1. 1 IN SEARCH OF A BETTER WORLD Stabilization Policies in Developing Countries Ministry of Economy & Finance Madrid February 2-3 2006 Javier Santiso Chief Development Economist & Deputy Director OECD Development Centre

2. 2 1 Catching up versus falling down The quest for efficient stabilization 2 (c) Remittances: a new holy grail? 3 Conclusions (a) Macroeconomic anchoring (b) Stabilization funds: the lost paradise?

3. 3 Growth performance in developing countries has been disappointing and highly volatile Source: The World Bank (2006) Growth volatility rates in the past 25 years Latin America2.3% South-East Asia2.2% USA2.1% European Union1.1% World1.0%

4. 4 In Latin America, macroeconomic volatility has been a major issue… Source: Hausmann/Reisen (1996) ** 1970-1992

5. 5 …and still remains a serious concern… Source: LACEA (2005) * periods between 1970 and 2000

6. 6 …although the situation has improved over past years Cyclical Volatility Estimates (standard deviations in %) Cyclical VolatilityForeign OutputDomestic OutputFixed Investment Argentina 1870-19293.466.49107.8 1930-19707.084.5667.96 1971-20042.975.0116.39 Brazil 1870-19293.464.8437.16 1930-19707.083.2529.56 1971-20042.972.9415.82 Chile 1870-19293.466.2576.05 1930-19707.087.6964.6 1971-20042.975.3516.1 Mexico 1870-19293.467.2979 1930-19707.082.9102.36 1971-20042.973.314.93 Source: IMF (2005)

7. 7 As a consequence per capita income gap has increased Source: Based World Development Indicators (2005)

8. 8 While Latin American countries experienced a decline…

9. 9

10. 10 …the Asian countries experienced an historical jump

11. 11 1 Catching up versus falling down The quest for efficient stabilization 2 (c) Remittances: a new holy grail? 3 Conclusions (a) Macroeconomic anchoring (b) Stabilization funds: the lost paradise?

12. 12 Stabilization through fiscal mechanisms is difficult… * without taxes on hydrocarbons Source: Lora (2006)

13. 13 …so is stabilization through reserves… Source: Economist Intelligence Unit (2006) and World Bank (GDP 2004)

14. 14 Developing countries following this strategy face social costs and economic arbitrage According to Guidotti-Greenspan rule, liquid reserves should equal a countrys foreign liabilities. This strategy implies costs arising from spread between private sectors cost of short-term borrowing abroad and the yield Central Banks earn on liquid foreign assets. According to Rodrik (2005), social costs of holding reserves can amount to 1% of developing countries GDP (assuming spread of 5%). This amount is roughly the same as the projected gains for developing nations from successful conclusion of the Doha negotiations. Insurance premium to stabilise a country through reserves may therefore outweigh expected benefits. Contrary to what has happened, strategy should be to increase reserves AND simultaneously reduce short-term liabilities.

15. 15 Stabilization through financial market access in local currencies is for a lucky few… CountryDate IssuedMaturity Amount issued (mill. US$) ArgentinaDec-96Dec-98250 ArgentinaFeb-97Feb-07500 ArgentinaJun-97Jul-49500 ArgentinaJul-97Jul-49500 ArgentinaJun-01Sep-08931 UruguayOct-03Oct-06290 UruguayAug-04Feb-06250 ColombiaFeb-05Oct-15325 BrazilSep-05Jan-161479 ColombiaNov-05Mar-10500 Source: BIS (2005)

16. 16 1 Catching up versus falling down The quest for efficient stabilization 2 (c) Remittances: a new holy grail? 3 Conclusions (a) Macroeconomic anchoring (b) Stabilization funds: the lost paradise?

17. 17 Latin American growth is linked to the performance of primary products… Source: BBVA based on national statistics 2004 Venezuela 83% Peru 71% Chile 60% Colombia 46% Argentina 38% Brazil 30% Mexico 14% Latam 31% Total exports Export of commodities/ Source: BBVA; BBVA-MAP Latam index monitors the trading prices of commodities in the region

18. 18 5% 10% 15% 20% 25% 30% 35% 40% 45% Capital Goods (USA) Oil Gas (USA) Coffee Tin Aluminium Copper Bananas Silver Zinc Shrimp Soy Sugar Gold Consumer Goods (USA) Production Goods (USA) Estimated deviation of the annual change rate Source: CAF (2004) …where price volatility is particularly high

19. 19 Changes in commodity prices have a large impact on the public budget… Source: Based on J.P. Morgan (2005) * using average WTI forecast of crude oil price of US$ 56.25

20. 20 …but countries have varying success in using this revenue for macroeconomic stabilization Colombia, Mexico, Russia (4.5) Algeria (3.5) Nigeria (2.5) Chad, Ecuador, Venezuela (1) 5 4 3 2 1 0 Source: Own estimates and J.P. Morgan (2006) Scale runs from 0 (bad) to 5 (very good) Oil revenues are captured in stabilization funds while money is spent on debt repayment, investment projects, or stabilization programmes Oil revenues above budget assumption are channelled into stabilization fund while some portion is used to finance larger public budget Newly set-up stabilization fund has so far financed deficits rather than being used to build up savings Stabilization funds are either not utilised (Venezuela) or financial resources are used to support the budget rather than to repay debt Chad has defied The World Bank by changing in 2006 its laws on managing petroleum revenues, to gain more freedom on spending it.

21. 21 IN PRACTICE: When prices soar, funds are dropped (Zambia in 1970s with mineral fund) When they go up or down, the orgy of domestic spending continues (Venezuela after 1974) Institutions are key stabilisers (Lynn, 1997) IN THEORY When commodity prices are high revenues are set aside When prices go down, funds are used to cushion the blow Commodity shocks have the same impacts …success stories are rare

22. 22 AND THEIR CONSEQUENCES: Sharp appreciations and loss of competitiveness Wasteful government spending and cronyism Civil war in an African country varies from less than 1% to nearly 25% depending on resources (Collier, 2002) COMMODITY BONANZAS… Sudden inflow of dollar- denominated revenues Rent-seeking behaviour in weak institutional contexts Military spending and conflict propensity The paradox of plenty

23. 23 Beyond economics: resource rents countries show lower democracy scores PeriodSample High Natural Rents Countries 19703.29 (4.16)0.96 (2.56) 1974 3.08 (4.22)0.89 (2.56) 19783.18 (4.28)1.32 (3.09) 19823.43 (4.29)1.76 (3.41) 19863.72 (4.35)1.28 (3.08) 1990 4.52 (4.27)1.89 (3.49) 19945.29 (3.96)2.00 (3.48) 19985.26 (3.98)1.92 (3.43) 1970-19984.03 (4.26)1.46 (3.11) Source: Based on Collier and Hoeffler (2005) Range: 0 (low) to 10 (high)

24. 24 One way of fostering growth is through cluster approaches… Gas, Bolivia Aluminum, Venezuela Oil, Ecuador Minerals, Bolivia Flowers, Ecuador Minerals, Peru Wood, Bolivia Iron, Venezuela Shrimp, Ecuador Soy, Bolivia Bananas, Ecuador Asparagus, Peru Fruits, Colombia Oil, Venezuela Coffee, Colombia Flowers, Colombia Fish Flour, Peru 0.0 2.0 3.0 0.0 1.0 Average growth rate of certain regional clusters (1998) Source: CAF (2004)

25. 25 …but success has so far been limited Source: Osmel Manzano, 2006 Development Level of natural resource clusters in the Andean region (0=low, 10=high)

26. 26 1 Catching up versus falling down The quest for efficient stabilization 2 (c) Remittances: a new holy grail? 3 Conclusions (a) Macroeconomic anchoring (b) Stabilization funds: the lost paradise?

27. 27 Remittances have grown stronger than official flows and FDI… in absolute terms… …and as a percentage of GDP Source: Guiliano and Ruiz-Arranz, IMF (2005)

28. 28 …largely outweighing the inflow of capital through development assistance Source: Based on OECD and World Bank (2006) in bn of US$ 0 20 40 60 80 100 120 140 160 180 Workers remittances Foreign direct investment Official development assistance Private debt and portfolio equity bn US$ 1995 2004

29. 29 Remittances flows are particularly strong towards low-income countries… Source: Based on OECD and The World Bank (2006) Billions of Dollars 21.7 21.3 18.1 12.7 11.6 6.9 6.8 6.5 6.4 4.2 4.1 3.9 3.6 3.4 3.3 3.2 3 2.8 0510152025 India China Mexico France Philippines Spain Belgium Germany United Kingdom Morocco Serbia Pakistan Brazil Bangladesh Egypt, Arab Rep. Portugal Vietnam Colombia United States Nigeria

30. 30 …having a large impact on a countrys indebtedness classification Source: Based on The World Bank (2005); data: 2003

31. 31 Although remittances seem to have a pro- cyclical effect in 2/3 of developing countries… Source: Giuliano/Arranz (2005)

32. 32 …there is also evidence that remittance flows can act counter-cyclicaly Source: Based on The World Bank (2006) Note: in a 5 year interval, red denotes year of external shock

33. 33 Remittances flows could even grow further through adequate policy measures Source: The World Bank (2006) * assuming reduction of transactions cost to 2-5% and elimination of dual exchange rates

34. 34 The central issue for developing countries: Transaction costs but not in all countries Remittances costs in Mexico (%, for 200 USD) 13.0 7.3 7.4 9.2 8.1 20002001 200220032004 Source: Pew Hispanic Center Remittances costs in Latin America * (%, 200 USD) 12.1 11.3 10.6 8.9 8.6 8.2 7.3 6.9 6.4 5.8 5.6 5.4 7.9 Cuba Rep. Dominicana Jamaica Haiti Venezuela Bolivia México Honduras Guatemala Nicaragua Colombia El Salvador Peru Ecuador Average * From USA; 2004 Source: PEW Hispanic Center

35. 35 Uses of remittances in Mexico in 2004 % of total Source: Fomin y Pew Hispanic Center 78.0 7.0 5.0 4.0 1.0 Consummer Goods Education SavingsOthersInvestmentHouseholds The central issue for developing countries: How to capitalize remittances bonanza?

36. 36 More remittances channeled through formal financial systems in order to increase the potential tax base of the recipient country. More competition, combined with appropriate legislations and institutions, in order to reduce transaction costs: -60% between USA and Mexico since 2000. More interconnected banking systems between OECD and non OECD countries in order to facilitate the access to credit in low income countries. Trans-national systems of guarantees in order to facilitate the access to credit for durable goods. Banking accounts in hard currencies in recipient countries in order to transfer the exchange rate risk, and highly remunerate in order to incentive savings and capital accumulation in low income countries. Banking accounts in sending countries highly remunerated (spread with the market covered by the State as ODA?), if the previous option is not technically feasible (second best option). The central issue for developing countries: How to capitalize remittances bonanza?

37. 37 1 Catching up versus falling down The quest for efficient stabilization 2 (c) Remittances: a new holy grail? 3 Conclusions (a) Macroeconomic anchoring (b) Stabilization funds: the lost paradise?

38. 38 European countries experienced an impressive catching up process …

39. 39 … which invite to focus on some of the key drivers of their success stories European anchoring and sound macro-economic policies have been major drivers of the impressive Spanish catching up. Interestingly Spain has been a major recipient of remittances: Spanish emigrants had a positive impact in the development of Spanish financial sector. What could be the lessons of the Made in Spain for developing countries? Highly remunerated banking accounts in hard currencies for recipient countries? A Policy Dialogue activity in order to share experiences between bankers and policy makers. Spain is a major sending country of remittances (3,4 billons of Euros in 2004 according to the Banco de España), most of them towards 3 countries (Ecuador, Colombia and Morocco) and at the same time Spanish private institutions are major financial operators in Latin America. A window of opportunity for innovative development finance based on public private partnerships and co-development finance?

40. 40 Thank you for your attention!