Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 13 Balance of Payments, Developing-Country Debt, and the Macroeconomic Stabilization

Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

Chapter 13

Balance of Payments, Developing-Country Debt, and the Macroeconomic Stabilization Controversy

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 13-2

The Balance of Payments

• The current account: net flow of merchandise trade

• The capital account: net flow of financial capital



The current account:

• Exports (+)

• Imports (-)

• Investment income (+)

• Debt-service payments (-)

• Net remittances and transfers (+)



The capital account:

• Direct private investment (+)

• Foreign loans (+)

• Foreign assets of domestic banks (-)

• Resident capital outflow (-)





• The balance of payments position:– Surplus: inflows > outflows

– Deficit: outflows > inflows

• Consequence: – Surplus: increase in cash reserves account

– Deficit: decrease in cash reserves account


Payments Balances on Current Account, 1980–2006 (billions of dollars)


Consequences of BOP Deficit

• Reduce cash reserves account

• Inhabit imports: impose tariffs/quotas; foreign exchange devaluation

• Increase exports: foreign exchange devaluation


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


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


Dimensions of the LDC Debt Burden, 1970–2008


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



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


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


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


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


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


The Mechanics of Petrodollar Recycling


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



Success in LDCs:

• Reduce inflation

• Improve balance of payments

• Eliminate parallel exchange rates

• Improve economic efficiency



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


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


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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Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 13 Balance of Payments, Developing-Country Debt, and the Macroeconomic Stabilization