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G. Srinivasan

Making a candid appraisal of the global financial conditions, especially vis-à-vis the developing countries, the World Bank minces no words in reminding the rich nations that their policymakers can help stabilise development financing by improving aid and trade policies. G. Srinivasan reports.

WITH THE World Trade Organisation increasingly gaining notoriety for being the bete noire for number of developing countries, with its all-encompassing agenda of evolving a global trading architecture that is free and open, the Bretton Woods twins, the World Bank and the International Monetary Fund, must become the Good Samaritan for the beleaguered countries of the poor South.

Of late, the policy-based lending strategy of these twin institutions reflects an abiding concern for the development dimensions with their lending programmes focussed on providing ownership to stakeholders, so that they would become veritable participants in projects, instead of merely doling out financial assistance. This inclusive approach to development is widely hailed as the right step in empowering stakeholders and insulating them from any sense of debt or obligation as the beneficiaries put their heart and soul to ensure that the programme and project being carried out with multilateral development agencies would, over time, lift them from poverty.

Viewed in this context, the recently released annual review of global financial conditions confronting developing countries in the form of its tome, Global Development Finance — Striving for Stability in Development Finance, is a candid appraisal of the distinct shifts in private sector financing for developing countries since 1998 when developing countries had repaid external debt to the private creditor in developed countries. Coupled with the developing countries' steady accumulation of financial assets in high-income economies, these debt repayments meant that the developing world has become a net capital exporter to the developed world.

According to the report, the net capital flows to developing countries were down last year for the second year in a row. In 2002, the net private debt and equity and net official flow was $192 billion, or 3.2 per cent of developing countries' nominal gross domestic product (GDP), down from $210 billion in 2001 (3.6 per cent of GDP) and $215 billion in 2000 (3.7 per cent of GDP). Disquieting is the steady decline since 1997 when net flows to developing countries peaked at about $325 billion (5.5 per cent of GDP).

The decline since 1997 has been primarily in net capital flows from the private sector, particularly in the debt component (both banks and bonds). From the peak years of 1995-96, when net debt inflows from the private sector was about $135 billion per annum, they have dropped steadily, becoming net outflows in 2001 and 2002.

As debt is being repaid to private sector creditors, the net equity inflows to developing countries remain pronounced, mainly through the FDI route. The net inward FDI flows did slow in 2002 with most of the slowdown occurring in Latin America. The shifting pattern of private flows — debt down, equity up — has had an important implication for the associated stocks of debt. Thus, the World Bank report claims that while the stock of developing country external debt outstanding from all sources has fallen since 1998, that of equity capital owned and controlled by foreigners has risen sharply over the past decade.

The Bank ascribes the shift to private investor preferences. Debt investors (both banks and bondholders) have become chary of holding debt claims on developing countries, while non-financial corporations have come increasingly to believe that the developing world provides significant growth opportunities both as an export platform at a source of domestic consumption. Yet another reason is that chastened by the debt crisis of the 1990s and the massive bailout package this entailed to defaulting countries, many developing countries increasingly came to feel that dependence on external debt financing could lead to sharp, sudden reversals of capital flows.

It is in this context that majority of the developing countries have bolstered and beefed up their precautionary reserve holdings and altered their liabilities to more stable forms of investment, especially FDI. India's massive foreign exchange reserves of $75 billion, with a substantial portion of the fresh accretion being by way of current account surplus, non-debt creating flows and currency valuation which do not cast any extra cost to maintenance of such reserves need to be noted. It is also gratifying to note from the Bank's report that India is expected to lead the rise in FDI flows in South Asia in 2003-05. But the Bank puts a rider here, which is if economic reforms and the Government's efforts to attract foreign investment continue over the next three years. India's attractiveness to investors in non-financial services (telecommunications and utilities) increased significantly following deregulation of the services sector and reductions in tax and tariff rates affecting the wholesale and retail sectors.

The Reserve Bank of India too has contended that almost the entire addition to reserves in the last few years has been made without increasing the overall level of external debt. The World Bank report said the fundamental rotation in capital flows is proving to be quite a challenge. For one, the current account balance must move into or at least towards surplus in order to generate the foreign exchange to pay down external debt. India has also recently paid back $3 billion external loans to multilateral lending agencies such as the World Bank and the ADB and is now enjoying a modest current account surplus.

Though the World Bank report has not taken note of these developments in its latest report, the external debt management by the authorities in India continues to be a deft admixture of caution and circumspection. Perhaps, the Bank's admission that the acquisition of substantial foreign assets by individuals, companies and governments in developing countries has some positives but also "a number of more troubling aspects" need to be reckoned. This is important especially in the wake of the mounting need to mobilise savings by the developing countries and high forex reserves imply a fear of floating with countries in East and South Asia the policy being geared towards precluding exchange rate appreciation through the purchase of substantial reserves.

Even as the Bank report sets store by prudent management of sovereign financial risks both in relation to external capital and also in nascent local-currency debt markets for ensuring growth and poverty reduction in the developing countries, it said that apart from non-debt creating FDI, an under-recognised trend in the external finances of developing countries is the steadily growing importance of workers' remittances. At $80 billion in 2002, remittances were about double the level of official aid-related inflows and displayed a remarkably steady growth through the 1990s.

Finally, the Bank minces no words in reminding the rich countries and donors that their policymakers could help stabilise development financing by improving aid and trade policies. In a pithy foreword to the report, the Bank's Chief Economist and Senior Vice-President, Mr Nicholas Stern, warns: "With private capital flows low, raising the flow of official development assistance — as agreed at the Monterrey Conference in 2001 — is of key importance to the poorest countries".

The rich countries have been told to foster an open, competitive world trading system especially in goods such as textiles and agricultural products in which developing countries have an obvious comparative advantage. This would also accord a chance to countries groaning under debt burden to service their debt to generate the requisite export revenue and also help establish conditions fostering the continuation of a steady and significant flow of FDI to developing countries.

The report says that aid effectiveness can be improved by reallocating funds to poorer countries that have the policies, institutions and governance that could be expected to reduce poverty.

The report makes no bones about admitting that aid is also likely to be more productive in those same countries if "channelled through government institutions, with the close involvement of civil society, rather than through project-oriented institutions with intrusive management by donors".

Industrial countries can spur development by pruning agricultural subsidies and trade barriers that discriminate against developing countries' exports. Industrial countries spend more than $300 billion each year in agricultural subsidies, about six times they spend on foreign aid, the report bluntly noted.

Such plain speaking and concern for the real problems plaguing the developing countries by multilateral lending agencies should also characterise their rich donors so that poverty and under-development could be minimised, if not banished from our midst.

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