Attaction of foreign inflows in east asia - конспект - Международные отношения, Рефераты из Международные отношения
Guzeev_anton10 июня 2013 г.

Attaction of foreign inflows in east asia - конспект - Международные отношения, Рефераты из Международные отношения

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Samara State University of Economics . Конспект лекций по предмету Международные отношения. Plan Integration, globalization and economic openness- basical principles in attraction of capital inflows Macroeconomic cons...
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Economic faculty

Department of applied economy

Course work on theme:


Student of the third course


Superviser of studies,

Candidate of economic science,

Senior lecturer

Linkov Alexei Yakovlevich

St. Petersburg

2000 y.



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



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


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


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


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


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 Western financial industry, moreover, has been lobbying heavily for even

more secure protection from future losses. One plan, put forward last year by the US

and US Treasuries, envisions a $90 billion fund of public money, supposedly to avert

currency crises. The idea is that G7 governments will, henceforth, underwrite the

finance industry’s speculative ventures into emerging, markets before, rather than

after, they turn sour. In this way, when bankers and fund mangers grow bored with a

particular market, withdraw their funds and send the currency into a tailspin, they

can collect on their losses immediately, without the tedious and time- consuming

delays generated by IMF negotiations.

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


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


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

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