V Short-Term Prospects for the International Capital Markets
- International Monetary Fund
- Published Date:
- August 1981
The major question about the prospects for the international capital markets in 1981 continues to be the extent to which they will serve as the major conduit of funds to the oil importing developing countries. This assessment of the prospects begins with the present outlook for payments imbalances and other macroeconomic factors affecting the demand for and supply of market finance, as projected in the most recent World Economic Outlook (June 1981). Taking into account the extent to which prudential considerations might constrain the ability of banks to continue large-scale international financial intermediation, some tentative conclusions are given on the prospective flows through the markets in 1981.
Balance of Payments Prospects
As noted in the recent World Economic Outlook, a major feature of the prospective international payments situation is a continued large, if declining, current account surplus for the oil exporting developing countries during 1981, but with a substantial shift in the pattern of the corresponding current account deficits (Table 4). The current account of the seven largest industrial countries together is projected to be approximately in balance, in contrast to a deficit of about $16 billion in 1980. The deficit of the smaller industrial countries is projected to remain approximately unchanged from 1980 at $28 billion. The aggregate current account deficit of the non-oil developing countries is projected to increase to almost $100 billion (from $82 billion in 1980), an increase which is broadly distributed among these countries. Thus, the requirement for balance of payments finance by the groups of countries most dependent on the international capital markets for such finance—the smaller industrial countries and the middle-income to high-income non-oil developing countries—can be expected to increase in the current year.
|Balances on current account|
|Oil exporting developing countries||3||68||112||96|
|Non-oil developing countries||-38||-58||-82||-97|
|Net oil exporters||-8||-8||-11||-15|
|Major exporters of manufactures||-10||-22||-32||-38.5|
|Other net oil importers||-13||-17||-24||-27.5|
|Global sum of current account deficits||-87||-94||-153||-160|
|Non-oil developing countries: Financing of current account deficits|
|Balance of current accounts||-38||-58||-82||-97|
|Accumulation of reserves (increase –)||-15||-12||-2||-1|
|Total financing requirement||-53||-70||-84||-98|
|Nondebt-creating flows and long-term borrowing from official sources (net)||30||36||42||48|
|Use of reserve-related credit facilities (net)||-1||–||3||8|
|Other borrowing (net)2||24||34||39||42|
|Oil exporting countries: Bank deposits in per cent of cash surplus||25.0||58.0||35.0||…|
Goods, services, and private transfers.
Includes errors and omissions.
Goods, services, and private transfers.
Includes errors and omissions.
The larger financing requirement of the non-oil developing countries is projected to be met partly through some increase in nondebt-creating flows and official loans and through a quadrupling in the use of reserve-related credit facilities. Nevertheless, the residual financing requirement of those countries with access to the private financial markets still is expected to increase significantly in 1981. For the smaller industrial countries, there may be some scope for additional off-market financing of the deficits through direct recycling of oil producer surpluses, although this is not likely to reduce significantly their aggregate demand for market finance over the next year or so.
As the largest industrial countries rely much less on market borrowing by public entities for balance of payments finance, the projected improvement in their payments position does not in itself have a major direct impact on aggregate demand for market finance. The fact that much of the improvement comes from a slowdown in the rate of growth of the value of their imports, however, means that their demand for additional bank trade finance in 1981 should be less than in 1980. The growth of imports of the non-oil developing countries is also projected to slow to some degree. Trade developments thus suggest a slowdown in the growth of demand for short-term trade-related finance. For the smaller industrial countries and the non-oil developing countries, however, the slowdown in the growth of trade finance means that the increase in their requirement for longer-term credit will be that much larger.
An aspect of balance of payments developments that is likely to be important in 1981 is the growing tendency of the oil producing countries to move their surplus funds through channels other than banks. The World Economic Outlook estimates the proportion of the cash surplus that went into bank deposits at 35 per cent in 1980, compared with 58 per cent in 1979. BIS data, moreover, show a sharp decline in the pace of oil exporters’ accumulation of bank deposits in the second half of 1980, and there is no reason to expect that the trend toward direct recycling will not continue. Such flows can satisfy part of the demand for finance that would otherwise be focused on banks, at least in the industrial countries.
Other Macroeconomic Factors
The growth rate of real GNP in the industrial countries is projected in the World Economic Outlook to decline slightly in 1981, and gross fixed investment is projected to fall in real terms. These declines are likely to be associated with a decelerating demand for credit in real terms in the industrial countries, thus providing banks with an incentive to seek lending opportunities outside the major industrial countries, including lending to the non-oil developing countries.
Judging by the monetary targets announced for 1981 by the seven largest industrial countries, the slowdown in the rate of monetary expansion in those countries in 1979 and 1980 can be expected to continue. With inflation continuing at a high, if declining, rate, no substantial easing of interest rates from the high levels of 1980 is expected in 1981 by most observers. Besides their effects on domestic economic activity and credit demand, high real interest rates affect the demand for international credit, but for balance of payments finance the demand is likely to be rather inelastic with respect to the real rate of interest, at least in the shorter term.
Taken together with the balance of payments outlook, these considerations suggest that some easing in the global demand for capital market finance is probable. Within that global aggregate, however, the decline is likely to be most concentrated in shorter maturities, particularly trade finance, and in longer-term credit to industrial countries, other than for purposes of balance of payments finance. The demand for longer-term credit by the non-oil developing countries, on the other hand, can be expected to increase strongly.
Bond Market Prospects
The weakness of domestic and international bond markets in 1979 and 1980 has been to a large extent the result of the rise in short-term interest rates and uncertainties about future rates reflected in inverse yield curves in major currencies. So far in 1981 interest rates in many major currencies have continued to be highly volatile, and they show no signs of early stabilization at lower levels. The inihibiting effect of the interest rate situation on international bond market activity also is exacerbated by exchange rate fluctuations. Under such circumstances, the major bond markets are likely to remain relatively weak in 1981, though “windows” are likely to continue to emerge from time to time, helping to maintain gross volume of issues at the levels of recent years.
Prospects are far from uniform, however. In Japan and Switzerland, for example, the concerns about financial market instability and balance of payments weakness, which led to a slowdown of new issues in 1980, have diminished. In Japan, the recovery is expected to be particularly strong, and the total amount of foreign public offerings may be close to $2 billion equivalent, about twice the volume of 1980. At the same time, the possibility of foreign private placements, which was very limited in 1980, was considerably eased at the outset of 1981. As long-term interest rates remained relatively low by international standards—in the first quarter of 1981, interest rates on bonds were below 9 per cent—foreign borrowers’ interest in this market has been strong in the first months of 1981 and is expected to continue.
A significant increase in the volume of foreign issues since the beginning of the year has also taken place in the United Kingdom, where three issues by sovereign borrowers, including one developing country, were launched in the first four months. A relatively high volume of foreign issues in the rest of 1981 is possible, given the attractive features provided to borrowers by the U.K. bond market, such as the large size of issues, well-developed secondary markets, and long maturities. On the other hand, prospects for issuing activity are less favorable than in 1980 in the Federal Republic of Germany. Although the temporary ban on foreign and Euro-deutsche mark issues imposed toward the end of 1980 was allowed to expire at the end of March 1981, the issue calendar is likely to be managed cautiously, in part because of the magnitude of the current account deficit. In the light of what happened in the first quarter of the year and continuing weak conditions in the capital market, the volume of foreign deutsche mark-denominated new issues is expected to be lower than it was in 1980.
In the dollar sector of the Eurobond market, the strength of the dollar is currently maintaining investor interest, but the continuing fluctuations in short-term interest rates, which have been more accentuated than in other markets, are leading to frequent changes in market sentiment and fluctuations in the flow of new issues. Prospects for issuing activity over the rest of 1981, at least for issues with fixed interest rates, will thus greatly depend on the direction and degree of stability of interest rates, and the same considerations continue to inhibit new foreign issues in the U.S. bond market. Issue volume in the Euro-French franc sector in the first quarter of 1981 was, at an annual rate, twice as large as in 1980, but subsequent exchange market developments may well dampen foreign investor interest in issues denominated in that currency for a time.
In light of the factors mentioned above, the total volume of international bond issues in 1981 may somewhat exceed that of 1980. However, the outlook depends greatly on the course of interest rate developments and expectations. The outlook for developing country borrowing in the international bond markets has been set out in Section IV. Broadly, some recovery from the exceptionally low level of those countries’ issues and placements recorded in 1980 is in prospect for 1981, but no major increase should be expected.
The prospects for the bond markets have a major bearing on the prospective demand for bank credit. After the first round of oil price increases, the rapid expansion of international bond issues, from $12 billion in 1974 to $34 billion in 1976, played an important role in increasing the flow of international finance at a time when there were some strains on international intermediation by banks. Although the developing countries did not meet a major part of their external borrowing requirements in the bond markets, the fact that other borrowers were able to do so helped indirectly to ease the access of such countries to bank credit. In 1980, net new issues in the bond markets were below the level of 1975 in real terms; with no major improvement in prospect for 1981, the demands for bank intermediation will be high.
Prudential and Supervisory Constraints on Bank Intermediation
As noted in Section III, bankers continue to express concern about the riskiness of international intermediation, particularly vis-à-vis developing countries. The growth of current account deficits, which is exacerbated by high interest rates as well as high oil prices, is a discouraging factor, and bankers’ concerns are not likely to dissipate until there are clear signs of an improvement in current account situations. Nonetheless, some signs of a more relaxed attitude have become apparent in recent months, and it seems unlikely that concerns about risk will be so great in 1981 as to imply any significant slowing of international bank lending in the aggregate or to the non-oil developing countries as a group.
There appears to be an increasing tendency to focus on the fundamental economic strength and appropriate policy stance of the major borrowers among the non-oil developing countries. Bankers continue to express doubts about the longer-run prospects for some countries, but in contrast to the views they were expressing in 1980, they do not appear to foresee any imminent difficulties for the major borrowers. The recent signs of a softening in oil prices have contributed to an easing of bankers’ concerns in this regard. Encouragement has come from the fact that no wave of debt crises has emerged, despite the strains of the last two years, and that relatively orderly procedures now seem to have been worked out for restructuring bank debt in those few cases where problems have arisen. Similarly, the growing role of the Fund in financing adjustment programs has helped to maintain market confidence. Concerns expressed in 1980 about other aspects of the environment for international lending also seem to have dissipated to some extent. This generally more sanguine attitude has tended to be self-reinforcing, as part of the uneasiness of a year ago reflected concern that a collective pullback by banks could precipitate crises.
Supervisory practices do not seem likely to be a major constraint on international banking flows in 1981. In some respects changes in regulations (for example, the greater flexibility given to Canadian banks in raising capital) have eased the situation. Against this, the fact that balance sheet consolidation in Switzerland is being phased in and is in prospect in the Federal Republic of Germany may have some continuing inhibiting effect in those countries. Although supervisors continue to impress upon banks the need to be aware of their concentration of exposure, the differences among banks in the geographical concentrations of their exposures provide considerable flexibility on a system-wide basis. This flexibility has been demonstrated recently by the ability of some borrowers to attract large amounts of new finance through an acceptance of higher spreads.
Prospects for International Bank Lending
While it is not feasible to quantify the prospects for international bank lending—its volume, direction, and terms—with any degree of precision, it is possible to suggest some broad orders of magnitude that appear to be consistent with the current outlook for the macroeconomic environment and the prudential constraints perceived by banks. The actual outcome, of course, will differ from the projection to the extent that the actual evolution of macroeconomic and prudential factors diverges from current expectations.30 In 1980, for example, many observers expected a slowdown in international bank lending, particularly to the non-oil developing countries, because bankers were increasingly concerned about the risk of such lending. The view expressed in the Fund staff paper (Occasional Paper No. 1) was that, for a number of reasons, the increase in bank claims was not likely to decelerate from the pace of 1979 (24 per cent) but in view of bankers’ prudential concerns, no significant increase was likely. In the event, the balance of payments financing requirements of the smaller industrial countries and of the non-oil developing countries exceeded expectations, prudential factors proved less of a constraint than many observers had anticipated, and the growth in bank claims was 25 per cent.
The current outlook for the macroeconomic environment, as summarized earlier in this section, suggests that while there may be a slight moderation when compared with 1980, the demand for international credit will remain strong in 1981. Its composition, however, will shift to lower demand for increases in trade credit and in credit to finance investment and business activity in the industrial countries but stronger demand for balance of payments finance by the countries that rely heavily on the international capital markets for such finance. Some of the increased demand for balance of payments finance may be met through channels other than banks, such as additional use of Fund resources, but there will nonetheless still need to be some increase in the amounts borrowed by such countries from banks.
A major factor in the maintenance of bank lending in 1981 is thus the extent to which banks will be prepared to respond to the shifting pattern of demand by increasing their lending to countries needing balance of payments finance. Under normal circumstances, a declining demand for business and investment finance in the industrial countries would lead banks to expand their role elsewhere, but given their already large exposure to the non-oil developing countries, they express reluctance to do so. A large part of the increase in their claims on such countries in 1980, moreover, was in the form of short-term trade finance, on which banks are more flexible than on other types of credit. In view of the prospective slowdown in the growth of the value of trade in 1981, the proportion of the financing requirement that will have to be met through forms of credit more affected by prudential constraints will need to increase.
The extent to which banks are willing to accommodate the increase in the demand for longer-term finance of the non-oil developing countries is thus of major importance. The total increase in bank claims needed to meet the prospective financing requirements of such countries, however, is somewhat less in percentage terms than in 1980.31 As banks’ perceptions of the risk of lending to such countries seem to be easing to some extent, on balance it seems likely that the required lending will be forthcoming for developing countries in the aggregate. It is encouraging in this regard that the volume of new syndicated medium-term loans to non-oil developing countries in the first half of 1981 seems to have maintained the momentum seen during the latter part of 1980. But for individual countries among them (which have achieved access to medium-term credits) whose adjustment policies are viewed as inadequate, market resistance may well stiffen considerably.
Maintenance of the growth of bank assets vis-à-vis the smaller industrial countries and the non-oil developing countries at the rate of 1980, together with some slowdown in lending to borrowers in the major industrial countries, implies an overall growth rate somewhat below that recorded in 1980, but still somewhat in excess of 20 per cent. As the stock of bank claims was some $810 billion at the end of 1980, it seems reasonable to expect $1 trillion by the end of 1981, implying an increase of 23 per cent. In dollar terms such an increase would involve net financing flows of $190 billion, compared with $165 billion in 1980.
Such a prospect is consistent with what is known of the lending plans of banks in the capital market countries. U.S. banks, which substantially accelerated their international lending in 1980, are expected to continue to be active. Canadian banks, which through the rapid expansion of their international assets in the last few years have become much more significant in the overall picture, also are expected to remain active. Japanese banks, whose international activity in 1980 was heavily concentrated in channeling short-term capital flows into Japan, are now set for a substantial resumption of their international lending to other countries. Although new commitments are not expected to reach the record level of 1979, nonetheless, the lending programs proposed by the banks suggest that their longer-term international assets should grow considerably faster in 1981 than the growth of 17 per cent recorded in 1980.
In Europe the picture is mixed. With the end of exchange control, U.K. banks are rapidly increasing their international assets after many years of relatively slow growth of such assets. At the other extreme are German banks, for which the relatively slow pace of lending recorded in 1980 may well continue. The pace of their lending is affected by their large exposures in Eastern Europe at a time of significant political uncertainty, by the poor profitability of many banks resulting from their relatively large portfolios of fixed-interest rate assets, by the Federal Republic of Germany’s balance of payments position (which resulted in the sharp temporary curtailment of their longer-term deutsche mark lending early this year), and by the tightening in capital requirements in prospect under new legislative proposals. Other banks in Europe fall between the two extremes. Swiss bank lending, like that of German banks, is being affected by tighter capital requirements resulting from balance sheet consolidation. French banks, whose lending is exceptionally concentrated in credit related to the country’s exports, may be affected by the slowdown in world import demand. This factor may also affect German banks, which under present circumstances are concentrating their activity in lending that gives rise to ancillary business. The continuing strength of U.S. and Canadian bank lending, however, together with the probable increase in Japanese bank activity in the longer maturities, suggests that even a continued slowdown in activity by European banks will not lead to any major slowdown at the aggregate level.
The steady reduction in lending spreads which began in 1976 appears to have come to an end in 1980. Though a few borrowers are still managing to obtain better terms, for many borrowers a slight hardening seems to be occurring. In view of the large demands for credit of the non-oil developing countries in 1981 and the concentration of those demands in the longer maturities, the trend in 1980 toward greater differentiation of spreads may continue. The degree to which banks lose lending opportunities through the slowdown in the industrial countries will be a major determinant of their willingness to continue lending to many developing countries on relatively fine terms. The fineness of those terms suggests that the banks’ interest in lending to developing countries is still strong, and a hardening of terms is by no means a foregone conclusion. Any increase in spreads, moreover, will be small relative to the current high level of interest rates.
On the funding side, some of the largest depositors reportedly are facing some reluctance by the major banks to increase their concentration of deposit exposure. If such depositors neither accept those lower interest rate offers nor expand the lists of banks with which they do business, the result will be an acceleration of the disintermediation of which direct recycling is an example. Since disintermediation lessens demand for bank services on both the lending and deposit sides, however, the competition among banks for the remaining business may well lead to easier access to bank credit by those borrowers who cannot shift to other sources of finance.
Beyond 1981 the picture remains uncertain. If the projections given above for 1981 are fulfilled, bank claims on the non-oil developing countries will once again have increased relative to the total size of bank balance sheets (though not necessarily relative to banks’ total international book), and the volume of debt to banks as well as debt service requirements will be larger for many countries relative to their total output and their exports. Banks’ concerns about the risk of lending to such countries will thus remain high and will continue to do so until there are clear signs of improvement in such countries’ prospects.
Even without early improvement in those prospects, however, the general level of bank exposure to developing countries is not likely to be so high even by mid-1982 as to seriously impede their willingness to continue lending. The fact that spreads have risen so little for most countries—and the extremely large volumes of additional finance that have been forthcoming for the few countries whose spreads have risen—supports this view. While banks in some countries may from time to time slow their activity, the experience of the last few years suggests that, in the absence of crises such as those which followed the 1974 bank failures, any such slowdown is not likely to be general. As time goes by, moreover, banks outside the traditional capital market countries are playing a larger role. Banks with a Middle Eastern base, for example, are growing very rapidly and are beginning to play a significant role in international lending.