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Concentration

Commercial flows are heavily skewed towards the better-off and more industrialised developing countries. Equity financing, in particular is much greater for larger middle-income countries, particularly in East and South East Asia and in Latin America, and very limited in the smaller, less developed and mostly low-income countries typical of Sub-Saharan Africa. Public sector bond issues and non-guaranteed loans to the private sector tend to follow a similar pattern.


FDI too demonstrates a broadly similar pattern; while the exclusion of smaller and poorer countries is less absolute, such FDI as does occur in these countries tends to be heavily concentrated within natural resource-based sectors, particularly mineral and fuel production. However, some very small middle-income economies (eg., the smaller Caribbean islands) tend to receive large FDI flows relative to GDP.
In varying degrees for different types of flow, this pattern of concentration arises because of differences in the expected rates of return and in perceived levels of risk, related, for example, to the size and financial security of corporate sectors, the development of financial systems and the size of domestic markets. As commercial flows, and particularly direct and equity investment, become more important, these factors can be expected to be an increasingly important constraint on overall capital flows to poorer and less developed countries. As a result their relative position may be seriously weakened if this tendency is not off-set by larger and better targeted official flows.

Table 1: COMMERCIAL CAPITAL FLOWS TO THE PRIVATE SECTOR

TYPE OF INVESTMENT


SOURCE OF FUNDS


USE OF FUNDS


DURATION OF INVESTMENT


WHO BEARS THE RISK?


FOREIGN DIRECT INVESTMENT


Mainly transnational corporations; may be some from individuals.


To buy share (at least 20% of) existing companies or existing productive capacity, or to build new productive capacity.


Until the investment is sold to a local investor; at the discretion of the foreign investor, but generally assumed to be long-term.


Investor bears risk of failure to make a profit (commercial risk) and of devaluation (foreign exchange risk). May be guaranteed against political risks (eg of war, nationalisation, etc) eg by MIGA.


PORTFOLIO EQUITY INVESTMENT


Mainly institutional investors (eg., pension funds, financial institutions); some individuals.


To buy shares of companies (less than 20%) from local owners, or new share issues (eg., for privatisation or expansion).


Until the investment is sold to a local investor; at the discretion of the foreign investor, but generally assumed to be shorter-term than FDI. May be very short term.


Investor bears the risk of changes in stock market value, non-payment of dividends, company failure, etc.


COMMERCIAL BANK LOANS


Commercial banks.


Lent to local companies (and affiliates of transnational corporations), generally to finance investment.


Variable, but generally long-term; typically 4-8 years.


Investor bears the risk of delays in payments, eg due to illiquidity, and non-payment, eg because of bankruptcy; but risks may be covered by guarantees from the government of the recipient country. Borrower bears all risks arising from the investment.


BONDS

Mainly institutional investors; may be some individuals.

To buy bonds issued by local companies, generally to finance investment.


Variable, but typically 5-10 years.


Investor bears the risk of delays in payments, eg due to illiquidity, non-payment, eg because of bankruptcy.


DEPOSITS

Mainly institutional investors; may be some individuals.

Placed on deposit with local commercial banks; on-lent by the recipient to local borrowers.


Variable, between over-night and six months; fixed when the deposit is made.


Investor bears the risk of the local bank failing, although this may be covered by a Central Bank guarantee; the local bank bears the risk of devaluation (as well as commercial risk of local borrowers).


EXPORT CREDITS


Commercial banks; some transnational corporations (to finance their own exports).


To pay for imports.


Generally short-term; typically 3-6 months.


Lender bears the risk of delays in payments, eg due to illiquidity, and non-payment, eg because of bankruptcy; but risks may be covered by guarantees from the government of the recipient country and/or an export credit guarantee agency in the lending country.


DERIVATIVES


Mainly institutional investors (as a speculative investment) and transnational companies (to “hedge” - protect - against risk, eg., against changes in commodity prices, exchange rates, etc.); may be some individuals.


To buy derivatives issued from local financial institutions which issue them.


Fixed by the terms of the derivative. Variable, but generally short-term.


Investors bear the risk of the variables (exchange rate, prices etc) on which the derivative is based changing in the opposite direction to that which was anticipated. For those buying derivatives as a hedge, losses merely off-set gains in their commercial operations, and vice versa.



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