Chapter5

FinancialFlowstoDevelopingCountriesTheeffortoftheSouthtoobtainfinancialcapitalfordevelopmentisacentralthemeinNorth-Southrelations.Thischapterexaminestheevolutionoffinancialflows,bothpublicandprivate,inNorth-Southrelations.BrettonWoodsandForeignAidTheOriginalBrettonWoodsTwointernationalinstitutions:WorldBankandIMF

PurposeoftheWorldBank:financetherebuildingofwar-torncountriesandthedevelopmentofmembersofthebankNorthernpolicyonbilateralaidcloselyresembledthatininternationalforums.Self-helpwasemphasized;externalcapital,whereneeded,wastobeprimarilyprivate;andwhereprivatecapitalwasunavailable,externalfinancingwastocomeprimarilyfromtheWorldBank.TheLinkBetweenAidandForeignPolicyInthemid-1950s,Northernpoliciesshifted.TheUnitedStatesbeganaprogramofmilitaryassistancetodevelopingcountries.Reason:theemergenceoftheLDCsasincreasinglyactive,albeitweak,actorsininternationalrelations.TheUnitedStatesconcludethateconomicassistancetotheSouthcouldbeapowerfultoolintheColdWar.AidwouldserveU.S.foreignpolicyby“helpingthesocietiesoftheworlddevelopinwaysthatwillnotmenaceoursecurity——eitherasaresultoftheirowninternaldynamicsorbecausetheyareweakenoughtobeusedastoolsbyothers”.Multilateralaidalsoincreased.WorldBanklendingshiftedtodevelopingcountries,andthebank’scapitalwasincreasedtoallowgreaterlending.StagnationofAidFrom1965to1969,theriseindebtservicepaymentsontheofficialandofficiallyguaranteedloanstoeightyLDCsexceededtheriseingrossflowsofnewcapitalaid.Asaresult,thenettransferofresourcesfellslightlyduringthisperiod.Thestagnation,andinsomecasesdecline,inaidflowsalsodisillusionedSoutherngovernments.Afewdevelopingcountries,suchasMyanmar,rejectedaidandturnedtootherself-helppolicies.FinancialflowsintheeraofinterdependenceConfrontationandthenewinternationaleconomicorderInthe1970s,theissueofaidflowsbecamepoliticizedasSoutherncountriesconfronteddevelopedcountrieswithdemandsforaNewInternationalEconomicOrder(NIEO).Thefoodcrisishaditsrootsinpostwarindustrializationstrategies.Developmentfundswerechanneledtoindustryandagriculturalpriceskeptlowtofeedthegrowingurbanpopulation.ThesecondcrisisfortheSouthinthe1970swastheoilandenergycrisis.Themajorstrategyofthe1970swasSouthernunityandconfrontation.TheabilityofaunifiedOrganizationofPetroleumExportingCountries(OPEC)toattainsignificantrewardsfromtheNorthdemonstratedthepotentialeffectivenessofSouthernunityinbargainingwiththeNorth.TheSouthwasabletoforcetheNorthtodiscusstheconceptofreformintheUnitedNationsandothermultilateralforums,butitwasnotabletomaketheNorthactuallynegotiateforsystemicchange.BecauseofSouthernpressure,therewassomeimprovementinfinancialflows,especiallymultilateralflows,totheSouth.PrivatizationofFinancialFlowsInthe1970s,certaindevelopingcountrieswereabletoborrowfromtheprivatecommercialbanksofdevelopedcountries.TheresultwasamassivesurgeinprivatefinancialflowstotheSouthandadeclineintheshareofaidintotalflowsfromNorthtoSouth.Lendinghelpedexpandproductivecapacityandmaintainedgrowth,evenafterthefirstoilshock.Low-incomedevelopingcountries,unabletoborrowfrombanks,remaineddependentonconcessionalflows.TheDeclineofAidinthe1980sIntheearly1980s,aseriesofchangesintheworldeconomicsituationturnedprivatebankflowsintoadebtcrisis.Asaresult,totalfinancialflowstodevelopingcountries(concessionalandcommercial)declined.Twoexternalshocks:Thesecondoilcrisisof1978-1979Anti-inflationarypoliciesinthedevelopedcountriesandasteeprecessionTheseinternationalshockswereaggravatedbyexpansionarydomesticeconomicpoliciesinmanyoftheLDCs:increasedgovernmentspendingtomaintaingrowthratesexacerbatedbothfiscalandtradedeficits.From1980to1983,domesticpoliticaloppositiontoforeignaidexpendituresgrewintheNorth.Theseeconomicandpoliticalchangesledtoanotherdeclineinmultilateralaid.Bythemid-tolate-1980s,however,someconcessionalaidwasrestored.

Newsurpluscountries,suchasJapan,beganextendingmoreaidtothedevelopingcountries.TheUnitedStatesbecamemorereceptivetotheneedforsomeconcessionalflowsinparticularlyhard-hitareassuchassub-SaharanAfrica.Thedistributionofrecipientsacrossthemajordonorcountriesreflectedaspecializationofdonorsinaidtoparticularregions.Europeancountriestendedtoprovideaidtoformercolonies.TheUnitedStateswasthemainaiddonortotheMiddleEastandLatinAmerica.JapanfocusedmostofitsaideffortsinAsia.TheDebtCrisisofthe1980sInthe1980s,theriseinthepriceofoilcombinedwithrestrictivemonetarypoliciesinthemajorindustrialcountries,ledtorecord-highrealinterestratesandworldrecession.Before1979,borrowinghadbeenforrelativelylongtermsofthreetofiveyears.In1979to1981,asleadersbecamecautious,borrowingturnedincreasinglytoshort-termcredits.Defaultsbydebtornationscouldhaveledtoacollapseofconfidenceintheinternationalbankingsystem,possibleilliquidityorinsolvencyofthebanks,dangerousdisruptionofthefinancialmarkets,and,inaworst-casescenario,worldrecessionordepression.AsbanklendingtodevelopingcountrieshaltedabruptlyafterAugust1982,thedebtcrisisspreadrapidly.DebtCrisisManagementApatternofcrisismanagementemerged.ThecentralfocuswasanagreementwiththeIMFonanewloanfromtheIMFthatwasconditionalupontheadoptionofastructuraladjustmentprogram——aprogramofgovernmentreforms.From1982to1984,thestrategyofdebtmanagementthroughausterity,rescheduling,andnewlendingseemedtowork.InSeptember1985,UnitedStatesTreasurySecretaryJamesBakerproposedathree-partplan——theBakerPlan.

Purpose:torestoregrowthinfifteenofthemostheavilyindebtedcountriesandtocomplementtheongoingcountry-by-countrydebtrestructuringefforts.Result:(1)didnotleadtoaresurgenceofgrowth.WhilecountriessuchasMexico,Chile,andUruguaypursuedreforms,mostdebtorsfounditpoliticallydifficulttoimplementsignificanteconomicchanges.(2)ThefinancialinflowsprescribedbytheBakerPlanwerenotforthcoming.SomemodificationsweremadeinanefforttoimprovetheworkingoftheBakerPlan.

AnincreaseinWorldBankcapitalauthorizedin1988wasintendedtoenablebankflowstocontinueandpossiblyincrease.Avarietyoffinancialtechniquesweredeveloped.Secondarydebtmarketsenablecreditorstoexchangedebtwitheachotherasawayofbalancingexposuretocertaincountriesorofbalancingdebtmaturities.DespitetheBakerPlanandthemenumodification,debtoreconomiesstagnatedandthesystemcontinuedtolurchfromcrisistocrisis.DebtFatigueBythemid-1980s,thedebtcrisishadenteredanewphasecharacterizedbydebtfatigueanddisintegratingcooperationamongtheparticipants.Pressureonbigbandsincreased.Reasons:notonlyfromreluctantcreditorsandfromthesecondarymarketwhereloanvaluesofthemajorbankswithexposureindevelopingcountriesweredepressedbecauseoftheLDCdebtoverhang.Debt-restructuringpackagesbecamehardertonegotiatebecauseofthedivisionsamongbanks,andthisdifficultyraisedconcernthatoverallnewflowswoulddecline.Thefirstrecognitionofaneedfordebtrelief:theheadsofstateatthe1988TorontoSummitagreedonaplantoalleviatethedebtserviceburdenforthepoorersub-SaharanAfricancountries.InMarch1989,TreasurySecretaryNicholasBradyannouncedanewLDCdebtstrategy.ThisstrategycalledforashiftinemphasisfromnewlendingtodebtreductionbybanksandstatedthatWorldBankandIMFresourcesshouldbeavailabletodebtorcountrieswithsoundeconomicreformpoliciesforuseinencouragingdebtreduction.Gradually,theeconomiesofmostdebtorcountriesstabilizedandtheyreturnedtoapatternofgrowth.However,anumberofimpoverished,slow-growingdebtorcountriescontinuedtoexperiencedebtservicingproblems.GlobalizationEmergingMarketsInthe1990s,anumberofdevelopingcountriesbecameparticipantsinanew,globalfinancialsystemthatchangedthemfrombeingdebtorstoemergingmarkets.Intheperiodofglobalization,portfolioinvestorsalsoinvestedinemergingmarkets.Netprivatefinancialflowstoemergingmarketsinthe1990swereprimarilyintwocategories:FDIandportfolioinvestments.Financialcrisesofthe1990s

Whilemanydevelopingcountriesliberalizedtheirdomesticcapitalmarketsduringthisperiod,theydidnotalwaysquicklyincreasetheircapabilitytoregulatedomesticfinancialmarkets,thusleavinganopeningforunscrupulousandcorruptbehavioronthepartofthemangersoffinancialfirmsandinstitutions.Thefollowingsectionsfocusonwhathappenedinthe1990sinfourcountries:Mexico,Indonesia,SouthKorea,andArgentina.Mexico:MexicohadjoinedtheGATTin1986andsubsequentlyreducedbothtariffandnontariffbarrierstoimportsaspartofashifttowardanexport-orienteddevelopmentstrategy.TheannouncementofthesigningandratificationofNAFTA(NorthAmericanFreeTradeAgreement)helpedtocementtheconfidenceofbothdomesticandforeigninvestorsintheoverallhealthoftheMexicaneconomy.Insteadofdevaluingthepeso,thegovernmentgraduallydepleteditsforeignexchangereservesinafutileefforttomaintainwhatitsawasthesymbolofitseconomicandpoliticalstrength.OnDecember20,1994,theMexicangovernmentdevaluedthepesoandonDecember22allowedittofloatagainstthedollar.TheUnitedStatesledinthemobilizationofaninternationalrescuepackagetostabilizetheMexicaneconomyand,thereby,theinternationalfinancialsystem.TheMexicangovernmentdevelopedaneweconomicplanthatincludedspendingcuts,curbsonwageincreases,andsubstantialincreasesingovernmentrevenues.LearningfromtheMexicanexperiencethatthebestwaytopreventcrisesisforborrowingcountriestofollowappropriatenationalpolicies.Argentina,PartOneFollowingMexico’sdevaluationofthepesoinDecember1994,theArgentinepesobecametheobjectofaspeculativeattack.Thecombinationofthedollar-pesoparityanddollar-denominatedbankdepositsinArgentinawaslatercalleddollarization.ItmeantthatArgentinahadrelinquishednationalcontroloveritscurrencyandnowreliedontheU.S.FederalReservetosetmonetarypolicy.Indonesia’seconomysufferedfromhighlevelsofcorruptioningovernment-ownedor–controlledbankstomakeloanstopoliticallypowerfulfriendsofpoliticiansinoffice.OnJanuary8,1998,therupiahbeganafree-fallthatresultedinageneraleconomicpanic,arunonthebanks,andwidespreadhoardingoffood.OnMarch13,1999,thegovernmentannouncedtheclosingofthirty-eightbanksandthetakeoverofsevenothersbyanewgovernmentagencycalledtheIndonesianBankRestructuringAgency(IBRA).Theunderlyingproblem:ThebankswerepartofalargerpoliticalpatronagesystemcontrolledbySuhartoandhisfamily.SouthKorea:TheSouthKoreanequitiesmarketsufferedasuddendrop,buttheKoreancurrency,thewon,remainedstrongforseveralmonthsafterthecrisisbegan.InNovember1997,aftertheBankofKoreagaveupdefendingthewon,itsvalueonforeignexchangemarketsfellrapidly.TheKoreangovernmentmadethenecessaryreforms,includingopeningupKoreaformoreinflowsofforeigninvestment,helpedtoreducethelengthoftherecessionthatfollowedthedevaluationofthewon.Argentina,PartTwoReason:TheArgentinegovernmentpersistedinitsdollarizationpolicyeventhoughgrowthslowed,thebalance-of-paymentsdeficitwidened,andforeigndirectinvestmentstoppedflowingintoArgentina.

Inappropriatepolicyledtoviolent.Thegovernmentdeclaredastateofemergencytodealwithit.OnDecember20,2001,boththepresidentandeconomyministerresignedtheirpositions.OnJanuary2,2002,acaretakergovernmenttookpower.OnFebruary11,2002,thepesowaspermittedtofloatagainstthedollar.CommonCauses,DistinctConsequencesAllinvolvedaperiodofspeculationaboutthevalueofthecurrencyfollowedbydevaluationsandlargeoutflowsofmostlyshort-termforeigninvestments.Allresultedinreducedgrowthratesandincreasesinunemployment.Eitherprecededbyorresultedinachangeofgovernment.Conclusion:demonstratedtheincreasedvolatilityofinternationalinvestmentflowsandtheincreasedflowsandtheincreasedeconomicandpoliticaldependenceofrecipientsonthoseflows.TheHIPCProgramInSeptember1996,theIMFandtheWorldBanklaunchedaninitiativefordebtreliefforheavilyindebtedpoorcountries(HIPCs).

ItmeanttosupplementthedebtreschedulingandreductionconductedthroughtheauspicesoftheParisClubbytakingintoaccountthespecialneedsofpoorcountries.Effects:reducingdebtmakingmoremoneyavailableforpovertyreductioninparticipatingcountries.TheImpactofFinancialFlowsUnevengrowthratesinthedevelopingworldledtogr