I Summary: Policy Issues and Short-Term Prospects
- International Monetary Fund
- Published Date:
- August 1981
This paper provides a review of recent developments and an assessment of short-term prospects for private international capital markets, which constitute one of the main sources of international capital flows. It emphasizes the role of international banks in intermediation between surplus and deficit countries, and includes a discussion of official actions affecting the markets. Four major topics are covered: the volume and terms of financial flows through these channels in 1980, and the factors accounting for them (Section II); prudential issues facing banks, the stance of supervisory authorities, and the implications for international intermediation by banks (Section III); the access of developing countries to bond markets (Section IV); and the prospects for financial flows through banks and the bond markets in the remainder of 1981, and some areas of uncertainty for the period beyond (Section V). Background materials are provided in appendices to the paper.1 The paper’s main findings on policy issues and short-term prospects are summarized in the second part of this first section.
Because the scope of the paper is limited to flows through capital markets, it does not deal with more general questions of capital flows, such as the current need of many developing countries—especially those which do not have significant access to the international capital markets—for concessional assistance, the needs of developing countries for resources from the multilateral development institutions,2 or the role of the Fund in providing financial assistance in support of adjustment programs of member countries. Nor does it discuss problems which might arise in the medium term. For a summary view of the principal findings that have emerged from studies in the Fund setting out broad scenarios for the world economy over the period through the mid-1980s, reference may be made to the World Economic Outlook.3 These scenarios focus particularly on medium-term prospects for the external positions and growth rates of four analytical subgroups of non-oil developing countries, one of which is the low-income countries.
With the sharp increase in oil prices in 1979, international attention focused on the possibility that the banking markets might be unable or unwilling to intermediate between the oil surplus countries and the deficit countries on a scale sufficient to avoid major downward pressure on world economic activity. By the beginning of 1980, international bank lending, particularly to the non-oil developing countries, was viewed by many market observers as increasingly risky for banks, so that a slowdown was widely viewed as inevitable. A Fund staff paper on international capital markets prepared toward the middle of 19804 suggested, however, that prospective financing flows would prove to be broadly commensurate with the requirements of deficit developing countries, which had been relying heavily on market finance in recent years. With a few possible exceptions, they would not be forced by market retrenchment into immediate financing difficulties nor into unduly severe adjustment policies. Beyond 1980, however, the outlook was very uncertain.
The magnitude and direction of market flows appear to have broadly matched the expectations for 1980.5 Inevitably, this favorable outcome involved a substantial absolute increase in the international exposure of banks. Moreover, unlike the situation at the corresponding stage of the earlier phase of “recycling,” the aggregate current account deficits of the non-oil developing countries are continuing to increase. Thus questions naturally have arisen about the ability of the private markets to sustain financing flows at levels sufficient to avoid overly severe reductions in economic activity by many of the deficit countries. This paper addresses such concerns.
Prudential Issues and Bank Supervision6
Although prudential considerations do not appear to have been a significant constraint on their international lending activity in 1980, bankers in several countries continue to express concern that such factors will limit their ability to continue international financial intermediation on the scale of recent years. In particular, they find worrisome the extent to which the balance of payments and debt management prospects of many of the non-oil developing countries7 have been eroded in recent years.
Nonetheless, over the past year such worries appear to have eased in some respects. First, although frequently characterized as an aggregate problem, cross-border risk is more a matter of the circumstances and prospects of individual countries. The bulk of bank exposure to the developing world is to a relatively few middle-income and upper-income countries, several of which strengthened their adjustment policies in 1980 in such a way that the market gained renewed confidence in lending to them. Bankers seem increasingly to be concentrating on the appropriateness of these policies and the strong longer-term growth potential of such countries, rather than focusing exclusively on their immediate balance of payments difficulties. Countries whose policies are not seen to be appropriate, on the other hand, are likely to find their access to bank credit increasingly limited. Second, the rash of private debt restructuring, which some commentators were predicting, has not taken place; and where such problems have arisen, they have by and large been handled in a way that has been acceptable to the banks. More generally, the loan-loss experience and overall profitability in banks’ international operations continues to be favorable, except for some losses related to the recent sharp fluctuations in interest rates. Third, there has been some increase in effective lending spreads for a few borrowers whose borrowing requirements appeared to banks to be large. The increase in financial flows that has followed this increase in the “spread of spreads” has inspired market confidence in the continuity of new lending and thus has been self-reinforcing.
Capital adequacy, portfolio concentration in claims on developing countries, and funding risk in the interbank markets have been frequently mentioned as possible impediments to international banking flows.8 The evidence suggests that while these are legitimate areas of concern, they will not be a serious impediment to the continuing expansion of international intermediation by banks in 1981; nor is it obvious that they will emerge as serious structural constraints even over the medium term.
The decline in capital-asset ratios has been evident for a number of years, but it does not clearly imply any serious threat to bank solvency. In any event, the decline has not accelerated in recent years, and in some countries the banking systems have actually reversed the downward trend.
The data do not suggest that portfolio concentration vis-à-vis developing countries has become a major problem for the banking system as a whole. Outstanding claims on the non-oil developing countries constitute a small proportion of total (domestic and foreign) assets of banks headquartered in the major financial market countries. Banks’ international assets have grown more rapidly than their domestic assets, but the proportions of international assets accounted for by the non-oil developing countries, and by the largest borrowers among those countries, have not increased in recent years. Moreover, portfolio management is a dynamic concept. In a world in which total bank assets have been increasing steadily and rapidly, even if the share of developing countries were to be held constant, there would still be considerable scope for continued large-scale lending to them.
The third area of prudential concern—funding risk—seems unlikely to be a major constraint unless there is another banking crisis such as that which occurred in 1974. Tightening of prudential standards in this area, as in other areas, may have reduced the possibility of funding problems in the future.
Over the past few years, the authorities of the financial market countries have played a major role in strengthening the prudential standards of their banks. Official action in this area has helped to underpin the continuity of international financing flows, including flows to the developing countries, and has been a positive and stabilizing factor. Given the reliance on market finance of an ever growing number of developing countries, the bank supervisory authorities have been cognizant of the need to implement changes in prudential bank regulation in a deliberate manner so as not to disrupt international bank lending.
The strengthening of bank supervisory practices has generally been carried out in a flexible manner. On occasion, however, actions by financial market countries for balance of payments reasons have temporarily restricted the international lending activities of their banks. In the aggregate, these measures seem not to have had a significant quantitative impact on financing flows to developing countries. Nevertheless, it has become increasingly important that, in framing their own balance of payments management policies, the financial market countries avoid measures restricting access to their markets.
Developing Countries’ Access to International Bond Markets
International bond issues9 by developing countries again declined sharply in 1980. Issue volume was $2.5 billion, or 30 per cent less than in 1979 and little more than half the average for 1977–79. Although the aggregate volume of international issues was somewhat larger than in 1979, the markets were more depressed for longer periods, mainly because of the volatility of interest rates around a generally rising trend. In these circumstances the markets were very selective about new issues, and when “windows” opened from time to time, it was mainly the “best names” that were brought to the markets. The share of developing countries in the markets thus declined to 6 per cent from the 1978 peak of almost 16 per cent.
To some extent the decline in issues by developing countries was the result of limitations on foreign access that were temporarily imposed or intensified in a few countries. These actions, although informal, sometimes involved official guidance to the major resident security dealers and reflected domestic balance of payments considerations, as well as deteriorating conditions in the capital markets. Developing country borrowers were not exempted from these measures, and indeed may have been disproportionately affected by them, although special consideration was given to multilateral development institutions, such as the World Bank.
On the positive side, there were some generally encouraging measures toward liberalization of the capital markets, including resident access to foreign securities and the greater use of certain currencies in the Eurobond markets. Although these measures were not taken specifically in response to the 1976 recommendation of the Development Committee on measures to promote developing countries’ access, over time they should serve to strengthen the markets for all potential borrowers. In general, the authorities of the capital market countries have been reluctant to discriminate in favor of developing country borrowers where an official policy on access is maintained, either because the principle of nondiscrimination is firmly held or, more generally, because they are not persuaded that official intervention to promote one issue or another would be productive.
A major question about the prospects for the private international capital markets continues to be the extent to which they will channel funds from the oil exporting countries and other sources of financial savings to deficit countries, particularly those non-oil developing countries which have relied in the past on finance from the private markets. The Fund’s World Economic Outlook provides projections of current account deficits as well as trends in other factors, such as world trade and economic growth. On the basis of these projections, the broad outlines of the aggregate demand for private international finance can be determined.
These projections suggest that the demand for market finance to cover current account deficits will remain strong in 1981. The counterpart of the reduction in oil exporters’ surpluses will be a sharp improvement in the current account positions of some of the large industrial countries. The combined deficit of the smaller industrial countries will be unchanged, while the deficit of the non-oil developing countries, including the middle-income and upper-income developing countries among them, will increase. In projecting these deficits, based on individual country assessments, account has been taken of the likely availability of financing from several sources. There is some scope for off-market financing by the smaller industrial countries through direct recycling of oil producer surpluses, and for the non-oil developing countries part of the increase in projected current account deficits is expected to be covered by nondebt-creating flows and the use of reserve-related credit facilities, such as use of Fund resources. In general, however, the total requirements for balance of payments financing from the international capital markets by those countries most dependent on them will rise.
As the increased demand of such countries for market finance will not be associated with such a sharp increase in the value of their imports as in 1980, the extent to which they will be able to increase their lines of bank trade finance will be more limited. Thus, the growth in the demand by such countries for longer-term finance, the availability of which is more affected by the prudential constraints on banks, will be larger. Credit demands in the major industrial countries, on the other hand, are likely to ease in response to slower growth of production, investment, and international trade. The shifting pattern of demand suggests that a major question in 1981 is the extent to which capital market flows can shift from lending to the industrial countries, much of it at the short end of the maturity spectrum, to longer-term lending to the non-oil developing countries.
These demand factors must be weighed against possible constraints on the ability of the market to provide financing. The international bond markets face continuing major uncertainties about interest rate and exchange rate developments and about official action in response to them. In the light of developments so far in 1981, it seems unlikely that the volume of issues will increase very much, and net flows (after redemptions) could well be lower than in 1980. Direct recycling of oil producer surpluses may help to ease conditions in the world’s bond markets, but at this point it appears that any significant growth of capital market flows will have to come from the banking sector.
An assessment of the response of the international banking system must take into account both the prudential constraints on the major banks and the regulatory environment. While certain banks in some financial market countries may be constrained by prudential considerations, at the aggregate level there do not appear to be major impediments to continuation of cross-border lending at a pace commensurate with emerging demands. Nor do official bank regulation and supervision seem to be designed or to be operating to slow such activity. On the contrary, in one or two countries, informal restraints directly affecting the ability of their banks to lend internationally have been eased. Thus, an increase in banks’ international claims of 20 per cent or so in 1981, somewhat less than the 25 per cent recorded in 1980, seems feasible. Given the likely easing in credit demand from the major industrial countries, such an outcome would leave room for continuing large increases in bank credit to the non-oil developing countries.
The prospects for continued large-scale access to banking credits by non-oil developing countries, therefore, appear to be reasonably positive at the present time. Claims on the 20 large borrowers, mainly net exporters of oil on a small scale or major exporters of manufactures, which account for about 85 per cent of the exposure of the banks to the non-oil developing countries, have not grown significantly as a proportion of banks’ international assets. In general, moreover, these countries have maintained or implemented adjustment policies that have generated market confidence. Although for a few countries lending spreads have recently increased because of the magnitude of their borrowing requirements and of their existing debt to the banks, the higher spreads appear to be attractive enough to banks to sustain the flow of finance to such countries. For most developing countries, moreover, spreads have not risen, suggesting further scope for increasing their use of market finance. In general, therefore, there are few signs that the major borrowers will have much difficulty in obtaining market finance consistent with the scale of their current account deficits as projected in the most recent World Economic Outlook (June 1981). It is worth noting that the increase in bank claims on the non-oil developing countries that would be consistent with the World Economic Outlook’s projections would be smaller in percentage terms in 1981 than the increase recorded in 1980.10 While the circumstances will vary for individual countries, particularly in view of the greater care that banks are taking in their assessment of country risk, there seems to be little ground for concern about a general crowding out of developing countries from a market that seems likely to continue to expand at a rapid pace. The preliminary data on medium-term syndicated credits for the first half of 1981 support this conclusion.