Presentation on theme: "Chapter 6. Balance of Payments, Foreign Debt and Financial Crises (Mostly Chapter 15 from Radelet text)"— Presentation transcript:
Chapter 6. Balance of Payments, Foreign Debt and Financial Crises (Mostly Chapter 15 from Radelet text)
Balance of Payments (BOP) Balance of Payments = Current Account + Capital Account (Net Capital Inflows) Balance of payments shows the net change in the foreign exchange (dollar) reserves of a country during a certain time period.
Balance of Payments 1. Current Account :Inflows (+) Outflows (-) 1. Trade Balance = +Exports – İmports 2. Services Balance 1. +Net Foreign Tourism Revenues 2. +Banking & Insurance Net Revenue 3. +Construction & Transportation Net Revenue 4. +Workers’ Remittances + Paid Military Service 3. Net Income from Foreign Capital 4. Unilateral transfers (Aid to other countries)
Balance of Payments “Current Account (CA) Deficit” means that CA is a negative number. This is usually because the largest item “Trade Balance” is negative. For example, Turkey’s 2008 (2007) January- March exports are $33 ($24.4) billion, imports are $49 ($33) billion, trade balance is -$16 (- $8.6) billion.
Balance of Payments 2. Capital Account = Net Capital İnflows =capital inflows – capital outflows 1. +Purchases of Domestic (Turkish) assets by Foreigners 2. – Purchases of Foreign Assets by Domestic (Turkish) Residents 3. Credits: + Net Borrowing of Turkish Residents from Foreign residents (+borrowing, -lending)
Balance of Payments Capital Inflows: Two types: 1. Foreign Direct Investments (FDI): Takes control of the firm, bank, etc. Ex: Migros sale to British, Finansbank sale to NBG, ToyotaSA, are FDI inflows. Ülker purchase of Godiva is FDI outflow. 2. Foreign Portfolio Investment (FPI) (stocks, bonds, credits). Foreign investors buying stocks at ISE, Turkish banks & firms borrowing from foreign banks are FPI inflows. Turkish banks lending to Azeri firms is FPI outflow.
Balance of Payments Difference btw FDI and FPI: In FDI, the investor has a share in the investment enough to control the decisions of the company. In FPI, investor is only creditor, takes less risk. Has a small share in various companies.
Balance of Payments Except for year 2001, TR’s current account has been negative. However, TR’s capital account surplus is by far greater than its current account deficit. This means that there was a net dollar inflow into TR. This is why dollar has depreciated against TL in the last few years. 20002001200220032004200520062007 Current Account/GNP(%)-4.902.37-0.99-2.86-5.17-6.39-6.62-5.7
Foreign Debt After WWI, war reparations payments that Germany, Austria, Hungary were forced to pay fed the extremist currents such as Nazism in these countries. Hyperinflation was observed. International capital flows were high before 1914, low in 1918- 1945, and high again aftyer 1950, especially 60s and 70s and 80s Especially Latin America borrowed heavily in 70s. Developing countires’ total debt stock increased from $19bn to $307bn between 1970-83 (to private banks). Latin American Debt Crisis erupted in 1982, continued until 87. Debt restructuring: increasing the maturity of debt.
1980s Latin American Debt Crisis 15 countries in Central and South America was caught. Causes : Oil crisis that started in 1973 caused imports and current account deficits to increase, global output and demand to fall, exports to fall. US announced that the dollar has left the gold standard in 1971, dollar was devaluated, US inflation reached double digits, dollar interest rates increased to %16 ya çıktı. Interest rate increases caused borrower Latin American countries to repay $13bn more for debt ONLY in 1981. Debt quickly became unsustainable.
1980s Latin American Debt Crisis South Korea and Indonesia also borrowed a lot but they were not caught in the crisis. WHY? Because they were prepared for interest rate hikes: lowered govt. budget deficits, decreased aggregate demand, inceased incentives for exports. In contrast, Latin America borrowed more to repay earlier debt. and int’l creditors (and creditor’s countries) supported this policy by lending more. They did this despite they saw that debt was unsustainable.
Debt Sustainability: Terms Stock of debt (stock) Debt service: qty of debt due to be repaid during a specific time period: (flow). Debt sustainability depends on stock of debt, its maturity and power to repay. Power to repay depends on GDP, exports, foreign exchange reserves and govt. tax revenues. In 97-98 Asian crisis, countries’ GDP were enough, but they did not have sufficient forex.
Debt Sustainability: Criteria Debt sustainability can be measured by debt indicators:: Short-term debt / Forex reserves. If Debt with maturity of less than a year is greater than forex reserves, then there is a risk of crisis (ratio>1). Govt. Debt stock / GDP: İf this exceeds 30-50% range, then there is risk of crisis. This shows if the country is about to go bankrupt. Greece, Japan, UK, Iceland, Ireland > 100%.
Debt Sustainability: Criteria Debt sustainability can be measured by debt indicators: Debt / Govt. Revenue or Debt service / Govt. Revenue. Especially critical for high-debt governments. Each indicator should be less than %200 and %15 respectively to avoid danger. Debt stock / exports or debt service/ exports measures the economy’s capacity to generate foreign exchange. This shows how liquid the economy is during a given time period. Should be under %200 and 25% for safety.
Debt Sustainability: Criteria There is difference between being “illiquid” and being “insolvent”. An insolvent unit (firm, bank, govt.) cannot pay its debts with all its assets in the long- run, i.e. given enough time. An illiquid unit lacks sufficient liquidity to pay for its debts only in the short-run, but in the long-run, it can repay its debts with future earnings.
Effects of a “Debt” or “Balance of Payments” Crisis Capital inflows turn into outflows. Becomes net creditor as inflows stop (sudden stop). This causes automatically to: Imports fall, exports rise Saving rises, investment falls Because Net Capital Inflows = M - X = I - S Effects of 1982-86 Mexican crisis. Table 15-3 in Radelet. Before crisis:1977-81 and after: 1982-86.
Debt Crisis of Low Income Countries Especially Africa : Uganda Kongo Zaire, etc. Difference from Latin American crisis: They borrowed usually not from private banks but from developed country governments, the IMF and WB. Many times the creditors lend these credits by imposing or forcing the projects that were not always welfare-improving for the borrower country. In some cases, creditors lend to a military dictator in order to gain his support in cold war. Ex: credits to Congo`s Mobutu even if they knew he is corrupt. Odious debt concept.
Debt Crisis of Low Income Countries “Odious debt”: Debts that were borrowed and stealed by a dictator and should not be paid by the citizens of the country. In 2004, Iraq`s $29 bn were forgiven by the Paris Club Paris Club: The institution that manages and collects the claims (credit) of the 19 richest countries. Result: Bad macroeconomic management, rising oil and other imports prices, falling agricultural exports prices, they cannot pay their debt: what happens next?
Debt Crisis of Low Income Countries For some time, creditors kept new lending just to let the borrowers repay older debt. : “defensive lending”. Paris Club forgave only part of the debt only after 1988, IMF and WB forgave part of the debt only after 1996.
Financial Crises of “Emerging Markets” in 1990s Which are emerging markets? Russia, TR, Brazil, India, China, Mexico, East Asia and other fast growing countries. Capital flows to these countries rose sharply in 1990s. Table: S. Korea, Indonesia, Malaysia, Singapore, Philippines (billion dollars) 19941995199619971998 40,577,4103,2-1,1-28,3
1997-98 Asian Financial Crisis In 1997-98, capital suddenly stopped flowing in, flew out (capital flight) of SE Asia. Started in Thailand, spread to others: contagion. But before the crisis, macro fundamentals were good, GDP was high, govt. debt was low. What was wrong? They liberalized their financial systems quickly in 1990s, without proper regulation and supervision.
1997-98 Asian Financial Crisis Fast entering capital looked for high return, and were invested mostly in real estate. But they should have been invested in export sectors because investing in real estate means exchange rate risk was taken. But profits in export sectors were not high. Banks were borrowing in dollars and borrowers from banks borrowed also in dollars or domestic currency. But the revenues in real estate were in domestic currency. From a macro perspective economies took too much exchange rate risk. Maturity mismatch risk: banks usually borrow short term from int`l creditors, their deposit liabilities are also short-term. But their credits were long-term (real estate). If foreign creditors stop lending, domestic banks cannot rollover debt and easily fall into a liquidity crisis (forex liquidity crunch). If CBs follow fixed exchange rate policies (which they do in Asia) exchange rate risk is mostly taken by the govt-CB. This causes a moral hazard problem as banks, firms, households take too much exchange rate risk. High Leverage=Assets/Equity means financial institutions, firms, hh’s rely too much debt instead of own funds.
1997-98 Asian Financial Crisis As a result: Fast entering capital flew out fast. Contagion, herding and creditor panic: Int`l creditors withdraw funds from similar countries in the region, not looking at individual countries` status. Can think of countries like banks: This is essentially a bank-run. In a country, the CB can prevent a panic and save a bank by lender of last resort policy, but who will save a country when there is run on it? IMF? After Asian crisis, in 1998 Brazil and Russia, in 2001 Turkey and Argentina had crises.
Real GDP growth rates before and after a crisis (Radelet) CountryCrisis YrPreviousCrisis yrAfter2After Arjantin19955.8-18.104.22.168 Arjantin2001-0.8-4.4-10.97 Brezilya19922.214.171.124.4 Endonzya19977.64.7-13.10.8 G Kore19976.85-6.710.9 Malezya1997107.3-7.46.1 Meksika19954.4-126.96.36.199 Filipinler19975.85.2-0.63.4 Tayland19975.9-1.4-10.54.4 Türkiye19948.0-5.57.27 Türkiye20017.4-188.8.131.52 Venezuela19940.3-2.34-0.2
Common Properties of 1990s emerging market crises Short-term foreign capital rises fast in the few years preceding the crisis When foreign creditors starts to doubt the perceived repayment capacity of the borrower, they stop lending or rolling over debt. Maturity mismatch risk and foreign exchange risk causes banks and firms to go bankrupt. Forex liquidity crunch is observed in the borrower country. The CB tries to defend the domestic currency by selling dollars but may run out of dollar reserves. Then CB is forced to float or devalue the currency. Balance sheets of banks and firms go bankrupt due to exch. rate risk.
Common Properties of 1990s emerging market crises Self-fulfilling prophecies: Adverse Expectations possibly unrelated to economic fundamentals can realize themselves. “Bank run” can become a reality for a country. Herding: most investors do not want to pay for collecting info. about economies instead they follow what bigger investors are doing. Contagion of crises
Different Properties of 1990s Financial Crises Difference of Argentina&TR crises with Asian crisis: Argent. & TR had massive govt. debt and deficits which caused the crisis, but Asian governments did not have debt and deficit problems (except Thailand) Common feature: In all financial crises, there were maturity mismatch risk, exchange rate risk, fixed exchange rate regime helped cause the crisis.
How can Crises be prevented? Domestic banks must borrow longer term. They also should try to lend in foreign currency. Borrowers must try to borrow long term and in domestic currency, especially if they are not earning dollars (forex). Banks sould not take `open position` in foreign exchange.
How can Crises be prevented? “Short-term foreign debt/ CB forex reserves” ratio must be less than one. The basic reason why Taiwan did not get caught in Asian crisis was its 90 bn dollars reserves in 1997 (Radelet 2008) In 2009 TR`s above ratio was 0.80. In 1994 it was 2.06, and in 2001 it was 1.26. In all crisis countries except Malaysia this ratio was above 0.80.
What can be done after crisis? Restructuring of debt and new lending negaotiated with creditors. Apply to IMF for credit Increase int. rates, restrict imports,, banking reforms (stricter regulations and supervision).
IMFcredits TR received largest (33.8 bn USD) and Brazil (35.1 bn USD).
2007-2010 Global Crisis Why did it happen? Global imbalances (Caballero et al. 2008) Emerging markets (China, Asia, etc.) produces and sells, trade (CA) surplus, US consumes, CA deficit. Commodity prices increasing, (goods, oil, gas) exporters earning much money. These capital looking for safe assets, which they can find only in US and Europe because their own markets are shallow. So they purchase US bonds.
2007-2010 Global Crisis US reduces interest rates increases liquidity to prevent a recession after the dot-com bubble. Real int. rates fall in US. So extra liquidity coming into US looks for higher rate of return because bonds pay very little. So banks start to lend to even people who does not have enough income to repay. Especially mortgage market grows fast.
2007-2010 Global Crisis In US-Europe banks securitize credits, they package mortgage credits and make them securities and sell to other financial institutions worldwide. Credits are divided into risk categories `tranches`. Mortgage based securities (MBS) were also insured by other institutions, but much depends on house prices which have increased fast in 2000s.
2007-2010 Global Crisis There is so much liquidity that US banks lend “NINJA: no income, no job or assets” credits. House prices start to decline in 2007 February which increases defaults in mortgages, which were perfectly rational for borrowers. Ex:
2007-2010 Global Crisis As Defaults increase, insurers of the papers cannot provide enough reserves Rating agencies reduce ratings of tehse papers. So their value drops sharply. Banks and other financials who held these toxic papers start to go bankrupt: IKB, Bear Stearns, American Home Mortgage Investment Corporation, Lehman Brothers. Governments lent massive sums to banks. Nouriel Roubini said the only way out is to nationalize banks, which is what happened in US to a large extent.
2007-2010 Global Crisis Even if Banks are bailed out,global imbalances continue. Excess international capital will hit which county next? Source of imbalances: Developing countries want to grow by exporting, but developed countries that buy these exports give huge trade deficits (US). This cannot continue forever. Developed countries must consume less and developing countries should consume more of their product, or produce less maybe?.