As investment in developing nations grinds to a halt, Stephany Griffith-Jones considers the alternatives.Encouraging capital flows to developing countries is crucial at a time when they are faced with a dearth of investment. If a drought of capital flows to emerging markets continues, the policy agenda needs to shift sharply, both nationally and internationally, encouraging sufficient stable private flows.
Since the Asian crisis, net capital flows to emerging market economies have fallen sharply; net debt flows turned strongly negative, prompting the World Bank to conclude that “the developing world has become a net capital exporter to the developed world”. The Inter-American development Bank estimates that net private flows to Latin America have declined from 5% of the region’s GDP in 1996 to zero in 2002.
This sharp decline is due in part to structural changes. International banks have crossed the border by establishing subsidiaries or branches in developing countries and substituted foreign lending with domestic intermediation. Some portfolio equity investors feel that there are not many “sufficiently large” companies left for equity investors to buy in developing countries.
A novel problem that has arisen during and after crises is that trade credit has dried up, inhibiting the positive impact of large depreciations on expansions of exports, key to post-crisis recovery.
Government institutions, such as export credit guarantee agencies (ECAs) and multilateral development banks, limit their activities (providing guarantees and credits) to longer-term assets. An important policy question is whether they should also cover trade finance. The Inter-American Development Bank is exploring the creation of a guarantee mechanism to encourage trade finance by commercial banks. An institution such as an ECA or the IADB could also grant trade credit in special circumstances. Such a program for guarantees or direct provision of trade credits could be phased out once full access to trade credit was restored.
In the case of long-term trade credit, ECAs already play a large, though declining, role in guaranteeing credits. It is widely accepted that international financial markets tend to overestimate risk in difficult times and underestimate it in good times, which implies a strong case for introducing an explicit counter-cyclical element into risk evaluations made by export credit agencies. When banks lowered their exposure to a country, ECAs would boost their levels of guarantees. When matters improved and banks were willing to lend, ECAs could drop their exposure, for example, by selling export credit guarantees in the secondary market. This would avoid greater counter-cyclicality of guarantees, resulting in a higher average level of guarantees.
Another suggestion is that socially responsible investment (SRI) takes on a more developmental role. Traditionally, it has shied from markets that do not meet environmental or labour standards. But a central aim of SRI should be supporting long-term private flows to developing countries that help fund pro-poor growth. This shift from “anti-bad things” to a focus on pro-poor growth in developing countries could boost the level and stability of private flows to those sectors. In particular, pension funds could provide more stable flows as their liabilities are usually long term. Further, the return-risk ratio of a portfolio with part of its assets invested in emerging markets will be higher than if it invests solely in developed nations.
The potential is large, given the rapid growth and high level of SRI assets. In the UK, SRI funds increased ten-fold in recent years to reach more than $300bn. Global SRI assets reach almost $3000bn.
A switch by SRI investors to pro-poor growth would be consistent with their aims. In a recent survey of UK SRI investors, 97.7% cited “Third World people” as their chief concern, but this is not yet reflected in their investment patterns; they invest only small sums in developing countries. It is time for SRI investors to re-allocate funds to reflect their development ethos.
Professor Stephany Griffith-Jones is Professorial Fellow at the Institute for Development Studies, University of Sussex.
