Economic Prospects and the Sustainability of Commercial Flows

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Economic Prospects and the Sustainability of Commercial Flows

In principle, it may be sensible for a country to incur debt in order to finance investment projects. The questions are:

 is the existing level of debt (and other external liabilities such as FDI and equity investment) sustainable?

 given the level of these liabilities, how much new capital inflow of which types can be sustained? and

 what sort of investment projects should these inflows finance?
The answers to these questions depend largely on the economic prospects for developing countries. The Bank is generally very enthusiastic about the prospect of increasing commercial capital flows, at least in the case of FDI and equity investment. This is no doubt partly because of its generally favourable predisposition towards the private sector and free markets. However, it also rests at least partly on its characteristically optimistic view of the economic prospects of developing countries and therefore their potential to earn foreign exchange.
The Bank expects developments in the global economy in the coming years to be broadly favourable to the developing countries.
"World trade growth is expected to pick up in tandem with industrial country growth in 1997-98, reaching a longer-term trend of around 6.4 percent....Although there is a near-term risk to private capital flows associated with the expected rise in interest rates in industrial countries over the next twelve to eighteen months, the outlook for continued growth in private flows in the medium and longer term remains favorable on both the supply and the demand side...Prospects for official development assistance flows are not encouraging....[Oil prices] are projected to fall by more than 3 percent a year in real terms in 1997-2006....Nonfuel commodity prices are forecast to gradually decline in real terms, at perhaps 1-2 percent a year over the coming decade." (World Bank, 1997e, pp 11, 15-16, 18.)

On this basis, the Bank projects fairly strong export growth for all developing regions in 1997-2006.

 4½-5½% per year for the Middle East and North Africa, Europe and Central Asia and Sub-Saharan Africa;

 6.7% per year for Latin America and the Caribbean; and

 9½-10½% for East and South Asia.

Longer-term export growth (for 1992-2020) is somewhat faster for the first group, at 6-7% per year (World Bank, 1997e, Tables 1-5 and 1-8).
As a general rule of thumb, if debt (and other foreign exchange liabilities) are initially sustainable, they can be expected to remain so only if the growth rate of foreign exchange earnings is at least as much as the rate of return on the liabilities. Otherwise, maintaining inward net transfers will mean liabilities growing faster than the economy's ability to bear them, until ultimately they become unsustainable. The only alternative is to allow outward net transfers (probably on a substantial scale and for a long period), which will be a serious drain on the economy.
Table 3 shows the World Bank's long-term projections for export volume growth, and the average interest rate on new commercial loans to different regions in 1996. Several points need to be taken into account in comparing these two sets of figures.
 The export volume figures need to be adjusted for export price changes, which might be in the order of 2½% per year for manufactured exports, 1% per year for non-fuel commodities and -½% for fuel.
 The Bank's projections show both real and nominal US interest rates ½% higher in 1997-2006 than in 1996, suggesting that the figures in the final column should be increased by this amount.
 The figures given are regional averages, and there is likely to be a very wide variation between different countries in both regions, both in terms of interest rates and especially in export volume growth.
 The projections were made before the Asian financial crisis. This makes the starting-point of most East Asian countries much less secure than it appeared at the time. It can also be expected to give rise to an increase in export growth for several countries in East Asia (eg., Thailand, Korea and Malaysia) at the beginning of the period, as they attempt to rectify this situation; but reductions for others both in Asia (eg., China) and elsewhere (notably in Latin America), as their Asian markets decline and their competitive position against the most affected Asian economies is weakened. Export prices are also likely to be weaker - especially for manufactured goods exported from the region, as they increase supply, but also for commodities (especially fuel) as demand is reduced.
Applying the rule of thumb outlined above, and taking account of these factors suggests the following (rather tentative) conclusions for commercial borrowing up to 2006.

 Those countries which have been severely affected by the East Asian crisis must now be regarded as having an unsustainable starting point, suggesting a potentially limited capacity for new commercial borrowing. Some other East Asian economies (notably China) may be better able to afford commercial borrowing, and South Asia as a whole more comfortably so.
In Latin America, commercial borrowing was barely sustainable before the Asian crisis, and may well be unsustainable since, except in countries with particularly rapid export growth or a large proportion of manufactured exports.
 In Sub-Saharan Africa, the Middle East and North Africa, and Eastern Europe and Central Asia, commercial borrowing was not sustainable overall even before the Asian crisis, and is likely to be even less so now. This applies particularly strongly to countries which have an unsustainable financial situation already, notably most of Sub-Saharan Africa and Russia.
This suggests that only a handful of developing countries can regard commercial borrowing as potentially sustainable over the next decade, based on the World Bank's projections. After 2006, it should be comfortably sustainable for the two regions for which projections are available (the Middle East and North Africa, and Sub-Saharan Africa), barring a large increase in interest rates and an exceptionally serious and sustained fall in oil prices during the period, as export volume growth is projected to accelerate markedly. However, this will depend critically on whether the financial position of the countries in these regions is sustainable at the beginning of the period. In no case are the rates of return on direct and equity investment sustainable by this criterion - although direct investment in export production and import substitution might nonetheless be justified, if it generates enough extra foreign exchange earnings or savings to off-set profit remittances.


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