Annex I International Financial Activity—Recent Developments
- International Monetary Fund
- Published Date:
- January 1993
International financial activity in 1992 took place against the background of sluggish world economic growth, divergent monetary and fiscal policies across countries, and uncertainties over the prospects of European economic and monetary union.123 These pressures resulted in turbulence in financial markets that tested the system’s resilience, but generally the markets continued to function well under difficult conditions. Although cross-border financial activity revived for the year as a whole, much of this recovery was associated with the September 1992 crisis in European foreign exchange markets.124 For example, banking flows, which had contracted early in the year, expanded strongly in the third quarter as banks provided financing for the position-taking and hedging activities of market participants.
The first part of this annex reviews some underlying factors that shaped international financial activity, including current account imbalances of both industrial and developing countries; the course of monetary policy and developments in domestic financial markets; and the trends toward international portfolio diversification and securitization. The second part examines major developments in cross-border financing, including international banking activity and international securities transactions.
Underlying Macroeconomic Conditions and Financial Trends
Current account imbalances are a measure of the net movement of capital that must be accommodated by international financial activity. The sum of the current account deficits of the industrial countries widened to an estimated $190 billion in 1992, a substantial increase in relation to the 1991 level of $127 billion, which reflected the one-time receipt of war-related transfers from countries in the Middle East (Table A9). The sum of those current account deficits was, however, still significantly below the levels of the four years before 1991.
The current accounts of the largest countries accounted for much of the movement in the industrial country aggregate. The deficit of the United States rebounded to $38 billion in the first three quarters of 1992, up from $4 billion in the whole of 1991, as the transient effect of the war-related transfers ended (Table A10); this 1992 deficit was still substantially below those of 1986–90, indicating a return to an overall trend of adjustment. Germany’s current account moved into a wider deficit of some $21 billion in the first three quarters of 1992, reflecting the continuing expenditures associated with unification; this widening continued the trend of 1991, and contrasts with surpluses of about $50 billion during each of the previous several years. Japan’s current account surplus continued to widen to $85 billion in the first three quarters of 1992.
Official flows played a more substantial role than they had in recent years: in the first three quarters of 1992, the U.S. current account deficit was financed mainly by a reduction in official reserves (Table A10). Germany’s deficit was overfinanced from private sources, leading to an accumulation of international reserves of some $65 billion; this was largely the result of the massive flow of private funds into Germany associated with the speculative attacks on other currencies participating in the exchange rate mechanism of the European Monetary System (EMS).125 Japan’s current account surplus was financed mainly through an almost equal volume of private capital outflows.
The sum of current account deficits of developing countries in 1992 was an estimated $106 billion, down from $129 billion in 1991, but higher than in the preceding years (Table A9). The decrease compared with 1991 was due almost entirely to the transient effect of war-related transfers from Kuwait and Saudi Arabia to France, the United Kingdom, and the United States. Thus, the sum of current account deficits of developing countries in the Middle East and Europe declined in 1992 to less than half of its 1991 spike. In contrast, the current account deficit of the Western Hemisphere countries as a group widened substantially, corresponding to the reflow of financing into the heavily indebted countries in the region. The four Asian newly industrializing economies (NIEs) reduced their current account deficit from $9 billion in 1991 to $5 billion in 1992, while the Central European economies in transition reduced theirs from $8 billion to $2 billion during the same period. The former U.S.S.R. meanwhile incurred a deficit of $7 billion in 1992, after a small surplus in 1991. There was relatively little change in the current accounts of other groups of countries.
Monetary policies were another important influence on international financial activity. In 1992, policies differed significantly across several of the major industrial countries. Yield curves reflected these differences (Chart 25). For example, the substantial easing of policy in the United States and Japan in response to their domestic economic conditions produced a wide positive spread between bond rates and three-month bill rates. The tightening of policy in Germany, intended to contain inflation in the face of the expansionary fiscal shocks of unification, led to an inverted yield curve with short-term rates more than 100 basis points above long-term rates, and a similar pattern emerged in other ERM countries. In September, German policy eased somewhat, and a greater easing occurred in countries that suspended their participation in the ERM—notably the United Kingdom, where the yield curve reversed itself. The growth in money and credit also reveals divergent financial conditions; in general, though, the world recession and heightened perceptions of credit risks resulted in a very modest expansion (Chart 26). The behavior of credit may also reflect the need of some banks to curtail growth in their assets in relation to their capital base to satisfy the Basle capital adequacy standards that were to become fully effective beginning in 1993 (discussed in Section IV, above). In most countries, money and credit aggregates declined in real terms, giving little room for growth in domestic banking activity, and therefore in international lending.126 An exception is Germany, where broad money and bank claims expanded more rapidly, by 7 and 9 percent respectively, possibly reflecting a portfolio shift into German bank deposits. The lack of synchronization among financial developments in the United States and other countries is also evident in the performance of stock markets depicted in Chart 27—with stock prices generally rising in the United States while remaining sluggish in most other countries.
Chart 25.Major Industrial Countries: Yield Curves1
Sources: Organization for Economic Cooperation and Development, Financial Statistics Monthly; and IMF staff estimates.
1 Defined as government bond yield minus three-month treasury bill rate except for Germany.
2 Government bond yield minus three-month FIBOR rate.
Chart 26.Major Industrial Countries: Growth Rates in Broad Money and Bank Claims1
Sources: International Monetary Fund, International Financial Statistics; and World Economic Outlook.
1 Based on end-of-period data.
2 Data through 1990 apply to west Germany only. The growth rates for the monetary aggregates after 1990 are statistically adjusted for the extension of the currency area.
Chart 27.Major Industrial Countries: Changes in Stock Market Indices
Source: International Monetary Fund, World Economic Outlook.
Another key influence on international capital movements in recent years was the rising international diversification of investment portfolios, which is generally believed to have increased in response to the liberalization of exchange and capital controls in many industrial countries in the 1970s and 1980s. Although difficult to measure directly owing to limited data on the residency of investors in industrial country securities, this process can be gauged by examining the scale of cumulative international capital flows relative to new issues of all domestic assets (Table A11).127 The rise in this ratio in 1983–90 compared with that of 1975–82, for the 12 OECD countries for which standardized data are available, indicates an increase in international diversification associated with heightened capital mobility.128 The average share of inward foreign investment relative to new issues of domestic assets increased to 16.7 percent in 1983–90 from 13.6 percent in 1975–82, while the average share of outward foreign investment rose to 16.6 percent from 11.2 percent during the corresponding period. Only the United Kingdom did not show an increase in at least one of the two measures of capital mobility—and it was already relatively open in the earlier period.
A further important development in capital markets in recent years was the shift of financial activity to securities markets and away from bank intermediation of credit.129 Such securitization reflects the increasing liquidity of secondary markets for securities and also facilitates international capital movements, since it provides investors with the means of rearranging their global portfolios quickly in response to new information about expected returns and risks. The trend toward securitization is evident from the cumulative international flows of bonds and equities relative to new domestic issues of these securities (Table A11). Indeed, securities flows relative to the creation of these domestic assets have grown considerably faster than total cross-border flows relative to the creation of total domestic assets (loans plus securities). The average share of inward investment in bonds and equities relative to new domestic issues of these securities increased to 24.5 percent in 1983–90 from 11.9 percent in the earlier period, whereas the average share of outward investment in bonds and equities rose to 23.2 percent from 8.1 percent. In all the countries, at least one of the two measures of capital mobility increased. Moreover, the largest gains in capital mobility were concentrated in European countries, with Belgium, Germany, Spain, Sweden, and the United Kingdom scoring relatively large increases.
Recent Cross-Border Financial Activity
Net lending through banks and bond markets recovered, expanding by $264 billion in the first three quarters of 1992, compared with a decrease of $73 billion in the same period of 1991 (Table A12). There were, however, important differences between developments in international banking and in securities market activity.
International Banking Activity
The expansion of cross-border financial activity associated with the ERM crisis was felt particularly strongly in the banking sector. During the first two quarters of 1992, banking flows actually declined, reflecting the uncertain economic prospects as well as lenders’ heightened sense of country risk.130 Syndicated lending was approximately flat during this period, despite the boost it received from the large recapitalization loans undertaken by some heavily indebted U.S. corporations.
Cross-border banking activity rebounded in the third quarter. The banking system’s involvement in the ERM crisis consisted mainly of covered intermediation activity that provided financing for their customers’ position-taking activity. The result was a surge in banking activities in the third quarter. During the first three quarters of 1992, bank claims on industrial countries rose by $161 billion, in contrast to a $140 billion decline in the same period of 1991 (Table A13). Overall, however, cross-border bank lending was still barely more than one-fourth of its 1989 peak—reflecting the developments unrelated to the crisis that militated toward a decline in banking flows.
As a result of these developments, cross-border deposits increased by $213 billion in the first three quarters of 1992 in contrast to a fall of $251 billion in the same period of the previous year. Around half the expansion of cross-border lending and deposit-taking during 1992 was interbank claims (Table A14); a sharp decline in interbank lending during 1990 and 1991 had also accounted for much of the earlier decline in cross-border banking activity.
The most important exception to the pattern of recovery of cross-border lending was Japan—where banks did not have the benefit of the surge in activity associated with the ERM crisis. There, total lending fell by $90 billion in the first three quarters of 1992, following an $89 billion fall in 1991. This reflected a decline in interbank activity associated with continuing strains in the Japanese banking system (Table A14) (examined in Section II above).
International banking activity involving nonbanks expanded strongly in 1992, after tapering off during 1991 (Table A15). Much of this expanding activity appears to have been associated with financing position taking and hedging during the ERM crisis. In the first three quarters of 1992, banks’ cross-border claims on nonbanks expanded by $120 billion, almost double their expansion in the same period of 1991; at the same time, deposits held by nonbanks expanded by $86 billion, in contrast with a small decline in the first three quarters of 1991.
International bank lending to developing countries increased by $33 billion in the first three quarters of 1992, following a $20 billion increase in the same period of 1991, which was already high by historical standards (Table A16). Much of this expansion reflected the $13 billion turnaround in lending to the Middle East and Europe (from a $2 billion contraction to an $11 billion expansion) between the first three quarters of 1991 and the same period of 1992. Lending to countries in transition expanded strongly, particularly to the former U.S.S.R., where credit increased by $6 billion during the first three quarters of 1992 in comparison with the decrease of $1 billion in the same period of the previous year. International banks’ exposure to the four Asian NIEs also rebounded sharply, increasing by $12 billion in the first three quarters of 1992, in contrast with a $24 billion decline in the same period of 1991. Bank liabilities to developing countries also expanded more rapidly in 1992 than in the previous year, with the expansion dominated by the countries in transition, the Asian NIEs, and some Western Hemisphere countries.
Cross-Border Securities Transactions
Activity in international bond markets continued to increase during 1992, with gross issues rising by $249 billion during the first three quarters, compared with $229 billion during the same period of 1991 (Table A17). Much of this increase came from refinancing of existing bond issues rather than net issues. Amortizations increased from $103 billion to $170 billion, while net issues declined from $126 billion to $79 billion. Net issues less purchases by banks declined even more sharply, from $103 billion to $44 billion. Bond issues continued to be dominated by industrial country borrowers, which accounted for nearly all the decline in net issues. The share of developing countries in gross issues expanded from 6 percent in the first three quarters of 1991 to 13 percent in the same period of 1992, reflecting continued improvement in several Latin American countries’ access to international bond markets.
In the last quarter of 1992, industrial country sovereigns, which sought to replenish their foreign exchange reserves, increased their bond issues. The rush of sovereign borrowers to the market tested the market’s liquidity and depth.131
The composition of securities issues also shifted in 1992 (Table A18). The share of bond issues consisting of equity-related bonds declined from 14 percent in 1991 to 6 percent in 1992, apparently reflecting the sluggishness of several national stock markets. In particular, many Japanese borrowers redeemed equity-linked issues, reflecting the slide of the Japanese stock market. These declines were largely made up by the expansion of the share of floating rate notes from 6 percent in 1991 to 13 percent in 1992. In particular, issues of medium-term notes (MTNs) experienced growth that some observers characterized as “spectacular”; the newfound popularity of this form of borrowing was attributed to its flexibility and relatively low underwriting costs.132 The establishment of new Euro-commercial paper facilities slowed, however, as a result of the maturing of this segment of the market and the consequent lack of new borrowers.
The currency composition of bonds also shifted (Table A17): the proportion of bonds denominated in U.S. dollars expanded from 31 percent in the first three quarters of 1991 to 38 percent during the same period in 1992, as investors sought the traditional “safe haven” currencies during the exchange market crisis and reduced their exposure to high-yielding currencies. In particular, the share of ECU bonds declined from 13 percent to 9 percent, partly reflecting problems in the ECU bond market during and for some time after the ERM crisis of September 1992; these problems are discussed in Section VI above.
Data on international equity market activity are available only for 1991; for that year, the picture is mixed. Net cross-border purchases of equity on domestic exchanges by foreign institutional and retail investors rebounded to $101 billion in 1991, compared with $11 billion in 1990 (Table A19). This rebound reflected mainly the return of foreign investors to the U.S. and Japanese markets. Gross cross-border equity flows continued to slacken, however, to $1,322 billion in 1991, from $1,441 billion in 1990. The sharp declines in equities issued by Japanese firms and equities held by Japanese investors were of particular note. Equity issues by firms located in continental Europe also declined markedly. The decline in gross equity flows is part and parcel of the decline in activity on domestic and international equity markets worldwide.
International mergers and acquisitions fell from $128 billion in 1990 to $81 billion in 1991, leveling off in 1992 (Table A20). The decline was particularly sharp for target companies in North America and in the United Kingdom. Mergers with West European target companies also declined from 1990 to 1991, and then recovered in 1992: Western Europe maintained the largest share of both target and bidder nationalities, reflecting the ongoing reorganization associated with the single market program.
These macroeconomic developments are reviewed in International Monetary Fund (1993a).
These attacks are discussed at length in Goldstein and others (1993).
Monetary conditions during 1992 are discussed in much more detail in International Monetary Fund (1993a).
See Golub (1990).
The data are grouped into these two subperiods to isolate longer-run structural developments from cyclical developments. The two periods roughly correspond with two business cycles in the world economy.
Goldstein and others (1992), pp. 2–9, examines the trend toward the securitization of finance.
For instance, in Italy the liquidation of the state holding company EFIM (Ente Partecipazione e Finanziamento Industria Manifatturiera) was announced in July 1992, and it initially appeared that creditors would incur losses. International creditor banks protested, and at one point it seemed possible that the Republic of Italy could formally be declared in default. The situation remained uncertain for some time. Moody’s downgraded the Republic of Italy’s foreign-currency-denominated bonds to Aa3 on August 14.