By Yilmaz Akyüz
GENEVA, Feb 16 2015 (IPS)

After a series of crises with severe economic and social consequences in the 1990s and early 2000s, emerging and developing economies have become even more closely integrated into what is widely recognised as an inherently unstable international financial system. 

Both policies in these countries and a highly accommodating global financial environment have played a role. Not only have their traditional cross-border linkages been deepened and external balance sheets expanded rapidly, but also foreign presence in their domestic credit, bond, equity and property markets has reached unprecedented levels.

Yilmaz Akyuz

New channels have thus emerged for the transmission of financial shocks from global boom-bust cycles.

Almost all developing countries are now vulnerable, irrespective of their balance-of-payments, external debt, net foreign assets and international reserve positions, although these play an important role in the way such shocks could affect them.

Stability of domestic banking and asset markets is susceptible even in countries with strong external positions.

Those heavily dependent on foreign capital are prone to liquidity and solvency crises as well as domestic financial turmoil.

The new practices adopted in recent years – including more flexible exchange rate regimes, accumulation of large stocks of international reserves or borrowing in local currency – would not provide much of a buffer against severe external shocks such as those that may result from the normalisation of monetary policy in the United States. “The surge in capital inflows that started in the early years of the new millennium, and continued with full force after a temporary blip due to the collapse in 2008 of the Lehman Brothers financial services firm, holds the key to the growing internationalisation of finance in developing countries”

And the multilateral system is still lacking adequate mechanisms for an orderly and equitable resolution of external financial instability and crises in developing economies.

This process of closer integration was greatly helped by highly favourable global financial conditions before 2008, thanks to the very same credit and spending bubbles that culminated in a severe crisis in the United States and Europe. The crisis did not slow this process despite initial fears that it could lead to a retreat from globalisation.  Integration has even accelerated since then because of ultra-easy monetary policies pursued in advanced economies, notably in the United States, in response to the crisis.

The surge in capital inflows that started in the early years of the new millennium, and continued with full force after a temporary blip due to the collapse in 2008 of the Lehman Brothers financial services firm, holds the key to the growing internationalisation of finance in developing countries.

It has resulted in a rapid expansion of gross external assets and liabilities of developing economies. More importantly, the structure of their external balance sheets has undergone important changes, particularly on the liabilities side, bringing new vulnerabilities.

The share of direct and portfolio equity in external liabilities has been increasing. An important part of the increase in equity liabilities is due to capital gains by foreign holders. In many developing countries presence in equity markets is greater than that in the United States and Japan.

While still remaining below the levels seen a decade ago as a percentage of gross domestic product (GDP), external debt build-up has accelerated since the crisis in 2008. This is mainly due to borrowing by the private sector, which now accounts for a higher proportion of external debt than the public sector in both international bank loans and security issues. A very large proportion of private external debt is in foreign currency. There is also a renewed tendency for dollarisation in domestic loan markets.

As a result of a shift of governments from international to domestic bond markets and opening them to foreigners, the participation of non-residents in these markets has been growing. The proportion of local-currency sovereign debt held abroad is greater in many developing countries than in reserve-issuers such as the United States, the United Kingdom and Japan. It is held by fickle investors rather than by foreign central banks as international reserves.

International banks have been shifting from cross-border lending to local lending by establishing commercial presence in developing countries. Their market share in these countries has reached 50 percent compared with 20 percent in developed countries.

These banks tend to act as conduits of expansionary and contractionary impulses from global financial cycles and increase the exposure of developing economies to financial shocks from advanced economies.

One of the key lessons of history of economic development is that successful policies are associated not with autarky or full integration into the global economy, but strategic integration seeking to use the opportunities that a broader economic space may offer while minimising the potential risks it may entail. This is more so in finance than in trade, investment and technology.

For one thing, the international financial system is inherently unstable in large part because multilateral arrangements fail to impose adequate discipline over financial markets and policies in systemically important countries which exert a disproportionately large impact on global conditions.

For another, the multilateral system also lacks effective mechanisms for orderly resolution of financial crises with international dimensions.

Thus, closer integration of several into the international financial system in the past ten years, after a series of crises with severe economic and social consequences, is a cause for concern.

In all likelihood, these countries will be facing strong destabilising pressures in the years ahead as monetary policy in the United States returns to normalcy after six years of flooding the world with dollars at exceptionally low interest rates.

In weathering a possible renewed instability, they cannot count on the more flexible currency regimes they came to adopt after the last bouts of crises or the reserves they have built from capital inflows or the reduced currency exposure of the sovereign.

It is important that they, as well as the international community, avoid going back to business-as-usual in responding to a new round of financial shocks, bailing out investors and creditors and maintaining an open capital account at the expense of incomes and jobs.

They need to include many unconventional policy instruments in their arsenals to help lower the price that may have to be paid for the financial excesses of the past several years

They should also take the occasion to rebalance the pendulum and to bring about genuine changes in the international financial architecture. (END/IPS COLUMNIST SERVICE)

Edited by Phil Harris   

The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, IPS – Inter Press Service. 

* This column is based on Internationalization of Finance and Changing Vulnerabilities in Emerging and Developing Economies, South Centre Research Paper 60, January 2015, which is available here.

Excerpt:

At a makeshift e-waste workshop in China's Guiyu town, a migrant worker cooks computer motherboards over solder to remove chips and valuable metals. Credit: Jeffrey Lau/IPS

By Yilmaz Akyüz
GENEVA, Aug 9 2012 (IPS)

Growth in developing economies (DEs) has accelerated significantly in the new millennium.

Whereas in the 1980s and 1990s their average growth was barely higher than that of advanced economies (AEs), from the early years of the 2000s until the global crisis, the difference shot up to five percentage points. It widened further during 2008-11 with the collapse in AEs.

Although there is diversity, the acceleration is broad-based with all developing regions enjoying faster growth than in the past. The notable exception is China, which has grown in the new millennium at broadly the same (albeit rapid) pace as in the 1990s.

This divergence has widely been interpreted as the South “decoupling” from the North. However, the evidence does not show the desynchronisation of cycles between developed and advanced economies, and deviations of economic activity from underlying trends continue to be highly correlated.

The more significant question is whether there has been a durable shift in the trend growth of the South relative to the North. Such a view is widely held, including among policy makers in DEs. However, a closer look suggests that the growth surge in the South owes as much, if not more, to exceptional and unsustainable global economic conditions as it does to improvements in their own fundamentals. There is, consequently, no room for complacency in policy circles in developing countries.

Until the financial crisis hit in 2008, the credit, consumption and property bubbles in the industrialised North, particularly the U.S., generated a highly favourable global environment for emerging countries in trade and investment, capital flows and commodity prices.

At least one-third of pre-crisis growth in China was due to exports, mostly to AEs, and the ratio is even higher for smaller Asian export-led economies.

There is a strikingly strong correlation between property booms and current account deficits both in the U.S. and other countries that have subsequently experienced financial turmoil. China’s accession to the WTO also provided a major impetus to outsourcing and exports to AEs by removing uncertainties surrounding its access to the U.S. market.

From the early years of the 2000s, historically low interest rates and rapid expansion of liquidity in the U.S., Europe and Japan triggered a search for yield and a boom in capital flows to DEs.

This was supplemented by a surge in workers’ remittances, which amounted to over 25 percent of gross domestic product (GDP) in some smaller countries but exceeded three percent of GDP even in India. Commodity prices also rose strongly, largely thanks to rapid growth in China driven by exports to advanced economies.

The boom was accentuated as financial investors started to diversify into commodity-linked assets and search for yield in commodity markets. On some estimates, Latin America would not have seen much growth over the last decade had terms-of-trade, dollar interest rates and capital flows remained at the levels of the late 1990s.

With the subprime crisis the international economic environment deteriorated in all areas that had previously supported expansion in DEs. Capital flows and commodity prices were reversed and AEs contracted.

However, emerging economies showed resilience and were able to rebound quickly, particularly where a strong countercyclical response was made possible by favourable payments, reserves and fiscal positions built-up during the preceding expansion.

As a result, the growth impulse in some leading Southern economies has shifted to domestic demand, including in countries that had previously been export-led.

China has played a key role, launching a massive stimulus package in infrastructure and property investment. Because of its high commodity intensity, this investment-led growth has given an even stronger boost to commodity prices than the pre-crisis export-led growth.

Capital flows also recovered briskly thanks to sharp cuts in interest rates and quantitative easing in AEs in response to the crisis. They have been more than sufficient to meet growing deficits in several major DEs including India, Brazil, Turkey and South Africa.

For several reasons the exceptional growth enjoyed by the South over the past ten years is unlikely to be sustained over the medium term. First, returning to the extremely favourable international economic conditions prevailing before the global crisis is precluded by the large adjustments now facing the AEs.

Indeed, efforts to move policy back to “business as usual”, with the U.S. acting as a locomotive and running growing deficits, would seriously destabilise the international trading and monetary systems.

But nor can the post-crisis domestic demand-driven growth be maintained for long. There are already strong signs of deceleration. China’s strategy of offsetting the slowdown in exports to AEs with accelerated investment cannot work indefinitely.

It needs to shift to consumption-led growth, lifting private consumption from its “wartime” level of some 35 percent of GDP. Doing so will entail overcoming political hurdles since it will require significant redistribution of wealth and income.

Even a moderate slowdown in China, towards seven percent, could bring an end to the commodity boom, threatening growth prospects in a number of Latin American and African countries.

Moreover, the risk-return configuration that has sustained the surge in capital flows to DEs, notably the historically low interest rates and rapid liquidity expansion in AEs, cannot last forever. The most vulnerable are those that have so far enjoyed the twin booms in commodity prices and capital flows.

Most DEs need to overhaul their development models in order to sustain the kind of growth they have enjoyed over the past ten years.

The export-led Asian economies need to reduce their dependence on consumers in AEs by expanding domestic and regional markets.

Commodity exporters need to reduce their reliance on capital flows and commodity earnings ­the two key determinants of their growth, which are largely beyond national control. These call for a genuine departure from market fundamentalism and neoliberalism both in macroeconomic and structural policies.

(END/COPYRIGHT IPS)

* Yilmaz Akyuz, chief economist of the South Centre, Geneva. For further analysis see South Centre Research Paper 44 (http://www.southcentre.org)

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