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Debt And Stabilisation Notes

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Lecture 7 - Debt and Stabilisation BALANCE OF PAYMENTS ACCOUNT The Balance of Payments shows/measures a nation's financial transactions with the rest of the world. A positive balance represents a surplus and a negative one a deficit. Anything where money flows in is a credit and anything where money flows out of a country is a debit to the account. The capital account records the value of private foreign direct investment e.g. foreign loans then subtracts resident capital outflow (capital flight). A large surplus implies that a country is not using all its resources towards improving current living standards. A large deficit means you are eating into further earnings. So the best situation would be to have an approximately balanced BOP. Deficits are dangerous because they cannot be corrected with policy. Credits to the BOP Debits to the BOP Exports Investment income Net remittances and transfers received Direct private investment Foreign loans taken International reserves

Imports Debt-service payments Increase in foreign assets in banking system Resident capital outflow

Consequences of a deficit Reduction in imports (problem if food or fuel needs to be imported). Debt service must be paid in foreign exchange. If export markets suffer, need to devalue. If devalue, debt service impossible as debts denominated in foreign currencies. Countries with larges exposure to foreign currency investment like East Asia are most at risk. Typical corrections to BOP problems Import substitution industrialisation. As well as manipulation of import/export prices via devaluation of currency to improve trade balance. Encouraging of foreign investment, seeking additional foreign aid, borrowing and restrictive fiscal and monetary policy can all help rectify BOP issues. Brief History of modern debt 1970s: loans primarily for purpose of development projects, at low interest. Late 1970s windfall to commercial banks from oil prices - "petrodollars" lent liberally to developing countries. High inflation kept service on the debt low. Loans used to promote export strategies. 1979: Second oil crisis meant oil imports and industrial production became very expensive. Late 1970s and early 80s: Capital flight from developing countries (50% of total borrowing of LDCs in the same period). Two options - reduce imports and restrictive fiscal, monetary measures or borrow more. 1980s: Debts grow and debt service e becomes difficult. "LOST DECADE" OF LATIN AMERICA States' ability to tax weakened, debt rose and kept rising until 2000s. Terms of trade worsened as exchange rates depreciated. Move to cities meant agricultural sector lagged. Governments monetised debt by printing money allowing the savings ration to remain stable. Therefore gov-led growth, not FDI so involvement of commercial banks occurred. These capital outflows worsened BOP problems.
- ER fell: lowering import availability.
- IR rose: difficult to borrow for investment or consumption.
- Employment dropped: mass migration to USA.
- Private investment took until 1990s to come back to Latin America. DEBT CRISIS The accumulation of external debt is common with developing countries at the stage of development where the supply of domestic savings is low, current account payments deficits are high and imports of capital are needed to augment domestic resources. This occurs when a country announces it cannot make a scheduled debt payment. Problem with contagion - when one country defaults other DCs are cut off from capital markets which can cause their cash flow to stop - leading to further defaults.

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