Acknowledgements


Price elasticity of demand/supply



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Price elasticity of demand/supply: the extent to which demand for/supply of a good or service changes in response to a change in its price.
Private sector: activities undertaken by individuals or commercial businesses.
Profit remittances: transfers to foreign investors of part or all of the profits on their investments.
Public sector: activities undertaken by the government.
Rate of return: the average annual income on an investment as a percentage of the amount invested.
Recurrent spending: the continuing operational costs of an investment, as opposed to its initial capital cost.
Reserves: a government’s holdings of foreign exchange, usually held by the Central Bank.
Return: income earned from an investment.
Syndicated bank loans: a commercial bank loan in which a number of banks participate.

Terms of trade: the ratio between the average price of exports and the average price of imports, expressed as an index. The terms of trade show how much a country can buy abroad for each unit of exports it sells.


1.The following (World Bank) convention is followed in debt terminology in this paper: loans from and debts owed to the private sector are referred to as commercial, and loans from and debts owed to governments (or guaranteed by government agencies in the creditor country) as official; loans to and debts owed by private sector companies are referred to as private (private non-guaranteed if they are not covered by guarantees provided by the government of the borrowing country), and loans to and debts owed by the public sector as public.

2.The arrangements in the IMF’s Articles for the removal of controls on current account transactions essentially represent a ratchet mechanism: while exchange restrictions which exist when a country joins the Fund remain (largely) protected, the introduction of new restrictions (including the reintroduction of restrictions which have been removed) is heavily proscribed. Article VIII Section 2(a) of the Fund's Articles of Agreement states that "no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions". This is modified by Article XIV Section 2 to allow a member to "maintain and adapt to changing circumstances the restrictions...that were in effect on the date on which it became a member", but this in turn is subject to a requirement that "members shall withdraw restrictions maintained under this Section as soon as they are satisfied that they will be able, in the absence of such restrictions, to settle their balance of payments in a manner which will not unduly encumber their access to the general resources of the Fund". While this places the decision firmly on the member government, the Fund has some scope for over-riding their decisions: "The Fund may, if it deems such action necessary in exceptional circumstances, make representations to any member that conditions are favourable for the withdrawal of any particular restriction, or for the general abandonment of restrictions" (Article XIV Section 3). If the member retains the restriction, a process may be initiated culminating in the member's effective expulsion from the Fund, under Article XXVI.

3.For a description of some of the major types of investors see Ganzi and Seymour (1998) and Singh (1998).

4.Loans which are guaranteed are treated in statistical sources as if they were borrowed or lent by the guarantor - that is, as debts of the public sector if they are guaranteed by the government of the recipient country, and as debts to governments (official debts) if they are guaranteed by an export credit guarantee agency.

5. The first two trends are likely to be substantially understated because private non-guaranteed loans are almost certainly under-estimated in 1990 and 1996 (as witness the under-reporting of such loans to East Asian countries revealed by the current financial crisis); and derivatives and inter-bank deposits are not included in the data.

6.Gross commercial borrowing by governments increased from $51.7bn in 1991 to $69.8bn in 1993, and to $99.2bn in 1996. However, while commercial principal repayments fell slightly between 1991 and 1993, they increased from $46.3bn to $65.6bn between 1993 and 1996, so that net lending rose only from $23.5bn to $33.6bn. Over the same period, grants and net official lending fell from $53.5bn to $34.7bn, so that overall external financing for governments fell from $77.0bn to $68.2bn, while interest payments increased from $44.8bn to $63.9bn. This implies a reduction in net transfers (grants and loans minus principal and interest payments) from $32.2bn to just $4.1bn in three years.

7.Domestic debts are also potentially problematic in a number of low-income countries, particularly in view of their much weaker tax bases in many cases: if domestic interest payments are 5% of GDP, and government revenue is 30% of GDP, as in Brazil, one-sixth of the money the government raises will go in interest; but if government revenues are only 15% of GDP, as in Tanzania, the proportion rises to one-third. Apart from Tanzania, other low-income countries with large domestic debts include Ghana, Kenya, Malawi, Tanzania and Zimbabwe.

8.Bhinda and Martin, 1997, p8.

9.Bhinda and Martin, 1997, p15.

10.This might be explained by TNCs selling some of their assets to local investors, thereby realising the capital gains accumulated over previous years, and repatriating the proceeds.

11. There is, of course, a substantial overlap between privatisation and FDI in services: "some 40 percent of the revenues generated by privatization programs during the 1990s have been directed to services, and this share has increased rapidly in recent years" (World Bank, 1998, p22).

12. According to the sensitivity analysis of the projections (World Bank, 1991, Box Table 4.3, p50), faster export growth coupled with much higher FDI ($65bn per year in 1991-5, compared with a projection of $27bn per year for the 1990s as a whole) should have added 2½% per year to the overall growth rate for developing countries. In addition, real US interest rates were 2% less than projected, which should have added a further 0.4% PA, although a shortfall of perhaps 1% in OECD growth would be expected to reduce developing countries’ growth by 0.7% PA. This combination of circumstances implies a growth rate significantly above the "high" scenario, not only for developing countries as a whole (by 2-2½% PA), but also for every individual region.

13.There may be some production, for example where investment in real estate entails the construction of new buildings rather than the purchase of existing ones. However, most of the capital gain is likely to be in the value of the land rather than of the building; and much of the construction which takes place during a speculative boom may well be surplus to long-term requirements.

14

.This occurred in Latin America in 1994-5, and in East Asia in 1997. Equity flows to Latin America fell from $27.2bn in 1993 to $7.2bn in 1995, while flows to East Asia fell from $14.4bn in 1996 to an estimated $1.5bn in 1997. Moreover, these aggregate figures understate the severity of the reversal for the most seriously affected countries. Equity flows to Mexico fell from $14.3bn to just $0.5bn in 1993-5, a reduction equivalent to 6% of 1995 GNP; and those to Argentina fell from $5.5bn to $0.2bn. Since the loss of confidence in East Asia did not become a full-scale crisis until the middle of the year, it seems likely that there was a substantial net outflow in the second half of the year in at least some countries.



15.This is most clearly demonstrated by the experience of Latin America in the 1980s. After the debt crisis of 1982, Latin America faced a particularly acute need for foreign exchange (and for investment), as foreign lending dried up and adjustment weakened economic activity. This problem was compounded by a major reduction in FDI, which remained well below its 1980-82 level throughout the rest of the 1980s. Only once the foreign exchange constraint was relieved by renewed access to foreign lending in the early 1990s (so that FDI was less needed as a source of foreign exchange) was there a substantial recovery in direct investment inflows.

16.The reason for this is far from clear, but may involve some degree of creative accounting.

17.Equity investment and FDI through the purchase of existing assets will only create new capacity to the extent that the original owner invests the proceeds of the sale productively in the local economy.

18.Five of the six countries categorised as less affected by the Mexican crisis were among those which imposed or reimposed capital controls, while the sixth (Korea) already had a relatively restrictive capital account regime. Apart from Mexico itself, only Brazil was among the seven countries classified as more affected by the crisis despite tightening capital controls.

19.An essentially similar process could occur without capital account liberalisation or inflows of foreign capital; and it would still have damaging economic effects. However, there are two critical differences. Firstly, a domestically-financed speculative bubble is limited by the domestic resources available for investment, whereas with capital account liberalisation the resources available to inflate the bubble are virtually unlimited, both accelerating and compounding the process. Secondly, while a domestically-financed bubble will have an impact on the financial system, with capital account liberalisation there is also a serious effect on the balance of payments, which greatly complicates the policy response.

20. "Asia's New Jobless", The Economist, 25 April 1998, p20.

21. However, not all these benefits actually arise in all cases. For example, the transfer of technology is often limited where foreign investment is in assembly plants, particularly in "enclave" areas with limited linkages to the rest of the economy; improvements in managerial and technical skills may be limited by the use of ex-patriate staff in senior positions; and the effects of job creation may be off-set by the displacement of locally-owned firms from the market in the case of non-tradeable goods and services.

22.The role of TNCs (particularly US-based fruit companies) in Central America, especially from the 1920s until the 1940s, illustrate the potential problems. (See Barry et al, 1982; or, for a more measured assessment, Bulmer-Thomas, 1987, pp285-7).

23.Interest rates on commercial loans generally vary in line with market rates, whereas most official lending is at a fixed interest rate.

24.While other multilateral institutions such as the Asian and Inter-American Development Banks and the European Union are growing in importance, the Bank and Fund are still dominant in terms of their influence on policy and research agendas.

25.The International Finance Corporation is slightly different in that it provides resources to the private sector for projects which are expected to earn a profit so that they will be self-sustaining once official support is withdrawn.

26.The Bank has four arms which provide finance for different purposes: the International Bank for Reconstruction and Development (IBRD) provides non-concessional loans and guarantees; International Development Association (IDA) provides concessional loans to low-income countries, partly financed by income earned on IBRD loans; the International Finance Corporation (IFC) provides loans to local or foreign private sector companies in developing countries; and the Multilateral Insurance Guarantee Agency (MIGA) provides guarantees to foreign private sector companies investing in developing companies.



27.The IMF has various funding facilities but this report is only concerned with the Enhanced Structural Adjustment Facility (ESAF) which provides concessional finance to low-income countries.

28

.The IMF and World Bank have “preferred creditor status”, which means that borrowers must pay them before they pay other creditors. This protects the Fund and the Bank as creditors from the effects of their borrowers' debt problems. While most countries have continued to repay the Bank and Fund, this has often been at the expense of increasing arrears to other creditors.



29.The net income the IBRD earns on its loans to middle income countries is used to fund IDA and other programmes which do not generate sufficient returns themselves to be fully self-sustaining.

30.Previously, the notional interest rate was 0.5% above the Bank's cost of borrowing, but 0.25% of this was waived, so that the extra charge was effectively 0.25%. In future, the interest rate will be 0.75% above the Bank's cost of borrowing, of which only 0.05% will be waived (at least in the current financial year and probably in subsequent years), implying an effective extra charge of 0.7%.

31."World Bank's Board Approves New Loan Charge Policy", World Bank press release, 31 July 1998.

32.In the case of ESAF loans, the present value of a $100m loan would be reduced from $66m to $63m by reducing the interest rate to zero; for IDA credits, the reduction would be somewhat greater, from $40m to $31m.

33.The ESAF has 3 accounts: the loan Account; the Subsidy Account; and the Reserve Account. Funds paid into the Loan Account are only lent to the IMF, and must be repaid at roughly market interest rates. The resources in the Subsidy account are provided by donors as grants (often from their aid budgets), and the Fund uses them to subsidise the rate of interest on the loans it makes from the Loan Account. Reflows on past ESAF loans are deposited in the Reserve Account and used to ensure the that donors to the Loan Account can be repaid if a country defaults on its ESAF loan.

34.This negative effect would be increased if contributions to the capital of ESAF were also made from aid budgets, so that bilateral aid flows were reduced by the amount of the increase in ESAF loans. If the contributions to the ESAF were returned to aid budgets when ESAF loans were repaid, the liquidity effect would ultimately be reversed by the extra bilateral aid resources this would provide.

35.However, bailing out commercial lenders and investors is not an appropriate use of IBRD resources, and it has not been demonstrated that bail-out packages are effective.

36.There might be some negative effect if lending to the Bank were seen as a substitute for direct lending to developing countries - for example, if investors bought the additional World Bank bonds instead of developing country bonds which they buy at present. However, the two have very different profiles of risk and return: World Bank bonds are generally seen as being safe investments, with relatively low rates of return, while developing country bond issues offer higher rates of return at higher levels of risk. The extent of substitution between the two is therefore likely to be limited.

37. Robert Chote, "World Bank's Loans to Prop up Asia Leave Little for the Poor", Financial Times, 28th April 1998.

38.It would, in principle, be possible for the Bank to increase its capital base by issuing more shares to its members. Since only a small part of the capital is paid-in ($11.05bn of $182.4bn in mid-1997) the immediate financial cost to the members would be relatively limited; and, while the remainder ("uncalled capital") would be a contingent liability, which could be called on in the future, the actual payments would almost certainly be very limited.

39.In the past, the Bank made loans at fixed interest rates. As market rates fell, so did the cost of the Bank's own borrowing; but the interest rates on these loans was not reduced, so that they generated higher profits. Partly because this increased the costs to borrowers, the Bank switched to its present formula of charging a fixed spread above its cost of borrowing. As the old fixed rate debts are paid off, so this source of extra profit is drying up, reducing the Bank's net income.

40.Robert Chote, op. cit.

41.The reduction in the interest waiver should generate about an extra $200m in the 1997/8 financial year (growing slightly over subsequent years if it is maintained); the 1% charge on loan effectiveness about another $150m per year; and the increase in the margin charged on new loans above the Bank's cost of borrowing will generate further additional net income, progressively increasing over time. However, the increase in income arising from these last two changes will be much slower to materialise, as they apply only to loans on which the initial invitation to negotiate is issued after 31st July 1998. The negotiation process can be expected to take perhaps two years on average, with a further delay of between six months and a year before loans become effective (when the 1% fee is charged). Disbursements are spread over a period of years - often a very long period in the case of project loans - and the extra interest will be received only on the money which has been disbursed on each loan. The delay will be increased by the projected reduction in faster-disbursing adjustment lending. Provided the lower interest waiver is retained, this suggests that IBRD net income may be increased by about $200m in each of the next two financial years, reaching perhaps $350m above its current level in four years (due to the new front-end fees), and will increase more slowly thereafter (due to the higher interest rate margin).

42

.Other observers argue that the Bank's AAA rating and low borrowing costs are based, not so much on its financial position as on the fact that it is effectively under-written by the major developed country governments. The African Development Bank, for example, is able to borrow on similar terms despite a much weaker financial position (and indeed more equivocal support from leading developed country governments).



43. A policy environment seen as promoting growth, particularly open trade regimes, fiscal discipline, and avoidance of high inflation.

44.These countries would still be eligible for project finance and technical assistance but not programme support.

45. See, for example, Tjonneland, E. N., et al (1998) and Woodward, D. (1992, Volume I Annex I).

46.This proposal puts developing country governments, and their people, at the centre of the development process by requiring governments, in consultation with civil society, to develop national development strategies as the first stage in the process. Donors would then provide resources in support of this programme. While this approach is potentially very useful, it lacks detail and it is as yet unclear whether it can work in practice. Moreover, it is based on a selective approach, which could simply imply a disguised form of conditionality. See Bretton Woods Project, 1998, forthcoming.

47.The commercial debts of the HIPCS are reduced through the IDA Debt Reduction Facility, which provides grants for low-income countries to "buy back" their debts to commercial banks at their market price, which is far below their face value. This is not materially affected by the HIPC Initiative.

48.This is a significant change from the equivalent passage in the 1996 Annual Report, where potential losses are described as being charged against IDA's accumulated surplus (World Bank, 1996, p212). Sources of development resources include member countries’ subscriptions, and contributions and transfers from IBRD, as well as IDA's cumulative surplus.

49. No reference was made to the HIPC Initiative in the context of the Special Contingency Accounts in the 1997 Annual Report (IMF, 1997).

50.This represents a proportion of provisions equivalent to the share of HIPCS in the total commitments of countries with arrears greater than six months

51.These include, for example, the Jubilee 2000 Coalition (1998); Oxfam International (1998); Christian Aid (1998); and the Catholic Fund for Overseas Development (Northover et al, 1998).

52.An ESCROW account is an account within the control of a third party, into which money can be paid by one party to a contract without being received by the other party until a certain date, or until certain conditions have been met. The reason for using the ESCROW account approach is a practical one: on paper, the cost of cancelling or paying off a concessional loan immediately is its face value; using the ESCROW approach, this can be reduced to the present value of the debt.

53.From an economic perspective, the opportunity cost of gold sales to the developing countries is the present value of the net proceeds of sales at a future date, at the projected world market price at that time. If this were in 2010, using a discount rate of 6% per year, this would amount to about $160 per ounce, or about two-thirds of the potential net proceeds at present. Deferring the sale to 2010 would thus effectively impose a cost of $75 per ounce, or $7½bn on the Fund's total reserves of 100m ounces. Any further delay, or a faster decline in the international price (which is already one-fifth below the projection on which the above estimate is based) would increase the cost of delay, and reduce the opportunity cost of using the reserves, still further.

54.The gold price at end-April 1997 was $340 per ounce, so the sale of 5m ounces would have raised $1.7bn ($1.45bn net of the mandatory SDR35 per ounce). Allowing for a 5% per year rate of return over seven years, this would have provided investment income totalling nearly $600m. By August 1998, the price had fallen to $285 per ounce, reducing the proceeds to $1.42bn ($1.17bn net) as well as shortening the period of investment by sixteen months. This would imply total investment income of only $375m.

55.Sales of 50m ounces of gold would provide net proceeds of around $12bn at current world prices. By comparison, the total present value of debt owed to the Fund by the 20 HIPCS classified as unsustainable or possibly stressed at end-1994 amounted to less than $5bn (based on IMF/World Bank, 1996, Table 9a), and actual debt reduction by the IMF under the HIPC Initiative would be a fraction of this amount. This suggests that IMF gold sales would be sufficient to finance a considerably greater degree of IMF debt reduction than is currently envisaged, for a much wider range of countries, and could still leave a substantial surplus to finance reduction by other multilateral agencies, such as the African Development Bank.

56. See endnote 33.

57.The funds could, however, be redirected as unsubsidised loans to middle-income countries, eg as part of the current East Asian (or similar future) rescue packages.

58

.These figures are based on ordinary least squares regression, using the ratio of debt to exports and the ratio of net official financing to GDP in the first case, and the changes in these ratios in the second. The figures of $20-25 and $3 are based on the median exports/GNP ratio for HIPCS of 32.5% (estimated from World Bank, 1997, Table A1.4).



59.Based on the median present value/nominal debt ratio for HIPCS of 73.5% (estimated from World Bank, 1997, Table A1.4).

60. This would also require a reduction in the reserves target of 13-15% of lending. However, this target is not mandatory, and a lower reserves coverage would be unlikely to increase the Bank’s borrowing costs.

61. See, for example, Cornford (1996) Halifax Initiative (1996), UNCTAD (1996),

62.This is roughly in line with the figures for East Asia in 1996, or for the developed countries in 1980 (World Bank, 1998b, Table 4.4), and higher than for any other developing region in 1992 (World Bank, 1994, Annex Table 15).

63.Definitions are taken from Woodward 1992.








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