Global competition for attracting capital flows

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• Global competition for attracting capital flows
• September 2007
• Michel Henry Bouchet

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I- What drives global capital flows?
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Globalizations impact?

• Misconception capital should flow from rich
  countries to poor ones, which have less capital
  and offer higher returns! By borrowing abroad,
  LDCs should be able to boost investment and the
  growth rate.
• Facts capital is flowing  uphill  and the US
  current account deficit is financed by emerging
  countries purchase of US Treasury securities
• Facts LDCs have limited capacity to absorb
  foreign capital, due to underdeveloped financial
  systems. Dynamic growth boosts saving relative to
  investment, hence a current account surplus
  (China!).
• Facts US bond yields are 2 lower than they
  otherwise would be, thanks to the purchase of US
  securities by China and other EMCs. If these
  countries loose their appetite for US assets,
  bond yields could jump and the dollar plunge!

Source IMF/Prasad-Rajan, 2006
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US Current account deficit in US billion
-7 PBI
US Treasury, IMF
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Global competition in financial markets
DEFICIT
-800 billion 2200 million/day
?
SURPLUS
?
?
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Who finances whom?Current account balances of
OECD and EMCs (billions of US)
Asian crisis
Source FMI/2006
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Why do EMCs show such large CA surpluses and
rising reserves?

• 1982 debt crisis 1994 Tequila crisis 1997
  Asia crisis 1998 Russian crisis 2001
  Argentina crisis
• Strong IMF-monitored adjustment economic and
  trade liberalization
• Devaluation Boost in investment ratio trade
  and current account surpluses
• Improvement in debt indicators!

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Successful economic adjustmentImprovement in
EMCs solvency ratios (drop in Debt/X )
Source FMI/2007
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Current account surpluses Global
liquidity Sharp drop in the cost of borrowing of
EMCs
México consigue el Grado de Inversión
Embi Mexico
BCRP, Banco Central de Chile
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II- Global competition in financial markets
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Globalization Index Top 20 

• 1. Singapore
• 2. Ireland
• 3. Switzerland
• 4. USA
• 5. Netherland
• 6. Canada
• 7. Denmark
• 8. Sweden
• 9. Austria
• 12. UK
• 18. France
• 19. Malaysia
• 20. Slovenia

• 26. Spain
• 34. Chile
• 42. Mexico
• 47. Argentina
• 51. Colombia
• 53. Peru
• 54. China
• 55. Venezuela
• 57. Brazil
• 61. India

ATKearney
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The 30 most attractive EMCs for FDI

• India
• Russia
• Vietnam
• Ukraine
• China
• Chile
• Latvia
• Slovenia
• Croacia
• Turkey
• Tunisia
• Tailandia
• Korea
• Malaysia
• Macedonia
• UAE
• Arabia Saudita
• Slovakia
• México

Economic political risk Market Potential AT
Kearney GRDI 2006
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The most attractive EMCs in 2006
LOW Risk
HIGH Risk
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Identifying the next leaders?

• The BRICs  The path to 2040  Goldman Sachs
• Brazil, Russia, China Indias GDP gt G7 en US
• Challenge How to forecast the Top 10  of 2040?

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The BRICs catching up with the G7
Goldman Sachs 2007
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Share in global GDP
Chine 15,4 Japon 6,4 Inde 6
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The leaders of 2040?
GDP in billions of US
The  BRICs 
Source Goldman Sachs
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III- The Asian challenge

• Strong Investment rate
• High Savings rate
• Dynamic Productivity
• Low Labour cost
• Current account surplus
• Large Internacional reserves
• High liquidity and solvency indicators

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The dynamics of investment rate
I/GDP
IMF, IIF
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National savings and Investment dynamics
IIF
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Share of EMCs Official Reserves in 2007
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Asian crisis and Thailands recovery
FMI
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FDI and portfolio flows in Thailand
US million
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CHINA Inc. A Global supremacy strategy
Oil
MNCs
Oil
NTIC
FDI
US
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 Made in China  and  Made by China 

• China Inc holds a two-fold comparative advantage
  to attract foreign capital flows
• Labour intensive activities with very competitive
  labour costs textile, shoes, garment,
  components
• High value added activites incorporating new
  technologies (electronics, software, NTIC)
• Key role of MNCs (majority from Asia South
  Korea, Japan, Malaysia) 60 of Chinas exports
  stem from foreign companies and/or joint-ventures

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made in China y made by ChinaShare of capital
origins in Chinas exports

Source Le Monde, 16/6/2006
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IV- Where do capital flows go?
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Who finances whom?Current account balances of
OECD and EMCs (billions of US)
Asian crisis
Source FMI/2006
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Net capital sources for emerging market countries
US billion
IIF/IMF
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Net capital flow sources for Latin American
countries (US billion)
Net private flows
Net public flows
IIF-2006
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Net private capital flows to EMCs
Billion of US
Source IIF/IMF
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Net portfolio capital funds to EMCs (US
billion)
IIF-2006
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GLOBAL FDI FLOWS
EMCs
EMCs (19)
ASIA (64)
OECD (81)
LATIN AMERICA (29)
GLOBAL ECONOMY
PERU (4)
CHILE (10)
CHINA (80)
MEXICO (32)
ASIA
LATIN AMERICA
Source IIF, OECD
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IIF/FMI
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Net FDI and portfolio capital flows to EMCs
US billion
Fuente IMF/IIF
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Total FDI inflows in US trillion
Post-2003 bounceback has been driven by emerging
markets. However, FDI flows to emerging markets
will remain buoyant in 2006-10, averaging over
US400bn per year, but growth rates will be
modest as privatisation tails off and the global
economy slows.
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Incestuous globalization?The key recipients of
FDI
In US billion
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FDI in China
US billion
OCDE
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V- How analyzing global risk and
opportunities?The role of Rating agencies
(after the Asian crisis, Enron, LTCM, Arthur
Andersen, Parmelat, and the US subprime market)
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Risk Ratings

• Shortcomings/Cons
• reductionist
• oversimplistic
• risk of self-fulfilling prophecy
• little predictive value
• weighted average tends to bury salient trends
• Gives market consensus often made of herd
  instinct

• Advantages/ Pros
• Simple
• cross-country comparison
• comparison across time
• shrinks a large number of variables into one
  single grade
• Reliable for smooth risk evolution

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• Moody, Fitch, SPs, Coface
• Objective
• assessing willingness capacity to repay a debt
  at maturity

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Investment grade vs speculative investment
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LT ST Ratings of Moodys
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Rating Moodys
2007
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RATING MOODYS (mid- 2007)
Baa1
Baa1
Ba2
Ba3
Ba3
Investment grade
Fuente Scotiabank/Moodys
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How does SP build its Rating?

• 10 Parameters
• Political risk, Economic structures, Growth
  potential, fiscal flexibility, budget balance,
  debt ratios, Inflation, external liquidity,
  public and private external debt (liquidity and
  solvency)

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Rating of SP
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RATING SP LT
A
BBB
BB
BB
BB
BB-
B
Investment grade
Source SP
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RATING FITCH
Source Fitch IBCA
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OECD Country risk classification in 2007
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COFACE

• 140 countries
• Country rating definition
• Investment grade
• A1 steady economic and political situation
• A2 weak default probability
• A3 adverse circumstances may lead to worsening
  payment record
• A4 patchy payment record could be worsened by
  adverse econmic/politicval developments
• Speculative grade
• B unsteady economic and poltical environment
• C bad payment record
• D high risk profile and very bad payment record

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Coface credit Rating (2007)

• Canada A1
• Australia A1
• USA A1
• Japan A1
• Korea A2
• Chile A2
• Thailand A3
• China A3
• India A3
• Poland A3
• Mexico A4
• Morocco A4
• Algeria A4
• RomaniaA4

• Egypt B
• Brazil B
• Russia B
• Turkey B
• Vietnam B
• Congo C
• Ukraine C
• Venezuela C
• Argentina D
• Turkménistan D
• Chad D
• RCI D
• Nigeria D

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Ratings09/2007
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KOREA Index of payment arrears 1993-2006 (base
1995 100)
COFACE
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VI-Shortcomings of rating agencies?

• Criticisms
• Power without accountability
• Conformity bias
• Sociocultural bias
• Punishment of disobedient firms/countries that
  do not request a rating
• Procyclical bias, hence followjng the majority
  opinion of market participants without any early
  warning signals nor predictability track record
• Spill-over effect!

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Rating poor early warning signals?

• South Korea was rated as Italy and Sweden as
  recently as October of 1997! But has been
  downgraded abruptly to junk bond status during
  the crisis
•  There were no early warnings about Korea from
  us or, to the best of our knowledge, from other
  market participants and our customers should
  expect a better job from us 
• FICHT IBCA January 14, 1998

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After Asia some lessons of the crisis

• Any agency which rated the Republic of Korea at
  the high investment grade rating of AA- (in the
  case of Fitch IBCA and SPs) or A1 (in the case
  of Moodys) before the crisis, and which now
  rates Korea at a speculative grade B-, was
  clearly either wrong initially or subsequently.
  Clients are entitled to expect us to perform
  better in the future!
• Fitch IBCA January 13, 1998

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The Perceived Situation

• Was the crisis anticipated by rating agencies?

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EUROMONEY Risk Ratingthe higher the ranking, the
higher the risk
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Macroeconomic success of the tigers until 1996
Source IMF/International Financial Statistics
1999
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Prudent macroeconomic management of the tigers
low inflation, low budget deficits
Fuente IMF/ International Financial Statistics
1999
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Example Russia attracts large capital inflows
thanks to a strong rating by Coface and Fitch
despite bad competitiveness and governance
indicators!
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Ratings and the US subprime mortgage-backed
securities market in the summer of 2007

• Rating agencies responded to issuers rating
  requests and kept a AAA rating for debts whose
  collateral was rapidly deteriorating!
• Ratings agencies failed to warn investors about
  the risk of complex financial instruments
• Challenge how measuring liquidity and market
  value risks?

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World Bank Doing business in 2007

• 7 criteria
• 175 countries
• New company creation employment procedure
  company registration financing mobilization
  investment protection contract enforcement
  liquidation
• 3 days to set up a company in Canada vs 12 days
  in New Zealand and 52 in Slovakia and 153 in
  Mozambique

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World Bank Doing Business in 2007

• Singapore
• New Zealand
• USA
• Canada
• HK
• UK
• Denmark
• Australa
• Norway
• 11. Japan
• 21. Germany
• 35. France (44 en 2006)
• 39. Spain
• 93. China
• 96. Russia
• 121. Brazil
• 134. India
• 171. RDC

 Ease of doing business  The ranking does not
take into account the macroeconomic framework nor
organized crime
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Quality of regulatory framework matters
World Bank 2007
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Economic Freedom Rating/Fraser Institute 2006

• Hongkong
• Singapore
• New Zealand
• Switzerland
• US
• Ireland
• UK
• Canada
• Iceland
• Luxembourg
• Australia
• Austria
• Estonia
• Finland
• Netherland

• 20. Chile
• 24. France
• 30. Spain
• 35. Korea
• 45. Italy
• 60. Mexico
• 60. Thailand
• 83. Indonesia
• 88. Brazil
• 95. China
• 102. Russia
• 124. Algeria
• 126. Venezuela
• 130. Zimbabwe

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World Economic Forum competitiveness ranking

• The Global Competitiveness Report, which examines
  the growth prospects of 80 countries, remains the
  most up-to-date and comprehensive data source
  available on the comparative strengths and
  weaknesses of leading economies of the world.
• Countries in The Global Competitiveness Report
  are ranked by the Growth Competitiveness Index
  (GCI) (GCI Rankings) and the Microeconomic
  Competitiveness Index (MICI) (MICI Rankings),
  which combined encapsulate the relative strengths
  and weaknesses of growth within each economy.

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Davos-WEF 2007 Competitiveness Index
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Davos-WEF 2007 Competitiveness Index

• Thailand 38
• China 57
• Mexico 58
• Russia 62
• Brazil 66
• Vietnam 77
• Venezuela 88
• Pakistan 91

• Bolivia 97
• Nigeria 101
• Cambodia 103
• Paraguay 106
• Cameroon 108
• Zimbabwe 119
• Ethiopia 120
• Angola 125

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IMD Criteria

• Over 300 competitiveness criteria are selected.

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IMD 2007 Competitiveness Index

• 1. USA
• 2. Singapore
• 3. HK
• 3. Luxembourg
• 4. Denmark
• 5. Switzerland
• 15. China
• 16. Germany
• 20. UK
• 24. Japan
• 26. Chile

• 27. India
• 28. France
• 29. Korea
• 30. Spain
• 33. Thailand
• 35. Hungary
• 38. Colombia
• 43. Russia
• 44. Romania
• 47. Mexico
• 55. Venezuela

BEST
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VII- What are the drivers of sustainable economic
growth?

• Sustainable development
• Economic growth those conditions that make it
  sustainable!
• Strong infrastructures socio-political
  stability flexible institutions good
  governance democracy

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Correlation economic liberalization/growth
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Correlation economic freedom human development
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Correlation between trade openness and corruption?
Correlation corruption trade openness
High corruption
Low trade openness
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Correlation Human development /Corruption
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The monitoring of corruption by the World Bank
World Bank 2006
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World Bank comparing the relative intensity of
corruption in Latin America?
Control de la Corrupción (América Latina, 2004)
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Conclusion How to assess sustainability of
global capital flows?

• Economic and financial risk analysis
  (quantitative)
• Socio-polítical, institutional development, and
  structural reforms (qualitative)