High liquidity and reduced credits: An important cause of Economic

Recessions in Dev eloping countries

Paper prepared for the Conference “Re-regulating global finance in the light of

the global crisis”by

Noemi Levy

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BACKGROUNDS OF THE ACTUAL CRISES

• A rise of capital index prices (financial inflation ―pF) along financial deepness induced a credit boom channeled to consumption and housing

• Financial expansion was stopped by the limitation of DC productive capacity (low investment, income redistribution in favor K owner) which demanded increased credits to support economic expansion

• DeC face different crisis, not anteceded by credit booms. Economic recession was led by reduction of external demand (financial crisis can unfold)

• Main problem of DeC: A dichotomy of high levels of liquidity and reduced finance.

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HYPOTHESIS • Financial liquidity (and innovation) have limited effects

in DeC (credit booms are lows low with reduced & short term impact on economic growth)

• New financial structure eliminated domestic mechanisms to revert economic growth in DeC

• Economic neoliberal policies based on market mechanisms cannot solve DeC crises (e.r stability, higher interest rate gaps with DC and economic globalization (free trade production and finance).

We start discussing • Different financial structure ant its impact finance

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I. FINANCIAL STRUCTURES, LIQUIDITY AND FINANCE i) Anglo-Saxon system: Capital markets rules

with high liquidity • Market mechanisms need to get right prices• Deregulation and globalization • Privatization of the economy

Financial Structures • Capital market deepness (capitalization + turnover

+ pF) • Financial deepening (M3-M1/ GDP)

Macroeconomic stability maximizes economic growth

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ii) The bank-based system: banks main providers of finance with limited liquidity

• High state intervention • Monetary policies: finance “priority” sectors w/ low &

stable prices credit channeling policy• Active fiscal policies: priority sectors, anti-cyclical policies

• Price differentiation• Compensatory mechanisms

Financial structural characteristic • Strong public regulation, financial segmentation• Limited capital mobility (market mechanisms are

blocked )Strong relation between government, banks and

enterprises5

iii) Capital Market based system in the Financial led capitalist system (1980s)

• Financial segmentation and Q regulation abolished

• Capital mobility raised in search of financial gains • Exchange and interest rate risks shifts to the

private sector Financial innovations (Derivates + Securitization)

• Big banks & financial corporations (supranational entities) with limited domestic control

• Institutional investors (Pension funds, mutual funds, insurance companies, investment trusts, etc.) increased financiarization

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Financiarization Financial inflation: DFS > money market outflows

(FS remain in the K market, not linked to finance) Finance wealth & redistribution of income in favor K ownersFinancial Securities modify agents behavior: institutional

investors & banks, non – financial corporations and families

ConsequencesRedistribution of wealth in favor of agents possessing FS

Reduced finance to domestic small & medium firmsPoverty increasesBig gaps between DC, DevC and especially w/poor countries DevC reduced access to counter-cyclical policies

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II. MEXICAN FINANCIAL ORGANIZATION IN THE FINANCIAL LED SUSTEM

Deep institutional changes Bank Deregulation: disappearance of compensatory

mechanisms Financial deepening bond and capital segments Trade openness & Financial market globalizationPromotion of institutional investors …… more importantly after NAFTAAdoption of the North-American Financial System :Derivatives & Securitization FDI deregulation

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• High Liquidity and reduced finance

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Two periods of financial inflation: Financial innovation limited to external K movement and Mexican K-based remained weak

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Financial deepening increased i) After 1994 crisis lead by non bank instruments

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Private non financial sectors finance decreased in a context of financial and capital deepness

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Finance to private non financial sectors

Main finance sources Favored activities

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Finance to private non financial sectors dropped Commercial bank credits shrank New domestic sources of finance External finance did not increase

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Enterprises the most affect sector: export led model does not leave space to domestic enterprises and high uncertainty became an important issue

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Why finance to private non-financial enterprises shrank

No competition within institutions of the financial sectors

Bank credit cards have high interest rates Small & medium enterprises have low access

depended in supplier finance

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Financial Institutions specializationEnterprises low access to bank credits (supplier finance important for small & medium enterprises)

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Consumption credit card costs are very high and development banks concentrated in housing finance. High commercial bank income margins

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Worrying signs

Bank financial indexesProductive StructureExternal capital movement

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Bank index start to show some fragility (Default index)

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The Mexican productive structure changed: internal market shrank (Reduced internal market, Led Export economy w/ negative net exports)

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External capital flows highly unstable: Higher current account deficit & unstable FPI and FDI flows

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Counter-cyclical economic programs • PICE (Program to increase employment and

economic growth) October 2008• Program to support families economies and

employment (January, 2009) The spirit these programs remain neoliberal Exchange rate Stability & market mechanisms No policies to strengthen internal market

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Exchange rate stability policy: External reserves fall and FMI debt

• Loose Monetary policy (2009): Interest rate objective had not strong impact on finance

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Interest rate central bank goal

Average interbanking interest rate

21/01/2008 - 19/06/2008 7.5 7.930620/06/2008 - 16/07/2008 7.75 8.172717/07/2007 - 14/08/2008 8 7.875015/08/2008 - 15/01/2009 8.25 8.639216/01/2009 - 19/02/2009 7.75 8.059120/02/2009- 09/03/2009 7.5 7.908

Other policies • Integral reform to PEMEX & the construction of one refinery: Postponed Collective Transport (1300 millions of dollars). Not done

• Program to support families economies and employment (January, 2009). Insufficient to increase economic growth . Supported corporations linked to the external market (car industry)

Deters unemployment in big enterprises link to the external market

Price squeeze of goods that undergone before strong rises (electricity and gasoline)

Social Policies • Extended coverage of social security from 3 to 6 months • Ability to retire savings from workers own pension funds

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• Fiscal policy: No serous contra-cyclical measure

• Based on exchange rate market intervention and more foreign trade: Market based policies - Tariff reduction - Exchange rate stability (central bank sold reserve to prevent exchange rate devaluation

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Conclusions Need to reform the Mexican Financial System increasing links

between bank and non-bank financial institutions and enterprises Excess liquidity needs to be limited : External capital mobility need to be restricted (taxes) Banks ownership need to be domestic Institutional investors need to be re-organized Public bonds need to be reduced Financial segmentation needs to come back (increase capital

reserves for investment activities) Limit non-bank financial institutions Active fiscal policies: Priority sectors

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New Monetary instruments Reserve requirement in case of excess liquidity Interest rate cups, commissions and fees need to

be limited Reintroduce direct central credit to government Compensatory mechanisms are required Development bank Government guarantees for domestic productive

entrepreneurs Reduce external dependence & internal market Distribution of income to be changed in favor of

salaries and production 29