Transcript Reserve Uncertainty and the Supply of International Credit

Sources for financing domestic
capital – is foreign saving a viable
option for developing countries?
Joshua Aizenman, Brian Pinto
& Artur Radziwill
UCSC & the NBER; The World Bank
& CASE – Center for Social and Economic Research
Department of Economics, Warsaw University
6 March, 2008
1
The purpose

Studying the importance of external
financing and financial integration in the
development process.


We propose a new and simple method for
tracing the patterns and the depth of selffinancing.
We apply this method, investigating the impact
of financial liberalizations, in the 1990s, on
self-financing rates and growth.
2
Two opposing views about
financial integration

Private debt or portfolio inflows in response to
economic liberalisation have expanded sizeably,
from less than $40 billion per year over the period
1983-1990, to an average of about $200 billion a
year in the last five years. These capital inflows
have provided additional resources to supplement
domestic savings and support high levels of
investment.”
Andrew Crockett, 13/2/98.

“Neither a borrower nor a lender be, for loan oft
loses both itself and friend, and borrowing dulls the
edge of husbandry.”
W. Shakespeare, from Hamlet.
3
Financial liberalization in the
1990’s: global perspectives



The 1980s -- stagnation of economic
growth and the rise in inflation associated
with the 1982-89 debt crisis.
1990s – sweeping reforms in LATAM,
exchange rate based stabilization
programs, coupled with deep trade and
financial liberalizations.
The presumption – renewed external
financing would augment domestic saving,
increasing investment and the growth rate.
4
De jure measures of capital
mobility




Normalizing completely free capital mobility at
100, Edwards (2004) reports indexes of capital
mobility.
LATAM: increased from about 40 in the 1980s to
about 75 in the 1990s.
Asia: increased mildly from about 40 in the 1980s
to 60 prior to the 1997 crisis, dropping to 55 in the
aftermath of the crisis.
The Middle East and North Africa: a much smaller
increase throughout that time, from about 40 to
50.
5
Financial Openness
(capital Inflow + outflow, % of GDP)
20
15
10
5
0
1970s
East Asia
1980s
Latin America
1990s
Others
OECD
6
Background literature I: conflicting
views about financial liberalization



The gains from financial integration are
illusive (at best).
 Rodrik (1999), Stiglitz (2002),
Gourinchas and Jeanne (2004).
Significant gains from financial openness
 Bekaert et. al. (2002) and Henry
(2003).
All these studies focused on the formal
acts associated with de-jure financial
opening.
7
Background literature II
Feldstein and Horioka (1980)


S/I correlations as a measure of capital
mobility; concluded that financial markets
had a long way to go towards meaningful
integration.
Follow up studies:


Some concluded that financial markets have become
more integrated in recent decades.
Others concluded that such correlations do not provide
enough information to ascertain the true degree of
integration of financial markets
[see Obstfeld and Rogoff (1999) and Coakleya,
Kulasib and Smithc (1998) for useful overviews of
the literature].
8
Methodology



We focus on the ratio of cumulative
discounted gross national saving and
gross national investment.
This ratio provides us with a measure of
self-financing – the share of tangible
capital that was financed by domestic
savings. We use this ratio to investigate
the 1990s.
No obvious association between S/I
correlations and self finance ratios.
9
Ideal Self financing ratio,
fˆ
unbounded backward discounting

(1)
fˆt 
S
i 1

I
i 1
t i
t i
(1  d )
i 1
(1  d )
i 1
d = depreciation rate
I = gross investment in constant PPP
S = gross national saving in constant PPP
10
Interpretation

fˆt = 1  the entire stock of domestic
capital is self-financed.


1- fˆt = foreign-financing ratio = the
fraction of domestic capital that was
financed by foreign saving.
In practice, the unbounded backward
discounting is not feasible due to
scarcity of data.
11
Self financing ratio, with
discounting horizon n
n
(2) f 
t ;n
S
i 1
n
t i
(1  d )
i 1
 kYt  n (1  d )
n
i 1
n
I
(
1

d
)

kY
(
1

d
)
 t i
t n
i 1



k = fixed initial capital/GDP ratio,
The denominator: the stock of capital.
For a large n, the numerator is the
hypothetical self-financed stock of capital,
assuming that the country would have self
financed its investment, without borrowing.
12
For an economy growing at a
constant rate g
(3)
f t ;n  fˆt
n

(1  d ) /(1  g )
 (1  f t ;n )
n
1  (1  d ) /(1  g )
K t ;n
gt 
 1 is the growth rate of the
K t 1;n
stock of capital at time t.

For large n and d, the gap between
measured and the ideal self-financing
measure is inconsequential.
13
Self financing overtime
(4) f t ;n  f t 1;n
St 1  I t 1
d  gt

 (1  f t 1;n )
K t ;n
1  gt
K t ;n
is the growth rate of the
gt 
1
stock of capital at time t.
K t 1;n

Current account surpluses exceeding
d  gt
( ft 1;n  1)
1  gt
would increase the self-financing ratio.
14
No obvious association between S/I
correlations and self finance ratios.




Consider a simple example, no
uncertainty.
Suppose that S = f I
Trivially, correlation (S, I) = 1,
independently from f .
Our focus is on f , measuring the share
of investment financed domestically.
15
Self financing: estimation




We calculate f varying t, holding n constant.
Base specification, k = 3, n = 10 and d = 0.1.
A panel of self-finance ratios covering the 1990s for
47 developing and 22 OECD countries [data
requirements: available S and I for every year 19812001, Source: 2004 WDI].
Variables GDP, gross national savings (including
net current transfers from abroad) and gross fixed
capital formation are expressed in constant local
currency units. GDP per capita is expressed in
constant 1995 US$.
16
All Developing Countries
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
91
92
93
94
95
96
97
98
99
00
01
Mean
Mean - Standard Deviation
Mean + Standard Deviation
17
LATAM
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
91
92
93
94
95
96
97
98
99
00
01
Mean
Mean - Standard Deviation
Mean + Standard Deviation
18
Asian Countries
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
91
92
93
94
95
96
97
98
Mean
Mean - Standard Deviation
Mean + Standard Deviation
99
00
01
19
African Countries
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
91
92
93
94
95
96
97
98
99
00
01
Mean
Mean - Standard Deviation
Mean + Standard Deviation
20
China
India
1.2
1.3
15
1.2
1.1
10
1.1
10
1.0
5
1.0
0.9
0
5
0.9
-5
0
-10
91
92
93
94
95
Growth rate /left axis
96
97
98
99
00
01
Self-financing ratio /right axis
91
92
93
94
95
Growth rate /left axis
96
97
98
99
00
01
Self-financing ratio /right axis
21
Argentina
Mexico
1.2
1.2
1.1
1.0
0.9
10
1.1
10
1.0
5
0.9
5
0
0
-5
-5
-10
-15
-10
91
92
93
94
95
Growth rate /left axis
96
97
98
99
00
01
02
Self-financing ratio /right axis
91
92
93
94
95
Growth rate /left axis
96
97
98
99
00
01
Self-financing ratio /right axis
22
Korea
Malaysia
1.2
1.2
1.1
1.1
1.0
1.0
10
0.9
10
0.9
5
5
0
0
-5
-5
-10
-10
91
92
93
94
95
Growth rate /left axis
96
97
98
99
00
01
Self-financing ratio /right axis
91
92
93
94
95
Growth rate /left axis
96
97
98
99
00
01
Self-financing ratio /right axis
23
Financial openness and self
financing


The correlation between the change in defacto financial openness between 80s and
90s and the change in self-financing rates
between 1991 and 2001 is zero.
The financial opening was substantial - the
average and median increases in financial
openness were 65%, and 30%,
respectively, changes in the self- financing
rates were insignificant by comparison.
24
The association between deeper defacto financial integration and changes
in self-financing ratios
Self-financing ratio
2001/1991
3
2
1
0
0
1
2
3
4
5
6
Average ratio of gross financial flows to GDP
90s/80s
25
Self financing and growth


Higher f are associated with higher growth
rates.
This effect is convex.




A rise (drop) in f from 1 to 1.1 (from 1 to 0.9 ) is
associated with an increase in the growth rate from
2.8% to 4.4% (from 2.8% to 2.2%).
Better institutions are associated with less
volatile f s.
Better institutions are associated with a higher
growth rate.
The quality of institutions variable “soaks” the
explanatory power from the volatility of selffinancing ratios, but leaving intact the positive
convex effect of self-financing ratios on real
per capita GDP growth.
26
Growth and self-financing ratio,
cross-country analysis, 1990s
27
Main results

No evidence of changes in the pattern of
financing ratios of developing countries.

Greater financial integration has resulted in
inflows of foreign saving financing outflows of
domestic saving, with little net impact on
financing ratios [Dooley (1988), Mody &
Murshid (2002), Bosworth and Collins (1999)]

The average self-financing ratio for
developing countries is about 90%.
28
Results II

Greater integration of financial markets
has not changed the dispersion of selffinancing rates


S.d. of the cross-country distribution of selffinancing ratios in the 1990s is about 0.18.
In the 1990s, countries with higher selffinancing ratios grew significantly faster
than countries with low self-financing ratios.
29
Results III


In a growth regression, a positive convex effect
of self-financing ratios on real per capita GDP
growth.

Higher volatility of self-financing ratios is
associated with lower growth rates.

Better institutions are associated with a higher
growth rate.
In a growth regression, the quality of institutions
variable “soaks” the explanatory power from the
volatility of self-financing ratios, leaving intact the
positive convex effect of self-financing ratios on
real per capita GDP growth.
30
Inferences



Despite greater financial integration,
foreign savings have not provided, on
average, a viable source of financing.
Instead, financial integration leads to
deeper diversification.
No inference about direct causality – we
cannot infer that policies aimed at
increasing self-financing ratios would be
growth and welfare improving.
Our results do not rule out the possibility
that financial liberalization may impact the
“quality of growth,” as measured by TFP.
31