1 FOREIGN CAPITAL TO THE RESCUE –
DANNY CASSIMON
When domestic capital is too limited to finance all investments needed for
development, would turning to foreign capital providers (always) be a good idea?
Or would these foreigners (only) make the economy more vulnerable to
instability and crisis, and/or unfairly extract wealth out of the country?
1.1 Defining and measuring capital account openness
Capital account = balance of payments of a country, it shows the total of cross-
border financial transactions that a country is doing with the rest of the world
Capital account openness = you are open to capital flows, not evident
Concepts: 2 perspectives
- De jure: policy: absence of restrictions (controls, taxes) a country can
decide ‘we want or we don’t want it
Extreme case against capital flows = North-Korea
- De facto: practice: actual cross-border transactions consequence of de
jure, what you actually observe from the flows
Measuring:
- De jure indicators: AREAERS report (IMF) and Chinn-Ito measure (KAOPEN)
- De facto indicators: foreign ‘assets’ and ‘liabilities’ look at the balance of
payments
o Liabilities include FDI, portfolio investment, loans (debt) and
deposits, derivatives; assets include all the former plus foreign
exchange reserves
o Based on flows: (financial account of) Balance of Payments
o Based on stocks: EWN database
What is the difference between flows and stocks:
You see flows in the balance of payments, stocks refers to the total
outstanding amount at a particular time.
Relationship between them: flow is the change of the stock over the
year, how much did the stock change in the year that we are looking
at?
o Measures can be ‘gross’ or ‘net’
Foreign flows: what are we really talking about? 3 basic foreign capital flows:
- FDI = foreign d? investment, private firms that invest in a firm of another
country equity of a firm
Why? For the dividend payments (= the return), but this is not guaranteed,
depends on how well your firm is doing
Long term investment
- Portfolio investment: 2 types short term investment
, o Equity: same financial instrument as FDI, what is the difference
then, under FDI the foreign investors has enough shares to get
involved and control the firm, FDI is a long term investment
portfolio: investor will by a few shares in the firm, not with the
purpose of participating in the daily control, the foreign money that
comes in through portfolio is considered short-term investment, if
you bought it yesterday, you can sell it tomorrow because the
market for it went up
o Loan bonds! Bonds are publicly traded, the price of that bond is
determined by the secondary market, also short-term financial
flows, the return are interest payments, it is more fixed than
dividends. You always have to pay with a loan, it doesn’t matter
where you used the mony for, and no matter if the things are going
bad/good. With dividends you only have to pay when it goes well.
- Other investment:
o Loans with interest payments as return
o Deposits (banks), mostly because of higher interest rates risks:
you get this high interest rate, but your money is eaten by the lower
currency of the country, devaluation of the foreign currency, this is a
speculative transaction (= putting yourself in a risky position, where
you can get a lot of money, but you can loose even more)
1.2 Global capital flows
Evaluation of the openness + global flow (from where to where)
- Increased ‘de jure’ openness does not necessarily lead to increased ‘de
facto’ inflows (and the reverse) – see slide 4
- Global stocks rebound after the GlobFinCrisis (GFC) (slide 5-6), flows
increased up to the GFC, lower after (slide 8-9).
- Evolution of global gross capital flows: sum of incoming flows (‘liabilities’)
and outgoing flows (‘assets’); see slide 7–fig.2
- Global flows still largely to and between ‘advanced economies’; emerging
ecomonies gaining, lower income countries still left out:
‘Lucas paradox’ (slide 7, figure 2; slide 10-11) = why is it that so little of
the worldwide available capital end up in development countries
Flows of developing countries (‘EMDEs; now more lower-income part):
- Inflows remain restricted (in world GDP terms) but increase (7; 10-11);
- Outflows used to be a.o.linked to the investment of foreign currency
reserves (mainly to the US); now much larger and diversified
- Short and limited impact of the global financial crisis, relative to impact
- on advanced economies (see slide 7, fig 2)
- Important to look at capital inflows in a broad sense, incl. aid and
remittances (see slide 12-14).
This is the conclusion, but look at the slides for the illustration
,1.3 Slide 4 – ‘De jure’ versus ‘de facto’ capital openness:
Emerging market = Brazil, China …
They use this for their measure: Foreign assets (= outflows) + Foreign liabilities
(= inflows) / GDP (in percentages of BBP)
The inflow of a loan creates a liability, receiving country has to pay back.
Worldwide (top left): ‘de facto’ goes up more than ‘de jure’
BUT very different evolutions if we split the world in different economies
- Advanced economies moved till almost full openness
- Emerging economies: they didn’t increase openness very much, but de
facto is very high (vb China) they don’t open the door really, but
investors try to push the door open
- Other developing economies: they opened the door more than emerging
economies, hoping op more transactions, but hardly anything happened
, 1.4 Slide 5 – Evolution of the total stock of global foreign
investment relative to GDP:
It grew a lot between 95 - 06, it peeked in 2007, but there was the global
financial crisis. It kept growing afterwards, but at a lower pace. It was absolute
growth but in relative terms to world GDP is kind of stayed the same.
DANNY CASSIMON
When domestic capital is too limited to finance all investments needed for
development, would turning to foreign capital providers (always) be a good idea?
Or would these foreigners (only) make the economy more vulnerable to
instability and crisis, and/or unfairly extract wealth out of the country?
1.1 Defining and measuring capital account openness
Capital account = balance of payments of a country, it shows the total of cross-
border financial transactions that a country is doing with the rest of the world
Capital account openness = you are open to capital flows, not evident
Concepts: 2 perspectives
- De jure: policy: absence of restrictions (controls, taxes) a country can
decide ‘we want or we don’t want it
Extreme case against capital flows = North-Korea
- De facto: practice: actual cross-border transactions consequence of de
jure, what you actually observe from the flows
Measuring:
- De jure indicators: AREAERS report (IMF) and Chinn-Ito measure (KAOPEN)
- De facto indicators: foreign ‘assets’ and ‘liabilities’ look at the balance of
payments
o Liabilities include FDI, portfolio investment, loans (debt) and
deposits, derivatives; assets include all the former plus foreign
exchange reserves
o Based on flows: (financial account of) Balance of Payments
o Based on stocks: EWN database
What is the difference between flows and stocks:
You see flows in the balance of payments, stocks refers to the total
outstanding amount at a particular time.
Relationship between them: flow is the change of the stock over the
year, how much did the stock change in the year that we are looking
at?
o Measures can be ‘gross’ or ‘net’
Foreign flows: what are we really talking about? 3 basic foreign capital flows:
- FDI = foreign d? investment, private firms that invest in a firm of another
country equity of a firm
Why? For the dividend payments (= the return), but this is not guaranteed,
depends on how well your firm is doing
Long term investment
- Portfolio investment: 2 types short term investment
, o Equity: same financial instrument as FDI, what is the difference
then, under FDI the foreign investors has enough shares to get
involved and control the firm, FDI is a long term investment
portfolio: investor will by a few shares in the firm, not with the
purpose of participating in the daily control, the foreign money that
comes in through portfolio is considered short-term investment, if
you bought it yesterday, you can sell it tomorrow because the
market for it went up
o Loan bonds! Bonds are publicly traded, the price of that bond is
determined by the secondary market, also short-term financial
flows, the return are interest payments, it is more fixed than
dividends. You always have to pay with a loan, it doesn’t matter
where you used the mony for, and no matter if the things are going
bad/good. With dividends you only have to pay when it goes well.
- Other investment:
o Loans with interest payments as return
o Deposits (banks), mostly because of higher interest rates risks:
you get this high interest rate, but your money is eaten by the lower
currency of the country, devaluation of the foreign currency, this is a
speculative transaction (= putting yourself in a risky position, where
you can get a lot of money, but you can loose even more)
1.2 Global capital flows
Evaluation of the openness + global flow (from where to where)
- Increased ‘de jure’ openness does not necessarily lead to increased ‘de
facto’ inflows (and the reverse) – see slide 4
- Global stocks rebound after the GlobFinCrisis (GFC) (slide 5-6), flows
increased up to the GFC, lower after (slide 8-9).
- Evolution of global gross capital flows: sum of incoming flows (‘liabilities’)
and outgoing flows (‘assets’); see slide 7–fig.2
- Global flows still largely to and between ‘advanced economies’; emerging
ecomonies gaining, lower income countries still left out:
‘Lucas paradox’ (slide 7, figure 2; slide 10-11) = why is it that so little of
the worldwide available capital end up in development countries
Flows of developing countries (‘EMDEs; now more lower-income part):
- Inflows remain restricted (in world GDP terms) but increase (7; 10-11);
- Outflows used to be a.o.linked to the investment of foreign currency
reserves (mainly to the US); now much larger and diversified
- Short and limited impact of the global financial crisis, relative to impact
- on advanced economies (see slide 7, fig 2)
- Important to look at capital inflows in a broad sense, incl. aid and
remittances (see slide 12-14).
This is the conclusion, but look at the slides for the illustration
,1.3 Slide 4 – ‘De jure’ versus ‘de facto’ capital openness:
Emerging market = Brazil, China …
They use this for their measure: Foreign assets (= outflows) + Foreign liabilities
(= inflows) / GDP (in percentages of BBP)
The inflow of a loan creates a liability, receiving country has to pay back.
Worldwide (top left): ‘de facto’ goes up more than ‘de jure’
BUT very different evolutions if we split the world in different economies
- Advanced economies moved till almost full openness
- Emerging economies: they didn’t increase openness very much, but de
facto is very high (vb China) they don’t open the door really, but
investors try to push the door open
- Other developing economies: they opened the door more than emerging
economies, hoping op more transactions, but hardly anything happened
, 1.4 Slide 5 – Evolution of the total stock of global foreign
investment relative to GDP:
It grew a lot between 95 - 06, it peeked in 2007, but there was the global
financial crisis. It kept growing afterwards, but at a lower pace. It was absolute
growth but in relative terms to world GDP is kind of stayed the same.
