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Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
Chapter 13
Balance of Payments, Developing-Country Debt, and the Macroeconomic Stabilization Controversy
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The Balance of Payments
• The current account: net flow of merchandise trade
• The capital account: net flow of financial capital
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The Balance of Payments
The current account:
• Exports (+)
• Imports (-)
• Investment income (+)
• Debt-service payments (-)
• Net remittances and transfers (+)
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The Balance of Payments
The capital account:
• Direct private investment (+)
• Foreign loans (+)
• Foreign assets of domestic banks (-)
• Resident capital outflow (-)
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The Balance of Payments
• The balance of payments position:– Surplus: inflows > outflows
– Deficit: outflows > inflows
• Consequence: – Surplus: increase in cash reserves account
– Deficit: decrease in cash reserves account
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Payments Balances on Current Account, 1980–2006 (billions of dollars)
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Consequences of BOP Deficit
• Reduce cash reserves account
• Inhabit imports: impose tariffs/quotas; foreign exchange devaluation
• Increase exports: foreign exchange devaluation
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Consequences of BOP Deficit
• Impose restrictive fiscal and monetary policy
– Reduce income expansion to lower import growth
– Reduce inflation for exports to compete internationally
• Attract direct foreign investment
• Receive a greater share of the IMF’s “paper gold” known as the Special Drawing Rights (SDRs)
• Increase external debt
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Third World Debt Crisis
• The accumulation of external debt Since early 1980s
• Allocation of a larger percentage of the GDP (from export earnings) to service external debt
• Scarcity of development funds: lack of investment in physical, human, and social capital
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Dimensions of the LDC Debt Burden, 1970–2008
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Severely Indebted Countries
• Large outstanding debt
• Debt as a large percentage of GDP and exports
• High debt service-to-GDP (or GNI) ratio
• High debt service-to-exports ratio
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External Debt Accumulation
Define Fn as the capital inflow (i.e., the amount of debt accumulation)
Fn = dD
D = total external debt
d = percentage increase in total external debt
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External Debt Accumulation
• Define BT as the basic transfer and r as average interest rate charged on external debt
BT = dD – rD = (d - r)D
- dD: external debt - rD: amortized debt - d>r: debt accumulation
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The Debt Crisis
• Rising d and d > r
• Switching from fixed, concessional rates to short-term, variable rates
• BOP deficits as LDCs’ commodity prices plummeted
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The Debt Crisis
• Global recession, reducing demand for LDC exports
• Lack of confidence in LDCs’ ability to repay foreign loans
• Substantial amount of capital flight from the LDCs
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Petrodollars and Third World Debt
The OPEC (i.e., Qatar, Saudi Arabia, Kuwait):• Exports oil to LDCs and MDCs
• Deposits some of their export earnings in Western banks
• Provides grants and interest-free loans to LDCs
Western Banks: • Lend petrodollars to LDCs
• Receive debt service payments from LDCs
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The Mechanics of Petrodollar Recycling
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The IMF Stabilization Policy
• Remove foreign exchange and import controls
• Use a floating foreign exchange rate
• Adopt stringent anti-inflationary policy– Increase interest rates– Reduce budget deficits – Control wage increases– Eliminate price subsidies
• Invite foreign investment and improve economic openness
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The IMF Stabilization Policy
Success in LDCs:
• Reduce inflation
• Improve balance of payments
• Eliminate parallel exchange rates
• Improve economic efficiency
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The IMF Stabilization Policy
Failure in LDCs:
• Double standards – Harsh adjustments for the LDCs
– No adjustment for the MDCs
• Lending agencies– Agents of international capitalism
– Increase LDC dependence and poverty
– Prefer short-term to long-term developmental loans
– Provide funds for corrupt LDC governments
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Global Dimensions of LDC Debt
• Restructuring of short-term to long-term loans
• Debt forgiveness to selected LDCs if they continue to use IMF stabilization policy
• Debt-for-equity swap: banks exchange loans for ownership of domestic industries
• Debt-for-nature swap: MDC government forgive loans if LDCs invest in preserving the environment
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Has the Debt Crisis Disappeared?
No! Debt crisis is just postponed!
• LDCs continue to borrow
• LDCs continue to make large debt service payments
• In addition to the severely indebted LDCs, countries in Africa are greatly dependent on external debt
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