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Balance of payments is a summary statement of a nation s financial transactions with the outside world. Current account is the portion of a balance of payments that states the market value of a country s visible and invisible exports and imports. Capital account is the portion of a country s balance of payments that shows the volume of private foreign investment and public grants and loans that flow into and out of a country over a given period. Sherif Khalifa () Foreign Finance 2 / 49
Current Account Export Receipts Import Payments Net Investment Income Debt Service Net Remittances Foreign Direct Investment Capital Account Foreign Portfolio Investment Foreign Loans Increase in Foreign Assets Resident Capital Outflow Developing Developed Sherif Khalifa () Foreign Finance 3 / 49
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Surplus is an excess of revenues over expenditures. Deficit is an excess of expenditure over revenues. The balance on the current and capital accounts must be offset by the balance on cash account. If the country is poor, it is likely to have limited stock of these international reserves. The overall balance of payments deficit place severe strains on the entire economy. Sherif Khalifa () Foreign Finance 7 / 49
Cash account or international reserve account is the balancing portion of a country s balance of payments, showing how cash balances or foreign reserves and short term financial claims have changed in response to current account and capital account transactions. International reserves is a country s balance of gold, hard currencies, and special drawing rights used to settle international transactions. Hard currency is the currency of a major industrial country or currency area that is freely convertible into other currencies. Sherif Khalifa () Foreign Finance 8 / 49
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External debt is the total private and public foreign debt owed by a country. Debt service is the sum of interest payments and repayments of principal on external public and publicly guaranteed debt. Debt service is the payment of amortization, liquidation of principle, and accumulated interest. Sherif Khalifa () Foreign Finance 12 / 49
The accumulation of external debt is a common phenomenon of developing countries. At the stage where the supply of domestic savings is low and current account deficits are high. Developing countries sought to sustain high growth and industrialization through borrowing. Concessional lending from offi cial sources was insuffi cient to satisfy growth needs. The first oil price shock increased the revenues of oil producing and exporting countries. The surplus of oil export earnings was deposited in commercial banks in developed countries. Sherif Khalifa () Foreign Finance 13 / 49
Developing countries turned to borrowing from commercial banks and other private lenders. Commercial banks faced low demand for capital from developed countries due to the recession. Commercial banks began playing a larger role in international lending by recycling surplus petrodollars. Commercial banks competed in lending to developing countries to provide balance of payments support. The cost associated with the accumulation of external debt is debt service which must be made with foreign exchange. Sherif Khalifa () Foreign Finance 14 / 49
Debt service obligations can be met with export earnings, curtailed imports, or further external borrowing. There was an increase in oil import bills and a decrease in export earnings due to slowed growth in developed countries. Debt service obligations accumulated so that some countries faced severe diffi culties in paying even the interest on the debt Total external debt of developing countries increased significantly and they sought to face this with further borrowing..these economies could no longer borrow funds in the world s private capital markets. Sherif Khalifa () Foreign Finance 15 / 49
Developing countries sought loans and assistance from international financial organizations. This requires that the countries follow restrictive fiscal and monetary policies called conditionality. Conditionality is the requirement imposed by the International Monetary Fund that a borrowing country undertake fiscal, monetary and international commercial reforms as a condition for receiving a loan to resolve balance of payments diffi culties. Sherif Khalifa () Foreign Finance 16 / 49
Debtor s cartel is a group of debtors who join together to bargain as a group with creditors. Debt restructuring is altering the terms of debt repayment, usually by lowering interest rates or expanding the repayment period. Debt for equity swap is a mechanism used by indebted developing countries to reduce the value of external debt by exchanging equity in domestic companies, stocks, or fixed interest obligations of the government, bonds, for private foreign debt at large discounts. Sherif Khalifa () Foreign Finance 17 / 49
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Foreign direct investment is overseas equity investments by private multinational corporations. Multinational corporation is a corporation with production activities in more than one country. A multinational corporation is a corporation or an enterprise that conducts and controls productive activities in more than one country. Sherif Khalifa () Foreign Finance 27 / 49
The objective of Multinational corporations is to maximize their return on capital and to seek best profit opportunities. Private capital gravitates toward countries with the highest financial returns and the greatest perceived safety. Multinationals carry with them technologies of production, styles of living, managerial philosophies and diverse business practices. Before the financial crisis, most of global foreign direct investment went to industrial countries and the fastest growing developing countries. After the financial crisis, developing countries received more than half of global foreign direct investment flows. Sherif Khalifa () Foreign Finance 28 / 49
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Multinational corporations are large in size compared to developing countries. Poorer countries are dwarfed in size by any of the major multinational corporation. This combined with limited competition conveys great bargaining power. Some multinational corporations control most of world trade, and the production and sale products from developing countries. This situation gives them the ability to manipulate prices and profits, and to collude to determine areas of control. This situation allows them to restrict potential competition by dominating new technologies and skills. Sherif Khalifa () Foreign Finance 34 / 49 Foreign Finance Global factories are production facilities whose various operations are distributed across a number of countries to take advantage of existing price differentials.
Pros for Development It fills the gaps between the domestic savings and the desired level of investment. It fills the gap between the targeted foreign exchange requirements and those derived from net export earnings plus foreign aid. It fills the gap between targeted governmental tax revenues and locally raised taxes by taxing their profits. It fills the gap in managerial talents, entrepreneurial abilities, and technological skills. Sherif Khalifa () Foreign Finance 35 / 49
Cons for Development They lower domestic investment by stifling competition through exclusive production agreements with host governments. They may suppress domestic entrepreneurship using their knowledge, contacts and skills to drive out local small scale competitors. They may inhibit the growth of indigenous entrepreneurship as a result of their dominance of local markets. The current account may deteriorate as a result of substantial importation of intermediate products and capital goods. The capital account may worsen because of the overseas repatriation of profits, interest royalties, and management fees. Their contribution to public revenue is low as a result of tax concessions and disguised public subsidies and tariff protection. Sherif Khalifa () Foreign Finance 36 / 49
Cons for Development They promote the interests of local factory managers and modern sector workers against the interests of the rest. They divert resources from food production to sophisticated products catering to the demands of the elite and foreign consumers. They stimulate inappropriate consumption patterns through advertising, and produce this with inappropriate technologies of production. They worsen the imbalance between rural and urban areas by locating in urban enclaves contributing to rural urban migration. They use their power to influence government policies in directions unfavorable to development by extracting concessions. Sherif Khalifa () Foreign Finance 37 / 49
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Foreign portfolio investment consists of foreign purchases of the stocks, bonds, certificates of deposit and commercial paper. Foreign portfolio investment is financial investments by private individuals, and mutual funds in stocks, bonds, certificates of deposits, and notes issued by private companies and the public agencies. Sherif Khalifa () Foreign Finance 40 / 49
With the increased liberalization of financial markets, private portfolio investment accounts for a significant share of overall net flows to developing countries. For buyers, investing in the emerging countries markets permits investors to increase their returns while diversify their risks. For issuers, it is a vehicle for attracting capital for domestic firms to finance their investments. Improves the effi ciency of the financial sector by monitoring the allocation of funds to industries with the highest potential returns. The destabilizing effect of large and volatile private portfolio flows, especially that as perceived profits decline speculators withdraw their investments as quickly as they brought them in. Sherif Khalifa () Foreign Finance 41 / 49
Brain drain refers to the emigration of highly skilled, well educated, well trained or intelligent people from a particular country. A remittance is a transfer of money by a foreign worker to an individual in his or her home country. Migration can hamper development because of the loss of skilled workers via the brain drain. Migration can benefit development through remittances to relatives in migrants country of origin. Remittances provide a pathway out of poverty as migrants build houses for their families and send money for school. Remittances increased due to the increase in the number of migrants and the advances in financial intermediation. Sherif Khalifa () Foreign Finance 42 / 49
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Foreign aid is the international transfer of public funds in the form of loans or grants either directly from one government to another or indirectly through the vehicle of a multilateral assistance agency. Foreign aid encompasses all offi cial grants and concessional loans, in currency or in kind. It is broadly aimed at transferring resources from developed to less developed countries on development, poverty, or income distribution grounds. Its objective should be noncommercial from the point of view of the donor. It should be characterized by concessional terms, that is the interest rate and repayment period should be softer than commercial terms. Sherif Khalifa () Foreign Finance 45 / 49
Concessional terms are terms for the extension of credit that are more favorable to the borrower than those available through standard financial markets. Offi cial development assistance is the net disbursements of loans or grants made on concessional terms by offi cial agencies. Sherif Khalifa () Foreign Finance 46 / 49
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Donor countries do not provide aid equivalent to the target set by the United Nations. Donor countries use foreign aid as political lever to support friendly political regimes. Aid oriented towards purchasing security for strategic alliances rather than long term economic development. Increases in aid to countries with public health crises is due to concerns that disease may spread internationally. Sherif Khalifa () Foreign Finance 49 / 49