The Hindu Business Line : Money on a merry-go-round — The recycling of poor country resources

IN its report on Global Development Finance 2004, the World Bank has, as usual, done a professionally competent job of analysing the trend in development finance over the last year and assessing prospects for the future. It sets the stage for the discussion of various issues that concern not only developing countries but the world as a whole.

At the outset, it is fair to point out that the report stresses the criticality of solving the problems of structural imbalances not only in the developing world but also in the high-income countries. In particular, it lays emphasis on the need to set right the twin deficits — both on current account and budget — that afflict the US. Above all, it stresses the dangers implicit in this for developing countries themselves.

If the US slows down, it naturally will mean a slowdown for the global economy as a whole. But, the contradiction is that it is the inflow of resources from the poorer countries that is sustaining the high-spending economy of the US. If this support is withdrawn, there can be grave risk to both the US and the rest of the world. The developing world supports the developed economies in ways that tend to produce a win-win game. But, it has built-in contradictions.

There have been some recent trends in terms of withdrawal of investor support from the rest of the world to US equities, especially from the developing world. This has, in part, led to the decline of the value of the dollar, which is apt to result in a vicious cycle of speculative outflows from the US.

But, as at present, the confidence trick practised by the US is holding. The rest of the world is rushing with support for the economy of the greatest power of the world, which is also having the greatest deficit and most indebted.

The World Bank report has a revealing Table on the criss-cross flows of resources in the global economy. There are a few revealing data in the Table. The contribution of institutions such as the World Bank has been relatively small in the total flow of resources to developing countries.

They are small, in particular, in relation to the reverse contribution made by the developing countries' reserves, which support the richer economies. The flow of aid from the rich countries to the poorer is just that — a mind-tripping of our own dollars through the intermediaries located in the West.

The Table also shows, in particular, that the developing countries as a whole have been having a current account surplus in 2003. It amounts to a mind-boggling figure of $76 billion. This, in effect, means the developing countries are exporting more goods and services by this order to the rest of the world.

In addition, the developing countries support the economies of the richer half of the world by investing their reserves to the extent of $276 billion, mostly by buying the debt paper and equities of the richer countries. This means, in effect, that the developing countries have supported the richer countries through their current account surplus as well as by investing their reserves — in all, a total of $352 billion.

In this context, the talk of foreign direct investment, aid, portfolio investment and so on means, in effect, a recycling of poor countries' resources. It is out of this nest egg of poor countries' dollars that rich countries' financial institutions finance their foreign direct investments into poorer countries. So also, portfolio investments come out of the same pool. The official aid figure, which is a relatively small figure of $28 billion comes out of the rich countries' budget, which in turn is supported by poor countries' infusion.

The poorer countries' earnings flow into the richer countries and are re-channelled out of them. This, however, is passed off as generosity and aid. The financial veil has to be pierced if we are to understand that it is our own dollars, which are, in effect, coming back as loans and grants and even as FDI and portfolio investment.

But, the merry-go-round continues because the developed countries have the institutions and instrumentalities that attract our investors and are "credible" as avenues of investments. It is no use grudging them this success, which they have attained through practice precedent and institutional innovation. Not for nothing do central banks of poorer countries invest in the securities available in New York. They will be questioned if they say they prefer to invest even in high-grade investment vehicles of the poorer countries.

There is no use bemoaning the state of affairs, which hands over the control of the world economy to its principal debtor. While the World Bank report on global development finance has many useful points of emphasis, it touches on this aspect of development only in passing when it says:

"Since 2000, the developing world has been a net exporter of capital to advanced economies. For developing countries as a whole, foreign exchange reserves rose about $276 billion in 2003 bringing about the total reserves to $1.227 billion, equivalent of nearly four times their short-term external debt. This underlines the strong financial interdependence between developed and developing countries. The interdependence, intensified in recent years, gives the developed world and developing economies a common interest in addressing macroeconomic imbalance."

Fine words these, but they do not break any bones. The reality of global financial architecture remains unchanged, immune to radical transformation in the relationships between the rich and the poor. One is inclined to reflect what is the use of gnashing our teeth at the inevitability of our resources being sucked up by the giant vacuum cleaner — the US? The Global Development Finance report, while it does not predictably address this critical issue of structural imbalance in the world as a whole, has, however, a few sensible suggestions for our countries to note.

First, it notes that the time has come when the monetary easing now observed in the US and other economies may come to an end. Already, points out the report, the Reserve Bank of Australia has increased interest rate. The US Federal Reserve has suggested that it is likely in time to return to a more neutral monetary stance though concerns persist about job creation.

Fiscal imbalances in high-income countries have widened every year since 2000. "Uncorrected fiscal balances could push real interest rate higher globally, potentially dampening capital flows to developing countries as the public sector in advanced economies compete with developing countries for global savings," incidentally for global savings, which belong to the latter countries themselves.

With this caveat, I must note that the Global Development Finance report has a few important suggestions — sensible ones — on infrastructure financing. In particular, it points out that the developing countries have to take steps to develop their own capital markets to sustain the contribution to infrastructure funding.

Indeed, in the context of large current account surpluses of poorer countries, the relevance of external aid for infrastructure projects — which mostly consists of dollar financing — may itself be in doubt. The answer to the problem lies not in seeking more and more foreign aid for infrastructure project, which translates into higher additions to forex reserve stock, but in developing appropriate capital market structures for the resources to flow to infrastructure projects from domestic institutions themselves.

True, this requires a radical restructuring of the way we invest our reserves. But, there is no harm in thinking through the mechanics of a dedicated investment vehicle set up by developing countries themselves, which can lend for infrastructure out of their own reserves.

Such an institution, if set up by China, India, Hong Kong, Singapore and Japan, can be an engine of growth. This, of course, will mean that the new institution will lend to or invest in infrastructure projects of the developing world with dollar-denominated funds.

This, in turn, raises the perennial question of a recycling of forex. It is dollars that will be lent to them, even if it be from the new institution. But at least it will avoid the complex route of going through IBRD and the New York financial markets. The problem is solvable at our own discretion. By all means, the new institution can draw on the technical expertise of the multilaterals. But the time has come for a third world Infrastructure Development Corporation, funded by the third world itself so that we stop funding the rich to fund us.