After increasing more than threefold between 1990 and 1996, total net resource flows to developing countries have since halved, despite a brief recovery in 1999 (Figure 1.1).1, 2 Resource flows from private sources, comprising foreign direct investment (FDI), portfolio investment, bank lending, and international bond issuance by developing countries, dominated these developments. Private flows accounted for nearly 80 percent of the total net resource flows to these countries in 1996 and have remained around 60–70 percent since 1997. However, the overall dominance of private flows masked a vast difference in the composition of flows across income groups in developing countries. While private flows contributed the bulk of the resource flows to middle-income and transition economies, they accounted for less than 10 percent of net financing to low-income countries in the last two years. These countries, particularly the heavily indebted poor countries (HIPCs), have relied primarily on official development finance (ODF), absorbing about half of the net official development assistance (ODA) flows to developing countries (Figure 1.2).
Over 90 percent of world trade is conducted on the basis of cash or short-term credit, with the remainder supported by medium- and long-term credit and other means of financing. Trade financing therefore is an important component of external financing for developing countries. Export credits supported by official export credit agencies (ECAs) are a key element of nonconcessional financing from bilateral sources to developing countries and economies in transition (Box 2.1).7 The Berne Union of ECAs accounted for more than 16 percent of the total indebtedness of these countries and almost half of their indebtedness to official creditors in 2001.8
Gross multilateral development bank (MDB) lending to developing countries remained relatively flat over the second half of the 1990s and through 2001 (Table 3.1). Lending did increase briefly, in 1998, as MDBs expanded financing to Brazil following its crisis. This trend of MDB gross financing is reflected in the nearly constant share of MDB disbursements in total disbursements to developing countries. However, unlike trends in gross financing over 1998–2001, net financing to developing countries exhibited a much lumpier pattern mainly on account of repayments to MDBs following the Asian and Russian crises, namely by Korea. Overall, the pattern of MDB lending to all developing countries reflected that of middle-income countries (Table 3.2).
During 2001–02, Paris Club creditors concluded 30 rescheduling or deferral agreements, involving debt-service obligations and arrears amounting to about 44 billion (Table 4.1). As in previous years, most of the rescheduling agreements were concluded with low-income countries, usually on concessional terms17 (Table 4.2). Most middle-income countries have graduated from rescheduling agreements with Paris Club creditors, as evidenced by the fact that there were only three rescheduling agreements with debtor countries in this category during the period under review: Jordan, Ukraine, and the Federal Republic of Yugoslavia18 (Table 4.3). Although the possibility of further reschedulings with middle-income countries cannot be excluded, the debt treatment offered by official creditors, as well as the progress many of these countries are making in stabilizing their economies, should make this less likely.
Excessively high levels of external debt have been a serious obstacle to economic growth and poverty alleviation in heavily indebted poor countries. A high external debt-service burden can directly reduce resources available for social expenditures and adversely affect economic growth, hence indirectly leading to increases in poverty (Box 5.1). The HIPC Initiative, launched in 1996 and enhanced in 1999, aims to reduce heavily indebted poor countries’ external debt to sustainable levels, removing this obstacle to poverty reduction and growth in these countries.
The past year has been a remarkable one in the international capital markets as the Asian emerging markets have experienced turbulence unseen since the debt problems of the heavily indebted emerging markets at the beginning of the 1980s.1 Even though the financial crisis has been largely confined to Asia, Japan’s growing economic weaknesses and banking problems have spilled over outside the region and the crisis has produced a reevaluation of the risks and vulnerabilities in emerging markets outside Asia. The mature financial markets in North America and Europe have not thus far been very adversely affected by the crisis because of their generally relatively small and well-provisioned on-balance-sheet banking sector exposures to the Asian emerging markets in “crisis” (Indonesia, Korea, Malaysia, and Thailand2), and the avoidance of widespread defaults as a result, in part, of the prompt response of the international community. Indeed, several mature markets have benefited to some extent from a “flight to quality” and the implications of weaker Asian economic activity and lower commodity prices for inflation. A continued favorable performance is not, however, assured and the outlook could change if Japan’s problems are not quickly addressed, the difficulties in emerging markets deepen or spread, or the current very high valuations in the U.S. and many European equity markets are subject to sharp downward revision. The consequences for global capital markets of these risks unfolding could be severe.
Having successfully weathered several bouts of speculative pressures, the Bank of Thailand on July 2, 1997 let the baht float. Its immediate depreciation triggered, in relatively quick succession, the depreciations of several of the regional currencies—the Philippine peso, the Malaysian ringgit, and the Indonesian rupiah. Early characterizations of this first round of currency devaluations were as exchange rate “corrections” that were expected to lead to manageable external adjustment. At that point, no one predicted the large depreciations that would fundamentally call into question the underlying assumptions on which past cross-border borrowing, lending, and investment decisions had been based, and provoke a massive retrenchment of capital flows. Outside the region, the rest of the emerging markets remained relatively insulated from the events in Southeast Asia until late October 1997. Then, what began as a localized disturbance in Hong Kong SAR’s foreign exchange and equity markets was transmitted rapidly and forcefully across the emerging markets, bringing strong pressures to bear, most notably on Brazil and Argentina in Latin America, on Russia, and in Asia on Korea. It resulted in an across-the-board external liquidity squeeze for emerging market borrowers and a deepening of pressures on the already affected countries in Asia.
The Mexican crisis of 1994–95 and the ongoing crisis in Asia have raised issues regarding the effects of global integration, the sustainability of the linkages between emerging capital markets and more developed ones, and the management of risks associated with surges of capital inflows followed by possible cessation, or at least a substantial reduction, in such flows. A number of these issues are examined in this chapter. The first section considers the similarities and differences among the recent Asian crisis, the Mexican crisis of 1995, and the debt crisis of the 1980s. The second section analyzes the price and market dynamics that affect the terms and conditions under which countries obtain international finance and factors that contribute to surges in capital flows. Assuming that sharp changes in capital movements are likely to be a feature of the new global financial environment, the third section examines what the experience of the 1990s implies about the policies and institutional arrangements that are needed to manage the macroeconomic and financial risks created by large-scale capital inflows. The last section contains some concluding remarks.
This year's capital markets report provides a comprehensive survey of recent developments and trends in the advanced and emerging capital markets, focusing on financial market behavior during the Asian crisis, policy lessons for dealing with volatility in capital flows, banking sector developments in the advanced and emerging markets, initiatives in banking system supervision and regulation, and the financial infrastructure for managing systemic risk in EMU.
Recent macroeconomic trends in the major advanced countries have been broadly supportive of continued favorable developments in the mature capital markets, notwithstanding intermittent pauses, in some cases related to market uncertainty about economic policies or the impact of the Asian crisis.1,2 Inflation has remained low, economic activity has remained robust in North America and has picked up in much of Europe, and the convergence process in Europe has been smooth. Fiscal consolidation in a wide range of advanced countries has provided ample space for private market participants to borrow in a wide variety of domestic and international credit markets. Monetary conditions too have remained broadly supportive of capital market activity. The main risks in the period ahead revolve around the performance of the Japanese yen, the fragilities in emerging markets, whether bond markets have appropriately priced-in a number of uncertainties, the sustainability of equity prices, and changes in the structure of global financial markets.