Volkan EMRE Danald KUGONZA

Transcription

1 Problem and Development Volkan EMRE Danald KUGONZA

2 Presentation Summary Introduction Overview of external debt Origins of 1970 s 1980 s External Dilemma Petrodollar Recycling and OPEC s Absorption Problem When is it prudent to borrow? Sustainability External borrowing, adjustment policies, and savings 1980 debt crisis Longer term efforts to overcome the debt crisis overhang and future economic growth Graphical Explanations Conclusions

3 Overview of External Origins of 1970s- 1980s Dilemma Petrodollar Recycling & OPEC s Absorption Problem When Is It Prudent To Borrow Sustain ability External Borrowing Adjustment Policies & Savings

4 Overview of External What is an External? It is the total private and public foreign debt owned by a country (Todaro). How is it paid? Its usually paid by using foreign currency.therefore a country should have sufficient foreign exchange for its servicing. Less Developed Countries can t borrow in their local currency-original Sin How is it different from an internal debt? An internal debt is a borrowing owed to the citizens or institutions of a country.normally borrowed and paid in the local currency. Public A Combination of external and internal debt. Why is an external debt a point of concern? Its payment is dependent on foreign exchange-recall currency mismatch & think of local curreny depreciation!

5 External Stocks (% of GNI) in Developing Countries (1970 & 1982) Graph 1 Graph 2 Source: World Bank,World Bank Development Indicators, own calculations

6 Total External in Developing Countries

7 External Stocks (% of GNI) in Heavily Indebted Poor Countries (1970 & 1982) Mauritania Somalia Nicaragua Cote d'ivoire Togo Guinea-Bissau Liberia Zambia Gambia, The Congo, Rep. Sudan Malawi Honduras Mali Comoros Bolivia Senegal Benin Madagascar Sierra Leone Niger Ethiopia Uganda Cameroon Congo, Dem. Rep. Ghana Central African Republic Chad Burkina Faso Rwanda Source: World Bank,World Bank Development Indicators, own calculations

8 Overview of External Origins of 1970s- 1980s Dilemma Petrodollar Recycling & OPEC s Absorption Problem When Is It Prudent To Borrow Sustain ability External Borrowing Adjustment Policies & Savings

9 Origins of 1970 s 1980 s External Dilemma Why did nations continue to inccur external debts? Needed to finance their current account deficit What caused their current account deficits? 1. Arise in petroleum prices (External event) During the above period, OPEC hiked Oil Prices January 1973 = $ 2,59 November 1973 = $ 5,18 January 1974 = $ 11,65

10 Origins of 1970 s 1980 s External Dilemma Between 1973 and 1981 Oil Prices Increased approximately by 500 %

11 Origins of 1970 s 1980 s External Dilemma 2. Financing unproductive consumption e.g. military expenditures, repayment of the past external debts at the expense of productive investments which would have generated or saved foreign exchange 3.Problems and failures of internal economic policy that resulted in: High levels of inflation Over-valued exchange rates 4.Failure of economies to successfully negotiate a series of strategy switches in economic policy that would have contributed to the necessary structural transformations on the path towards greater industrialisation and diversification of production e.g. Failed ISI

12 Origins of 1970 s 1980 s External Dilemma The Remedy to a current account deficit would be : 1. A Surplus on Capital and Financial Account (say by borrowing externaly) 2. Reducing the Import Bill 3. Increasing Export Earnings How did these economies respond? 1. Reduced the Overall Volume of Imports moreso oil? 2. Increased export earnings? 3. Accumulated Further External to Pay for More Expensive Oil and Other desired Imports? 1. Dilemma!

13 Overview of External Origins of 1970s- 1980s Dilemma Petrodollar Recycling & OPEC s Absorption Problem When Is It Prudent To Borrow Sustaina bility External Borrowing Adjustment Policies & Savings

14 Petrodollar Recycling and OPEC s Absorption Problem What exactly is Petrodollar Recycling? Increased Export Revenues Amid not enough projects to absorb them thus the absorption problem Deposited Excess Earnings in International Banks Euro- Dollar or Euro Currency Markets ( New York, London, Frankfurt, Tokyo ) to earn interest Excess Deposits in Banks Amid Limited Clients Threatens profitablity of banks which brings search for new markets Oil Price Hikes by OPEC Promote Econ.Dev t in OPEC through improving infrastructure,education,technol ogy,etc than spuring econ dev t in the U.S,Europe & Japan Serving payments in exchange for oil Creation of Sovereign Borrowers Less developed oil importing countries with current account deficits

15 Petrodollar Recycling and OPEC s Absorption Problem Petrodollar recycling is the circulation and recirculation of petroleum revenues from the oil-importing nations to the OPEC economies to the private international banks and then back again to the oil-importing nations in the form of loans, only to make the round again and again(devlin 1989). Trade Balances for Oil Exporting and Importing Countries between 1973 & 1981(Billions of U.S dollars) Source: Cypher&Dietz, 2009

16 Overview of External Origins of 1970s- 1980s Dilemma Petrodollar Recycling & OPEC s Absorption Problem When Is It Prudent To Borrow Sustaina bility External Borrowing Adjustment Policies & Savings

17 When is it Prudent to Borrow? 1. If it s to finance what s expected to be short-term current account deficit so as to avoid disruption of production and employment. i.e. smoothen out consumption of imports over a short term. 2. And for Long-term, external debt accumulation must contribute to either foreign exchange savings or earnings-consider Import substitution and export promotion(recall, chapter 10) 3. If external debt is to be directed towards productive investments that expand output of tradable goods and services that can generate foreign exchange required to pay borrowed funds-self liquidating. 4. If its to finance infrastructure that can contribute to greater export earnings or import substitution production by lowering costs Key Issue The undertaking should generate (exportation) or save (import substitution) foreign exchange sufficient to pay down both the principal and interest on the external loan over the its life time!

18 When is it Prudent to Borrow? Betterstill,there is no guarantee of Transformation or achievement of the above.why? Caution Ineffective use of external debt.e.g military expenditure World prices might fall-mexican Dilemma! Emergence of better exporters Inefficiencies may arise-decline in labour productivity, increase in capital output ratios e.g. Incremental capital output ratios (ICOR) of countries which had borrowed either remained the same (South Korea) or rose substantially-philippines, Argentina, and Morocco-World Bank! External borrowing should be approached consciously otherwise future growth and development prospects can be compromised It should be based on conservative projections i.e. based on the assumption that future prices of exports & imports will be lower even lower than the current prices- Mexican Dilemma! Key issue: External borrowing should not be the wayforward!

19 Overview of External Origins of 1970s- 1980s Dilemma Petrodollar Recycling & OPEC s Absorption Problem When Is It Prudent To Borrow Sustaina bility External Borrowing Adjustment Policies & Savings

20 sustainability sustainability It is the ability of a debtor country to continue meeting its debt obligations on a continuous basis without going into default. Determinants of external debt sustainability 1. Nominal interest rate on external debt 2. Nominal growth in export earnings(foreign exhange) Circumstances under which the external debt is sustainable 1. When the average nominal growth in foreign exchange earnings is greater than the nominal interest rate on the debt. 2. Case of existence of a surplus on the capital and financial account.

21 Overview of External Origins of 1970s- 1980s Dilemma Petrodollar Recycling & OPEC s Absorption Problem When Is It Prudent To Borrow Sustaina bility External Borrowing Adjustment Policies & Savings

22 External Borrowing, Adjustment Policies, and Savings? The Twin Deficit and Productive Borrowing Assuming there is no central government deficit, and no debt accumulation S I = X M = 0 If savings (S) equals investment (I) There will be no trade!!!! S = s(y/l)l s: saving ratio L= Population Y/L = Per capita income Savings ratio (s) is likely to be smaller the lower per capita income, Y/L, which is typical with low-income countries and thus low levels of total domestic savings (I = Sd + Sf). Domestic savings augmented with foreign resources. And thus the 1 st equation becomes: Sd I = X M < 0 since Sd I = Sf, which is negative for all Sf > 0

23 Service Obligation: The Real Cost of Repayment Service Ratio and the Burden

24 Current Account Deficits in Developing Countries - Source: World Bank,World Bank Development Indicators, own calculations

25 1980s Crisis 1980s Crisis International Banking Sector Longer Term Efforts to Overcome the Crisis Overhang & Future Economic Growth Graphical Explanations

26 The 1980s Crisis 1980s Crisis Originates from 1970s unsustainable debt accumulation Accumulation was based on availability of funds from OPEC It started in August 1982 when Mexico anounced suspension of scheduled debt payment ( Moratorium) for which other countries followed.

27 The 1980s Crisis What set off 1980 Crisis that threatend the stability of the financial markets? By mid 1982, the private international banks had dramatically begun reducing their lending (petro-dollar recyling) to sovereign borrowers. Why? Slowdown in the growth rates of the international economy ( Inflation in the US and UK triggerd the application of stringent monetary policies and which led to recession) Recession resulted into declines in income and subsequently imports from Less Developed Countries Decline in export earnings of LDC s! Yet Less Developed Countries were using this money for debt repayment, import expenditure and very little for productive uses

28 The 1980s Crisis Causality and Reasons What exactly happened? Loan window of the private banks closed because of recession related reasons or nations faced with a daunting foreign exchange crisis Without access to new loans debtor nations were faced with difficult decissions Transformation would occur primarily by repressing import spending. Countries import spending was now limited to the export earnings. Yet exports could not be expanded rapidly Continuing to service past debt Maintaining previous import levels Lower current living standards Lower GDP (Critical inputs for domestic industry affected by cutbacks) or countries declared moratarium IMF and US Treasury forced large banks into involuntary lending to avoid collapse of international financial system

29 1980s Crisis 1980s Crisis International Banking Sector Longer Term Efforts to Overcome the Crisis Overhang & Future Economic Growth Graphical Explanations

30 The 1980s Crisis International Banking Sector Majority of total borrowed funds provided by private banks Period 1: Over-lending Higher interest rates Shorter repayment schedules Impending crisis!! Period 2: Under-lending Lower interest rates Longer repayment schedules Involuntary lending with the assistance of IMF and US Treasury Bridge loans for continued debt repayment

31 The 1980s Crisis International Banking Sector Downgrade

32 1980s Crisis 1980s Crisis International Banking Sector Longer Term Efforts to Overcome the Crisis Overhang & Future Economic Growth Graphical Explanations

33 Longer Term Efforts to Overcome Crisis 1) Involuntary Lending by private banks 2) Lengthening maturities of commercial loans 3) Reducing Interest Rates 4) Capitalizing overdue payments by adding them to the principle value of loans 5) Turning loans into long term bonds 6) Swaps An indebted country trades something of value to a holder of its debt in return for a reduction or even a cancellation of some of the countries external debt for equity swap ( e.g giving a share in a SOE through privatization) for nature swap ( could be purchased in the secondary debt markets by NGO s, e.g WWF) 7) Writing Downs / Cancellation Multilateral (e.g., World Bank, IMF loans) and bilateral (e.g.,governmet-to-government ) loans were easier to reschedule or cancel

34 1980s Crisis 1980s Crisis International Banking Sector Longer Term Efforts to Overcome the Crisis Overhang & Future Economic Growth Graphical Explanations

35 Overhang and Future Economic Growth Overhang: A situation where a debt stock of a country exceeds its future capacity to repay it. Countries accumulated a lot of debt with poor economic policy decissions compromising growth. Many Countries in Latin America and Sub-Saharan Africa accumulated large external debt in the 1970s to finance unsustainable CA deficits (Lost Decade) overhang inversely effected investment decissions of both domestic and foreign investors, which led reduced economic growth (Expectations towards increased tax rates in the future)

36 Overhang and Future Economic Growth overhang of accumulated external debt and its repayment blocked the transformation towards more sustainable,productive, efficient economy Hampers formation of human capital & technology acquisition capabilities Countries like Korea and India managed to increase their investment rates thus increasing export revenues Countries like Sudan, Tanzania and Zimbabwe do not have optimistic future to pay their debts despite the extraordinary efforts by the international community to delay repayments.

37 Overhang and Future Economic Growth burden Ratio (D/X) Despite the attempts, the debt ratio is still high

38 1980s Crisis 1980s Crisis International Banking Sector Longer Term Efforts to Overcome the Crisis Overhang & Future Economic Growth Graphical Explanations

39 External Stocks (% of GNI) in Developing Countries (1982 & 2009) Graph 1 Graph 2 Source: World Bank,World Bank Development Indicators, own calculations

40 External Stocks (% of GNI) in Heavily Indebted Poor Countries (1982 & 2009) Mauritania Somalia Nicaragua Cote d'ivoire Togo Guinea-Bissau Liberia Zambia Gambia, The Congo, Rep. Sudan Malawi Honduras Mali Comoros Bolivia Senegal Benin Madagascar Sierra Leone Niger Ethiopia Uganda Cameroon Congo, Dem. Rep. Ghana Central African Republic Chad Burkina Faso Rwanda Source: World Bank,World Bank Development Indicators, own calculations

41 Current Account Balance (% GDP) in Developing Countries Majority still have CA deficits Likeliness of continous external debt accumulation is high Source: World Bank,World Bank Development Indicators, own calculations

42 External Stocks (% of GNI) - Source: World Bank Development Indicators, 2011

43 Interest Payments on External (% of GNI) - Source: World Bank Development Indicators, 2011

44 Manufactured Exports (% of Merchandise exports) - Source: World Bank Development Indicators, 2011

45 Conclusions The rapid build up of the debt was mostly due to OPEC s price hikes Much of the external debt was owed to private commercial banks Most economies borrowed for wrong reasons / unproductive use Many economies continue to suffer from some degree of debt overhang and current account deficits If countries have to borrow, a lot of conciousness and consertiveness need to be taken inorder not to hamper future growth of a country. Note: Achieving development is more than External borrowing alone.it entails more complementary factors as discussed in the several chapters like education and moreso the political will by leaders and citizens of the respective countries to achieve development.

46 Thank you

47 References Cypher&Dietz,2009, Problem and Development, The Process of Economic Development. Todaro & Smith,2009 Economic Developement An Examination of Banking Cases of the 1980s and early 1990s, Volume 1