1.3. The Balance of Payments II


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1.3. The Balance of Payments II

  1. 1. <ul><li>Global competition for attracting capital flows </li></ul><ul><li>September 2007 </li></ul><ul><li>Michel Henry Bouchet </li></ul>
  2. 2. I- What drives global capital flows?
  3. 3. Globalization’s impact? <ul><li>Misconception : capital should flow from rich countries to poor ones , which have less capital and offer higher returns! By borrowing abroad, LDCs should be able to boost investment and the growth rate. </li></ul><ul><li>Facts : capital is flowing « uphill » and the US current account deficit is financed by emerging countries’ purchase of US Treasury securities </li></ul><ul><li>Facts : LDCs have limited capacity to absorb foreign capital, due to underdeveloped financial systems. Dynamic growth boosts saving relative to investment, hence a current account surplus (China!). </li></ul><ul><li>Facts : US bond yields are 2% lower than they otherwise would be, thanks to the purchase of US securities by China and other EMCs. If these countries loose their appetite for US assets, bond yields could jump and the dollar plunge! </li></ul>Source: IMF/Prasad-Rajan, 2006
  4. 4. US Current account deficit in US$ billion -7% PBI US Treasury, IMF
  5. 5. Global competition in financial markets DEFICIT SURPLUS ? -$800 billion = $2200 million/day ? ?
  6. 6. Who finances whom? Current account balances of OECD and EMCs (billions of US$) Source: FMI/2006 Asian crisis
  7. 7. Why do EMCs show such large CA surpluses and rising reserves? <ul><li>1982 debt crisis + 1994 Tequila crisis + 1997 Asia crisis + 1998 Russian crisis + 2001 Argentina crisis </li></ul><ul><li>Strong IMF-monitored adjustment + economic and trade liberalization </li></ul><ul><li>Devaluation + Boost in investment ratio= trade and current account surpluses </li></ul><ul><li>Improvement in debt indicators! </li></ul>
  8. 8. Successful economic adjustment: Improvement in EMCs’ solvency ratios (drop in Debt/X %) Source: FMI/2007
  9. 9. México consigue el Grado de Inversión Embi+ Mexico Current account surpluses + Global liquidity: Sharp drop in the cost of borrowing of EMCs BCRP, Banco Central de Chile
  10. 10. II- Global competition in financial markets
  11. 11. Globalization Index = « Top 20 » <ul><li>1. Singapore </li></ul><ul><li>2. Ireland </li></ul><ul><li>3. Switzerland </li></ul><ul><li>4. USA </li></ul><ul><li>5. Netherland </li></ul><ul><li>6. Canada </li></ul><ul><li>7. Denmark </li></ul><ul><li>8. Sweden </li></ul><ul><li>9. Austria </li></ul><ul><li>12. UK </li></ul><ul><li>18. France </li></ul><ul><li>19. Malaysia </li></ul><ul><li>20. Slovenia </li></ul><ul><li>26. Spain </li></ul><ul><li>34. Chile </li></ul><ul><li>42. Mexico </li></ul><ul><li>47. Argentina </li></ul><ul><li>51. Colombia </li></ul><ul><li>53. Peru </li></ul><ul><li>54. China </li></ul><ul><li>55. Venezuela </li></ul><ul><li>57. Brazil </li></ul><ul><li>61. India </li></ul>ATKearney
  12. 12. The 30 most attractive EMCs for FDI <ul><li>India </li></ul><ul><li>Russia </li></ul><ul><li>Vietnam </li></ul><ul><li>Ukraine </li></ul><ul><li>China </li></ul><ul><li>Chile </li></ul><ul><li>Latvia </li></ul><ul><li>Slovenia </li></ul><ul><li>Croacia </li></ul><ul><li>Turkey </li></ul><ul><li>Tunisia </li></ul><ul><li>Tailandia </li></ul><ul><li>Korea </li></ul><ul><li>Malaysia </li></ul><ul><li>Macedonia </li></ul><ul><li>UAE </li></ul><ul><li>Arabia Saudita </li></ul><ul><li>Slovakia </li></ul><ul><li>México </li></ul><ul><li>Egypt </li></ul><ul><li>Bulgaria </li></ul><ul><li>Rumania </li></ul><ul><li>Hungary </li></ul><ul><li>Taiwan </li></ul><ul><li>Bosnia </li></ul><ul><li>Lituania </li></ul><ul><li>Brasil </li></ul><ul><li>Morroco </li></ul><ul><li>Colombia </li></ul><ul><li>Kazajstan </li></ul>Economic + political risk Market Potential AT Kearney GRDI 2006
  13. 13. The most attractive EMCs in 2006 HIGH Risk LOW Risk
  14. 14. Identifying the next leaders? <ul><li>The BRICs : «  The path to 2040  » : Goldman Sachs: </li></ul><ul><li>Brazil, Russia, China & India’s GDP > G7 en US$ </li></ul><ul><li>Challenge: How to forecast the « Top 10  » of 2040? </li></ul>
  15. 15. The BRICs catching up with the G7 Goldman Sachs 2007
  16. 16. Share in global GDP Chine= 15,4% Japon= 6,4% Inde= 6%
  17. 17. The leaders of 2040? Source: Goldman Sachs GDP in billions of US$ The « BRICs »
  18. 18. III- The Asian challenge <ul><li>Strong Investment rate </li></ul><ul><li>High Savings rate </li></ul><ul><li>Dynamic Productivity </li></ul><ul><li>Low Labour cost </li></ul><ul><li>Current account surplus </li></ul><ul><li>Large Internacional reserves </li></ul><ul><li>High liquidity and solvency indicators </li></ul>
  19. 19. The dynamics of investment rate I/GDP % IMF, IIF
  20. 20. National savings and Investment dynamics IIF
  21. 21. Share of EMCs Official Reserves in 2007
  22. 22. Asian crisis and Thailand’s recovery FMI
  23. 23. FDI and portfolio flows in Thailand US$ million
  24. 24. CHINA Inc. : A Global supremacy strategy Oil Oil US$ NTIC FDI MNCs
  25. 25. « Made in China » and « Made by China » <ul><li>China Inc holds a two-fold comparative advantage to attract foreign capital flows: </li></ul><ul><li>Labour intensive activities with very competitive labour costs: textile, shoes, garment, components… </li></ul><ul><li>High value added activites incorporating new technologies (electronics, software, NTIC…) </li></ul><ul><li>Key role of MNCs (majority from Asia: South Korea, Japan, Malaysia) : 60% of China’s exports stem from foreign companies and/or joint-ventures </li></ul>
  26. 26. made in China y made by China Share of capital origins in China’s exports Source: Le Monde, 16/6/2006 %
  27. 27. IV- Where do capital flows go ?
  28. 28. Who finances whom? Current account balances of OECD and EMCs (billions of US$) Source: FMI/2006 Asian crisis
  29. 29. Net capital sources for emerging market countries IIF/IMF US$ billion
  30. 30. Net capital flow sources for Latin American countries (US$ billion) IIF-2006 Net private flows Net public flows
  31. 31. Net private capital flows to EMCs Billion of US$ Source: IIF/IMF
  32. 32. Net portfolio capital funds to EMCs (US$ billion) IIF-2006
  34. 34. IIF/FMI
  35. 35. Net FDI and portfolio capital flows to EMCs US$ billion Fuente: IMF/IIF
  36. 36. Total FDI inflows in US$ trillion Post-2003 bounceback has been driven by emerging markets. However, FDI flows to emerging markets will remain buoyant in 2006-10, averaging over US$400bn per year, but growth rates will be modest as privatisation tails off and the global economy slows.
  37. 37. Incestuous globalization? The key recipients of FDI In US$ billion
  38. 38. FDI in China US$ billion OCDE
  39. 39. V- How analyzing global risk and opportunities? The role of Rating agencies (after the Asian crisis, Enron, LTCM, Arthur Andersen, Parmelat, and the US subprime market…)
  40. 40. Risk Ratings <ul><li>Advantages/ Pros </li></ul><ul><li>Simple </li></ul><ul><li>cross-country comparison </li></ul><ul><li>comparison across time </li></ul><ul><li>shrinks a large number of variables into one single grade </li></ul><ul><li>Reliable for smooth risk evolution </li></ul><ul><li>Shortcomings/Cons </li></ul><ul><li>“ reductionist” </li></ul><ul><li>oversimplistic </li></ul><ul><li>risk of self-fulfilling prophecy </li></ul><ul><li>little predictive value </li></ul><ul><li>weighted average tends to bury salient trends </li></ul><ul><li>Gives “market consensus” often made of herd instinct </li></ul>
  41. 41. Moody’, Fitch, S&P’s, Coface Objective: assessing willingness + capacity to repay a debt at maturity
  42. 42. Investment grade vs speculative investment D   Default BB B CCC CC C Ba B Caa Ca C Speculative risk (&quot;Junk Bonds&quot;) AAA AA A BBB Aaa Aa A Baa Investment grade S & P Moody's  
  43. 43. LT & ST Ratings of Moody’s Subprime B; Caa; Ca; C Speculative investment From Prime 1 to Prime 3 Aaa; Aa; A Baa, Ba Investment grade S.T. L.T.
  44. 44. Rating Moody’s 2007 Ba2 Colombia B2 Venezuela Ba2 Perú Baa2 (stable) Russia Baa2 Túnisia Baa1 México Ba3 Brazil Baa1 Chile B3 Argentina Rating Countries
  45. 45. RATING MOODY´S (mid- 2007) Investment grade Fuente: Scotiabank/Moody’s Baa1 Baa1 Ba2 Ba3 Ba3
  46. 46. How does S&P build its Rating? <ul><li>10 Parameters: </li></ul><ul><li>Political risk, Economic structures, Growth potential, fiscal flexibility, budget balance, debt ratios, Inflation, external liquidity, public and private external debt (liquidity and solvency) </li></ul>
  47. 47. Rating of S&P B; C; SD; D B; CCC; C; SD; D Speculative investment A1; A2; A3 AAA; AA; A BBB; BB; Investment grade S.T. L.T.
  48. 48. Investment grade B BB- BB BB BB+ BBB A Source: S&P RATING S&P LT
  49. 49. RATING FITCH Source: Fitch IBCA
  50. 50. OECD Country risk classification in 2007 Gabon RCI Guatemala Mexico Kuwait Argentina Brazil Vietnam Russia Thailand Trinidad & Tobago Cameroon Niger Nigeria Pakistan Turkey Bulgaria South Africa Hungary Bolivia Haiti Albania Peru Algeria Morocco Israel Chile 7 6 5 4 3 2 1
  51. 51. COFACE <ul><li>140 countries </li></ul><ul><li>Country rating definition: </li></ul><ul><li>Investment grade </li></ul><ul><li>A1= steady economic and political situation </li></ul><ul><li>A2= weak default probability </li></ul><ul><li>A3= adverse circumstances may lead to worsening payment record </li></ul><ul><li>A4= patchy payment record could be worsened by adverse econmic/politicval developments </li></ul><ul><li>Speculative grade : </li></ul><ul><li>B= unsteady economic and poltical environment </li></ul><ul><li>C= bad payment record </li></ul><ul><li>D= high risk profile and very bad payment record </li></ul>
  52. 52. Coface credit Rating (2007) <ul><li>Canada= A1 </li></ul><ul><li>Australia= A1 </li></ul><ul><li>USA= A1 </li></ul><ul><li>Japan= A1 </li></ul><ul><li>Korea= A2 </li></ul><ul><li>Chile = A2 </li></ul><ul><li>Thailand= A3 </li></ul><ul><li>China= A3 </li></ul><ul><li>India= A3 </li></ul><ul><li>Poland= A3 </li></ul><ul><li>Mexico= A4 </li></ul><ul><li>Morocco= A4 </li></ul><ul><li>Algeria= A4 </li></ul><ul><li>Romania=A4 </li></ul><ul><li>Egypt= B </li></ul><ul><li>Brazil= B </li></ul><ul><li>Russia= B </li></ul><ul><li>Turkey= B </li></ul><ul><li>Vietnam= B </li></ul><ul><li>Congo= C </li></ul><ul><li>Ukraine= C </li></ul><ul><li>Venezuela= C </li></ul><ul><li>Argentina= D </li></ul><ul><li>Turkménistan= D </li></ul><ul><li>Chad= D </li></ul><ul><li>RCI= D </li></ul><ul><li>Nigeria= D </li></ul>
  53. 53. Ratings 09/2007 D Cuba A3 China B Perú D North Korea B Russia A2 Chile A4 Brazil D Bolivia C Argentina Rating Countries
  54. 54. KOREA: Index of payment arrears 1993-2006 (base 1995 = 100) COFACE
  55. 55. VI-Shortcomings of rating agencies? <ul><li>Criticisms: </li></ul><ul><li>* Power without accountability </li></ul><ul><li>* Conformity bias </li></ul><ul><li>* Sociocultural bias </li></ul><ul><li>* Punishment of disobedient firms/countries that do not request a rating </li></ul><ul><li>* Procyclical bias, hence followjng the majority opinion of market participants without any early warning signals nor predictability track record </li></ul><ul><li>Spill-over effect! </li></ul>
  56. 56. Rating = poor early warning signals? <ul><li>South Korea was rated as Italy and Sweden as recently as October of 1997! But has been downgraded abruptly to junk bond status during the crisis </li></ul><ul><li>«  There were no early warnings about Korea from us or, to the best of our knowledge, from other market participants and our customers should expect a better job from us » </li></ul><ul><li>FICHT IBCA January 14, 1998 </li></ul>
  57. 57. After Asia: some lessons of the crisis <ul><li>“Any agency which rated the Republic of Korea at the high investment grade rating of AA- (in the case of Fitch IBCA and S&Ps) or A1 (in the case of Moody’s) before the crisis, and which now rates Korea at a speculative grade B-, was clearly either wrong initially or subsequently. Clients are entitled to expect us to perform better in the future!” </li></ul><ul><li>Fitch IBCA January 13, 1998 </li></ul>
  58. 58. The Perceived Situation <ul><li>Was the crisis anticipated by rating agencies? </li></ul>
  59. 59. EUROMONEY Risk Rating the higher the ranking, the higher the risk 107 46 78 65 29 2000 81 98 91 49 45 Indonesia 46 46 56 35 33 Malaysia 75 53 55 57 55 Philippines 49 49 54 51 45 Thailand 28 44 42 30 28 Korea 2005 1999 1998 1997 1996
  60. 60. Macroeconomic success of the tigers… until 1996 Source: IMF/International Financial Statistics 1999
  61. 61. Prudent macroeconomic management of the tigers: low inflation, low budget deficits Fuente: IMF/ International Financial Statistics 1999
  62. 62. Example: Russia attracts large capital inflows thanks to a strong rating by Coface and Fitch… despite bad competitiveness and governance indicators! Transparency International 126 / 158 CPI PriceWaterhouseCoopers 46 / 59 Opacity Index World Economic Forum 75 / 117 Growth Competitive Index OECD 158 / 209 Country risk Fitch BBB stable Credit Rating Coface B Credit Rating World Bank 70 / 155 Ease of Doing Business UNDP 62 / 177 HDI Heritage Foundation 122 / 157 Económic Freedom
  63. 63. Ratings and the US subprime mortgage-backed securities market in the summer of 2007 <ul><li>Rating agencies responded to issuers’ rating requests and kept a AAA rating for debts whose collateral was rapidly deteriorating! </li></ul><ul><li>Ratings agencies failed to warn investors about the risk of complex financial instruments </li></ul><ul><li>Challenge: how measuring liquidity and market value risks? </li></ul>
  64. 64. World Bank: Doing business in 2007 <ul><li>7 criteria </li></ul><ul><li>175 countries </li></ul><ul><li>New company creation; employment procedure; company registration; financing mobilization; investment protection; contract enforcement; liquidation </li></ul><ul><li>3 days to set up a company in Canada vs 12 days in New Zealand and 52 in Slovakia and 153 in Mozambique </li></ul>
  65. 65. World Bank: « Doing Business » in 2007 <ul><li>Singapore </li></ul><ul><li>New Zealand </li></ul><ul><li>USA </li></ul><ul><li>Canada </li></ul><ul><li>HK </li></ul><ul><li>UK </li></ul><ul><li>Denmark </li></ul><ul><li>Australa </li></ul><ul><li>Norway </li></ul><ul><li>11. Japan </li></ul><ul><li>21. Germany </li></ul><ul><li>35. France (44 en 2006) </li></ul><ul><li>39. Spain </li></ul><ul><li>93. China </li></ul><ul><li>96. Russia </li></ul><ul><li>121. Brazil </li></ul><ul><li>134. India </li></ul><ul><li>171. RDC </li></ul>«  Ease of doing business » The ranking does not take into account the macroeconomic framework nor organized crime
  66. 66. Quality of regulatory framework matters World Bank 2007
  67. 67. Economic Freedom Rating/Fraser Institute 2006 <ul><li>Hongkong </li></ul><ul><li>Singapore </li></ul><ul><li>New Zealand </li></ul><ul><li>Switzerland </li></ul><ul><li>US </li></ul><ul><li>Ireland </li></ul><ul><li>UK </li></ul><ul><li>Canada </li></ul><ul><li>Iceland </li></ul><ul><li>Luxembourg </li></ul><ul><li>Australia </li></ul><ul><li>Austria </li></ul><ul><li>Estonia </li></ul><ul><li>Finland </li></ul><ul><li>Netherland </li></ul><ul><li>20. Chile </li></ul><ul><li>24. France </li></ul><ul><li>30. Spain </li></ul><ul><li>35. Korea </li></ul><ul><li>45. Italy </li></ul><ul><li>60. Mexico </li></ul><ul><li>60. Thailand </li></ul><ul><li>83. Indonesia </li></ul><ul><li>88. Brazil </li></ul><ul><li>95. China </li></ul><ul><li>102. Russia </li></ul><ul><li>124. Algeria </li></ul><ul><li>126. Venezuela </li></ul><ul><li>130. Zimbabwe </li></ul>
  68. 68. World Economic Forum: competitiveness ranking <ul><li>The Global Competitiveness Report , which examines the growth prospects of 80 countries, remains the most up-to-date and comprehensive data source available on the comparative strengths and weaknesses of leading economies of the world. </li></ul><ul><li>Countries in The Global Competitiveness Report are ranked by the Growth Competitiveness Index (GCI) (GCI Rankings) and the Microeconomic Competitiveness Index (MICI) (MICI Rankings), which combined encapsulate the relative strengths and weaknesses of growth within each economy . </li></ul>
  69. 69. Davos-WEF 2007 Competitiveness Index 30 Tunisia 15 Israel 29 Czech Republic 14 Iceland 28 Spain 13 Taiwan, China 27 Chile 12 Norway 26 Malaysia 11 Hong Kong SAR 25 Estonia 10 United Kingdom 24 Korea, Rep. 9 Netherlands 23 New Zealand 8 Germany 22 Luxembourg 7 Japan 21 Ireland 6 United States 20 Belgium 5 Singapore 19 Australia 4 Denmark 18 France 3 Sweden 17 Austria 2 Finland 16 Canada 1 Switzerland
  70. 70. Davos-WEF 2007 Competitiveness Index <ul><li>Thailand= 38 </li></ul><ul><li>China= 57 </li></ul><ul><li>Mexico= 58 </li></ul><ul><li>Russia= 62 </li></ul><ul><li>Brazil= 66 </li></ul><ul><li>Vietnam= 77 </li></ul><ul><li>Venezuela= 88 </li></ul><ul><li>Pakistan= 91 </li></ul><ul><li>Bolivia= 97 </li></ul><ul><li>Nigeria= 101 </li></ul><ul><li>Cambodia= 103 </li></ul><ul><li>Paraguay= 106 </li></ul><ul><li>Cameroon= 108 </li></ul><ul><li>Zimbabwe= 119 </li></ul><ul><li>Ethiopia= 120 </li></ul><ul><li>Angola= 125 </li></ul>
  71. 71. IMD Criteria <ul><li>Over 300 competitiveness criteria are selected . </li></ul>Extent to which basic, technological, scientific and human resources meet the needs of business. (90 criteria) Infrastructure Extent to which enterprises are performing in an innovative, profitable and responsible manner. (66 criteria) Business Efficiency Extent to which government policies are conducive to competitiveness. (84 criteria) Government Efficiency Macro-economic evaluation of the domestic economy. ( 74 criteria) Economic Performance
  72. 72. IMD 2007 Competitiveness Index <ul><li>1. USA </li></ul><ul><li>2. Singapore </li></ul><ul><li>3. HK </li></ul><ul><li>3. Luxembourg </li></ul><ul><li>4. Denmark </li></ul><ul><li>5. Switzerland </li></ul><ul><li>15. China </li></ul><ul><li>16. Germany </li></ul><ul><li>20. UK </li></ul><ul><li>24. Japan </li></ul><ul><li>26. Chile </li></ul><ul><li>27. India </li></ul><ul><li>28. France </li></ul><ul><li>29. Korea </li></ul><ul><li>30. Spain </li></ul><ul><li>33. Thailand </li></ul><ul><li>35. Hungary </li></ul><ul><li>38. Colombia </li></ul><ul><li>43. Russia </li></ul><ul><li>44. Romania </li></ul><ul><li>47. Mexico </li></ul><ul><li>55. Venezuela </li></ul>BEST
  73. 73. VII- What are the drivers of sustainable economic growth? <ul><li>Sustainable development = </li></ul><ul><li>Economic growth + those conditions that make it … sustainable! = </li></ul><ul><li>Strong infrastructures + socio-political stability + flexible institutions + good governance… + democracy </li></ul>
  74. 74. Correlation economic liberalization/growth
  75. 75. Correlation economic freedom – human development
  76. 76. Correlation between trade openness and corruption? Correlati o n corrupti o n – trade openness Low trade openness High corruption
  77. 77. Correlation Human development /Corruption
  78. 78. The monitoring of corruption by the World Bank World Bank 2006
  79. 79. World Bank: comparing the relative intensity of corruption in Latin America? Control de la Corrupción (América Latina, 2004)
  80. 80. Conclusion: How to assess sustainability of global capital flows? <ul><li>Economic and financial risk analysis (quantitative) </li></ul><ul><li>Socio-pol í tical, institutional development, and structural reforms (qualitative) </li></ul>
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