The World Bank’s annual report on capital flows to developing countries highlights two facts that shouldn’t be much of a surprise:
- Developing economies – the World Bank’s definitions leaves out the rich oil exporting economies in the Middle East – attracted record amounts of private capital in 2006. They attracted net private inflows of around $650b (see table 2.1).
- Developing economies also ran a large – over $350b – aggregate current account surplus.
The logical corollary of a 3% of GDP (aggregate) current account surplus and along with private capital inflows of between 5-6% of GDP is simple: the central banks of the developing world provided a record amount of financing to the US and Europe.
That is why reports that emphasize how private capital flows now trump official capital flows are incomplete. (Net) private capital flows to the emerging world are far larger than (net) official capital flows from the rich world to the emerging world. But (net) official capital outflows from the emerging world to the rich world are even bigger than (net) private capital flows into the emerging world.Here, there is no disagreement between the IMF and the World Bank. Once you adjust for differences in country coverage, the WEO data – see table 1.2 -- tells the same story. Big current account surplus and big (net) inflows of private capital.
Indeed, lots of countries are now attracting more money from abroad than they want. Colombia just joined Thailand in imposing capital controls. India and others are quietly making it a lot harder for banks to borrow from abroad …
I consequently think the answer to the question posed in Randy Kroszner’s recent speech, namely why does capital flow (on net) out of emerging economies is actually pretty simple: policy choices in emerging economies.
I don’t think – unlike some – it has much to do with private demand from savers in emerging economies for “safe” financial assets emerging market financial systems cannot supply. Rather emerging market governments with large commodity windfalls have opted to save a decent (though falling) chunk of that windfall offshore, and nearly every emerging market central banks is currently resisting pressure for their currencies to appreciate in a massive way. Right now, demand for “safe” US and European securities comes from governments, not private investors.
I have a second objection to the oft-made argument that private capital flows are now more important than official flows. The fact that emerging economies are unwilling to rely on private capital markets to finance current account deficit hardly represents a triumph of the market. Emerging economies – at least those outside the embrace of “Europe’s” institutional structure -- seem to have drawn two lessons from the crises of the 1990s.
- Massive reserves insure against the humiliation of turning to the IMF for financing – and the corresponding need to adopt the policies the IMF insists are necessary.
- And private capital markets cannot be trusted to finance ongoing current account deficits. Private markets provide tons of money at low cost when a country doesn’t need it (say when commodity prices are high), but very little money at very high costs when an emerging economy really does need it (say commodity prices are low). The easiest way to protect against “sudden stops” is not to need the money to begin with.
The irony: outside of South and Eastern Europe -- and a new small islands (New Zealand, Iceland) -- the big current account deficits in the world are generally financed by official flows, not private flows. The UK’s current account deficit is largely now financed by the growth of pound reserves. And the more I look at the data from q1 and April, the more convinced I am that the world’s central banks are now adding to their reserves at a stunning $1.2 trillion annual pace. Throw in another $100b from oil investment funds. Pick the fraction you think is going to the US …
I wonder if the US will eventually conclude that large external deficits financed by official flows are almost as risky – though in a different way – as emerging markets found large external deficits financed by private flows. So far, though, it has been almost all good – at least for those who don’t work in manufacturing.
Update: Stephen Roach is well worth reading today. He believes that China's problems stem in part from expectations associated with the end of the RMB peg that have made the RMB a one-way bet; I would argue that the "excess" domestic liquidity stems at least as much from the rise in China's trade and current account surplus, something that seems to me to be tightly tied to China's decision to basically keep a peg to the dollar with a modest pace of appreciation. But Roach no doubt is right to emphasize the growing internal challenges associated with rapid reserve growth, the counterpart to "official" financing of the US deficit.