Financial Liberalization

GNI vs. GDI

• Net Factor Income [NFI] is income earned on overseas work or investments minus income generated domestically but paid to foreigners.

GNI GDIGross National Income Gross Domestic Income

= income earned by domestic residents.

= income created within national borders.

GNI = GDI +NFI (GNP = GDP+NFI)

Compare Macau and the Philippines GDP or GNI

• Macau produces a lot of profits paid to overseas owners of casinos.

• Philippines workers earn a lot of income overseas.

• Which is larger Philippines’ GDP or Philippines GNI?

• Does Macau have greater GDP or GNI?

NFI/GDP 2009UN Main AggregatesChad -42.68%Russian Federation -3.23%China: Hong Kong SAR3.12%Liberia -20.14%China, People's Republic of -2.04%Switzerland 4.15%Ireland -16.94%Brazil -2.04%Haiti 9.62%Cambodia -15.64%India -0.13%Bangladesh 11.00%Angola -13.95%United States 0.28%Philippines 14.73%Chile -9.69% Bermuda 23.62%Panama -8.97% Lesotho 35.17%China: Macao SAR-6.03%Australia -4.65%

• 1. Current Account represents the net sum of trade in goods and services, primary income and secondary income: NX +NFI.

a. Net Exports1. Trade balance refers to net export (export less import) of goods2. Net Services, defined as the net export (export less import) of services. b. + c. Net Factor Incomeb. Primary Income comprises compensation of employees (wages, salary) and investment incomec. Secondary Income refers to donation or grant paid to or received from nonresidents

Meta Data

Balance of Payments(Unit : Millions of Baht) 2005 2010 2011 p

Current account (302493) 312944 180637 a. Goods and services (NX) (134816) 598735 195270 1. Goods (Trade Balance) 142235 937249 514848 Exports (f.o.b.) 4406673 6060184 6675068 Imports (f.o.b.) 4264438 5122935 6160220 2. Net Services (277052) (338515) (319577) Services receipts 800545 1084154 1266314 Services payments 1077596 1422669 1585892 b. Primary income (336302) (476312) (344427) Primary Income receipts 99032 161698 219152 (1) Compensation of employees n.a. 40501 52994 (2) Investment income 99032 121197 166158 Primary Income payments 435334 638011 563579 (1) Compensation of employees n.a. 41841 42942 (2) Investment income 435334 596169 520637 c. Secondary income 168625 190522 329794

Balance of Payments Table

Capital Account, Financial Account,

• Capital Account: transfer of ownership of fixed asset, and debt forgiveness), and acquisition and disposal of non-financial assets (tangible: land; intangibles: patents, trademarks)

• Financial Account: refers to net flows of financial transactions between residents and nonresidents, reflecting changes of ownership over financial assets and liabilities

• Capital and Financial Account measure net inflows Balance of Payments

(Unit : Millions of Baht) 2005 2010 2011 pCapital and financial account 282,757 802,666 (163,765) a. Capital account 0 7,719 (1,198) b. Financial account 282,757 794,948 (162,567)

• Current account is (net) domestic non-central bank actors acquiring foreign currency selling goods or services.

• Capital & Financial Account is (net) foreign actors selling foreign currency to acquire domestic currency.

• Reserve Assets is (net) acquisition by central bank of foreign currency

Accounting

• Net Capital Inflows = (Capital & Financial Account - Reserve Assets )

• Accounting Net Capital Outflows Should equal Current Account. If you earn more funds selling goods overseas, you can acqure overseas assets.

• Theory: Current Account + Net Inflows = 0• Accounting: Uncounted Inflows = Net Inflows –

Current Account

Balance of Payments(Unit : Billions of Baht) 2005 2010 2011 pCurrent account -302 313 181Capital and financial account 283 803 -164Reserve assets 221 987 35

Net errors and omissions 241 -129 18

Current Account

What if economy does not have enough capital inflows to support its current account deficit?

Net Capital Outflows

Too many buyers for foreign currency assets

Not enough buyers for domestic currency goods

Two Possibilities

• Floating Exchange Rates – Changes in the exchange rate equalize forex market.

• Pegged Exchange Rate – Changes in reserve assets equalize forex market.

Current Account

Not enough demand for domestic currency causes exchange rate to depreciate.

Net Capital Outflows

Falling price of currency makes domestic goods & financial assets more competitive

Current Account

Net Capital Outflows

Net Capital Outflows

Central bank must use forex reserves to buy domestic currency to absorb pressure on its value.

Current Account

Net Capital Outflows

Current Account

What if economy receives a surge in inflows?

Net Capital Outflows

Hot Money

Current Account

Excess demand for domestic currency causes exchange rate to appreciate?

Net Capital Outflows

Floating exchange rates

Current Account

Net Capital Outflows

Net Capital Outflows

Central bank purchases inflows and increases reserves

Current Account

Net Capital Outflows

Types of Capital Flows

• Direct Investment reflects the lasting interests of nonresidents of an economy in a resident entity. A direct investor may invest in equity capital, lending to affiliates, or reinvested earnings.

• Portfolio Investment refers to transaction that involves buying and selling of equity securities, debt securities in form of bonds, notes, money market instruments

• Other Investment includes loans, trade credits, deposits as well as other account receivables and payables

Balance of Payments(Unit : Millions of Baht) 2005 2010 2011 p

2. Portfolio investment 222,288 310,806 107,230

(1) Assets -60,948 24,478 -27,318

2.1 Equity securities -2,260 -43,211 -40,560

2.1.1 General government 0 3,013 29

Inflow 0 3,787 29

Outflow 0 773 0

2.1.2 depository corporations 3,881 -6,187 -4,723

Inflow 7,120 1,719 2,792

Outflow 3,239 7,906 7,515

2.1.3 Non-depository financial corporations -6,755 -36,786 -33,268

Inflow 2,041 81,348 171,801

Outflow 8,796 118,135 205,069

2.1.4 Non-financial corporations, households,… 613 -3,251 -2,598

Inflow 4,073 1,819 5,510

Outflow 3,460 5,070 8,108

(2) Liabilities 283,236 286,328 134,548

2.3 Equity securities 203,835 100,906 27,505

2.3.1 depository corporations 103,009 -32,654 -13,110

Inflow 463,410 327,095 269,981

Outflow 360,402 359,749 283,091

2.3.2 Non-depository financial corporations -196,841 7,485 4,263

Inflow 1,383,529 61,555 69,803

Outflow 1,580,369 54,070 65,540

2.3.3 Non-financial corporations, households,… 297,667 126,074 36,352

Inflow 1,159,441 881,063 1,123,078

Outflow 861,774 754,989 1,086,726

AssetInflow: Domestic Investors Sell Foreign Equities

Outflow: Domestic Investors Sell Foreign Equities

LiabilityInflow: Foreign Investors Sell Domestic Equities

Outflow: Foreign Investors Sell Domestic Equities

GrossFlows vs. Net Flows

Balance of Payments Table

II. The debate over financial globalization

• Broad agreement (among economists at least) that trade liberalization is beneficial and leads to faster growth

→ Free trade in good and services makes countries better off

• In contrast, much controversy over whether the liberalization of international financial flows is desirable

→ Free trade in financial assets may not make countries better off

Capital Controls• Stock Market: Limits on foreigners holdings of

shares, possibly in certain sectors.• Financial Institutions: Limits on businesses of

foreign banks, insurance co’s.• Restrictions on Direct Investors – Requirements

of Domestic Partners

http://www.imf.org/external/pubs/ft/fandd/2010/09/dataspot.htm

Liberalization and Economic Growth

i. Capital Deepening: Absent capital mobility, national investment must be financed with national savings. In low savings countries, investment may be slow.

ii. Allocative Efficiency: Capital mobility allows seeking out the highest rate of return. Investment can go to locations where it has the highest productivity.

iii. Technology Transfer: Foreign investors may bring along techniques of production.

Empirical Evidence:

Economic Growth

• Kose, Prasad, Rogoff, and Wei: 2006: “it remains difficult to find robust evidence that financial integration systematically increases growth.” summary of 40 studies. .

Link

Sudden Stops• International hot money (short-term lending) is

subject to herding behavior from international financial market. – Rapid inflows and rapid outflows.

• When capital inflows stop, either those can be replaced with forex reserves, or domestic borrowers will face bankruptcy. – Domestic firms can no longer finance investment– Demand, GDP, and employment fall. – Devaluation of currency.

Link

Financial Crises• Sudden Stops: Foreign investors herding behavior and

short-termism lead them to move in and out of countries rapidly. – “The greatest concern I have is that capital account

convertibility would leave economic policy in a typical ‘emerging market’ hostage to the whims and fancies of two dozens or so thirty-something country analysts in London, Frankfurt, and New York. ” Dani Rodrik, 1998

Reaping the Benefits of Financial Globalization

• But there are several factors which have been shown to allow countries with open capital accounts to:

A. Increase risk-sharing ;B. Increase economic

growth;C. Reduce the likelihood of

crises.

Empirical evidence shows that the benefits of opening capital account are mixed.

Keys to Benefiting from Globalization

1. Financial sector development. Well-regulated domestic financial markets

2. Institutional Quality. Low corruption, high transparency, good corporate governance.

3. Sound Macroeconomic Policies. Low deficits and price stability.

4. Trade Integration. High degree of trade openness.

http://www.imf.org/external/pubs/ft/fandd/2007/03/kose.htm

How to Liberalize

• During the early 1990’s, some authors argued in favor of a “big bang” approach to capital account liberalization.

• Since mid-1990’s, taking empirical evidence in mind, IMF has adopted a more moderate approach referred to as sequencing or ‘integrated approach’

Integrated Approach

(1) capital account liberalization is best undertaken against a background of sound and sustainable macroeconomic policies;

(2)domestic financial reform should be complemented by prudential regulation and supervision, and financial restructuring policies;

(3) liberalization of capital flows by instruments and/or sectors should be sequenced to take into account concomitant risks—in general, long-term and non-debt creating flows (especially FDI) should be liberalized before short-term and debt-creating flows; Link

Link

Imbalances