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Financial
Developments in the World Economy
by
Prof. J.D.Agarwal
Professor of Finance & Founder
Chairman & Director, Indian Institute of Finance
Chief Editor, Finance India
Email: jda@iif.edu
__________
Acknowledgement
I would like to thank my colleagues at Indian Institute
of Finance, Professor Aman Agarwal, Mr. Deepak Bansal, Senior Lecturer,
and Ms. Yamini Agarwal, Lecturer, for their assistance in preparation
of this paper. I would like to mention that the paper is developed using
vast material including World Bank Report, World Investment Report of
United Nations, IMF Reports and RIS report on South Asia Development
& Cooperation Reports. However, for all errors and omissions, I
am solely responsible.
© J.D.Agarwal, Indian Institute of Finance
_______________
Soft
copy of the paper (In PDF Format)
Professor K.L. Sharma, Honorable Vice-Chancellor, University of Rajasthan,
Dr. K.M. Bhattacharya, Managing Director and CEO, The Bank of Rajasthan
Ltd., Dr. K.L.Jain, Honorary Secretary General, Rajasthan Chamber of
Commerce and Industry; Professor Sugan Jain, Head of the Department,
Dr. B.L. Gupta, Dr. Govind Pareek, Dr. M.L. Sharma, other dignitaries
on the dais, the distinguished members of the audience, Ladies and Gentlemen,
I feel privileged for the honor given me to deliver the late Professor
K.S. Mathur memorial lecture, by University of Rajasthan on Saturday,
3rd January 2004 in Senate Hall of University of Rajasthan, Jaipur.
It has been my pleasure to accept to deliver Professor K.S.Mathur memorial
lecture for several reasons. First and foremost is that Professor Sugan
C. Jain is known to me and I have great appreciation for the excellent
work he has been doing in the department and this prestigious University.
Secondly, this memorial lecture is one of the greatest and befitting
tributes to professor K.S.Mathur one of the honored teachers of this
University, by this great University, which is at the forefront of higher
education in the country for decades, known internationally. It is both
a reward and recognition being bestowed on the noble sole for his academic
contributions. This by itself would provide a great motivation to the
intelligentsia of this university, who are gifted with the treasure
of knowledge, and charged with the responsibility of building human
resource appropriate to the needs of the country. Thirdly, I personally
knew Professor K.S. Mathur for a long time since mid seventies. My long
association with him in different capacities has impressed me most for
his admirable capabilities. He was an academician and a gentleman par
excellence.
I wonder as to what extent I would be able to justify this great responsibility
of delivering this memorial lecture. It is a very difficult task and
a great responsibility. However, it would be my endeavor to be up to
the mark as far as possible or to the expectations of the organizers
and galaxy of intelligentsia who is gathered here to pay their tribute
to Professor K.S Mathur.
Before
I share my views on the subject, it is pertinent to say a few words
about Dr. K.S. Mathur. Dr. Mathur has served as Professor & Head,
Department of Accountancy and Statistics, University of Rajasthan and
retired as Dean, Faculty of Commerce and also Principal, University
Commerce College. Dr. Mathur began his academic career from the famous
Allahabad University – one time popularly known as the Oxford of the
east, passing his M.Com in 1944. He was the founder of Department of
Accountancy and Business Statistics in the University. Dr. Mathur produced
sixteen Ph.D. candidates and written several books and contributed research
papers in leading journals. He also pioneered the Rajasthan Accountancy
Association and remained its President till his retirement. He also
honored the office of the President of Indian Accounting Association.
He visited several countries including USSR and was often invited by
UPSC, RPSC, Institute of Chartered Accountants of India, and Institute
of Companies Secretaries for his expert contributions.
He was a great mentor, a well known teacher. He was upright and simple
man who has devoted all his life in the promotion of accounting education
with total dedication and commitment. His students are holding senior
positions in academia and government. His academic contributions would
be remembered for the times to come. This memorial lecture is a befitting
tribute to him.
The theme of this memorial lecture – Financial Development in the World
Economy - has been rightly chosen by the organizers. It reflects the
vision of the Department and the University.
World Economy: Review & Synthesis
World Economy has witnessed drastic changes in the preceding century
particularly after World War II. Two world wars, great depression of
thirties, formation of various international agencies to resolve international
conflict and help member states in development, like United Nations,
UNCTAD, GATT, WHO, IBRD, ILO, World Bank, IMF, IFC etc., reconstruction
of war torn and destructed economies like Japan, U.K., erstwhile West
Germany and others, fall of British Empire in terms loosing control
and administration of many countries and many countries gaining independence
from foreign rule, partition of India, large flow of international capital
in far eastern economies like Thailand, Taiwan, Hong Kong, Singapore,
S. Korea, and Philippines etc., discovery of oil in the middle east
and part of Africa and development of various middle east countries
on modern lines of living, discovery of gold and copper and other minerals
in different parts of world particularly in Africa, beginning the process
of economic liberalization, privatization and globalization world over
beginning in eighties, fall of Berlin wall resulting in the union of
two Germanys, Formation of European Union – having a European parliament,
Gorbochov Perestroika resulting in the fall of erstwhile USSR from its
dominant position and formation of 12 CIS states, Emergence of Euro
as a common currency of various European countries, Replacement of the
old hat of socialism and communism with Market driven economic system,
China a communist state opening its flood gates to the world economy
particularly inviting Foreign Direct Investment resulting in double
digit growth rate, The world has also witnessed fastest ever technological
innovations in almost every sphere of activity be science, education,
social sector, agriculture, industry, and services. The man landing
on moon, launching of satellites, U.S. investment in star wars, have
attracted major financial investments. The formation of WTO to provide
newer opportunities making the world as one integrated market through
multilateral trade agreements, is another land mark in the world economic
order.. The box type computer developed immediately after World War
II has witnessed fastest growth, shrinking the world to be accessible
in seconds merely with note book size machine with excellent power with
precision. The advancements in telecommunications and war fare have
attained newer heights. The mobile phone/internet and e-mail has made
the world easily reachable at low cost. The world has seen faster human
and economic development during the past half century than during any
previous comparable period in history. Almost everywhere, literacy rates
are up, infant mortality is down, and people are living longer lives.
The world trade has grown tremendously. Each day financial transactions
of more than 500 billion dollars take place in the world. There has
been unparallel growth in Banking, Insurance and Financial Services
sectors of the world economy despite the shocks in the first half of
the last century.
However, the world has seen several odds in the last century some of
which are overflowing in the new millennium. The inequalities of incomes
and consumption pattern amongst people and between nations have widened.
A part of the world unfortunately, suffered from extreme, hunger, poverty,
deprivation, underdevelopment illiteracy, lack of most basic necessities
of life despite the efforts of international agencies like world bank,
while other part of world were engaged in indulging in extravaganza.
There has been excessive dominance of United States in the world economy
in almost all spheres of activities because of its military, political
and financial strength. The financial crisis in the Far East including
Japan, Mexico, Brazil, Russia and few other countries has reflected
the weaknesses of the World Financial System. Four wars in Indian subcontinent
(Chinese aggression in 1962, Pakistani intrusion and aggression in 1965,
1971 and again in 1999), Strife in Sri Lanka and continuous terrorist
activities launched by foreign power, in India, gulf war has adversely
affected the developmental process of this region. Terrorism, militancy,
gorilla warfare, drug trafficking, activities have assumed gigantic
proportion threatening the world peace. In some of the countries democratic
governments have been replaced by military regime through military coup.
Natural disasters, diseases such as HIV/aids, and man made greed for
money and power has led the corruption and money laundering to assume
immeasurable proportions. Major earth quakes in the last century killed
people more than the people killed in the entire civilization since
AD era began. For instance earth quakes toll of people being killed
in Japan 70,000 in 1923, in China 200,000 in 1920, 200,000 in 1927,
70,000 in 1932, 256,000 in 1976 , in Iran 50,000 in 1990 and about 20,000
in 2003.
The change in the world economic order witnessed in the last century
would get accelerated at a much faster rate in the new millennium. In
just three years of the new millennium there has been an terrorist attack
on World Trade Centre, Afghanistan episode and fall of Iraq and Sadam
Hussain. Estimates indicate that China, U.S. Japan and India would emerge
as the most economically powerful economies of the world by 2025. But
some very real challenges remain.
In this millennium, the world is faced with new challenges. One of the
greatest is to fight against both natural and man made disasters and
seek solutions to provide necessary relief. Over a fifth of the world’s
population still lives in abject poverty (under $1 a day), and about
one-half lives below the barely more generous standard of $2 a day.
One-quarter of the population of developing countries are still illiterate.
The 2.5 billion people who live in the world’s low-income countries
still have an infant mortality rate of over 100 for every 1,000 live
births, compared with just 6 per 1,000 among the 900 million people
in the high-income countries. Illiteracy still averages 40 per cent
in low-income countries. Population growth, although slowing, remains
high. The Finance would be required not only for construction but also
reconstruction of economies affected by natural or man made disasters.
In September 2000, the meeting of the U.N. General Assembly concluded
with the adoption of the Millennium Declaration. This Declaration collectively
committed their governments to work to free the world of extreme poverty.
Towards that end, it endorsed the following International Development
Goals for 2015: to cut in half the proportion of people living in extreme
poverty, of those who are hungry, and of those who lack access to safe
drinking water; to achieve universal primary education and gender equality
in education; to accomplish a three-fourths decline in maternal mortality
and a two-thirds decline in mortality among children under five; to
halt and reverse the spread of HIV/AIDS and to provide special assistance
to AIDS orphans; and to improve the lives of 100 million slum dwellers.
The Millennium Declaration also highlighted the task of mobilizing the
financial resources needed—to achieve the International Development
Goals and, more generally, to finance the development process of developing
countries.
World Economy at the Turn of the Century
The world economy recovered smartly in 2000 from the East Asian crisis
of 1997- 99. The estimated world output growth of 4.7 per cent registered
in 2000 is the highest since 1988 while the estimate of world trade
at 12.4 per cent is the highest in the past 25 years. World real GDP
growth is estimated to have declined to 2.3% in 2001 (before increasing
to 3% in 2002). However, the recovery has proved to be fragile. The
world economy grew at the highest average rate in the late 1990s, despite
the marked slow down on account of the crisis in some countries. Similarly,
the average rate of growth of world trade at 7.18 per cent achieved
during 1996-2000 is higher than that registered during any sub-period
over the past two decades. In large part, the robust performance of
the world economy during the last five years of the last century reflects
the strong performance of the US economy in the past several years.
The continued expansion in the US economy has been considerably fuelled
by the productivity improvement in the US industries resulting from
IT applications. The impressive recovery of the world economy and world
trade in the early part of 2000 generated all around optimism as countries
expected to benefit from the favorable spillovers in the form of rise
in demand for their exports. However, the optimism has proved to be
short lived for various reasons.
The slow down of the US economy has a compound effect on the growth
of the world economy by adversely affecting the demand for the products
of partner countries as well. The effect of the impending slow down
will be more severe on the growth rate of world trade which is likely
to reduce to nearly a fifth of the rate achieved in 2000 to around 2.7
and 5.2 per cent in 2001 and 2002, respectively.
However, the Terrorist Attacks of 11 September, 2001, The Afghan Air
Strikes, The U.S. Intervention in Iraq in 2003 have serious economic
effects on World Economy. Some of the worst affected sectors were: Textiles
and garments exports, IT, air travel and tourism, hospitality and insurance;
financial services and the insurance industry. The implications for
developing countries are apparent in the form of reduced inflows of
foreign investments especially of those from foreign institutional investors.
The uncertainty coupled with the slow down also tends to affect foreign
direct investment inflows to the different regions as investors hold
back the investment decisions.
The volatility of oil prices is a highly destabilizing factor for the
world economy. It is more devastating for oil importing developing countries
than for other countries. Given the strong cartel in the form of OPEC
operating in this market, it is not possible to rule out oil price shocks
of the type faced in the early 1970s, early 1980s, early 1990s and 2000
or even in the future. It is imperative for international community
to create a mechanism to regulate and stabilize oil prices at a certain
reasonable and sustainable level. The intervention should bring the
OPEC and other oil producers to observe some international discipline.
Further, there should be some special fund to moderate the impact of
volatility in oil prices for the poorer developing countries. The OPEC
decision to cut output whenever oil prices tend to fall as witnessed
in early 2001 indicates that oil prices will fluctuate around $ 30-35
per. barrel. Therefore, oil importing countries will have to adjust
their economies to the new level of oil prices in the coming years.
Transition from GATT to WTO in 1995 constitutes one of the most important
developments in the world economy of the twentieth century. It has wide-ranging
implications for the global economy. The emerging WTO regime is important
for the national development, trade, investment and technology policies
member countries. The recent developments in Cancum WTO meeting is an
eye opener and a major set back to multilateral trade regime. But by
far the main beneficiaries of trade liberalization have been the industrial
countries. Developing countries’ products continue to face significant
impediments in rich country markets. Basic products in which developing
countries are highly competitive are precisely the ones that carry the
highest protection in the most advanced countries. These include not
only agricultural products, which still face pernicious protection,
but also many industrial products subject to tariff and non-tariff barriers.
The member developing countries need to prepare themselves to take part
in the ensuing negotiations effectively to safeguard their interests.
Issues of preparedness on their part require them to jointly take advantage
of the emerging multilateral regime rather than passively implementing
their commitments. This requires for an appropriate strategic thinking
and concerted action on their part.
One of the important events for the future of world trade is the entry
of China into the WTO regime. The accession of China to the WTO and
the consequent MFN status that it will receive from other WTO member
countries may have some implications for the competitiveness of the
some of the developing countries particularly South Asian countries’
exports. This is because South Asia and China compete in the international
market for a number of labor intensive and matured technology goods
such as textiles and garments, leather goods, light engineering products,
chemicals and pharmaceuticals, among others. China has already offered
tough competition to the South Asian exports in many commodities and
markets. There is a view that China’s accession to the WTO may further
strengthen its competitiveness and hence may affect exports particularly
of the South Asian Countries adversely. Another possibility is that
the accession of China to the WTO would force it to follow WTO norms
and procedures, etc. and will bring its trade policy under international
surveillance. State subsidies will be regulated and hence it will become
difficult for the Chinese exporters to dump their products in the world
market. The Chinese market may also become more accessible for other
countries.
It is clear, however, that the challenges of globalization today cannot
be adequately handled by a system that was largely designed for the
world of 50 years ago. Changes in international economic governance
have to keep pace with the growth of international interdependence.
World Economy: Regional Outlook
1. United States: The slow down of the US economy is
threatening to affect the growth prospects for many parts of the world
economy. America’s GDP growth has directly accounted for about one-third
of global growth. If the indirect benefits of American imports are added
in, then America has accounted for no less than half of the increase
in global output. If that engine stalls, everybody will be hurt. America’s
booming economy has sucked in imports from abroad. As its economy slows,
import growth will fall more sharply than GDP. Canada and Mexico are
the most dependent on the United States: their exports across the border
account for 33 per cent and 21 per cent, respectively of their GDPs.
Several East Asian economies, such as Malaysia, the Philippines and
Thailand, also export at least 10 per cent of their GDPs to America.
In Japan and Western Europe, the proportion is around 3 per cent only.
So the impact of a fall in exports to America will be more modest. A
second reason is the exchange rate. If a hard landing brings a short
fall in the dollar against the euro and the yen, it would further squeeze
exports from Japan and Europe. On the other hand, it would assist countries
such as Argentina that have pegged their currencies to the dollar. Last,
but not least, financial turmoil in America would drag down stock markets
worldwide. And it would also make it harder for emerging markets to
attract funds, as panicky investors would seek safer havens. The average
risk premium on emerging-market government debt over American Treasury
bonds has increased from 6.3 percentage points in early September to
8.1 points now.
Emerging economies have more to lose from a hard landing in America,
as the recoveries in Latin America and Asia have been driven largely
by exports to the United States. Asia is particularly dependent on exports
of electronic equipment. A slump in America would be doubly unfortunate,
since concerns over emerging economies are already rising. Turkey is
suffering a banking and currency crisis; Argentina is struggling to
service its debts; South Korea is being shaken by massive corporate
bankruptcies; and the Philippines and Indonesia are in the grip of political
tensions. The rate of growth of output in the US during the second half
of the 1990s has averaged at 4.4 per cent per annum compared to 3.1
during the 1992-95. The other notable factors that have contributed
to the strong economic expansion in the US include the low oil prices
since 1991 and the Gulf War. The declining prices of Information Communication
Technology equipment has also spurred a faster diffusion of the technology
leading to labor productivity improvements through increased automation
and capital deepening. Finally, returns to investment in Internet have
increased. ICT industry is estimated to have contributed a 35 per cent
share in US economic growth over the 1995-98.
The emerging trends in the US economy in the fourth quarter of 2000
suggest that the economy had reached its peak in 2000, with the growth
rate of output crossing the 5 per cent mark before starting to slow
down. To some extent this is owing to US industry reaching a plateau
in terms of diffusion of Information Communication Technologies, as
indicated by a sharp decline in the market capitalization of IT stocks
at Nasdaq in 2000. The rising crude prices in late 2000 have also compounded
the process of a slow down. The Terrorist Attacks of 11 September, 2001
have further worsened the outlook. The growth rate of the US economy
for 2001 has been scaled down to just over 1 per cent from the 5 per
cent achieved in 2000. In an effort to revive the economy and to contain
recession, interest rates have been lowered. Since September 2000 it
has already cut interest rates eight times.
2. European Union: The European countries have shown
signs of an upswing at the turn of the century. The growth rate of output
of 3.4 per cent is a nearly full one percentage point higher than that
recorded in 1999. The recovery of the European economies from the recession
of the late 1990s has also led to a strengthening of the euro against
dollar and other major currencies. The Information and Communication
Technology revolution which has helped the US in boosting its growth
rates in the second half of the 1990s is now occurring in the countries
of European Union. The weakening of dollar against major currencies
of the world in 2003 is also helping European Union.
3. Japan: The Japanese economy, has not only stagnated
over the past several years but suffered from recession, despite fastest
ever technological innovations in some of the sectors of world economy.
The East Asian crisis of 1997 has also adversely affected the Japanese
economy in 1998 and 1999. The Japanese economy has not shown signs of
a recovery either in terms of a pick up of consumer confidence or in
bank lending, despite the November 2000 fiscal stimulus package as well
as the depreciation of the yen in late 2000, . The US slow down has
also hit the economy negatively.
4. East and Southeast Asia: Indonesia, South Korea,
Malaysia, the Philippines and Thailand, the five Southeast and East
Asian countries most severely affected by the crisis of 1997 seem to
have recovered smartly with the growth of GDP averaging 6.7 per cent
in 1999, compared to an 8.2 per cent decline in the previous year. The
recovery has been further consolidated in 2000 with the average growth
rate approaching 7 per cent. However, there are variations in the extent
of recovery across the countries Korea and Malaysia showed a positive
recovery from the crisis in 1999 while Indonesia had still not emerged
from this, with recovery in the Philippines and Thailand being moderate.
The recovery of the region’s economies from the 1997 crisis was assisted
by the expansion of the global economy and world trade over the past
few years, led by the rapid expansion of the US economy. However, concerns
remain as the recovery has been accompanied by only limited corporate
restructuring and the health of the financial system continues to rely
on public intervention in the credit mechanism. The US slow down has
created fresh problems for these economies, particularly for electronics
and IT hardware industry which account for a considerable proportion
of the manufactured exports of most of these countries, especially Korea
and Malaysia, Furthermore, the rising oil prices are also expected to
strain the growth prospects of East Asian countries as most of them,
except for Indonesia and Malaysia, are oil importing countries.
5. India: India, the largest democracy of the world,
is all set to become major economic power. India faced its worst ever
financial crisis in 1991 when its foreign exchange reserves fell below
one billion dollars, inflation rate was as high as 16.7 percent, suffering
from high fiscal deficit, high unemployment rate and several other economic
weaknesses and other odds. India has successfully launched and handled
its economic reforms process of privatization and liberalization to
bring about macro economic stabilization despite the US sanctions. Its
foreign exchange reserves have crossed 100 billion dollars; fiscal deficit
is within tolerable limits, growth rate of 7 percent expected for the
current year; the rupee is gaining strength despite RBIs intervention,
banking and financial institutions have improved, sensex has crossed
over 5600 points from a low level of 3000 six months ago. The overall
outlook of the economy is encouraging.
6. Middle East: One region that has benefited from
the recent rise in oil prices is the Middle East which comprises some
of the prominent oil exporting countries. The growth rate of the region
spurted from a marginal 0.8 per cent in 1999 to a healthy 5.4 percent
in 2000. With oil prices continuing at a relatively high level, although
not the same as levels in late 2000, this will allow the region to record
robust growth rates in 2001 and 2002. Middle East countries are significant
trade partners of the South Asian countries. The economic expansion
may increase the demand for labor in these countries as has been the
case with the previous oil price shocks. Since the South Asian countries,
especially India, Bangladesh, Pakistan, and Sri Lanka, are important
sources of manpower for these countries, there may be an upswing in
the demand for labor consequent to the rise in oil prices. However,
the recent gulf crisis has adversely affected a rise in demand for workers
in the Middle East and also the growth prospects.
7. Latin America: There have been mixed results in
most of countries of Latin America, of reform agenda popularly known
as “Washington Consensus”. Economic liberalization was expected to generate
rapid economic expansion, but growth rates since 1990 have been half
of what Latin America achieved during the period of state-led industrialization.
The strong recession than began in 2001 deepened in 2002, when GDP fell
by 0.5 percent. Open unemployment reached 9.1 percent – a record figure
in Latin American history. The poor population has swollen by 20 million
in Latin America.
World
Economy:
Financial Developments:
Financial development played a critical role in promoting industrialization
in countries such as England by facilitating the mobilization of capital
for large investments. Financial development contributes significantly
to growth. It is central to poverty reduction. Some of the researches
have shown that financial development directly benefits the poorer segments
of society and also income redistribution. Strong financial systems
are the key factor for proper financial developments. One of the important
functions of Financial Systems is to shift risk to those who are willing
to bear it. Financial derivatives can help diversify risk. For strong
financial system, one requires supporting financial institutions and
well developed financial markets to reduce the information costs of
borrowing and lending and making financial transactions. Financial Institutions
include banks, insurance companies, provident and pension funds, mutual
funds, compulsory savings schemes, cooperative banks, credit unions,
informal financial intermediaries and securities markets. Financial
systems vary across countries and varying economic outcomes. Generally,
banks and financial institutions dominate most formal financial systems,
but lately stock markets are gaining importance particularly with international
capital flows through the entry of foreign investment institutions in
the stock markets.
However, in the current era of liberalization and globalization of financial
markets, the economies of developing countries have become highly vulnerable
to speculative capital movements in and out of the country. The economic
crisis in Mexico in 1994, more recently the currency crisis in the East
and South East Asian countries in 1997, the Russian crisis in 1998,
the Brazilian crisis of 1999 and the Argentinean crisis of 2001 have
highlighted the role played by speculative capital movements in triggering-off
the crisis situations. The financial crisis of July 1997 that has affected
some of the best performing Asian economies has been a subject of intense
concern. It has provoked rethinking world over on the risks and benefits
of liberalization of financial and capital markets and of global integration,
especially in the developing countries. It has also highlighted the
importance of the prudent regulation of the domestic financial and banking
sectors. Finally, it has exposed some of the weaknesses of the existing
approaches in handling the crises such as those enforced by the IMF.
Given the increasingly interdependent nature of the world economy, the
fortunes of all the countries are highly inter-linked.
1. Capital Flows to Developing Countries :
The decade of the 1990s has seen major transformations in the magnitude
and composition of external resource flows to developing countries.
The magnitude of the external resource inflows to developing countries
nearly trebled between 1991- 97. The inflows, however, declined during
1997-99, as the world was reeling under the shock of the economic crisis
in Mexico in 1994, East and South East Asian countries in 1997, the
Russian crisis in 1998, the Brazilian crisis of 1999 and the Argentinean
crisis of 2001. The most striking trend of the 1990s with respect to
the external resource flows has been their changing composition. The
official flows comprising of ODA and other official flows have gradually
dried up: from US$ 61 billion in 1991 to $ 39 billion by the end of
the decade. As a result, their share in the total resource flows has
come down from 50 per cent in 1991 to just 13 per cent in 2000. The
bulk of the resources received by developing countries now comprise
of private capital flows.
The composition of the private capital flows has also undergone change
over the 1990s. Flows from international capital markets, viz. portfolio
equity investments and bank lending and bonds, have grown rapidly between
1991-96. Since then they have declined, especially in the wake crisis
in some countries. The private debt flows (bank lending and bonds) turned
negative in 1999 before recovering somewhat in 2000. Portfolio equity
investments have also shrunk between 1996-98 but have staged a smart
recovery during 1999-2000. The private capital flows, therefore, are
highly volatile. They tend to aggravate a crisis situation by suddenly
leaving the host country.
The rising magnitude of external resources over the 1990s, has to be
evaluated in terms of resource requirements. It is a matter of interest
to ascertain whether the resource availability has been growing more
rapidly than the growth of the economies. It is evident that resource
flows to developing countries had been growing faster than their GNP
up to 1998, when it reached the level of 5.56 per cent. The proportion
of resource flows to GNP came down sharply in 1999, but it started to
recover in 2000, with the proportion in 2000 at 4.36 per cent being
slightly higher than 4.31 in 1994.
One striking feature of resource transfers to low income countries is
that the net transfers, after providing for total debt service, have
been declining and constitute a small proportion of the total disbursements.
This leads to the building up of the debt trap and an eventual collapse.
It is obvious that some way has to be found by the international community
to prevent such situations of negative net transfers from occurring
by monitoring the debt levels and net transfers and to take corrective
steps (e.g. restructuring of debt) at appropriate time.
2. FDI Inflows in Developing Countries
FDI has emerged as the most important channel of external resource transfers
to developing countries in the 1990s. FDI is also an agent of integration
of economic activities across the countries in the 1990s. Compared to
the average annual growth of trade in goods and services of about 6-7
per cent over the 1990s, FDI inflows have grown at an average annual
rate of 20 per cent over 1991-95 and at 32 per cent during 1996- 99
despite the economic crisis in some important regions of the world.
As a result, the magnitude of global FDI inflows has increased from
US$ 159 billion in 1991 to $ 1.27 trillion in 2000. FDI inflows are
expected to be less volatile and non-debt creating. They are also expected
to be accompanied by a number of other assets that are valuable for
development, such as technology, organizational skills, and sometimes
even market access, among others. Hence, most countries – developed
as well as developing – compete among themselves in attracting FDI inflows
with increasingly liberal policy regimes and incentive packages. However,
the expansion of the magnitude of FDI over the 1990s has benefited only
a handful of developing countries.
The recent growth of FDI flows has been fuelled by cross-border mergers
and acquisitions (M&As) in North America and Europe as a part of
ongoing wave of industrial restructuring and consolidation. The value
of cross-border M&As sales has grown from US$ 81 billion to $ 720
billion over 1991-99. The bulk of these M&As ($645 billion of the
$720 billion) are concentrated in the industrialized countries. The
industrial restructuring and consolidation in the industrialized world,
in turn, has been provoked by regional economic integration.
FDI inflows received by developing countries have expanded from under
US$42 billion in 1991 to $ 240 billion in 2000. The growth of FDI inflows
in developing countries seem to have been slower than that of global
inflows, especially in the late 1990s. The share of developing countries
in FDI inflows rose sharply during the early 1990s from 26 per cent
in 1991 to over 40 per cent in 1994. Since then it has steadily declined
to below 24 per cent in 2000. The sharp rise in the share of developing
countries in the early 1990s was largely owing to the emergence of China
as the most important host of FDI in the developing world.
There has also been a shift in the relative importance of different
regions as hosts of FDI inflows received by the developing countries
since 1993. Developing Asia has been the most important host region
of FDI inflows accounting for over half of FDI inflows to developing
countries. Initially, developing Asia’s share showed a rising trend
peaking at 70 per cent in 1993 However, its importance has declined
steadily since then. Latin American countries have steadily improved
their share since 1993 with their share converging to the Asian level
towards the end of the decade. The strong trend towards regional economic
integration has helped Latin American countries to improve their share
in FDI inflows while the East Asian crisis has taken a toll on the share
of Asian developing countries.
Within Asia also the relative importance of sub-regions is changing.
China dramatically improved her share in the inflows to developing countries
from 10 per cent in 1991 to 38 per cent in 1993. Since then, however,
China has not been able to keep its share in the inflows into Asia.
Share of Asian NIEs, viz. Hong Kong, Taiwan, and South Korea has fluctuated
around 14 per cent upto 1997. It has risen sharply over 1998-99 largely
owing to cross-border M&A activity in post-crisis South Korea. ASEAN
countries, particularly, Singapore, Malaysia, Thailand, Indonesia, Philippines,
have been popular hosts of FDI in the region. Vietnam has also become
an increasingly important host following its integration with ASEAN.
The region initially lost its share largely owing to the emergence of
China. During the 1994-96 periods, ASEAN countries actually improved
their share in Asian inflows. Since 1997, they have lost their share
owing to the crisis of 1997. In particular, there has been disinvestment
in Indonesia for the past two years in a row. South Asia, comprising
some of the poorest countries in the region, has been a marginal host
of FDI inflows. The region is facing a further marginalization as a
host of FDI inflows since 1998, even though it was spared from the direct
effect of the currency crisis.
There are sharp inter-country variations in FDI flows to different countries.
FDI inflows are highly concentrated in a handful of high and middle
income countries. Low income and least developed countries remain marginalized
in the distribution of FDI inflows. The share of 45 least developed
countries as a group in global FDI inflows is negligible at half a per
cent and it shows a declining trend over the 1991-99 period. Just ten
most important hosts of FDI among developing countries account for over
80 per cent of all inflows received by developing countries in 1999.
The concentration in the top ten recipients has increased from 66 per
cent in the mid-1980s to over 80 per cent in late 1990s. The expanding
magnitudes of FDI inflows tend to create optimism among poorer countries
regarding the potential of these inflows for expediting the process
of their development.
Global FDI inflows declined in 2002 for the second consecutive year,
falling by a fifth to $651 billion – the lowest level since 1998. Flows
declined in 108 of 195 economies. The main factor behind the decline
was slow economic growth in more parts of the world and dim prospects
for recovery at least in the short term. Besides there has been falling
stock market valuations, lower corporate profitability, a slow down
in pace of corporate restructuring in some industries and winding down
of privatization in some countries. A big drop in the value of cross-border
mergers and acquisitions figured heavily in the overall decline. The
number of mergers and acquisitions fell from a high of 7894 cases in
2000 to 4493 cases in 2002. Their average value fell from $145 million
in 2000 to $82 million in 2002. The number of deals of mergers and acquisitions
worth more than $ one billion i.e. from 175 in 2000 to only 81 in 2002
– the lowest since 1998.
The decline in FDI in 2002 was uneven across regions and countries.
It was also uneven across sectorally: flows into manufacturing and services
declined, while those into the primary sector rose by 70%. Services
are the single most largest sector for FDI inflows. The equity and intra-company
loan components of FDI declined more than reinvested earnings. Geographically,
flows to developed and developing countries each fell by 22% (to $460
billion and $162 billion respectively). Two countries – the United States
and UK accounted for half of the decline in the countries with reduced
inflows. Among developing regions, Latin America and Caribbean was hit
hard, suffering its third consecutive annual decline in FDI with a fall
in inflows of 33% in 2002. Africa registered a decline of 41%. FDI in
Asia and the Pacific declined the least in the developing world because
of China which with a record inflow of $53 billion became the world’s
largest host country. CEE did the best of all regions, increasing its
FDI inflows to a record $29 billion.
There was a sizable decline of FDI inflows in 16 of the 26 of the developed
countries. Australia, Germany, Finland and Japan were among the countries
with higher FDI inflows in 2002. FDI outflows from developed countries
also decline in 2002 to $600 billion. The fall was concentrated in France,
Netherlands and U.K. While FDI outflows from Austria, Finland, Greece,
Norway, Sweden and US increased.
International Financial Reforms: Policy Prescriptions:
The financial crisis in East Asian countries and subsequent crises in
Brazil, Russia, Turkey, and Argentina have highlighted the long-standing
need for the reform of international financial reengineering to prevent
the re-occurrence of the crisis. It is generally been seen that we awake
after the crisis has occurred and suggest measures to seek solutions
to cure such financial crisis. Signals for the possible financial crisis
are generally depicted through the financial statistics and overall
economic outlook of the economy. Steps are required to be taken to deal
with issues of financial crisis prevention. Prevention is always better
than cure. Some of the issues that merit the attention of Developing
countries are:
1. International Development Co-operation : International Development
Cooperation is urgently required to initiate development in countries
and sectors that do not attract much private investment and particularly
those who cannot afford to borrow extensively from commercial sources;
to confronting and accelerating recovery from financial crises; to providing
or preserving the supply of global public goods: such as peacekeeping;
prevention of contagious diseases; the prevention of CFC emissions;
limitation of carbon emissions; and preservation of biodiversity; and
Coping with humanitarian crises. It is to be appreciated that great
strides have been made in trade liberalization, domestic policy reform,
and capital inflows into developing countries. The international community
needs to consider whether the common interest would be furthered by
providing stable and contractual resources for these purposes.
While developing countries should do every thing to mobilize the domestic
resources, the importance of external resources in supplementing the
domestic resources cannot be minimized. The official sources of development
resource transfers to developing countries have declined sharply even
in nominal terms. For instance, net long-term official resource flows
to developing countries have steadily declined from $ 60.9 billion in
1991 to $38.6 billion in 2000. It has often been argued that since the
private flows have been expanding at a dramatic pace, the declining
levels of official resources would not affect the development process
of developing countries in a significant manner. This is primarily because
FDI inflows have expanded considerably over the 1990s. Hence, developing
countries have been advised by the Bretton woods institutions to liberalize
their policy framework to allow greater inflows of FDI which are expected
to take care of their resource requirements. Furthermore, it is generally
argued that FDI inflows are non-debt creating; they help host countries
to integrate with the global economy, and bring technology and market
access to their host countries. Although private capital flows, including
foreign direct and portfolio investments as well as bonds and bank borrowing,
have expanded a great deal during the 1990s, they are no substitutes
of declining levels of ODA. This is because the poorest, hence the most
needy, countries are least likely to receive the private capital flows.
2. Restructuring of IMF : There is an urgent need for
restructuring the IMF to handle the financial crisis faced various nations
in a more meaningful way. First, there is a need for considering in
a systematic fashion, not only the role of world institutions, but also
of regional arrangements. Accordingly, regional monetary funds to monitor
regulate and suggest measures to countries of the region may be set
up. Regional Monetary funds should be set up to assist developing countries
in different regions for meeting their temporary liquidity problems
and to help them avert default which may perpetuate the crisis by shaking
the confidence in these economies. An attempt was made in this regard
in 1997. The Japanese government had proposed to set up an Asian Monetary
Fund (AMF) first in 1997 to monitor the region’s economies and provide
early warning to the respective governments on the impending crisis.
It could also provide speedy assistance to deal with the crises in their
early stages so as to prevent them from spreading. AMF could also be
a significant step towards decentralization of international monetary
and financial decision making that is presently concentrated in the
Washington, DC. Regional Monetary Fund could understand region specific
issues better than IMF. However, despite strong support within the region,
the proposal for an AMF did not get far. It was opposed by the United
States and IMF, as it posed a threat to the monopoly of IMF. However,
in 1998, Japan proposed the Miyazawa Plan at the Annual IMF-World Bank
meeting, which is a more modest proposal. It seeks to provide a $ 30
billion package for the region for short-term trade financing as well
as recovery through long-term projects. It was suggested that the Japan
Export-Import Bank, the World Bank and the Asian Development Bank could
jointly take part in the initiative. As a part of this initiative, Japan
established short-term swap arrangements with South Korea ($5.0 billion)
and Malaysia ($2.5 billion). India needs to take initiative to form
a regional IMF- SAARC Monetary Fund to assess and help the member countries
of this region. Secondly, there is an urgent need to review the working
of IMF as IMF package of reviving economies is often counter productive
for most of the countries approaching IMF. Often IMF prescribes the
same set of conditionalties to every economy irrespective of its requirements.
For instance, the IMF package uniformly insists on belt tightening,
devaluation and demand compression measures that affect growth adversely
and hence make recovery even more difficult. Furthermore, despite a
widespread recognition of the role played by the capital account liberalization
in accentuating the crisis, the IMF has been pushing the affected countries
towards accelerated capital market liberalization in the wake of the
crisis. IMF often adopts a short sighted and rather inflexible approach
to crisis management. Malaysia decided to withdraw from the IMF Program
soon after it was initiated to the program after the crisis. Instead,
Malaysia adopted an unorthodox approach to dealing with the crisis that
included imposition of capital controls although temporarily and the
adoption of a fixed exchange rate regime. More importantly, Malaysia’s
approach also included lower interest rates and fiscal expansion or
pump priming by the government as against belt tightening measures and
balancing of budget included in the IMF package. As a result, Malaysia
did not suffer the kind of social consequences that other affected countries
did and the recovery was rather quick with a 5.8 per cent growth of
GDP in 1999 and 8.5 per cent in 2000, compared to much lower rates of
growth achieved by Thailand, Indonesia and the Philippines under the
IMF program. Thirdly, There is also need for revival of SDRs Allocation.
Special Drawing Rights (SDRs) were established by the IMF at the end
of the 1960s to supplement international liquidity. SDRs were supposed
to become the principle reserve asset. However, the allocation of SDRs
has been abruptly halted since 1981, thus adversely affecting the ability
of developing countries to supplement their reserves and making them
vulnerable to the liquidity crisis. They have been forced to borrow
on onerous terms to augment their international reserves. The institution
of SDRs continues to be relevant, especially for developing countries
and it should be restored as soon as possible by the IMF. There is,
therefore, need for a thorough reform of the IMF’s working and bringing
flexibility into the package that keeps in mind the specific needs of
the affected countries.
IMF is currently viewed as a single global institution with no alternatives.
It should rather become an apex institution with a network of regional
or sub-regional monetary funds.
3. International Borrowing and Lending: There is an
important need for transparency, monitoring and surveillance of international
borrowing by enterprises particularly because of The East Asian crisis
exposing the international borrowing and lending mechanism. The US alone
had created an exposure of more than a trillion dollars before its crash,
with a capital base of only about $ 5 billion The movements of capital
are affected to a considerable extent by the credit ratings assigned
to individual countries. The credit rating at times may suffer from
some inherent weaknesses. to objectively assess the economic situation
in the affected countries. For instance, the credit ratings of the Southeast
and East Asian (Indonesia, Korea, Malaysia and Thailand) countries in
June 1997 were exactly the same as in June 1996. They were down-graded
only after the crisis in these economies was in full swing. The Government
of Thailand was able to borrow in the Euro-bond market at a spread of
only 90 basis points over US Treasury Bills just a few months before
the crisis erupted. The other economic fundamentals of the economy need
to be stated together with credit rating for international lending and
borrowing. Bonds and bank loans are largely governed by the sovereign
credit ratings of the concerned countries and are increasingly for shorter
terms while being highly volatile in nature. The recent economic crisis
has also exposed the weaknesses of the existing system of evaluating
the credit rating of countries which affect the movements of speculative
capital to a considerable extent. Poor credit ratings not only make
it more difficult to borrow in the international markets, the terms
at which the funds are available also become more onerous.
4. Private Capital Flows. Foreign capital can provide
a valuable supplement to the resources a country can generate at home.
Nowadays, large sums of capital cross national borders in the form of
foreign direct investment (FDI), and the international capital markets
constitute a further vast pool of funds on which countries can draw.
Industrial countries need to remove artificial constraints on investment
in emerging markets, and refrain from imposing severe restrictions on
access to credit. While private capital cannot alleviate poverty by
itself, it can play a significant role in promoting growth, but its
provision needs to be organized in a way that reduces vulnerability
to crises. In the last one and half decade it has been observed that
large amount of funds flown by non-residents to their country of origin
such as in China and India.
5. Portfolio Equity Flows: Foreign portfolio equity
flows could either take the form of equity investments in a receiving
country’s stock markets by foreign institutional investors (FIIs) like
the pension funds, or GDR issues by domestic companies on the Western
capital markets. An important prerequisite for FII investments to flow
in is the existence of well-developed capital markets giving a good
return. Most of the low-income countries have capital markets that are
in their infancy or underdeveloped. The capital markets in some of the
developing countries at the turn of century have even been subdued for
various reasons. Hence, the prospects of these inflows in providing
considerable financing arise in only select emerging markets. Also these
inflows are highly volatile in nature popularly known as Hot Money.
It is also difficult to raise GDR/ADR inflows for enterprises from low-income
countries. The enterprises must, in the first place, be able to demonstrate
their competitiveness, follow international norms of disclosure, and
be in a position to bear substantial launching expenses before they
can hope to raise resources at international equity markets. These factors
act as formidable entry barriers. Although these inflows are more stable,
very few low-income countries can tap these resources.
6. Short-term Capital Movements: Short term capital
movements need to be regulated by the host countries depending upon
its own needs and requirements. A number of countries have imposed regulations
to curb short-term capital movements with great success. For instance,
Chile introduced restrictions on capital inflows in 1991 by imposing
unremunerated reserve requirements. These reserves have to be maintained
for one year irrespective of the maturity of the loan. Thus, they constitute
an implicit tax on foreign borrowing that varies inversely with the
holding period. The reserve requirements were extended to all types
of foreign financial investments, including ADRs in 1995. Colombia also
introduced similar reserve requirements in 1993 which were tightened
subsequently to apply to all external borrowings with a maturity of
less than five years.
7 Capital Account Convertibility: Capital market liberalizations
in Latin America, Eastern Europe, and Asia have been followed by extreme
macroeconomic crises. There is now almost a general consensus that developing
countries should adopt a cautious approach towards liberalization of
the capital account, keeping in mind the vulnerability that it brings
with it. Prudent norms of behavior and an effective mechanism for regulation
of the banking and financial sector needs to be in place before the
country could move towards liberalization of the capital account. Besides
the country suggested introducing capital account convertibility should
adhere to other conditions such as: low fiscal deficit, stable inflation,
appropriate foreign exchange reserves, stability of its currency, stable
GDP growth rate There is no evidence that capital controls lower growth.
8 Domestic Resource Mobilization. The primary responsibility
for achieving growth and equitable development lies with the developing
countries themselves. This responsibility includes creating the conditions
that make it possible to secure the needed financial resources for investment.
Almost all countries have initiated steps to mobilize savings, regulate
interest rates, strengthening stock and capital markets, improve banking
institutions, and offering tax incentives to accelerate savings and
investments. Many countries have also initiated the process of disinvestments,
and private public partnerships to involve the polity. Macroeconomic
financial stability is must for appropriate domestic resource mobilization
efforts.
The present complacency which exists in the capital markets needs to
be handled carefully. India is fortunate to have buoyancy in the stock
markets recently when its sensex has crossed more than 5500 points recently.
However, in India the Capital market is yet to recover fully. There
is need to improve the institutional framework in which financial markets
operate i.e. improving supervision and accounting practices of financial
systems world wide, adoption of codes of conduct of fiscal, monetary
and financial policies, introducing transparency, introducing sound
principles of corporate governance as well as governance, improving
information related to financial markets, Strengthening prudential regulation,
and adopting minimum international standards in these areas. Self regulation
and respect of law (domestic and international) should be the factor
while adhering to principles outlined here above. The standards adopted
in the industrialized countries and developing countries may vary according
to the conditions prevailing in those countries. There should be adequate
representation of developing countries in evolving the international
standards and codes of conduct. However, special focus needs to be given
to risk management, intended non-performing assets of banks, and capital
adequacy issues of banks and financial institutions. Excessive portfolio
investment of banks either in foreign exchange or in stock markets needs
to be viewed seriously to avoid serious nature of scams which shake
the investor’s confidence.
Conclusions
Financial development plays a critical role in promoting industrialization
and growth. This requires mobilization of resources for investments.
Strong Financial systems with strong financial institutional framework:
internationally, regionally and in the home countries is the key factor
for proper financial development. The financial development in the world
economy with the emergence of e- finance will make the world economy
grow at a faster rate, if handled, properly and may help meet the challenges
that lie ahead in the new millennium. All financial developments are
subject to high degree of risk of varying nature. Financial Developments
with emergence of e-finance has its own risks different from the risks
generally associated with financial systems. For instance, Money laundering,
IT based frauds might pose newer problems. Some of the smaller countries
(less developed) countries might find it difficult to handle such problems.
There is also an urgent need to devise a mechanism to unearth the swindled
money, by politicians, corrupt bureaucrats, drug traffickers, industry
through capital flight, and militancy outfits, which is deposited in
international banks, denying the use of such money in the developmental
process of such countries where from it is being swindled.
The world community need to consider the issues involving International
Development Cooperation, Restructuring IMF, International Borrowing
and Lending, Private Capital Flows, Portfolio Equity Flows, Short-term
capital movements, Capital Account Convertibility and Domestic Resource
Management more seriously to match them with the needs and requirements
of home countries, regions and the world economy. Of course the financial
systems as enumerated above need to be regulated controlled and developed
to reap the fruits of financial developments in the world economy to
make the world a better place for living. Finance would be required
not only for construction and development of economies but also for
reconstruction and rebuilding economies.
Once again I must thank the organizers to have given me an opportunity
to share my views on the subject. I must also thank you, ladies and
gentlemen, for your kind patience.
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