort economic incentives and
decisions. The contrast between growth in East Asia and stagnation in Latin
America is instructive in this regard (There are significant exceptions to this
generalization in both regions- the Philippines and other countries come to
mind). Second, realizing positive benefits from capital inflows depends on
sound macroeconomic and sectoral policies in the recipient country. Capital
flows are a complement to good policy, not a substitute for it.
The List of Literature.
1. Managing Capital Flows in East Asia. A world Bank
Publication. Wash 1996y.
2. Private Market Financing for Developing Countries. IMF
wash 1995 y.
3. The World Economy Global trade policy Edited by Sven Arndt
and Chris Milner. Oxford , 1996 y.
4. International Studies Review Edited by ISA and Thomas S.
Watcon Oxford Milner Sping 2000 y.
6.
The Would Bank
Research Program. The Would Bank Research.