The Hindu Business Line : Startling truth about capital flows

It is the developing countries' current account surpluses and savings that are being used to propel economic growth in the richest countries. It is time to rectify the global imbalance by devising an alternative system by which the former can use the abundant reserves to catalyse economic growth in their own countries rather than sustain the extravagance of the developed nations.

IT HAS been part of conventional wisdom in regard to global finance that developing countries receive aid from developed countries and that the latter organise the flow of aid. This aid is expected to take different forms.

It comes partly as direct official aid in the form of grants and loans from governmental sources in developed countries.

It is also routed as loans on both hard and soft terms from the IBRD as well as the major Regional Development Banks, such as the Asian Development Bank, Inter-American Development Bank, African Development Bank, and so on.

In addition to these official flows, there is the flow from the private sector sources. Primarily, these have taken the form of loans given by banks.

There are also subscriptions to bonds issued by developing countries. These loans from the private international finance grew rapidly during the 1980s in terms of recycling of financial surpluses of the oil-producing countries, which were deposited in the banks of developed countries.

This emerging surplus was followed in lending with its inevitable consequence of a bust.

A debt crisis followed in the 1980s, in which many developing countries that had taken loans literally went under. This was a natural consequence of banks' overenthusiastic lending and countries indulging in extravagant expenditure without controlling macro-economic factors.

A third major source for developing countries, which has gained ground recently, is foreign investment in equity, which is made up of two parts — foreign direct investment and foreign portfolio investment.

Foreign direct investment involves companies such as multinationals investing in manufacturing ventures in developing countries. Portfolio investment goes through the route of investing in the stock market of developing countries. It is significant that over the years equity funds have gained dominance over debt flows.

A recent Review of Global Development Finance by the World Bank issued in March 2003 makes the important point that, over the years, developing countries have turned out to be net exporters of capital instead of being recipients of capital from the developed world. On a net basis, capital is no longer flowing from high-income countries to developing economies that need it.

This is a very important development, which casts doubt on the declarations of the various developed countries, including the recent statements following the Evian Summit about their concern for poverty alleviation and determination to increase aid flows.

Table 1 brings out a picture of the net capital flows to developing countries, starting from 1997 to 2002.

In 2002, the total of net private debt and equity and net official flows from developed countries was $192 billion, down from $210 billion in 2001 and $215 billion in 2000. There has been a steady decline in these flows since 1997, when they had peaked at $325 billion.

If we take into account the reverse flow of resources represented by the growth in official reserves, the net outflow from developed countries would be seen to be substantially less.

Foreign direct investment also flows into the richer countries from the poorer.

The current account deficit of the US itself absorbs more than $500 billion a year from the rest of the world, mostly from the poorer countries, which are running a current account surplus. Hence, the conclusion that the poor countries are exporting capital to the rich.

In particular, the recent period has shown a considerable weakness in debt flows. The net debt flows from both official and private sources, which stood at $102 billion in 1997, declined to as low as $7.2 billion in 2002. The pattern of decline can be seen from Table 2.

The net resource flow from the World Bank is relatively small, compared to the influence it commands in the corridors of powers.

In addition, there were equity flows in the form of FDI and portfolio, the pattern of which is seen in Table 2.

Equity flows have been significantly in excess of debt flows, making them an important component of resource transfers from developed world to the developing world. The reverse flow is represented by change in reserves. This pattern is seen in Table 4.

The increases in reserves flow back to the developed countries, in effect offsetting much of the resource flow as exists from the developed parts of the world to the developing parts.

In addition, there is the reverse foreign direct investment flow from the poorer countries to the richer ones — which is quite substantial.

The data presented in the World Bank report also shows the important role played by workers' remittances in the flow of finances to developing countries.

Workers' remittances increased from $62 billion in 1997 to $80 billion in 2002. They are higher than most other forms of assistance.

Resources that should be used in developing countries for their development are today invested in the securities of richer countries.

The total reserves of the developing countries amount to as high a figure as $888 billion, which represents a loan by the poorer countries to the developed world.

The global flow of funds is considerably impacted by the preference shown by developing countries to invest at least part of their reserves in the securities of the richer countries.

The reserve accumulation is a reflection of the imbalance in the world's financial structure.

Time was when the developing countries fawned on the Governments of rich countries with requests for assistance and for support in the form of loans from the multilateral institutions as well as their commercial banks.

The statistics in the report show that things have changed substantially since those early days of development.

The resources of the developing countries show a robust surplus, which is being lent to sustain the consumption and the investment needs of the developed world.

It should not be beyond the ingenuity of the economic statesmen to develop methodologies for utilising the surplus resources of the developing countries for their own needs.

Why should not a Fund be created, which will galvanise the reserves of the developing countries to help the progress of projects in developing countries themselves instead of being invested in securities of the developed world, which go to sustain the latter's infrastructure and corporate investment?

This would, of course, mean a radically different approach. The investment of the developing countries' reserves in a suitably designed facility set up by regional development banks, such as the ADB, will constitute a sufficiently safe and secure avenue, while at the same time providing additional resources to the regional development banks to lend to the developing countries to "grow" their economies.

Instead of the circuitous route followed today by the developing countries by investing their reserves in the securities of the developed countries and the funds being channelled in a niggardly way through the World Bank and IMF, it should be possible to have a regional alternative that will concentrate on the needs of development of the poorer countries.

The developing countries have current account surpluses and their savings are today being used to sustain the living standards and the economic growth of the richest of the world.

It is time to rectify the global imbalance. This requires global economic statesmanship of the highest order, which can come only from within the developing countries themselves.

They have to think out of the box and develop methodologies and instrumentalities for utilising the abundant reserves they have for catalysing development and economic growth in their own countries rather than to sustain the extravagance and imperial ambitions of richer nations.

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