The foreign exchange crisis

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UNIT~D Ni.TICNS

AFRICAf.i IPJSTITUTE FOR XONOI<HC

D!:!:VELOPf<~EMT J.flD PLùfJPIING

THE FOREIGN EXCHANGE CRISIS.

Extract From THE DEBT TRA.F

The IhF and the Third World.

By

CHERYL FùYER.

0

112.

REPRODUCTIOI'l/ 019/79

MAY 1!:79.

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t

•

REPRODUCTION/019/79

Page 1

1

. THE FCREIGN EXCrJ.NGE Ô1ISIS.

All· nations· to:· trade wL'th other nations. They-may nee.d to Jmport food, _.• _.

;either ~toitc'bver. a harvest short.h .11 and avert a famine or to ma~e up- a defict t c'aUsedt

: by·

'the~'fact tha_t , tho-ir'•re~ources a.re d~voted to produc}.ng commoài:ties otb'er th'a'i:Lfood. They' may want tl'gricult~ral products that C[lll1.i1bt ..

lJ,e_

gro+•Jn w:i. thin 'thei'r. cou.n;try,' ·or minerais wh.'ich are not found there. '.Third World ¹ countri-e·s. ~- the subj'ect of . this ·book .... want to import capital goo . .ds anü .

·GOphistüiat'éd t-e'c):melog. ès· in~ '.order- to . raise. their own l.evel of pro::.\ucti.or:.

and 1eel a ~~r~~f the modern_worid. Their rich citizens wa~t ta lmport

luxurie~ which other nations produce.

. .· .• . . • . , ~ E. ~ . ..

Sorn-e itéms iQ ·thiS. list ,fill genuine neecis; others, like the luxury 'goods; may represent an pbvious waste of .scarce resources. Capi tai. goo_ds .. and

s<5phisticated technologies -may seem necessary imports to a country _. _c. _. th~t_. ::--... ;:....

wants td· ·industrialize; but. on the other. hand they .might. not be n~cesfijary if

' .. ' . '' '! f. '

the ·country reàrranged · i ts pr:lo_roit:\·JE!s o;r mo bi lJ .ized i ts own resc;• • • mrces more • ';•

effectively• It is important not.to confuse th~ desire fqr foreign .g9ods, or ^eve~the ^e~onomicdemand f~r them~ wit~ a genuine need. Vhatever a nation imports, how~ver, whether lu~ury or necessity_(unless obt~ined through a 'b~rter' or. 'bilateral' agreement w.ith one other nation); must be pa,id for with i.riter- nationally accepta:b~e ·'lloney., or_, at i t is commonly called1. for-ei:~n êJ[ebange ..

·In a capi talist economy, individuals and fit·ms b.1JY foreign ^exchang~

WÎ th their OWn CUÏ'r'ency for the tr.ansactions Which they \"lÏSh tc Carry. 01Jt

wi th foreigne-rs.-. The. priee. )V'h:ich they have to pay for-i t is ... the 'i!XChaQge rate.

Un der the so ... call·ed- 'Br~t·ton ;Wopds system'* gover.nrnents ··~;tre&)lppoped to. -~~Jel"'lilrie

·' .· : . . ^-~ ^.

the exchange rate for. the ir own ~ational currencies b;r oet·Üng __ ito vn~!Je. Ip .term~

- t "'.: •.

of gol~'f but in prac.ti.ce th.e· exchange rate is: usu~lly_ q~oteliin t1?.P<,_~s· ,. The

*

At the_ time

of~riting

this. had brol,(en down,- due to the

in~bility·o~-

the - major capit~list nations to keep thetr' ~urièrtcie~ steady~agnin~t ~~e ·anothér.

See the final chapter on the implications of this for the Third World.~ .

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Reproduction/019/79 Page 2

government is expected tc ¹<:i~fend '. .. --~~~~ __ C:~~~ar:ge -~_a~~- by:·making up the

difference between the ^de^~^a^n~for· ^an^~the supply of foreign exchange at that iexch.àng~ tate.

Tb.é'

sUpply of fôÏ'oig~ . cxéharige is determined

by

what ··tlle

'

'country is earning from its exports or rèceivitig iri the 'form of loans·; gi fts,

and ,i~vèstt:ients; •:'"~the ·. clêr.J~nd is ·determine·d by wha t people are ·wi lling· to

pec y

for

import~

/ o r-

s en~

out

br t t6

country as

inv~stinent

incbine or· capital f'Hght. Usuall·y·· sup,pl'y:' e.nri':dear.and are nol in ôxact bel~ nee at th-e given exchang~

ra te; ~_lien t'h:0 gôvie~~mcmt l't'as :nak~ up t'he ' diffe~ence

by

i ts'él f huying &r· · ·. · ··

seLÜng., i te.· O\<-in cu'r:r~nèy 'fe~ f~relg~ ·'exdhangë in order''to·lttaintain\ i'ts v·e.:l ùe •

.-.. ..

If the cupply and d.emand of foreign exchange at the offic-ial exc-hGnge

·,' ~-·. . '· . . . -:. .• '_.; .. ·. :> l .-<:

rate is persL:tently out of b""lance, the go'verament ¹s buying or sel ling

oper~:i'lo:Js

^i;^{; i l l}

< d~cdun:t'er

·se.ribué difficul tïe's'.

l'ri'

th'e

·câ~e

of persistent

d'~r1~ftf5·

iri

'trù? ,·baJ~n~=€; · · B r

paYJll'cnts:, \vhich is

th'~

problcm'

· we

are conc'er..ned

,~r i

^th

in

thi~ b~~k· ,' 'th~ gov~rn'rri~ri:'t • · s

ô\-/n'^h61Jdings ôf^fore'ign êxchange^·⁽^ft·^s ^re^&^êrv^cc⁾

:;11·: h~ -- ~~~'Aüs tec 1 ^by

^the^pere.^nnial·neccssi ty :to'

suppl;)~ ^the ^-'gaJi ^by

^whte'h

dema~'à· r6'r . {oreigh ùJ~chd~ge' eie'e:eds·

the

s~pp.ty,. '"rhfs is tlîe sftùatiori-~Jhic:h

. - .,_

~- .;

.. ' . ' ; ... / . . . ~ ~-) ". ~ --~- . ·. '!

1 .. :

1 Chronic fol.'~ign . exchangE;, Je:f.ic_:i ts and balance of payments cri sis e.re

·:::-~ •. - . ''!' ;:._ .. _-. . ·"';:· . . ·~:·· . . "'::•'· .· -:~h ~· · . . · . '•':...; ~-; ~·,.· ·-.:~· f . .•

,.c;:,l1ara,ct€_:r:iptic. ^q^:(: those ,countrü:n of the Third !c'orld that are tryfng to

.:...;· ... -- '· '! ' : ,-~ .• ·-.. ·-:: ~- :! ' :: ~-:~.; ·' ~.. ' ·: ~ . .-:: .. -~~-. -~ ~--· 1· • l .. , . . . : :·

d~,V.~l:OJJ .. ~I),d~,r ,._Ç,~;P,.~taliE>;~ aus..f:ices.. (The oïl-rich countries of the P.1iddle

·::···· r.r~ ·········~ ... ~'1·q••~T· .;: :,:~·:':'-:/ ~.,ti;.'•!· ^;^l ^. -;~ t' ^. ~· ^. ^t ^'"'

East ar~ an obvious ·excepticin). The factors contributing to their idiei~n

exchang'~ \;~ak~'es ~6~ ate

^coin'plex^·b^{ut ·can}

- P~~b~bly- ·

be S'ummëd -'up-:by • the

-~poli

ti cal and econorltic weakness~s ·~f

th.;f5e

è'o~ritries~· considèred-individually ,: .vis..:à..;.vir·

...• :,:/' ·. ~.:.· ••• ,,1 • ':·.·-~. · : . •• ,. ~ • ·., • • 0

·:::::t'hG ·(!:ev:è-lo'ped · ce.p'i talist 'nations artd the ir •muJ ti national ¹ corp·6rà ti ons.; :- ·

·;-: : ;;•.t-ei-t~i11Iy ,hicihl~Y~d~~:lop~d. c'~pf taÜ~t-

ne.

^{i i}

ons,

no'tâlHy: the· United StatêE -P;ond ,

: .. : \ .

:B :~i ta'in· , '' - mar ^~al.\~~ -~Jû~ ~hr6ni~ b~liinc~

o

:r •

payménté dëficits

ar.tl'·

have·:

rntcrr~ti tt c-n1

curr~nhiy. c'rises. tfhile ·. s·ome und~rd~vëloped côuntries, 'such

as_ ..

the rn~.) cr oil- exportin~ c:o~nt,ri_0s,: have . large foreign e:X~'hange" sui'p~u·s·et'f~--- ·•:nre~·g-eJrnrirl--1-n-i-e

~ · .. . ·• : . • • •. 1' •. ·.• •• · • ·\·~· {, -' ••. ·' ·:::--··.' ",:: (.,;_.y·, ': . • : ' . r" . ~ ... . • . . ;.:, •,

ho].de . truc, bo.wcvep,, , t.hél..t. poo_r ,cpuqt,ries .·are . cha-racterized by _foreign ,,exch~n~;c

. ^. . . , .. ' ' ' . . . . .,. ...... ' _;

shorta~eso ^'·^•'

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''

REn~cnucr::·IcN/C19/79 Page 3

... ·

·.· ;;;:•····

This situation has evolved historically since the en< of the Second

':lorld ~~r~ ; l)uri,ng .the war, t~e maiQ co_.rnbata,nts, which wer,e e.lso the most highlJ develope_d .. cnri talist countrieo, .cons~ed ~;:wre than they pror~uce;,..~·They bad few: partr,

" : ·: :· ~ : ; . .': __ .. : -··. ···--_: .. ____ ·,. .. -..... : r __ ,,· '. - . :... . . . : ; ··- . . "' ,. ~ .

to sell to their

fr p:di

tiè.f1ai.-·màrk.ets

:in

Asia, ;:.frica, and Lat in :~m.eri.ca;, but

. . . . : : ' . . : .... :.: • ··~ /1 ;· '.~ . ' . . : . . '

the ir need for import!' from _them was ^hi~h. ùt . the end of the uz.r , , as ^2. resul t.t many of these cpuntries (most of them at that ,time still colonios) held huge

. •. . . . l ' . ..:. . : .

reserves - claims .on, the future productio,n Pf. the .industriel states .whi,ch had fough~ the, war~

These.reserves were soon dissipated• .In ma:ny cases, th:e former colonial power i.mppse.d restrictions on the use of these reserves, us1ùd1y' as part ·of · the priee,: of poli tic.al independence;.· · Despi te· this. exterhal constrain(, most of the newly independent ex-colonies and the Latin American nation&wer~ · ··

.,fag~r( to sRend }~eir r,e~er.yef>i ?n a, flo,c;>4 of i,mports •.. M9st cf the~, although paying li~: ~~rvi_~e to, t.he desire,, for. eçonomi~ developmep:t, . had a .crimina.L

\_t· .. , . . _,... . _. ·: . . •

ignorance or indifferenc~ to ttte ~mportfince of for.eigll. exchange for r1evelopwent •.

~- " . ~ : •• : : .• •.. . • • ' • ' ~ : . . . • 1 1 • • •

Their reserves were dissiJ?ated with,i.n two 9r tJ;tree. ye_ars.

. . ' . ' . . ·. ~ . !

. if ·,

1 • .Sorne. other, Ço~n·tri ès ,_, ·In·Pia: and Yugoslavia are exampl~s from this :• book' -

pait.1 much more ·Sêf.'iOUS:' attention to ecotlontic rlevelbpment from the starti and

were :not guilty of· the ~onsumer s~enBing -spree ind~lged in by·couht~i~~ ~~ch

as Brazil · ànd t~e Philippines~ ·They were; · h<in>Tever, convinced · that heavy impQrt:surpluses- more import~ than could ~e p~id for b~ expbrt ~afninks.

'JJore essen ti al to the ir .. develppment efforts; so that ?• very much. like th~ spend- thrift nations, they firs~,,ran dçwn tt1-eir, r,~s~rve~ ;and then ran up fo,r-eign ùebts. ^{~or ~ost}of these countries, by the late 1950s.their foreign ^excha~ge reserves bad been used u.p, .and repayments of interest .an:drp~~n,ç·~·.P~a,l J >e,gan t.o,.~' . fnll due from tbe b?rrowing w~ich~~ad begun ea~lier, in the decade.

1

.-.'·-.!

,·.,

... ·.' : : : :'

::.\

·.· ... ^·. ^'^·.

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REPRCDUCTICN/019/79

Page 4.

HOW TO READ f.t. BAV:..NCE OF P.4n1ENTS TLBLE

·'i. Cn the nexf page a 'balanc·e of paymeilts table fer Rrazil in 1969 is

.·, · prés~ntecl, ·:~hi~'tt·

i"s

adapted' f~o~ the Balan~e·· of Pay~ents

Y

c.arbcok .. publishe'd by IFF.

rt i~

im·por'tant to u'nrlerstarid tne

p~i.ciple

behind the presentation of balàncè of 'payments figures.. This is· \~ot becau~e this brief expl"':n.?.tion will

-

^.

enable one to· interptet actUal tables; the figures can only be-ibtcrnrcted with any accuracy b~ spe~ialists wo~king with much m6~e detnile·- hrcekdowns than are found even in the HW yearbooks. Understanding ho~--" tc1 read a balance cf payment-s table, hcwever-; can give us a··g6od idea -of the categories which

contrib~te to a ilation's capacity to 'eatn or attract foreign exchange, aild

those .wh~ch·:r-epresent the' expenditure or drain on its carnings'and holdings of exchange. ..

,

, .

Furthet-, :by unèerstandirtg 'tllë metbod of double-entry book-kecpin&; which is uBed. in balance of paY'ménts tabies, one becÔmes e.ware of the aèco~ntiilg

,, principle 'tJhich is. âlsb an' economie fact. of l i fe: a nation can spend orily

' . .

as much as· the total which it can earn, bo~row, or receiv

.

e as gifts, o~ has saved (as reserves):from past eàrning$. Since gifts ('~nrcquited transfers' in b_alance of paym~ntts terminology) from a very, tiny proportion of mos't . countries' incarne, 'almost .all of a .country's imports will have to bè paid for by the export ot real ~oods ,nd services• either in the ptèèdnt, by 'ctitrent account' -~earnings; ·or in the future; t6 pay off 'èapi Ü.l account ¹ .borrowing.

· Iri thl~·ilitisirattoni !hoth thè double tol~~~ (debit -~n0 ^ctc^d^{ii) s}^ystem and

thesi~gle

column

(n~t ~tim) p~~~enta~i~~s

are shown

s i ~e

^b^y sidc;

althoug~·~o~i ~~tual tables will u~e either¹~n~ ^{or the}^'ôther^. Th~re â^rê advantnies to~

eaêh type

^a·^the d~uble column system allows one to sec the

absolute magnit~d~ of the econ~~ic and fina~ciai : t~ansac~i~n which are entered in the balance of payments; while the single column system provides

. ··. :

a quick summary of which items are in surplus or deficit. In the illustration ( to anticipa te for a moment our discussion of incH vi dual items) the right- hand single column shows us that Brazil bad a deficit of r;oods and services in 1969 of $367 million, despite a surplus on merchandise tra~e of $318

million. Every single item in the ¹serwices¹ category (numbers 3-8) was in deficit, with the largest outflow by far due to 'invest.ent income'~

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..

'

BRAZIL₁ 1969

Goc-ds and services 1. Merchanèlise

2. '· Non-monetary gold.

3. Freight and insurance merchandisc

4. Other transportation 5. Travel

6. Investment income 7. Cther e;overnment 8. Other priva te

UNREQUITED T~J~I,!SFZR

9. Private 10. Government

on

Capital (excluding reserves and rèlatell items)

Non-monetary sectors 11. Direct investment

12. Other priva te long-term 13. Other priva te short-term 14. Local government

15. Central goverrnment MO.NET.ARY ~ECTCiiS

16. Private institutions 17. Central bP.,nk

NET ERRCP..S .f.,.Jm CVIS3ICf'!f.l

Double column presentation

Credit

2,601 2,311

66

65 28 :?2

28 81

83 61 2?

1,519 1,321 218

~26

134 24 419

198 192 6 15

4,?18

REPRODUCTION/019/7S Page 5

(in million $'s) Single column

presentr,,_tio'

Debit

2,968 -~~67

1,993 318

119 -53

151 -86

77

- --* 9

366 -344

92 -64

170 -89

52 :"51

47 1<?,

5 17

697 8??.

473 848

11 ?07

200 326

3 131

;:.4

259 160

?2.4 -2G

9 183

215 -?.09

481 -466

20

- ::w

4,218

c

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• iiEPi10DUCTICH/019/79

Erazil received a net flow of $31 million in unrequited transfers - less than

one-t~nth of the dèfièl. t t'O be covèrèd :on goods p,nd s"erv:ices.. '.!'.he -car.,i.~al item;

ho~<!ever;: sh~w~· a.t huge inflow of -invéstl!'ent frôm abroad, ~nouch ^,.to. covc:r _th.e en tire goods and :s~rvices def'ic'i t arid aHow the acc.urnula t iN1 of

the·· amount ~-f

·

$46'6 ''mfllion. '.,:

·' :

.more

. .

X~es~ gr~ss figures are instructive but in mâily respécts

. . · .. ,. 1 . ' . .·, -. ; . : • . . . . ,.

t~an they rev~al. A closer look at the various com~one~t . . . ,. . . ' . ^~^·

they ·:conceal

i te ms ,

^an^d

some. e~planation of what.they in~iude ri~ ~xcltide~ will bè riséfui; tirst, · however, i t is time to gi ve a

fo~~l

déflhi

ti Jn

of' the ¹balânce of. paytnents 1 • .d.~~ording to a publication of the If."F. ^.^-~....

·.' :~

'J.'he balance ()f payments i~ ~ systein ür·accôunts ëovërting a:~iven period that is: inteildei:l to record system&tically· C<;>,)· flows _ oL re~l resources•, .includ.fng ~the servi.ces. of the original factors of

produ~tion,' between the ^dorne^stic econo~y of ^f.'_^"country an-.d' the rest of the worid, (b) changes in' the ·country ¹

s

·foreJgn, f.\S~ets- ~n;tl

liabiliti.es th-a-t: aris~ ·frolll economie_ .transactions, an(J_ (c) requited

transfe~s, which are the co~nterpart of ~eal ~esou~c~s- or fihancial . ci.a'ims ·p-r!ivi ded to ~ or -recei ved from, the -rest ^lo^f :-the: l''orld ,wi tho~t

re.qui-tal·. · -~ . . · . .. . . · . . , . _ _ ·

The ''bdia-ncè' df payments ·:re·côrrls transactions .be.t-ween rosi. dents of . the.

cou~iry anâ' th~ rest ~f the world, ':so i t is important to unàerstand the

definiiio.,; of.'residenti. ·The Brazilian subsidia.ry .of e. ,US-baser),m~~tinational

' . ' . . ·.. ~

corporatiOn

ià

·considered a resider1t df Brazil ;for :balance of J?aY!lJents purposes.

Ther~fbr~, goods frilported by the 'Subsidiary from its parent cm'\}pany, ,and.

thê~pa~ent,-mad~ fl:lr i t~ iii entered in the balance of p~yments, but if the_

. ' ·.:t•_;.·,, .

subsi ~iary borrows money fron'!' 'a Brazilian' bank this is--not • . Foreign embt,lSSies, consulates, and military eétablishmènts are-,. however; not considere. ^. d^._ 'residents• .

~f the côùntry in ·which theY' are situated, and the transactiops betwe.en the'!l an·d the local ·economy are ënt~red ·in-Jthé balance ùf payt:~ents (Une 7 .in the :lllustrationl'.

:.-: ...

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PE!"... r. J...PCD.. . , !T.f''i'<.J <..../ ·'· nn·_ ... - r·,l/0 10!/'79 ._~ ...

Page 7.

;,· Thé first large .c~tegory, •goods and services', represents the trc:n5fCr

-~·· •. ·.' ~--:• ·. -. . -..

for real r.eeourc_es bet~een residents of Brazil a.nd the · r~'st b~f the \vorld during the period covered by the table. It records these tr~nsfers at the priees actually charged, which of course does not touch t he questirn ôf \'Jhether thc_se priceo were by any defini ti on fair and equitable~ ''fra:de in merchanàise experts

a~d

'importe (credita au'd 'debits res pee ti vely) is h:y f.;>.r the h .rgcèt item in the bS:lance of payir.erlts of most countr'ï es. From· the' tf!_bl·a we can ce1CL1la te t~at 'nrazil exported in '1969 about ' 15 'per cent 'more in :nerchan(if.'<: tJ_ic.-n i t imported. '

Line

2,

non~rnonetary gold, is a c~tegory reserved for gold that is-mined within a country for_. _{_.} :expdri o~ addition td reserves; i t is not _.._. applicable in this case.· Ite~s 3-8 tomprise the '•ervicest ~ategory, in which Brazil is

' ' ~

heavily in deficit • . Lille:,

3_,

freight and insure.nce charges, io closely rela:ted

tb

merchandisetracte. This· item has occa~ion~d- _bitter ôeba:tè<: b~h1een poor

; ;

and· rich countrie~, sine~ the poor c6untries accuse the rich of monopolizing

.

• " .

~~e supply of these necessari services an~- char~ing artifici~lly high priees,

~~<&r'f;ic ulerJy

for shipping. 2

Other transportation, line 4, comprises mainly

. ' .

payments mad~

tor

^the^~se

of

^po~t^and ^navig^a^tion faciliti~s ir6m one country

to -anpther. ]:.in~- 5, travel, _inc,ludes touri'sni which in some countries, s'uch ·

Ds Yugq,slavi_a, may be an important

sur~l: ~s

^item·^. Fo·; most Th.ir(l Worl-d '.countries • .

. . '

however, . to,urism, receipts _are more than offs-et by the bùsi~>eso nnd study

expenses.of their

qwn . nat~onals

^abroad.

rithe~ ' govcrn~~nt,

^l{n^e ^7,·as mentioned

• ~ • • ·. .. l ·• • • • •< .·· . ,: • - ·;~ ·. .

ab,o.ve . .inclu~cs . embas~y an~: consular expendi ture-a, ··but espeéially the .unk~ep· of ~arge.,, military missions an~ ba~es abroad. For ~razil thi~ is

. . ~ . . ^. ~ ·. . : ^'' . .

a ~eficit i~em, in~içating the. absence o~\any large f6reign military presence;

but for Viet!lam and ~h~,Philip.J?ine~· th_is· would be a large surplus cat~coryo

Line· 8, ether private services, ·is a m~sc~llan~ous category. The ca~nings of

migrant workers abroad, which is quite and important surplus item for - · Yugoslavia, would be entered here.

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• /

•

'

REP;:WD\JC TI0N/019/7H

Page 8.

Investm~nt in~~L~e, __ line 6 1 ^deserves rather more extensive discus~ion

•, ·· ! . ' ·.,_· ; .• • • ' • !

for at. laaei ^.^t'rJo ,ren$om>. The first ie. that since investment i tself ·is

'f. _;. · . .. . : . . ·.:

. . ^{' \}

listed elG~~C·Jh<~i:'o

, !

^.in ^th^e ^c^;~^~'ⁱ^{te.J r.:.}^ccount, ^{i t}^.might seem reasorlable to includè

~ - -.. • '''-: . t.

investment inco~~ . (profi ts_o n -t:liJ;ect in~e~~n:ent and interest on intern-~:~~onèl a~. l!J::di • . The Ifvil'i' bas decreed, however, · tnàt "

loans) in th~ capital ~ccount

.. · . . ·1., r . the supply of ce.pi tal , is a service, anf1 th:lt profits and interest paymûiits should. be leei:tü;izec;l as e>. chaTge for this service. This has a practical significance:. l'!hen .a country accepts the obligatio~s set by· the H1F for .,

maintaining:the covert~~ility of its currency, i t agrees to pui no restri~~idns on

cur~e~t ~ ~cc, cunt

^paymentso^•^{. F}^:laci[l^g invest;;Jent income firmly in

th~ .·

¹

~q~d~

and services' sec t ien of the b&lence of payments enDures that re~trictions on

~~yment·~ ' t~ ,f~:;~i ~n

i;t!vestors cr:-.nnot leg'i timately be imposed

und~r

^ÏlW^rul^es^,

· ··: ··. ·).: :·:.:;:t~~:~7--:·:!~~ :~.·;i.fr. -·~-; .. ·. · . :-· .. -· .. · -_· - ·· .:

while i~s iriclu~ion in the capit~l ~ccourit ~ould allow them.* :.4hoth~r ~oint

to r~member about this 'cë.tei:;ory is that the amount listed aÉ3 · investment iiicome

·;·-~::_· ·::.-'.:'~:·;:.·~:: ... r,~ ·;. ·_._·.-., : ·. . - . ¹ ^•

includes

i l l

^'income 'earned on direct investment; whether itifl. rèphtrinted to thE:

country • .

-R~h1veotéd. i~cor.1c i~ .

^Iu'mped together wi th

n!~.W:5.''investoc:t". t

^iil^'the

capital nccount section of the balnnce "of p~yments~ ^.,

* Al thoug~,, this may corne as a st!rprise to many economîsts~-

it

is clèarly the sel,l_se.of this r~ragra.ph from <m. official Funà publiçation: . . 'The treatment that mÙf.;t be acb'ordeà income froni investmé'nt, or depreciation

b'r

aniortization

of

iin

inv~~tftt"ëent','i.¹f:HW re,ised

: - ,-fhe·

fl.Uê'stf~n ~n practice that may. indic~te-.why.

the ,drafc:'tero 0f ^t ^t ^c^·^.}.<'_^und.?tsrçe;::ent. specifi~ally included inte~est and net · · income as payments for ê~r.~·r'3'n.'t t ransactfons. Sinèe a ·niember co·untry }~:·.fr.eé to ré'gul'ate' capital movements :e.nd may attach c.ondi tions to the in f-low. of. capital, i t bas sornetimes bcen aAsumed that i t may, as a capital control measure, ~lco require thé investor t~ Ior~go the rep~triation 6f incdme~

aÔiortiÙî-tioiii, or. der reèia ti on · ^1.?\S a con(H ti on .of permi tting . the cap~ tal .. inflo'!tr.

This is not r:;o as the term$ of ilrticle VI, Section 3 make clear. Stich

a. · , .. ·.

requirement ~1ToÜlû clearly

be

~ restriction on the makirtg of payments' for' current transactions and accorèingly prohibite~ under the Fund agreement.' (James G. Evans, 'Current and Capital Transactions~ How the Fund Defines Them •·, Finance and Development, September 1968, p. 34.)

(10)

f~EPY?.CDUC TI ON/0 19/79 Page 9.

Another rcaeon for paying particular attention to investment income is the shee~ ^{si;z.e c}^f ü{i~ ^C^R^tegory ⁱⁿ th~ bu lance o"f .payments of most Third

. •. ·. . ^.

• ..

\forlè ,.coun·:~!'ies~· \'Iher.-: i t shoùld be more ace ;re.tely 'tenned investment paym(mts, . sirice the income [,~o~s ^t^o ^othercountries.: In Erazil in 1969 this category :.

.

accounted fer an o~tflow of $3~1 million~ which more than offs~t the country's

. . . 1

Thd drafn on poor countries¹ internatiortal · resèrlref: ~,:hich ·imrest"1e'nt pe.ymcnts rcpresénts cornes out even more strongly when a 'global' balance of 'p.!2ym(·nts is prepared for all 'l'hird \iorid· countrü :s ..

'. . !

ùngus Maà'd:ison,

.· ~~h o '~;·repare d

^a

s~~mary

balance of all Third

~lor

^id

co'ü~tries

for 1963,. founc1

t b~t imreslm ~nt pi·.'ymen'ts represe~ted Ù1ê

^largest

indf~i du.ril ·

deficit i~em, amo~~t:i.ng' to: a total of t5.tir billion• for thàt one year.3.

.... ^;.. : . _,.'' ^,^.

Curre~t :J.ccount tré'.nsactions recorcl the transfer C?f real resources - pood t

s

and service$~ - ~the t have takcm place during the period. covered .. 'll;be crapititJl ne-c

J • . . 1 • • • . • • ' ,. . ' • -

includes all items whic~ .will giverise to transfers of.real resources in

·.;ip·,.

the fpt~r~, after.the Qeriqd covered by the . t~ble itself •

• • 1, • • • • • • • •

Ano:th'er way

of .sayin~ ;the sam .. ~ , Ul'i~gc ⁱ i~ t hB.t this

. . . . . ' '·' .

ce..tegor:y ind.icates chan~è·s· 'in. th~ · .

. ^~ . ' '

. ^.

^. ⁾^.

debtor or credi tor position. The net

.- _, .... . . ' 1 ; 1 :·· 1• '.' • 1 '

capital account in~icates that Brazil incurred

countr ,inflow ~:f $822 million on

~ebts ' t~ ·f oreigne~s·

^to

th~J;·

amount during 1~69.

' ..

~lost Thi~d ^liô^rl^:i ^coû^ntriê^{s a}^rê: ^hèav:j.ly ⁱⁿ^debt~lready,. and theîr débtor po~iticp Ce~pens e~ch ye~r~ ·Whether thi~ i~

or

is not a gôod thi~g~ depe~dS on . fnctors _1'!hich one: ~annot reD.d in a balance Of payments table;

part~cularly~ whether the bC.rrowect money is being invested in enterprise~

which_! . _.will enable· ti'H~ _.country

to

^p^ay ^back ^the ^1ebt^as

ⁱ

^t ^falls ^due~. ^~The

subc~tegoriee of t '7e ca.pi tal accouht in. ·the balance of .payments. can ~ug~es;t; . only a· l i ttle about thp rate at whl.ch repaym_ent will Jall due.

.. ^·,·^{~ ~}. \

. ! ~

r. _'_:.

' .

(11)

\

"

..

_,

fceproduction/019/79 Page 10.

Line 11, direct investmentt refers· 'tO ·the acquis,;i tion or.' installation by foreigners of factories and. bu'sïilesSes in· Brazii-in the expectédion of

earning profitE;; in futur~. years~ . J-i ne. 14, prrl- vat9, long-terr:, re fers .. ,tc loans with maturities of more than. one. year, while short:-term c!lri tal has. na.turities of less than one year,. e!'g. trade; credits. If a large. pro pc rti on of d_ebt __ is held in short-term liab~lities this leave~_ a cocntry suscept ible to_a sudden reversai of capital flow, _. _. which _. caus.es. _" _'• . a .balance of : :· ,. payments . crü-:i.s ( t~w

1h_ot rnoney' phenomenon). In 1969 Bra~il 's: short-.term borrowi:-:.ç ':<as . r.w ... 'lest

compa~e~with the inflow_of l~ng~~erm and direct invest~ent, ~ut

·• . ... .... ·- ;in following

years short-term borrowing increased sharply while the ot~er two categories _. _{. .}

) .

declined- a fact which indicates possible danger to Brazil's current boom ( see· 'chapter Severi) ... : Lïri'e

l4 ..

local ~o'v.er~t!Îeht ( forei~n) b~r~owin.g ~'·' i.'s

a relatively srnaÙ. item;; i:ine 15 is where the official loans, usual·ly called

!foreign aid, w'ould be

ent~~ed.

•.• t

..

.

^.

.

^..^.;^·^.,;

.•. :.:' .: r .; 1; •• Jh-~ P'f>f1.";.~~~y; ;;~·~·f.t,o~~~-~;··~~~ t:~:?o~rr .~i ~~~ i ~h:: .,C:,~.~.n.~e~ .. ~~ _in.v:estment po si ti on of _privat~: b~nks an,d ~!te C~n.trel B~nk, respec.~ively. These ~rans~ctipns

•

are

separ~ted, from tho~e of the 'npn ... mopetary' se,ct?r befause .almost. al,l Central

Bank transactions, and _. _; _. ~pme-t;'im~:s tho.se of the priv?.te banks, are undertaken .. in

~ . . . ^. . . ^. ^. . . .

order. to· finance the ba~e\nce of pa~ent.s ,i,te!TJS .already discussed. ;rn ether

.• '•· .

words, these are. 'accommodating' or ¹compensato~y' ~apital ~ovement~. ~hich

. : .· ^.·. :· ··;·. : '· .. . . .

take _{,.. .}place_._' _._.._.solel~ _. to flll the gap_ _.in ₍_'.demand _{. . .} _! and_.·_{. .} . supply _. _{. .} left b_.y the _'o~her _'

transactions _. • . . In the sarne. lrl.ay, chang.e,s in national reserves <>.lso finance

~ . . . . . : ! . . . . ~ . . . the gap

1

u~tween supply and deman~.Jor ,fo . .reign,,exchange • .• ,In the balance of pa;ymen.ts ...

~ • • • 1

1:'.11 increa.se case in reserves is en.tered as ~ _debit, or 1.rith P. m.in:us sign, while

. • . . ' • . ' ! . f· . .

decrease •re entered as credits. This is confusing unless o_nc. conceptu.alizes .. ~ :.

the reserves as something external to the balance of paY!!ler.t:;: itself, into which ail surplus must

be

^_Pai;^d ⁱⁿ^a manne.r: anai:ogous tü' a lean 'tc a' fb~eigner,

e.nd from whi"Ch money ·t~ · financ~ :defi'cits may b:e· drS:wn (:the balance of :payments

: : ; • ~ ' ,. • • : • : ' : • • • • ·: ; . ~ . 1 • ~ . \ ' : .. •. • ' • . ·• • •

f!oes not!giy~ the .. si.:~w.of.- th~ ~e~~_rv;e~, but o·n~y.the .net¹cha_>~çe for ·th.e period covered) .··~·The f-ac't :the.t- many ·Third ·World countries ac·tual. keep. thei:r re-

serves .. i-n London

or

^New

Yor~

^s,ho.^U.l.^{d majie_}^,i,t ^.easier·

to ·

vl.suaÎÎ.ze. ^Fro'r.~^· the

'•

11able' i.'t

cân

'bé s·een that· in 1969 the large inflo'w. of capi·tal t o the non- monetary sectors and to prfvat:e'.bank~ was abl'e

t'6;

_• r'i'llance ·_. _{i .,} (a) the deficit on _. goods and services; (b) a fairly large debit item for central bank capital

(12)

Reproducticn/019/79 Page i1.

trànsa~Üons. (linè t7) which tlrobably represents repaYment

of

~Hl borrowings and (c) an inc~éase iri re~er~é• 6f $466 million.

'Net erroi-s ·

~~d o~issions

¹

is~

^·^a^'^standard

b~ok-keepi r.t-::'

^èc·ri.èe ^r^c^q^ui^r^e^d

.. \ .

b~. the principle that credi ~s must equai debits in the tcto.l 'hala;-; cc of·

Pa.yrnents. In practice, the .records'and statistics~ that: have to b~ us-2d. in

. ., ..

drawing up the table are in ~any cases o~ly esti~ates; and ~~~[~ 6;tego~ies

,

• ..

of transactio~s may es~ape the s~ati~tician. Part of the ¹cr~•·rs ~D~ 6~issions¹ it~m usually representa capi~al flight - unreco~ded, ~~obahly. ille~ni ~~ve~

ni

^eⁿ^ta^·of priva te

~hort~term : ca ~i t~l

particularly in the case· of third ·

"· . ' ..

World countries s~ch as.Brazil.

.

;'\:.

Was Brazil in syrplus or deficit in th.e-y~ar 1969? As ~e have se~n,

the. balancé of· PllYIRC:nts · i tself must always equ.al zero~: cr~di ts equal dcbi ts by definition. Surplus or deficit are concept~ which refer tc o~ly some. , , of _,_. _..the _. ' item~ . in t~e ~able, with the rest considere

.

d as ¹financing' the surplus or defic.i t~ In practice, however, there is ^nounani~us agreement as to W:hich sta.tis'tj..ca

c~tego~i~.~ r~p~esent

transactions enter'ed' into for their own sake ( 1

au t~homous'

.f :·: ~:~ : ~ '.' ~! . . . . ~ . .

~ovements) and which represe~t ¹financing ¹ or ¹accommodating¹ movements.

. . . ' f ' . . . . .. .. . . '

1.~ though central bank operations an_d changes in reserves, f'or ezample, are almos.t universally agr.eed to be ¹

Ù~an~ing

¹ opera ti ons, the laq;e ·lmild-up ·

. ·. ... . . . ! . .

of Brazil's reserves in 1969 may well ~epresent a~ons~io~~go~l of the ~onetary

~uthoriti.es, taken in preference to '· say' import li beralizaticn mcasures.

Or, the private capital and loan operations, iade in the ex~ect~tiori

of

profit

. 1 '":' \ •

. . or interest,

.may

^have^been^'induced

by gov~rnm~nt

^measures ^aⁱ⁶^ed·

~t :financitt~(

: . , . . ~., . .. Lt ' . . ' . . . .

a trade deficit." As an ÙW official specializing in beclance· 0f peyr:1e-rrits

~ . . _. _.\ ;.· .. ·. . ..

q·uestion~ adm~ ts:

In fact, the determination. of bala.nce _of peyments surplus or deficit is far from being a fully objeêtive exercise. It has thé ·clearly'

·normative aspect of"pro\Tiding a guide for economie ··pa:licy... •• It is 'notsurprising, therefo:w;-e, that the definition .of ~urplus or deficit

is by far· the most controversiai question in balnnce o'f p[\ymenta methùlo3Y•

. This has been evident ' a-f>meëtings\·:of· balance of payments experts whi~h the Fund ha • • held. When these meetings have taken up t~e

concept of a.surplus .~r ~ -deticit, the d~sc~ssion bas be~om~ Ilveli~r or even.'emotional• At'thè saine time i t-has·usually .been ·inconclusive, beihg conterned with •omething about whiçh reasonable men can forever

. hold different views.S · · · · · ' ·' '· ··

: ..

,

^.. .l . ' j·

(13)

t

.. •

~ ilEF~ODUCTIOH/019/79

Page 12.

Wi th this ~in mir~d, let us consfder sorne possible interpretation of ti"e

:.i

To saineone like the author, who is suspicio'us table use~ f~t illusir~tion.

of :the long--term effects of di ;reet. investment and loans, \'Jhether .long- or short-term~ ^{on the} ^fut^ure ba.lance of payments~ ^them~st ^important^measure^. might be ihe .$336 million d~ficit on current account (up to line 10). In this

. ' ·. .

pers~e~ti~~t the l~rge s~~pi~~ on capital account is ominous because it means h~avy r~paymant: obliga~tion in the future.

~any countries rdraw the liner under direct and long-term investment capital· to obtain what is ce.lled the 'basic balance ¹^' putÙng the volatile

- ^.

short,;.terrn capital movement below the line as 'financing'' flows. ,,. ^,^··.·

In this

. :·. _· ·. ' : •, ·:j}'· ';

illustratior;, lines 14 and 15 are not broken down into long and short term · loané. If ~é drâ~ the lin~ -6etween 12 ~rid 13, h~wever, Brazil had a'surplti~ by the 'basic balance' definition' of $266 million •

• l' ~ •.

'f~~ H~F recom.men(ls, the_use of an ¹official settlements' balance which would inclul;le onlz central, be:nk t~ansactions and. reserve, changes ¹below th!?

' .

line' as fin~ncing operation~~ with all short-term;capital, plus errors_an~

qmi~s~on~

^(which, ^as-note

ab~~e,

probably represents short-term

capit~l) abo~e

' ' ' ~ •• ' t' . . ' •

thb line •. By this standard, Brazil had a much larger ~urplus of $675 million!

3l,.L~NCE CF j;?,;-_l'l'ŒNTS C2ISES, l:.ND POSSIBLE SOLUTIONS

A:'bâ!a:nce of paymen:ts défl.~it is not the same thing as a balance of payments c'risis, altbough a lone; succession of d.efi~its will ofte11 le~d to

'ii

crisis. The ~official settle~e~ts' balance givea the most immediate clue to the imminence of a payments crisis, but the current transactions balance, studied o~er a peribd of y~~rs, will show whether ihe country i~ chronically consumirtg more than· i t earns and 'therefore building up a heavy debt. And,

·for the :countries we;

are

~~ncerned wi th, i t is usually the debt repayment burden which precipitates a payments crisis •

. ' r.

. '·

,•.

(14)

Reproduction/019/79 Page 13.

'

•

Tlw typice.l b;;l:lance . .of payrncntEJ, ·or foreign exchange, cr:isis in Third

\forld countriE·G arise/> 'iir~en fixed obligations in t,he excha,nge budget (a

projected .b:.l;;..nce of R.:;cym~nü; drawn up t o guide government po licy)- n~cessi b . tes the cgrmarkinp; of sc. much e~<:cha.n,ge th1'1t other parts of the budget ... usua-ll y imports -. l·roull.d ·hav:.:; t o be. P-.~.t back_ to _an unacceptable level. The most im-por.tcmt f,iz2ù obHze,·t~on in- most Thir.d· :lorld countries is: the pasment of invcstmunt incomc ( Hne 6) ^o In this ,way c.hronic deficits. ·on curren_t in past· ·' years rn.<:ty resul t in an cxchange .c:risis in. th.e present. :

The -importan:c.e. of .foreign exd<ang<e reserves lies in the· fact tha·t ;the

larger· the reserves, ·the: Jonger a. coun·try can avoid having to take steps. to · a.djust a _payments d~fici t. ùs-.long as a nation ca.n continue to <I:ra.w down i ts'

reserve~, there is np. c.risis. F.or this reason, one useful measure of the adequacy of reserves, <'r the impinenc·e of• a payments ,crisis··, is the relat'ion- ship between' res;ervc holdings and th~, current level of impo~ts. A country whose reserv~s ~re sufficient to pay tor six months' imports bas a fairly comfortable reserv~ 'cushion' against short-falls in earnings₁·~hile. one .p~th_ onl~ two months' wo~th is in a ~?re precariou~ •ituation. Reserves covering only_ a few weeks' imports si~na! a crisis. When net reserves_ are negative,, i~

means that the country~s debts due for repayment exceed the amount in the reserves available to pay them off~ .

The Interrnntional Monetary Fund 'N'as founded in order to supplement each member nnticD 'c reserves, so that by dra\-dng on i ts quota. . ^·' in ^.•the Fund·. ^•^:^•· ç;c country: could have e. longer· hre::-. tfüng space· in which to wai t out¹seasonal· or cyclifal fluctr.oations ~ or to . take correc ti ^{Vf) ._}measures which might n.ot have

imme~iate effect._. The purpose. of.thc IKF was tp prevent countries temporar~ly

in P~YJ!I.ent15· crise~:> from çurtailing imports \1hen they were short o·f liquidi ty (cash or assets \;rhich can be used for Qlaking payments), and particula·rly to · prevent them from imposing restric_:tions on tre.de in order to· deal wl.tb paymentc

crisè~. However, since i t was not the Fund's intention to finance large ~nd

persistent deficits, a procedure was evol ved requiring repayment of loans fr01;1 the Fund (technically speaking, 'repurchases' of the borrowers' dwn currency) in three to five years' time. The Fund also developed the practice of imposing progressively more severe conditions as the country borrowed more deeply ₁