Net private capital flows to emerging markets accelerated sharply in 2004 to reach a seven-year high of $279 billion, a 32 percent increase from the $211 billion in net flows in 2003. These estimates were published by a recent publication of the Institute of International Finance (IIF).[1] In terms of the composition of capital flows, there was a solid rise in net direct equity investment (a jump of $40 billion), which together with overseas commercial bank lending accounted for as much as 90 percent increase in net flows. Portfolio investment and non-bank credit flows also improved. Though on the official account net flows were negative due to repayments to bilateral and multilateral donors, attention is held entirely by the surge in private capital flows. The IIF projections for 2005 indicate that the overall net private flows would remain robust, roughly at the same level as last year. (see Table 1)
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In terms of the destinations of private capital flows, many of the recipient economies are the ones that were seriously affected not so long ago by severe economic crisis. Leaving aside China and a handful of countries such as India and the East European transition economies, the major emerging market economies attracting private capital in 2004, Russia, Turkey, Brazil, Mexico, Argentina, Korea, Malaysia, witnessed capital outflows associated with financial crisis within the past 7-8 years. The revival of private investors' confidence thus is taken to signal the strength of economic recovery and return to sound `fundamentals' supposed to guide long-term capital flows, particularly equity investments in emerging markets. IIF (2005) states, `solid, albeit slowing, global growth, improving fiscal balances, strong trade surpluses, and higher reserve levels in emerging market economies have improved credit quality and lowered default risk.'(p.17) On the other hand, supply-side factors have spurred the process mainly through a weakening of the dollar with expectations of its further weakening, particularly vis-à-vis major emerging market currencies, as the latter liberalize their foreign exchange markets.[2]
Reversal of Net Resource Transfer
This story of return to normalcy and apparent strength of emerging market economies is punctuated by concern about the growing current account deficit of the United States, which might cause the US treasury to raise short-term interest rates, and thus detract capital from moving into the emerging markets. US interest rates could also rise in response to inflationary expectations caused by oil price hike in the economy. (p.1 and 2) While the subject of `major global external imbalance' has been brought up in the report, its relevance to the discussion is almost reduced to a positive agency, which has supported the flow of foreign capital into the emerging markets. And it is the resolution of the global external balance through higher interest rate and inflation in the US, the report warns, that might disrupt capital flows to these economies in the near future. This limited reading of the impact of global external imbalances, however, deliberately hides the fact that it is the emerging market economies surpluses that have financed the enormous current account deficit ($513 billion in 2003) of the world's richest metropolitan country. Once this is factored in, it is obvious that from the emerging economies point of view, there is very little real movement of capital. The surge in private capital flows, at best, become redundant in such a scenario.
As the data presented in IIF (2005) shows, three of the emerging market sectors – Asia, Latin America and Africa & Middle East - have generated high current account surpluses in the past few years. Private capital flows to economies in these regions have added to pressures of exchange rate appreciation, to which the national Central Banks have responded by piling up massive stocks of international reserve currency. (see Table 2) Chandrasekhar and Ghosh (2004) argue that the international reserves of the emerging markets are being invested in US treasury bills thereby completing the loop of the capital's movement.[3] Note that investments in US treasury bills earn a much lower return than the cost of private capital to the Southern states. It is an issue of current debate whether this obvious economic loss is worth the future `fragile' insurance of stability, which the stockpiles of international reserves might provide in case of outflows of capital. Also, in the process of dealing with the excess supply of dollars, monetary authorities in the emerging markets are increasingly foregoing domestic monetary objectives. For instance, in India, the net domestic asset component of high powered money steadily declined over the 1990s, and by the end of the decade increments to high-powered money were constituted mainly by changes in net foreign assets.
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In an empirical study covering 26 developing economies, Boratav(2004)
poses the present problem within an overall framework of dependency and
exploitation through capital flows, which shows that historically relations
of dependency and exploitation have been forged through processes that
require metropolitan capital to move to the periphery, which gradually
become the means for surplus extraction and net resource transfer back
to the metropolis.[4] The present juncture
is one where the net resource transfer to the periphery is clearly negative.
Here net resource transfer is defined as the sum of current account balance
minus net income earnings as profit and interest income. In the early
1990s, after capital account liberalization in the South became widespread,
net resource transfer was positive, which was reflected in rising current
account deficit, though there were leakages in the form of outflows by
residents. Beyond 1997, and especially in the most recent years 2001 onwards,
net resource transfer turned positive as emerging market economies, even
Ghana, Kenya, Cote d'Ivoire have moved into current account surplus. Boratav's
estimates reflect that the US economy benefited upto $563 billions in
net resource transfers from the rest of the world in 2003.
A current account surplus for developing countries is not bad, if it is
accompanied simultaneously by buoyant growth of these economies. However,
an improved current account of a peripheral economy which emerges due
to declining growth and/enforced servicing of external obligations corresponds
to a position of weakness. Structural current account surplus under high
growth appear to have emerged definitely only for China in the recent
years. For the rest, the surpluses in the aftermath of financial crisis
indicate a position of weakness. The IIF projections for 2005, therefore,
do not come as a surprise:
''Emerging markets' import growth is expected to edge down this year
as economic activity slows in these countries. The balance on services,
income, and transfers is projected to continue to weaken. Interest payments
are projected to rise from $110 billion last year to more than $124 billion
in 2005.'' (p.9)
The only silver lining for the South that emerges from the IIF report
is the new feature of South-South foreign direct investment expanding
rapidly. The intra-emerging market flows now account for more than 30
percent of total foreign direct investment to emerging market economies,
which is nearly double the share in 1995. Could this beginning mark a
`real' change in shifting global balances towards the South?