Financialisation, foreign debt and crisis

2 February 2015 by Ahilan Kadirgamar


cc- en.wikipedia.org

Since the end of the war, Sri Lanka’s economy is being transformed through a rapid process of financialisation. Such widespread financialisation facilitated infrastructure development, a real estate boom linked to urbanisation and expansion of credit leading to increasing indebtedness of the rural population. In short, financialisation contributed to the geographical changes of the economy through beautification of Colombo and infrastructural connectivity of the country. Furthermore, it has changed the class structure of the society with increasing inequality leading to a new wealthy class and an increasingly indebted population.

In the context of such widespread political economic changes, this article addresses the impact of financialisation on the structure of the national debt. Finance Minister Ravi Karunanayake in a recent interview mentions seeking the assistance of the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

http://imf.org
to reduce the interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. payments on the large national debt. Indeed, such concern is prudent, because according to the budget estimates, debt repayments totalled Rs. 840 billion with an additional Rs. 425 billion for interest payments, and together they are close to the total revenue of the Government in 2014.

There are other aspects to the character of the national debt, particularly foreign debt which are alarming. First, national foreign debt is characterised by increasing non-concessional loans as opposed to historically high concessional development loans. In other words, the structure of our debt has gained the character of shorter-term higher interest loans rather than longer-term lower interest loans. Second, foreign debt is increasingly dependent on market borrowings from the financial markets as opposed to loans from multilateral and bilateral donors, which can be negotiated and less susceptible to market forces. Third, there has been the promotion of foreign borrowings by state-controlled commercial banks and other private entities; these do not add to the fiscal deficit, however, they put pressure on the balance of payments Balance of payments A country’s balance of current payments is the result of its commercial transactions (i.e. imported and exported goods and services) and its financial exchanges with foreign countries. The balance of payments is a measure of the financial position of a country vis-à-vis the rest of the world. A country with a surplus in its current payments is a lending country for the rest of the world. On the other hand, if a country’s balance is in the red, that country will have to turn to the international lenders to meet its funding needs. .

Structure of foreign debt

Sri Lanka’s total foreign debt accumulated over the decades is changing drastically. According to the Finance Ministry Annual Report 2013, total foreign debt is Rs. 2,960 billion of which multilateral and bilateral concessional loans was Rs. 1,492 billion and non-concessional loans was Rs. 459 billion. Market borrowing has increased considerably to Rs. 1,007 billion. Thus market borrowings are now a third of foreign Government financing.

Next, financial flows from the capital markets outweigh foreign aid. The total disbursement of aid from the multilateral and bilateral donors in 2013 including the World Bank World Bank
WB
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

, ADB, Japan, China and India was Rs.180 billion (US$1.4 billion) for public investment. However, the net flows after repayments amounted to only Rs. 68 billion ($520 million). Such foreign aid should be compared with $1.5 billion in sovereign bonds floated in 2014 pointing to the increasing reliance on capital markets.

There was a clear strategy to increase the flow of foreign funds few years back, according to several reports quoting former Central Bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

ECB : http://www.bankofengland.co.uk/Pages/home.aspx
Governor Ajit Nivard Cabraal.

The state-controlled Bank of Ceylon floated $1 billion and the National Savings Bank floated $750 million in euro dollar bonds, at very high interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
in recent years. These are dollar denominated loans boosting foreign exchange reserves, but they also have to be returned in dollars. These massive bonds can create a crisis in the banking sector if the rupee depreciates, and also put pressure on Sri Lanka’s balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. of payments.
Foreign funds flowing into the stock market and the promotion of corporate bonds Corporate bonds Securities issued by corporations in order to raise funds on the Money Markets. These bonds resemble government bonds but are considered to be more risky than government bonds and other guaranteed securities such as Mortgage Backed Securities, and therefore pay higher interest rates. including a $175 million by Sri Lankan Airlines in 2014 are contributing to further integration with the capital markets. In this way, global financial flows were encouraged through mounting foreign borrowing by the state, banks and companies.

Crisis tendencies

Why should we be concerned about such financialisation? It is such financialisation that has been at the root of the recent Western financial crisis starting in 2008 and continuing to ravage Southern Europe. According to economist Dani Rodrik, with liberalisation of the global capital markets starting in the late 1970s, such crises have been widespread. His book, ‘The Globalization Paradox: Why Global Markets, States and Democracy Cant Coexist’ (Oxford University Press, 2011), provides a profound analysis:“The waves of financial crises that buffeted countries who left themselves at the mercy of international capital markets produced severe damage indeed. First was the Latin American debt crisis of the 1980s, which, aggravated by poor economic management engulfed the countries of the region and produced a ‘lost decade’ of economic stagnation. It was Europe’s turn in the early 1990s… The mid-1990s saw another round of financial crises, the most severe of which was the “tequila crisis” in Mexico (1994) brought on by a sudden reversal in capital flows. The Asian financial crisis followed in 1997-98 which would then spill over to Russia (1998), Brazil (1999), Argentina (2000) and eventually Turkey (2001). These are only the better known cases. One review identified 124 banking crises, 208 currency crises, and 63 sovereign debt Sovereign debt Government debts or debts guaranteed by the government. crises between 1970 and 2008.”

Rodrik goes onto describe the common dynamics of these repeated crises:

“Most of these cases follow the same boom-and-bust pattern. First, there is the phase of relative euphoria during which a country receives a significant amount of foreign lending. This stage is fuelled by stories in financial markets that emphasise the bright prospects ahead. The country has reformed its policies and stands at the cusp of a productivity explosion. There is no need to worry about the debt build up because future incomes will be high and there will be ample capacity to repay the loans. The borrowers can be government, private banks, or corporate entities. In the end, it doesn’t seem to make much of a difference. Then a bit of bad news, either domestic or external… The country’s story in financial markets changes completely: the country has over borrowed, its government is acting irresponsibly, and the economy looks risky. Foreign finance dries up and in short order the economy has to go through painful contortions to adjust. Interest rates shoot up, the currency collapses, firms face a credit crunch, and domestic demand contracts, typically aggravated by tight fiscal policies aimed at restoring ‘market confidence.’ By the time it’s all over, the economy will have forfeited, on average, around 20 per cent of its GDP GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
.”

These passages from Rodrik are quoted at length as a warning to the new Government which only sees the problematic impact of recent economic policies as relating to high interest payments on debt, bad investments not providing returns and corruption. Rater, the underlying problem as evident from numerous cases around the world is the process of financialisation. If such financialisation is not reversed, it might result in another financial crisis which devastates the Lankan citizenry through the loss of production and jobs and eventually further cuts to welfare including of healthcare and education.

Source: http://www.sundaytimes.lk/150201/business-times/financialisation-foreign-debt-and-crisis-132297.html



The writer is a member of the Collective for Economic Democratisation in Sri Lanka: www. economicdemocratisation.org

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