Monetary globalization, north-south wealth distribution and useful resource transfers
Economy & Trade, Featured, Global, Headlines, TerraViva United Nations, Trade & Investment
Yilmaz Akyüz is former Director of UNCTAD and former Chief Economist, South Center, Geneva
– At a time when the global economy is facing further financial turmoil, it is widely recognized that emerging economies (EME) are particularly vulnerable due to their deepening integration into the global financial system. What is less appreciated is the impact of financial globalization and integration on the external distribution of wealth between emerging and developed countries and the transfer of resources from the former to the latter.
This is the subject of a new study by the author of the external balances of emerging countries, which covers nine emerging G-20 economies (Argentina, Brazil, China, India, Indonesia, Mexico, Russia, South Africa and Turkey) and four major advanced economies, the USA, Japan, Germany and the UK.
The new millennium has seen a rapid increase in the emerging economies’ gross external assets and liabilities, both as a result of the ultra-loose monetary policy in the large advanced economies (AE) and the liberalization of the financial account in the emerging economies – a process of deeper integration known as “Playing with” fire.
Almost 90 percent of the outstanding foreign claims and liabilities of the G-20 emerging economies have accumulated since the turn of the century. Although debtor-creditor relationships and foreign direct investment (FDI) have grown rapidly within the Global South, a very large portion of the gross external assets and liabilities of emerging economies are still with AE. This applies not only to financial assets and liabilities, but also to FDI. Even in China, less than 20 percent of FDI stock is in other emerging economies.
While foreign investment and lending have reached unprecedented levels in emerging economies, even emerging economies with current account deficits have been able to amass large amounts of gross external assets as capital inflows have often exceeded the amount needed to finance the deficits. With the exception of China and Russia, which have had current account surpluses since 2000, all of the accumulation of foreign assets in the G20 EME has been based on borrowed money, which has resulted in significant external debt indebtedness.
There are also considerable changes in the structure of the external balances of the emerging economies. The share of stocks (FDI plus portfolio equity) in total external debt rose and the debt share fell as governments tried to move from debt to stocks by opening up stock markets and liberalizing FDI regulations, as equity funding became more stable and less stable is riskier than debt.
The share of shares in gross foreign assets also increased, but not as strongly as in liabilities. As a result, the negative net equity position (external equity minus liabilities) of the G20 EME taken together continued to deteriorate at the beginning of the century.
The share of international reserves in total foreign claims rose rapidly as countries tried to protect themselves against speculative attacks, often with borrowed money. The share of the local currency in foreign government bonds increased as the bond markets were opened up to foreigners to take on the currency risk. However, the corporate sector is responsible for a growing portion of emerging market foreign debt by increasingly borrowing dollars in international markets to take advantage of lower interest rates.
These changes in the size and composition of emerging economies’ external balances have not only created new channels of transmission for external financial shocks (as discussed in Playing with Fire), but also resulted in significant resource transfers from emerging economies to UE.
The transfer of resources from the south to the north via financial channels will continue unabated as long as the flow of capital remains unrestricted. The system of international reserves favors a handful of wealthy countries which, regardless of their global impact, may pursue selfish policies that have made the value of their existing stocks of external assets and liabilities more vulnerable to changes in global financial conditions, particularly asset prices and exchange rates. resulting in capital gains and losses and changing their net international investment position (NFAP, or net international investment position, which is the difference between gross external assets and liabilities).
In the short term, these valuation changes may be much more important than current account balances in the development of the NFAP, especially during periods of severe instability such as those seen in 2008-09. As emerging market overseas assets and liabilities reside primarily with AE, these gains and losses lead to a reallocation of overseas assets between the global south and north.
Indeed, there is a strong negative correlation between the annual changes in net external assets of nine emerging G20 and four major AE in the new millennium, and much of these changes are balanced by capital gains and losses rather than the current account.
In the long-term current account, the main determinant of nations’ net external assets remains, but capital gains and losses resulting from changes in valuation can also be important. Since the beginning of the century, the NFAP of most of the emerging G-20 countries has deteriorated due to persistent current account deficits.
The NFAP of two emerging economies, China and Russia, improved, but not as much as their cumulative current account surpluses, as they both suffered large capital losses on their outstanding external assets and liabilities.
For example, China had a cumulative current account surplus of over $ 3 trillion from 2000 to 2016, but its net external assets only increased by $ 1.6 trillion. In contrast, the US had a cumulative current account deficit of over $ 8 trillion over the same period, but its net external debt deteriorated by less than $ 7 trillion due to capital gains. Although some minor G-20 EME’s also posted capital gains, the nine emerging markets combined suffered capital losses of $ 1.9 trillion over the period 2000-2016, while the four AE suffered capital gains of over $ 1.6 trillion recorded.
Second, with the expansion of gross foreign assets and foreign liabilities, incoming and outgoing payments from abroad have become more important in the current account. In general, emerging markets are red on international investment income not only because their external liabilities exceed assets, but also because the return on their external assets is less than the return on their external liabilities.
Its liabilities are concentrated in high-yielding stocks, while much of its assets consist of low-yielding currency reserves. For this reason, even some emerging economies with positive net international investment positions, such as China and Russia, have deficits in net international investment income.
In addition, all emerging economies, including China, have a lower return on their FDI than they pay on their FDI. They also pay more in risk premiums for their foreign debt than they get for their foreign debt, including reserves (US Treasury bonds), other bonds, or overseas deposits. The shift by emerging market governments to domestic currency bonds has widened the yield gap between debt and assets as the exchange rate risk taken by foreign investors needs to be offset.
In contrast, the difference in returns between foreign assets and liabilities is positive for all four major AE. The United States has the largest positive return differential and has a surplus of its international capital income, despite having negative net foreign assets on the order of about 25 percent of its GDP.
The return on its FDI is higher than in any other country and far exceeds the return on its FDI. As the country that issues the dominant reserve currency, the US also earns a higher rate of return on its external debt than it does on its external debt (mostly government bonds), enjoying what are commonly known as “exorbitant privileges”.
The nine emerging countries of the G-20 together have transferred around 2.7 percent of their combined GDP per year to AE mainly in the new millennium, due to the negative return differential between their foreign assets and liabilities and capital losses due to changes in wealth prices and exchange rates.
Much of this resource cost arises because emerging economies prefer a particular external balance sheet structure (highly liquid low-yielding assets, less liquid high-yielding liabilities) that is believed to be more resilient to external financial shocks.
This means that the emerging economies are indeed transferring large sums of resources to the AE to protect themselves from the shocks caused mainly by the policies of one and the same country. This is underpinned by an international reserve system that enables a handful of reserve-issuing countries, particularly the US, to continually extract resources from the rest of the world.
On the other hand, it is not clear whether emerging markets can adequately protect themselves against shocks with free capital movements. The judicious use of financial account measures can provide adequate protection while avoiding such costs.
For example, one would not have to issue high-yield debt to purchase large holdings of low-yielding reserves for self-insurance if the inflow of volatile capital is effectively controlled.
The transfer of resources from the south to the north through financial channels will continue unabated as long as capital flows remain unrestrained, the system of international reserves favors a handful of rich countries that can pursue selfish policies regardless of their global impact.