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Ecomomics evelopment 10th y p todaro and smith chapter 13

Chapter 13
Balance of
Payments,
Developing-Country
Debt, and the
Macroeconomic
Stabilization
Controversy

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The Balance of Payments


The current account: net flow of merchandise trade



The capital account: net flow of financial capital


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The Balance of Payments
The current account:



Exports (+)



Imports (-)



Investment income (+)



Debt-service payments (-)



Net remittances and transfers (+)

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The Balance of Payments
The capital account:



Direct private investment (+)




Foreign loans (+)



Foreign assets of domestic banks (-)



Resident capital outflow (-)

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The Balance of Payments




The balance of payments position:


Surplus: inflows > outflows



Deficit: outflows > inflows

Consequence:


Surplus: increase in cash reserves account



Deficit: decrease in cash reserves account

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

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Consequences of BOP Deficit


Reduce cash reserves account



Inhabit imports: impose tariffs/quotas; foreign exchange devaluation



Increase exports: foreign exchange devaluation

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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
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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

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Dimensions of the LDC Debt
Burden, 1970–2008

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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

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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

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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

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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

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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

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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

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The Mechanics of Petrodollar
Recycling

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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
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The IMF Stabilization Policy
Success in LDCs:



Reduce inflation



Improve balance of payments



Eliminate parallel exchange rates



Improve economic efficiency

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The IMF Stabilization Policy
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
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for corrupt
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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

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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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