«Role Reversal in Global Finance Eswar S. Prasad I. Introduction The global financial crisis has sparked a reconsideration of the role of unfettered ...»
Among the emerging markets shown in this table, China has a large net asset position, Brazil has a significant net liability position, and India has a small net liability position. Large net liability positions are no longer the norm for emerging markets. More importantly, there has been a dramatic shift in the external liability structure of emerging markets during the past decade. While in the past these economies’ external liabilities were dominated by debt, now FDI and portfolio equity have become predominant. In 2010, these two components 348 Eswar S. Prasad
Note: Data for Brazil, China, Japan, Germany, U.K. and the United States are for the year 2010, and data for India and Russia are for the year 2009.
Sources: IMF’s International Financial Statistics and U.S. Survey of Current Business Role Reversal in Global Finance 349
Notes: Median refers to the cross-sectional median of the ratio across the countries in the group. The group ratio is the sum of the numerator variable for all countries in the group divided by the sum of the denominator variable for those countries. Economies not included in “Euro area” are Cyprus, Luxembourg, and Malta. For some economies, 2009 data are used whenever 2010 data are not available, and 2001 or 2002 data are used whenever 2000 data are not available.
Sources: IMF’s International Financial Statistics, Lane-Milesi-Ferretti (2010) and U.S. Survey of Current Business 352 Eswar S. Prasad
Notes: The first column shows the change in the stock of a country’s FDI liabilities from 2000 to 2007 as a ratio of the change in that country’s total external liabilities over the same period. The group ratio is the sum of the numerator variable for all countries in the group divided by the sum of the denominator variable for those countries.
Sources: IMF’s International Financial Statistics and Lane-Milesi-Ferretti (2010) Role Reversal in Global Finance 353 continuation of a process that started in the mid-1980s and was only temporarily halted by the crisis.
These numbers reveal a striking shift in the composition of external portfolios of emerging markets. On the liabilities side, the shift toward FDI and portfolio equity is consistent with greater international risk sharing.8 As noted earlier, when the value of these investments falls either in domestic terms or due to a currency depreciation (or both), foreign investors bear part of the risk. One concern is that portfolio equity flows can be volatile and highly procyclical. In the face of a negative shock, portfolio investors might rapidly withdraw capital from a country, thereby putting downward pressure on the currency. Nevertheless, the threat posed by outflows of portfolio equity capital is far less devastating than the rollover risk on short-term foreign currency debt that used to plague emerging markets.
The change in the structure of liabilities and the proliferation of flexible exchange rate regimes has substantially reduced emerging markets’ vulnerability to balance of payments and currency crises.
This is not a uniformly true proposition, with emerging markets in Europe having become much more reliant on foreign bank loans before the crisis. But the large majority of emerging markets have indeed experienced these positive shifts.
Currency depreciations are far less of a risk for emerging markets now than they were in the debt-dominated era. First, the effects of such currency devaluations are likely to be small since emerging markets no longer have large stocks of foreign currency-denominated external debt, either sovereign or corporate. Thus, the devastating balance sheet effects that brought some Asian economies to their knees during the Asian financial crisis of 1997-98 are less of a concern today. Indeed, with many emerging markets now able to issue international debt denominated in their own currencies, even debt is no longer as fearsome as it once was.9 Second, currency depreciation generates a nominal wealth transfer in favor of the home country (in domestic currency terms) through valuation effects if a country’s liabilities are denominated in domestic currency and assets are denominated in foreign currencies. This 354 Eswar S. Prasad
Notes: Stocks of foreign direct investment (FDI), portfolio equity (PE) and external debt are shown as ratios of total external liabilities (L). The stock of foreign exchange reserves is shown as a ratio to total external assets (A).
The median is the cross-sectional median calculated separately for each year for the relevant group of countries. The weighted mean is the ratio of the sum of external assets and liabilities for all countries in the group expressed as a ratio of the sum of nominal GDP for all countries in that group.
Source: Lane and Milesi-Ferretti (2010) Role Reversal in Global Finance 355 privilege was once limited to the large reserve currency economies but is becoming more widespread.
Competitive nonappreciations through intervention in foreign exchange markets now take on a more complex function as they involve not just the maintenance of price competitiveness in external trade but also serve to limit a country’s wealth transfers to the rest of the world.10 Thus, among emerging markets, the fear of currency appreciation now has two underlying causes rather than just the implications for trade.
Even with this more benign structure of liabilities, emerging markets have not fully torn themselves away from the desire for insurance that would provide an infusion of liquidity at times of global crises.
Chart 4 shows the rapid rate of reserve accumulation by emerging markets, which peaked in 2007, declined but remained positive in 2008-09, and then began to pick up again in 2010. Total foreign exchange reserves of emerging markets now amount to about $6.4 trillion, with China accounting for half of this stock (Chart 5). The fact that several countries, including China and India, don’t report the currency composition of their reserves has led to a rising share of reserves of unknown currency composition. For reserves whose currency composition is known, the dollar still remains dominant, accounting for about 60 percent of reserves. The euro’s share has leveled off at around 30 percent. The Japanese yen and the pound sterling account for most of the remaining reserves whose currency composition is known.
The remarkable paradox in international finance is that the emerging markets’ increasing desire for self-insurance has, if anything, increased global risks and transferred the major risks on those countries’ balance sheets from the liability side to the asset side. The notion that the flow of official capital from emerging markets represents a search for “safe” assets seems rather tenuous if one examines the public debt trajectories of the advanced economies. I turn next to this issue.
356 Eswar S. Prasad
Sources: IMF COFER Database, June 30, 2011; The People’s Bank of China IV. Global Debt and Reserve Dynamics The accumulation of reserves has been associated with a search by emerging markets for “safe assets”—typically government bonds of advanced economies.11 To examine the evolution of such assets around the world, I now examine trajectories of net government debt around the world.12 The global financial crisis triggered a sharp increase in public debt levels, both in absolute terms and relative to GDP. Data from the IMF’s June 2011 Fiscal Monitor show that the level of aggregate net government debt in the world rose from $22 trillion in 2007 to an expected $34 trillion in 2011. IMF forecasts indicate the level will reach $48 trillion in 2016. The ratio of world net debt to world GDP rose from 42 percent in 2007 to 57 percent in 2011, and is expected to hit 58 percent in 2016.
Since the onset of the crisis, the bulk of the increase in global public debt is accounted for by advanced economies. Relative to their GDP, debt levels in these economies are expected to continue rising in the next few years. By contrast, debt ratios will shrink for emerging markets. Indeed, advanced economies account for the bulk of the increase in global public debt since 2007, both in absolute terms and relative to GDP.
Role Reversal in Global Finance 357
• Aggregate debt of advanced economies will increase from $18 trillion in 2007 to $30 trillion in 2011, and is expected to rise to $41 trillion in 2016 (Chart 6). The corresponding numbers for emerging markets are $4 trillion, $5 trillion and $7 trillion, respectively.13 • The ratio of aggregate debt to aggregate GDP for advanced economies will rise from 46 percent in 2007 to 70 percent in 2011 and to 80 percent in 2016. The corresponding ratios for emerging markets are 28 percent, 26 percent and 21 percent, respectively.
There is a stark contrast between the two groups of countries in their relative contributions to growth in world debt versus growth in world GDP. Emerging markets contribute far more to growth in
global GDP than to the growth in global public debt. Some illustrative statistics follow:
In 2007, emerging markets accounted for 25 percent of world GDP and 17 percent of world debt (Charts 7-8). By 2016, they are expected to produce 38 percent of world output and account for just 14 percent of world debt.
• In 2011 (based on IMF estimates at market exchange rates), the four major reserve currency areas together account for 58 percent of global GDP and 81 percent of global debt.
• Emerging markets account for 9 percent of the increase in global debt levels from 2007 to 2011 and are expected to account for 13 percent of the increase from 2011 to 2016 (Chart 9). By contrast, their contributions to increases in global GDP over these two periods are 66 percent and 56 percent, respectively.
• The two biggest advanced economies are making a far greater contribution to the rise in global debt than to the rise in global GDP. The United States contributes 37 percent of the increase in global debt from 2007 to 2011 and 40 percent from 2011 to
2016. Its contributions to the increases in global GDP over those two periods are 8 percent and 18 percent, respectively. Japan accounts for 20 percent of the increase in debt from 2007 to 2011 Role Reversal in Global Finance 359
Notes: This chart shows the aggregate level of general government debt (upper panel) and the ratio of this variable to aggregate world GDP (lower panel), with all variables converted to U.S. dollars at market exchange rates. In the upper panel, the data for advanced and emerging market economies add up to the world aggregates. In the lower panel, aggregate debt is expressed as a ratio of aggregate GDP for the respective group of countries. Net debt is used except for the following countries that report only gross debt data: Advanced Economies–Czech Republic, Greece, Hong Kong SAR, Singapore, Slovak Republic and Slovenia; Emerging Market Sources: IMF’s Fiscal Monitor, International Financial Statistics and World Economic Outlook 360 Eswar S. Prasad
Notes: Other AE denotes other advanced economies and EM stands for emerging markets. GDP is measured at current prices and converted to a common currency at market exchange rates.
Notes: Other AE denotes other advanced economies and EM stands for emerging markets. Net debt is used except for the following countries that report only gross debt data: Advanced Economies—Czech Republic, Greece, Hong Kong SAR, Singapore, Slovak Republic and Slovenia; Emerging Market Economies—Argentina, China, India, Indonesia, Malaysia, Pakistan, Peru, Philippines, Romania, Russia and Thailand.
Notes: These charts show the contributions of different countries/ country groups to the changes in the absolute levels of world net government debt and the absolute levels of world GDP (measured in a common currency at market exchange rates). Net debt is used except for the following countries that report only gross debt data: Advanced Economies—Czech Republic, Greece, Hong Kong SAR, Singapore, Slovak Republic and Slovenia; Emerging Market Economies—Argentina, China, India, Indonesia, Malaysia, Pakistan, Peru, Philippines, Romania, Russia and Thailand.
Sources: IMF’s Fiscal Monitor, International Financial Statistics and World Economic Outlook Role Reversal in Global Finance 363 and 34 percent from 2011 to 2016 while its contributions to the increase in global GDP are 4 percent and 8 percent, respectively.
High and rising debt levels among advanced economies pose serious risks to global macroeconomic stability. Of course, the implications of rising debt levels and their sustainability depend to a large extent on whether these debts are financed from domestic savings or by foreign investors. In the case of the U.S., foreign investors— both official and private—hold about half of the outstanding stock of net central government debt (Chart 10). This ratio is lower for the U.K.—about one-third of its net debt is held by foreign investors—and even lower—less than 10 percent—for Japan, which has a very high domestic savings rate. I have not been able to find comprehensive figures for the euro area. IMF data suggest that the ratio is between 40 percent and 50 percent for Germany, Italy and Spain and much higher for some of the smaller economies, such as Greece and Ireland, although these figures include within-euro-area holdings and do not provide a clear picture of how much euro area sovereign debt is held by investors from outside the euro area.
Chart 11 provides further detail on the extent to which foreign investors finance U.S. debt accumulation. The figure shows the increase in the net stock of outstanding debt and the increase in the share of net debt held by foreign investors. Foreign investors have played an important role in the financing of net U.S. debt. During 2008-10, when net debt accumulation soared to $1.3 trillion per year, foreign investors accumulated $695 billion per year, accounting for just over half of total U.S. net debt issuance.