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IV Developments in International Bond Markets and Other Capital Flows : International Capital Markets : Developments and Prospects, 1984:
Maxwell Watson, Peter Keller, and Donald Mathieson
http://dx.doi.org/10.5089/9781557750730.084
II Responses to Strains in Financial Markets
III Recent Developments in International Bank Lending
IV Developments in International Bond Markets and Other Capital Flows
V Prospects
Appendix I Measurement of International Bank Lending Flows
Appendix II An Econometric Analysis of the Growth in International Bank Claims
Appendix III Terms and Conditions of Bank Debt Restructurings, 1978-June 1984
Appendix IV Statistical Tables and Charts
Developments in International Bond Markets
Foreign Bonds Versus Eurobonds
Currency Composition and Market Share
Eurobond Markets
Type of Bonds and Other Instruments
The 1981–83 Bond Market Recovery
Foreign Direct Investment and Official Flows as Sources of Finance
Role of Foreign Direct Investment in Private Capital Flows
Official Transfers and Lending
Domestic Money Market Rates, 1982 and 1983
International Bank Credit Commitments and International Bond Issues, 1973–83
Developments in International Bond Markets, 1980–83
Yield Differentials on Public Bonds Denominated in Deutsche Mark Issued by Developing Countries, 1982–84 1
With the decline in the flow of net international bank lending in 1982 and 1983, other sources of external finance became important for both developed and developing countries. For many sovereign, financial, and nonfinancial private borrowers in the industrial countries, international bond issues have become an attractive alternative to international syndicated loans. As regards developing countries, there was almost a complete reversal of the relative role of foreign private credits, on the one hand, and of foreign direct investment and official transfers and lending, on the other, in balance of payments finance. This section reviews these recent changes in nonbank private and official flows.
Since 1981, issues of international bonds43 have risen in absolute terms and even more sharply relative to the declining volume of international syndicated loans. Following large increases in 1981 and 1982, international bond issues rose only slightly in 1983 to $77 billion, of which $48 billion represented net new issues (Table 9).44 In 1983, Eurobond issues remained at their 1982 value of $50 billion, and foreign bond sales rose from $25 billion to $27 billion. In contrast to the sharp decline in nominal interest rates experienced in 1982, most financial markets witnessed relatively limited changes in interest rates (especially for long-term maturities) between December 1982 and December 1983, although the average level of rates in 1983 was lower than in the preceding year. Declining rates of inflation in many financial market countries, however, implied the continuation of high ex post real returns on bonds. The vast majority of international bonds were issued and purchased by entities in the industrial countries. Developing countries as a group continued to have only very limited access to these markets. The relative importance of different types of bonds has been strongly affected by the rapid expansion in the issuance of floating rate notes.
Charts 4 and 5 and Table 37 show interest rate movements in the major financial markets during 1983. Between December 1982 and December 1983, short-term interest rate movements were relatively limited; in most cases, rates fluctuated within a 1 percentage point band throughout the year. These developments in conjunction with declining inflation sustained high ex post real interest rates (Table 36). The persistence of relatively high nominal and real interest rates reflected a number of factors, including the relatively tight monetary policies of many of the major industrial countries, the recovery of real activity, especially in Canada and the United States, and concerns about the future impact of large fiscal imbalances in certain major industrial countries.
Chart 4.Domestic Money Market Rates, 1982 and 1983
Chart 5.International Bank Credit Commitments and International Bond Issues, 1973–83
Sources: Organization for Economic Cooperation and Development, Financial Statistics Monthly and Financial Market Trends.
1 Excluding multibillion-dollar financing of U.S. corporations.
Following two years of rapid growth in international bond issues (35 percent in 1981 and 46 percent in 1982), these issues increased by only 2 percent in 1983 (Table 9). The volume of international bonds issued by industrial country entities remained virtually constant between 1982 and 1983, and these countries’ share in total bond issues thus declined marginally from 79 percent in 1982 to 77 percent in 1983. In contrast, issues by developing countries fell by 30 percent between 1982 and 1983, resulting in a decline in their share of total issues from 6 percent in 1982 to less than 4 percent in 1983. Over the same period, international organizations increased their total bond issuance by 24 percent, and their share in total issues thereby rose from 14 percent in 1982 to 17 percent in 1983.
Table 9.International Bond Issues and Placements, 1978–June 1984 1(In millions of U.S. dollars)
Industrial countries 10,328 13,421 11,339 14,129 16,837 18,624 11,406
Developing countries 2,583 1,431 746 1,212 726 894 775
Oil exporting 571 105 46 242 38 78 —
Non-oil developing 2,012 1,326 700 970 688 816 775
Centrally planned economies2 — 43 — — — — —
International organizations 4,906 5,259 5,714 5,030 7,461 7,265 2,756
Other 2,896 154 125 159 191 323 125
Total foreign bonds 20,713 20,308 17,924 20,530 25,215 27,106 15,062
Industrial countries 9,774 14,212 17,206 25,210 42,816 41,013 30,255
Developing countries 3,162 1,885 1,403 3,185 3,970 2,382 1,508
Oil exporting 1,110 329 132 170 470 288 50
Non-oil developing 2,052 1,556 1,271 3,015 3,500 2,094 1,458
Centrally planned economies2 30 30 — 55 — 25 —
International organizations 1,820 2,220 1,710 2,486 3,280 6,073 2,193
Other 175 344 75 358 263 602 557
Total Eurobonds 14,961 18,691 20,394 31,294 50,329 50,095 34,513
Industrial countries 20,102 27,633 28,545 39,339 59,653 59,637 41,661
Developing countries 5,745 3,316 2,149 4,397 4,696 3,276 2,283
Oil exporting 1,681 434 178 412 508 366 50
Non-oil developing 4,064 2,882 1,971 3,985 4,188 2,910 2,233
Centrally planned economies2 30 73 — 55 — 25 —
International organizations 6,726 7,479 7,424 7,516 10,741 13,338 4,949
Other 3,071 498 200 517 454 925 682
Total international bonds 35,674 38,999 38,318 51,824 75,544 77,201 49,575
1 The country classifications are those used by the Fund.
2 Excluding Fund member countries.
The decline in the relative share of developing countries reflected their reduced access to bond markets since August 1982. The recourse of individual developing countries to the bond markets is shown in Table 38. The major developing country issuers during 1983 were Indonesia, Korea, Malaysia, South Africa, and Thailand; these five countries accounting for 80 percent of total developing country issues. Although almost all developing countries have continued to service promptly their payments of interest and principal on outstanding bonds, access to international bond markets increasingly has become limited to what market participants regard as the “best” credit risks, primarily from the industrial countries, international organizations, and selected developing countries.
In 1983, international bond issues net of redemptions were $48 billion or approximately equal to net issues in 1982.45 These net flows went principally to the industrial countries and international organizations. The net flows to developing countries declined to very low levels as reduced levels of new issuance combined with rising redemptions in 1982 and 1983.
Foreign bond issues rose from $25 billion in 1982 to $27 billion in 1983 (Table 10); whereas Eurobond issues remained virtually unchanged at $50 billion (Table 11). Most foreign bonds were issued by industrial country borrowers ($19 billion) and international organizations ($7 billion). These two groups accounted for approximately 96 percent of total foreign bond issues in 1982 and 1983. This covered an increase in the share of industrial country borrowers from 67 percent in 1982 to 69 percent in 1983 and a decline in the share of international organizations from 30 percent in 1982 to 27 percent in 1983. While developing country issues increased from $726 million in 1982 to $894 million in 1983, this larger issuance was associated mainly with the activities of three countries (Korea, Malaysia, and South Africa), which accounted for nearly three fourths of developing country issues of foreign bonds. The share of developing countries in issues of foreign bonds amounted to 3 percent during both 1982 and 1983 (versus 6 percent in 1981).
Eurobond issues declined marginally between 1982 and 1983, reflecting lower levels of issuance by borrowers in industrial countries ($41 billion in 1983 against $43 billion in 1982) and developing countries ($2 billion in 1983 against $4 billion in 1982). The share of industrial country issues thus fell from 85 percent in 1982 to 82 percent in 1983, and the share of developing country issues declined from 8 percent in 1982 to 5 percent in 1983. In contrast, issues by international organizations rose from $3.3 billion to $6.1 billion and their share increased from 7 percent in 1982 to 12 percent in 1983.
During the first half of 1984, the scale of bond issuance accelerated; $15 billion of foreign bonds and $35 billion of Eurobonds were sold. If this rate of issuance were sustained throughout 1984, there would be about $100 billion of international bond issues—over one fourth higher than in 1983. Industrial country bond issues represented 76 percent of foreign bond issues and 88 percent of Eurobond offerings. Although developing countries issued $2 billion of international bonds, their share of total issues remained at 5 percent, and these issues were accounted for by only ten countries (with Malaysia and South Africa being the largest issuers) (Table 38). International bond issues by international organizations totaled $5 billion and accounted for 10 percent of total issues, which was considerably below the 17 percent share experienced in 1983.
The currency composition of international bond issues reflects the sales of foreign bonds in the various financial centers and the currency of denomination of Eurobonds (Table 11). Expectations regarding inflation, interest rates, and exchange rates, as well as official limitations on market access, play important roles in determining the extent to which individual currencies are utilized in international bond markets. During 1981 and 1982 these factors generally worked to increase the use of the U.S. dollar as the primary currency of denomination, although this trend was more pronounced in the Eurobond markets than in the foreign bond markets. In 1983, however, the relative importance of the U.S. dollar diminished somewhat in international bond markets as utilization of the deutsche mark, the Swiss franc, the Japanese yen, the pound sterling, and the European Currency Unit increased (Table 39).
Table 10.Foreign Bond Issues and Placements by Market Country, 1978–June 1984(In millions of U.S. dollars)
Austria 29 100 81 — 34 82 —
Belgium 147 137 63 54 45 137 63
France 230 198 261 89 221 188 —
Germany, Federal Republic of 1,431 2,690 4,951 1,196 2,109 2,616 972
Japan 4,387 2,671 1,543 2,723 3,317 3,854 2,146
Luxembourg 206 208 200 131 140 136 95
Netherlands 351 163 325 439 854 933 399
Saudi Arabia 164 30 123 — — — —
Switzerland 7,405 9,718 7,470 8,118 11,325 13,495 7,949
United Kingdom — — 178 911 1,129 856 808
United States 6,358 4,364 2,709 6,856 6,025 4,735 2,550
Other countries — 30 20 — — 10 80
Total 20,708 20,309 17,924 20,517 25,199 27,042 15,062
In foreign bond markets (Table 10), the diminished role of the U.S. dollar reflected the decline in new issues of foreign dollar-denominated (Yankee) bonds for the second consecutive year. After reaching a volume of $7 billion in 1981, new issues declined to $6 billion in 1982 and to $5 billion in 1983. To a significant degree, this reduced volume reflected the decision of international agencies such as the World Bank to reduce their bond issuance in the U.S. market. Issues by such institutions fell from $2 billion in 1982 to approximately $1 billion in 1983. Canadian issuers also reduced their issuance from about $3 billion in 1982 to $2 billion in 1983, as they found they could obtain lower borrowing costs at home or in the Euro-Canadian dollar markets. The share of U.S. dollar issues in total foreign bond issues thus declined from 24 percent in 1982 to 18 percent in 1983.
In contrast, the share of Swiss franc issues in total foreign bond sales rose from 45 percent in 1982 to 50 percent in 1983, as volume in this market increased from $11 billion to $13 billion. Borrowers were attracted to this market by relatively low interest rates, as well as by steps taken by the Swiss authorities toliberalize access to Swiss capital markets. The ceiling on individual public issues by foreigners was increased from Sw F 100 million to Sw F 200 million, effective January 1, 1984, and the authorities no longer establish an issuance calendar, although banks are still required to report regarding individual issues. It is still true, however, that foreign banks are not allowed to lead or co-manage public issues. Japanese companies were major issuers of Swiss franc convertible bonds during this period. The volume of Swiss franc convertible bonds grew from $1 billion in 1982 to $4 billion in 1983. This market also had increased use of dual currency bonds and bonds associated with both currency and interest rate swaps. These dual currency bonds and swap operations are discussed below in the subsection on types of bonds.
Foreign bond issues in the Japanese (Samurai) market increased from $3.3 billion in 1982 to $3.9 billion in 1983, and the share of foreign bonds denominated in yen thereby increased from 13 to 14 percent. While borrowers were attracted by relatively low interest rates, investors’ interest was sustained by the prospect of a yen appreciation.
The issuance of foreign bonds denominated in deutsche mark increased from $2 billion in 1982 to $3 billion in 1983. As a result, the proportion of foreign bonds denominated in deutsche mark rose from 8 percent in 1982 to 10 percent in 1983. Much of the issuing activity in 1983 was in the first half of the year, when monetary growth accelerated. Foreign issues took place at a much slower rate during the second half of 1983, when monetary conditions tightened as the Bundesbank brought the growth of central bank money back into its target range. The Bundesbank continues to discourage the use of bonds denominated in deutsche mark for currency swap operations.
Table 11.Total Eurobond Issues and Placements by Currency of Denomination by All Countries, 1978-June 1984(In millions of U.S. dollars; and in percent)
Jan.-June 1984
Deutsche mark 6,478 43.3 5,881 31.5 3,457 17.0 1,396 4.5 3,253 6.5 4,039 8.0 2,121 6.1
French franc 103 0.7 374 2.0 882 4.3 513 1.6 — — — — — —
Japanese yen 79 0.5 184 1.0 301 1.5 410 1.3 598 1.2 233 0.5 348 1.0
Netherlands guilder 384 2.6 308 1.6 549 2.7 490 1.6 618 1.2 747 1.5 589 1.7
U.S. dollar 6,767 45.2 10,360 55.4 13,649 66.9 25,761 82.3 42,228 83.9 39,205 78.2 27,273 79.0
Composite currency units 235 1.6 413 2.2 98 0.5 709 2.3 835 1.7 2,196 4.4 1,482 4.3
European currency units — — — — — — 153 0.5 823 1.6 2,196 4.4 1,482 4.3
European unit of account 203 1.4 306 1.6 78 0.4 126 0.4 12 0.1 — — — —
Special drawing right 32 0.2 107 0.6 20 0.1 430 1.4 — — — — — —
Canadian dollar — — 481 2.6 270 1.3 688 2.2 1,200 2.4 1,066 2.1 604 1.8
Kuwaiti dinar 481 3.2 384 2.0 26 0.1 388 1.2 173 0.3 — — — —
Pound sterling 287 1.9 291 1.6 975 4.8 535 1.7 846 1.7 2,148 4.3 1,801 5.2
Saudi Arabian riyal 95 0.6 — — — — — — — — — — — —
Norwegian krone — — — — 100 0.5 53 0.2 31 0.1 67 0.1 52 0.2
Other currencies 51 0.5 17 0.1 88 0.4 352 1.2 547 1.0 393 0.9 243 0.7
Total 14,960 100.0 18,692 100.0 20,394 100.0 31,294 100.0 50,330 100.0 50,094 100.0 34,513 100.0
Foreign bond issues in the Netherlands market increased from $854 million in 1982 to $933 million in 1983. A growing current account surplus and weak domestic private sector credit demands allowed increased foreign borrowing to take place despite a large volume of domestic issues by the Netherlands Government. Foreign bond issues also increased in the Austrian and Belgian markets, while they declined in the French, Luxembourg, and U.K. (bulldog) markets.
In the first half of 1984, over 50 percent of all foreign bond issues took place in Switzerland where $8 billion in bonds were marketed (Table 39). Foreign issues in the United States, which had represented 18 percent of all foreign issues in 1983, totaled almost $3 billion and equaled 17 percent of foreign issues in the first half of 1984. While no foreign bonds were issued on the Austrian and French markets, the other major European and Japanese markets witnessed a rate of bond issuance in the first half of 1984 not very different from that in 1983.
Although the total volume of issues in the Eurobond markets remained unchanged between 1982 and 1983, there was considerable change in the currency composition of Eurobonds (Table 11). Eurodollar bond issues declined from $42 billion in 1982 to $39 billion in 1983, and the share of Eurodollar bonds in total Eurobond issues thus fell from 84 percent in 1982 to 78 percent in 1983. While Eurodollar bonds had been issued at a rapid rate during the first half of 1983, rising yields for U.S. dollar-denominated instruments in July and August discouraged new borrowing, especially in the third quarter. This decline in volume took place despite a number of innovations designed to increase the attractiveness of Eurobonds to investors. International bond markets also witnessed the use of dual currency bonds, partially paid or deferred payment bonds, and bonds with warrants for bonds or common stock. These instruments were designed to increase the attractiveness of bonds to investors by allowing them to take advantage of declining interest rates, by reducing exchange rate risks, or by providing a mix of debt and equity instruments. The issuance of Eurodollar floating rate notes has also expanded sharply, and these instruments constituted over 50 percent of total Eurodollar issues during 1983. One other factor influencing the Eurodollar market was the prospect of a change in the U.S. withholding tax. In the past, nonresidents holding securities issued on U.S. markets have been subject to a deduction at source of 30 percent of their interest payments. In contrast, bearer bonds issued in the Eurodollar market are not subject to a withholding tax. In July 1984, legislation was enacted in the United States which repealed the with-holding tax on domestic bonds issued after July 18, 1984 purchased by foreigners (see Section I).
While the share of Eurobonds denominated in U.S. dollars declined in 1983, there was increased use of bonds denominated in deutsche mark, pounds sterling, and ECUs. Issues of Eurobonds denominated in deutsche mark increased from $3 billion in 1982 to $4 billion in 1983, and, as a result, the share of total Eurobonds denominated in deutsche mark rose from 7 to 8 percent. As with foreign bonds denominated in deutsche mark, the amount of bond issuance in Eurodeutsche mark was strongly affected by monetary conditions in the Federal Republic of Germany, as well as by the position of the deutsche mark in foreign exchange markets. Issues of Eurobonds denominated in deutsche mark slowed during the second half of 1983 from a rather rapid pace in the first half, as the stance of monetary policy was tightened and as the deutsche mark depreciated slowly against the U.S. dollar.
Eurosterling bond issues rose from nearly $1 billion in 1982 to over $2 billion in 1983, which raised the proportion of Eurobonds denominated in sterling from 2 to 4 percent. Declining interest rates (and hence rising bond prices) stimulated investor interest in sterling bonds, and borrowers were attracted by the fact that, late in 1983, yields on Eurosterling bonds fell below those on Eurodollar bonds.
Eurobond issues denominated in ECUs more than doubled in 1983, rising from nearly $1 billion in 1982 to over $2 billion in 1983 and increasing their share in total Eurobonds from 2 to 4 percent. ECU bond issuers have primarily been institutions of the European Community, such as the European Investment Bank, as well as borrowers from France and Italy. Generally, the latter have found it cheaper to raise funds through ECU-denominated issues than in U.S. dollars or their domestic currencies, once the depreciation of the domestic currency on foreign exchange markets has been taken into account. This market has been heavily dependent, however, on investors from Belgium and Luxembourg, who are reported to buy as much as 70 percent of all new issues. These investors appear to have been attracted to ECU bonds, in part, by the desire to protect themselves from depreciation of their domestic currencies. The ECU bond markets have also been aided by the growing activity in ECU-denominated loans and deposits. While outstanding ECU bonds totaled $5 billion, it is estimated that there are ECU-denominated loans and deposits of roughly $5-10 billion. The clearing arrangements for ECU deposits have become more sophisticated in recent years. While ECU deposits were initially cleared by “unbundling” the deposits into the component currencies, there now exists an ECU clearing arrangement between banks active in the ECU market without unbundling. Discussions are currently under way to formalize this clearing system to make use of clearing accounts with the Bank for International Settlements. As in 1982, there were no issues of SDR-denominated Eurobonds.
Issues of Euro-yen bonds declined from $0.6 billion in 1982 to $0.2 billion in 1983, and there was no issuance of such bonds during the second and third quarters of 1983. Euro-yen bonds have been issued by sovereign borrowers, international organizations, and government-guaranteed Japanese entities. Beginning in 1984, the level of activity in the Euro-yen bond market is likely to be affected by a series of measures aimed at broadening the use of the yen as an international currency and liberalizing the Japanese domestic financial markets. Effective on December 1, 1984, non-Japanese private corporations, national, state, and local governments, and government agencies and organizations will be authorized to issue bonds in the Euro-yen market. Initially, these issuers will have to meet the issuance criteria of the foreign (Samurai) bond market. From April 1985, there will be a relaxation of these criteria to allow general participation by borrowers with a credit rating of AA or better, as well as a number of international corporations with A ratings. As of April 1984, the conditions for Euro-yen issues by Japanese residents were also liberalized with the result that 30 Japanese corporations now may make straight debt issues and about 100 corporations may issue convertibles. There are no limits on the size or total number of issues. Withholding tax will continue to apply to interest payments on such issues.
In the first half of 1984, there was a sharp expansion in the rate of issuance of Eurobonds with total issues equaling $35 billion (an annual rate of $70 billion—nearly 50 percent higher than the rate experienced in 1983). Eurodollar bonds represented 79 percent of total issues ($27 billion) with much of this issuance taking the form of floating rate notes. Issues denominated in pounds sterling accounted for 5 percent and in deutsche mark for 6 percent of all Eurobonds.
Chart 6 and Table 12 indicate the types of bonds utilized in the international bond markets in recent years. While the share of fixed-rate, straight Eurodollar bonds increased from 53 percent in 1980 to 57 percent in 1981 and further to 68 percent in 1982, this type of bond accounted for only 55 percent of Eurodollar issues in 1983. In contrast, the share of floating rate notes increased from 29 percent of Eurodollar bonds in 1982 to 40 percent in 1983. Following the spread of debt servicing problems on international loans since mid-1982, there has been a shift by banks toward purchases of securities (which were regarded as relatively safe and liquid instruments) rather than participation in large syndicated international loans. Banks have regarded floating rate notes issued in large volumes by good credit risks not only as liquid assets but also as offering relatively attractive risk-adjusted returns, even though the nominal yields on these instruments is often as low as ¼ or ⅛ percent over LIBOR. These low spreads have not meant that the total return (interest income plus any capital gains or losses) on floating rate notes has been less than that on other international financial securities. The total returns over the period 1978–83 (in average annual percentage rates) are shown in Table 13. In addition, the fee and commissions associated with the issuance of floating rate notes could add ¼ or ½ percent to the yield over the lifetime of the floating rate notes.
Chart 6.Developments in International Bond Markets, 1980–83
Source: Organization for Economic Cooperation and Development, Financial Statistics Monthly; and International Monetary Fund, International Financial Statistics.
1 Three-month deposits.
2 Bonds with remaining maturity of 7 to 15 years.
3 Only in 1982 did this type of bond represent a significant proportion of total bond issues.
Table 12.International Bonds, by Type, Selected Eurobonds, 1979–83(In percent o f total)
Straight 57 53 57 68 55
Floating rate notes 36 33 33 29 40
Convertibles 7 14 10 3 5
Swiss franc bonds
Foreign straight and floating rate notes — 85 85 87 74
Foreign convertibles — 15 15 13 26
Eurodollar bonds issued by U.S. borrowers
Straight 65 71 83 90 87
Floating rate notes 29 8 9 8 5
Convertible 6 21 8 2 8
Eurodollar bonds issued by Canadian borrowers
Straight 100 88 92 87 85
Floating rate notes — 7 — 12 11
Convertible — 5 8 1 4
Source: Salomon Brothers. Inc., International Bond and Money Market Performance.
Table 13.Average Returns on Financial Securities, 1978–83(In percent)
Eurodollar floating rate notes 13.7
U.S. Treasury bills 11.0
Eurodollar bonds 8.6
Foreign dollar (Yankee) bonds 7.5
U.S. Government bonds 6.2
Source: Gioia M. Parente, An Anatomy of the Eurodollar Floating Rate Note Market, Salomon Brothers, Inc. (New York, March 1984).
The demand of financial institutions for floating rate notes has also been stimulated by a number of special factors. U.S. savings and loan associations have purchased these instruments to balance floating rate interest liabilities arising from their newly permitted money market deposits. Some international banks have purchased large amounts, at times possibly influenced by a treatment of these assets for the purposes of prudential regulation that was less onerous (in terms of capital ratios or maturity matching) than would be the case for syndicated lending.
Floating rate notes have been issued primarily by sovereign borrowers and commercial banks. Banks have thus been both major issuers and purchasers. Many banks have issued floating rate notes as a means of securing floating rate medium- and long-term funding, especially U.S. dollar funding for non-U.S. banks. One contributing factor was that many nondollar-based banks found short-term assets converted into longer-term claims as a result of debt rescheduling. Sovereign borrowers, which are regarded as good credit risks, often raised relatively large volumes of medium-term funds through floating rate notes at finer terms than in the syndicated loan markets. As noted earlier, this lower cost reflected the fact that banks regarded floating rate notes as more liquid (and more secure) assets than syndicated loans and therefore were willing to accept a lower spread on floating rate notes than on loans.
Interest and currency swaps have become increasingly important transactions in the international bond markets. Interest swaps have been used in the arbitrage of differences between the cost of funds in the fixed rate and floating rate Eurobond markets for different types of borrowers. For example, a highly rated bank would issue a fixed rate bond, while a relatively lower rated corporation would raise a corresponding amount of money in the floating rate market (where nonbank paper would be scarce). These borrowers would then agree to “swap” their interest payments obligations. The corporation thus obtains fixed rate financing at a rate well below what it would otherwise have had to pay had it directly accessed the fixed rate market. To induce the bank to engage in this swap of interest obligations, the corporation would also agree to pay a small proportion of the floating rate interest cost. The bank, therefore, often found that the net cost of raising floating rate funds by the swap operation was well below LIBOR. As interest swap operations expanded during 1983, however, banks had to pay relatively higher rates on the fixed rate market and, by late 1983, this higher cost reduced the incentive for interest swap operations.
In a typical currency swap, a borrower with a good credit rating in U.S. financial markets but with poor access to the Swiss franc market would agree to swap fixed rate dollar debt obligations for fixed rate Swiss franc obligations, to obtain relatively low Swiss franc interest rates. The other party to the swap arrangement would generally have good access to the Swiss franc market but would be looking for dollar funds that the good U.S. credit risk could provide at a relatively low cost. Currency swaps tend to be more complex than interest swaps as they involve evaluations not only of interest rate differentials but also of likely exchange rate movements over the period of the swap. It is estimated that $4 billion in currency swaps and $10 billion in interest rate swaps took place in 1983.
Interest and currency swaps represent an attempt to expand the arbitrage of interest rate differentials across countries from the short-term money markets to the short- and medium-term bond markets. In the money markets, interest rate arbitrage regularly ensures that interest rate differentials between two countries on comparable securities (e.g., treasury bills) will differ by the anticipated rate of change in the exchange rate.46 Since money market securities generally have short maturities, market participants can readily arbitrage on interest rate differentials that are larger or smaller than the expected rate of change in the exchange rate implied by the difference between the current spot exchange rate and the forward exchange rate that corresponds to the maturity of the security being considered. As forward exchange rate markets exist only for relatively short maturities, they cannot be as readily used in the arbitrage of medium- and long-term bond market interest rate differentials. In the absence of medium-term forward exchange markets, interest rate and currency swaps allow borrowers and lenders to arbitrage what they regard as “large” differentials in the cost of funds across countries, given their respective expectations regarding exchange rate movements. If this type of activity continues to expand, it should play an important role in linking financial market conditions across countries not only in the money markets but also in the short- and medium-term bond markets.
During the early part of 1983, partially paid or deferred payment bonds played an important role ($2.4 billion of issues during the first two months of 1983), as long as there was the prospect of declining interest rates. Issues of these bonds virtually disappeared as interest rates rose in midyear. In order to compete with equity markets, a number of issuers marketed bonds with warrants that could be converted into common stock. For example, Eurodollar bonds with warrants totaled $6 billion in 1983.
Late in 1983, dual currency bonds were used extensively in the Swiss capital market. These bonds typically consisted of a straight foreign Swiss franc issue with interest being paid in Swiss francs and principal paid in U.S. dollars at a fixed Swiss franc/U.S. dollar exchange rate. Swiss investors were attracted by the higher coupon rates generally available on these securities. In 1983, dual currency bond issues totaled $675 million.
In the first five months of 1984, floating rate notes accounted for about 35 percent of all international bond issues and the use of convertible bonds also expanded significantly. In the Eurodollar bond market, floating rate notes represented more than 50 percent of total issues; convertibles and bonds with equity warrants rose to 17 percent of all issues; and straight debt issues declined to roughly only 30 percent of these issues.
As indicated in Table 14, there have been only limited changes in bond maturities during the period since 1981. In a number of markets, there has been a shift out of relatively short (up to five years) maturities to medium-term (six to ten years) maturities. However, the proportion of international bonds with maturities of over ten years has not increased significantly, and most international bonds have a maturity of from six to ten years. As will be discussed in the next subsection, the absence of a significant lengthening of bond maturities during a period of record bond market issuance between 1981 and 1983 most likely reflected investor uncertainties regarding future changes in inflation, exchange rates, and interest rates.
As noted in the last Occasional Paper on capital markets, 47 the record level of bond market issuance during 1981–82 represented a recovery from an almost decade-long decline in bond market activity, especially during the late 1970s. The high level of bond issuance in 1983 was a continuation of that trend, but the pace of the recovery slowed considerably in 1983 relative to that in 1981 and 1982. This subsection examines the extent of this recovery, as well as the reasons for the slowing of the growth of issuing activity in 1983.
The decline in real activity in the international bond markets during the late 1970s is illustrated in Table 15. High levels of inflation and increased exchange rate and interest rate variability (Table 40), and the large capital losses experienced on fixed interest rate securities owing to rising interest rates combined to reduce the attractiveness of financial assets, in general, and long-term fixed interest rate bonds, in particular. This experience resulted in a reduction in the real volume of bond issuance, higher real bond yields, shorter bond maturities, and, over time, in the emergence of instruments that shifted interest rate and exchange rate risks from the investor to the issuers.48 The extent of the decline in real issue activity in the bond market is measured in three ways in Table 15. Since net issuance of international bonds is stated in current U.S. dollars, the value of bonds issued must be adjusted for the general rise in the price level to measure real activity; thus, the second item represents the results of deflating the U.S. dollar value of bond issues by the U.S. GNP deflator. In terms of 1975 prices, international bond issues declined from $29 billion in 1976 to $20 billion in 1980 (31 percent). Real activity then recovered to $24 billion in 1981 and to $35 billion in 1982 and 1983. As an alternative measure of the relative scale of bond market activity, the level of bond issuance can be scaled by the value of international trade. With the recovery in bond markets since 1981, the real value of net international bond issues also rose relative to the real size of international trade. As shown in the last part of Table 15, the recovery of bond market activity has combined with a reduction in new international bank lending to create a situation where net international bond issues rose from the equivalent of 26 percent in 1980 to more than 70 percent of the net international lending in 1983 (as reported by BIS reporting area banks). As discussed elsewhere in this paper, this situation reflected not only the recovery of bond market activity but also the sharp slowdown in international bank lending in recent years.
Table 14.Maturity Profile of International Bonds in 1981–83(In percent)
Currency of
U.S. dollar 25 20 14 54 59 60 21 21 26
Canadian dollar 35 21 17 58 79 80 7 0 3
Deutsche mark 12 11 12 82 81 83 6 8 5
Japanese yen 0 2 0 24 69 76 76 29 24
Pound sterling 41 32 17 2 27 40 57 41 42
Swiss franc 32 36 41 64 60 54 4 4 5
Netherlands guilder 37 39 30 35 48 54 28 13 5
Source: Salomon Brothers, Inc., International Bond and Money Market Performance.
Table 15.Measures of Real Size of Bond Market, 1975–83
Bond issues (net)1 20 30 31 30 32 28 41 62 60
Billion U.S. dollars at 1975 prices
Deflated by U.S. GNP deflator 20 29 28 25 25 20 24 35 35
Bond issues as ratio to world imports in U.S. dollars 2.5 3.2 2.9 2.4 2.2 1.5 2.1 3.4 3.5
As ratio to international bank lending (net)2 50.0 42.3 45.6 33.3 26.4 17.5 22.4 61.0 70.6
Sources: International Monetary Fund; Orion Royal Bank, Ltd. (London); and Bank for International Settlements.
1 New international bond issues less redemptions and repurchases.
2 International bank lending as measured by the external lending by banks in the BIS reporting area.
The decline in the real issues of bonds during the late 1970s resulted from investors’ primarily negative experience with greater variability of exchange rates, rising and variable interest rates, and higher rates of inflation. The rising interest rates imposed large capital losses on holdings of fixed interest rate securities during the late 1970s (Table 16). As a result of these developments, borrowers found that they had to offer high real yields as well as alter the risk-sharing characteristics of their bonds to attract purchasers. Real bond yields began to rise sharply in 1979 and 1980 (Tables 16 and 36) and remained at historically high levels during the 1981–83 period. In addition, there was increased issuance of bonds denominated in currencies expected to appreciate, a shift toward shorter bond maturities (to limit the extent of potential capital losses), the use of floating rate notes, and the introduction of a variety of other instruments designed to shift a portion of the risk associated with interest rate and exchange rate variability from bond purchasers to the issuers of bonds.
These changes in bond yields and characteristics were sufficient to allow borrowers to find a ready market for their bond issues in the period from late 1981 through 1983. The combination of a higher level of nominal interest rates, declining inflation, and major exchange rate movements led to a situation where the currency of denomination of a bond strongly influenced the total return earned by an investor. Table 16 illustrates examples of the real return earned by German and U.S. investors on bonds denominated in U.S. dollars or deutsche mark. Generally, investors earned a relatively high real return by purchasing bonds denominated in deutsche mark during the 1975–77 period and bonds denominated in U.S. dollars in the period since 1980. The high yields earned by German investors on U.S. dollar bonds in 1982 and 1983 reflected high nominal coupon rates, capital gains generated by declining interest rates, and the depreciation of the deutsche mark relative to the U.S. dollar over this period.
Table 16.Real Return on Bond Holdings, 1975–82 1(In percent per annum)
December of:
U.S. Investor Holding a U.S. Dollar Eurobond
Sold in Dec. of:
1976 11.32 — — — — — — —
1977 5.93 0.48 — — — — — —
1978 2.59 –2.00 –5.18 — — — — —
1979 –0.66 –4.65 –8.23 –13.42 — — — —
1980 –1.32 –4.97 –7.22 –9.91 –8.55 — — —
1981 –0.40 –3.41 –5.38 –6.72 –5.00 –3.09 — —
1982 1.35 –1.05 –2.13 –2.28 1.22 6.27 17.27 —
1983 2.37 0.40 –0.20 0.28 3.95 8.56 16.00 14.00
U.S. Investor Holding a Deutsche Mark Eurobond
1976 28.02 — — — — — — —
1977 29.29 27.12 — — — — — —
1978 25.14 20.38 10.80 — — — — —
1979 17.42 11.94 2.68 –5.95 — — — —
1980 7.37 1.59 –5.80 –13.65 —23.61 — — —
1981 3.37 –1.42 –7.54 –11.82 –16.10 –11.30 — —
1982 2.95 –0.99 –5.69 –9.28 –10.23 –4.41 3.71 —
1983 1.38 –1.80 –5.46 –8.07 –9.24 –5.44 –2.29 –7.72
German Investor Holding a Deutsche Mark Eurobond
1976 17.64 — — — — — — —
1977 17.86 18.40 — — — — — —
1978 13.22 10.98 3.07 — — — — —
1979 8.42 5.48 –1.50 –6.94 — — — —
1980 6.16 2.66 –2.59 –6.37 –7.32 — — —
1981 5.80 2.67 –2.12 –3.04 –1.76 4.05 — —
1982 6.28 3.69 –0.06 –1.46 1.65 6.91 10.35 —
1983 6.54 4.36 1.30 0.55 2.44 6.69 8.37 6.10
German Investor Holding a U.S. Dollar Eurobond
1976 2.29 — — — — — — —
1977 –2.13 –6.41 — — — — — —
1978 –4.73 –8.41 –11.79 — — — — —
1979 –5.83 –8.74 –11.55 –14.33 — — — —
1980 –2.15 –4.17 –4.17 –1.88 10.94 — — —
1981 1.57 0.02 0.71 4.15 14.04 13.68 — —
1982 4.36 3.61 4.90 9.04 18.99 20.24 24.78 —
1983 7.89 7.64 9.73 14.93 25.40 26.79 30.80 31.07
Sources: Orion Royal Bank, Ltd., The Orion Royal Guide to the International Capital Markets (Euromoney Publications Limited, London, 1982); the Organization for Economic Cooperation and Development; and the International Monetary Fund, International Financial Statistics.
1 In calculating the real rates of return in this table, the following assumptions were made: (1) The bond is assumed to be purchased in December of the year at the top of the table. (2) All interest on the bond is paid on December 31 of each year and the initial coupon rate of interest is taken as equal to the prevailing market interest rate. (3) Principal is repaid only at maturity. (4) Bonds are sold in December of the year given at the side of the table at a price which ensures that the bond yields a return to maturity equal to the prevailing (December) interest rate. (5) All coupon interest received is assumed to be continuously reinvested in three-month Eurocurrency deposits (at the prevailing Eurocurrency deposit rate) in the same currency as the interest rate payments and bonds are denominated. (6) In calculating the real return on bonds not denominated in the domestic currency, the accumulated interest income and bond sale proceeds are converted at the prevailing exchange rate, and any exchange gain or loss is included in the calculation of the real return. (7) The real return is calculated using the consumer price index in the investors’ home countries. (8) The bonds are those issued by private corporations.
Despite the recovery of bond market issuance and real yields, bond market maturities have not lengthened significantly. This probably reflects the presence of considerable uncertainty regarding the medium- and long-term outlook for inflation, interest rates, and exchange rates. A significant lengthening of bond maturities will require the emergence of lower real yields on short- and medium-term instruments and an extended period of stable financial market conditions.
Although the level of international bond issuance reached a historically high volume of $77 billion in 1983, Table 15 indicates that in real terms this volume was about the same as in 1982. This level of real activity was still 80 percent higher than the volume issued in 1980, but the rate of increase in real issuance slowed considerably from 20 percent in 1981 and 46 percent in 1982. The bond market recovery of 1981—83 basically restored the position of real bond market activity relative to the level of real activity in the world economy (which has been proxied by the level of world trade) that existed prior to the period of rising inflation and interest rates during the late 1970s. This recovery has been generated by a financial market environment characterized by lower rates of inflation and high real returns on bonds. This combination has made it possible for borrowers to market large volumes of bond issues that investors have found to be attractive portfolio assets. The bond market recovery has not been complete, in the sense that bond maturities are still considerably shorter than in the late 1960s and early 1970s, and bond issuers have found it necessary to take on an increasing share of the risk associated with interest rate and exchange rate movements. One of the keys to the future development of the bond markets will be the presence or absence of a significant lengthening of maturities.
In general, developing countries have not participated significantly in the recovery of bond market activity in the period 1981–83. As illustrated in Table 9, developing country issues declined from a peak of $4.7 billion in 1982 to $3.3 billion in 1983. The share of developing country issues in total issues declined from 8 percent in 1981 to 4 percent in 1983. Much of this issuance has been accounted for by a limited number of countries (Table 38). In 1983, for example, issues by Indonesia, Korea, Malaysia, South Africa, and Thailand represented nearly 80 percent of all developing country issues. Only those developing countries that are regarded as the “best” credit risks are able to have access to the international bond markets. While access to the international bond markets by developing countries has traditionally been more limited than to the syndicated loan market, the limitations on entry have become even more pronounced since the emergence in late 1982 of external payments strains for many developing countries. The position of developing countries in the bond market has nonetheless been strengthened by the fact that principal and interest payments on developing country bonds have generally been paid even by countries experiencing severe debt difficulties, and bond payments have usually not been included in reschedulings. The continued servicing of bonded debt had a strong impact on the differential between the returns on developing country bonds and those on industrial country bonds. Chart 7 illustrates the behavior of these yield differentials during 1982–83 in the secondary markets for bonds denominated in deutsche mark. In the period prior to mid-1982, the yield differentials do not appear to indicate any significant market anticipation of the external payments difficulties of the group of developing countries included in Chart 7. However, the yield differential between bonds issued by the Mexican Government and those of industrial country issuers rose from less than 2 percentage points in the period prior to mid-1982 to approximately 4 percent by the third quarter of 1982. The yield differential on Brazilian bonds increased from about 2 percent in the first half of 1982 to as much as 6 percent during certain periods of 1983. By late 1983 and early 1984, however, these differentials had declined to approximately 2 percent for Mexican bonds, 3 percent for Venezuelan bonds, 3 percent for Brazilian bonds, and 4 percent for Argentine bonds. These movements in yield differentials imply considerable changes in the risk that market participants perceive as attached to holding developing country bonds.
Chart 7.Yield Differentials on Public Bonds Denominated in Deutsche Mark Issued by Developing Countries, 1982–84 1
Source: Information provided by the Deutsche Bundesbank.
1 These differentials equal the yield on the bonds of the individual developing countries or the average for all developing countries and minus the average yield on bonds for industrial country entities other than bonds issued by German residents.
2 Since 1983, excluding southern European countries, particularly Spain.
Since many non-oil developing countries have faced greatly reduced access to the international bank credit and securities markets, it has been suggested that foreign direct investment and official flows could provide a higher proportion of the external financing of these countries in future. This subsection, therefore, reviews the role of foreign direct investment and official flows, in relation to private credit flows, as sources of financing for the current account deficits and reserve accumulations of non-oil developing countries during the 1970s and early 1980s and considers the role these flows are likely to play over the medium term.49
Foreign direct investment can take the form of new equity capital, reinvestment of earnings, or net short-and long-term borrowing from the parent company or its affiliates. Most foreign direct investment involves flows between developed economies. As shown in Table 17, developing countries (including both oil exporting and non-oil developing countries) have been the recipients of about one third of total foreign direct investment in the period 1960–79. The absolute flow of investment funds to the developing countries increased from less than $2 billion in the early 1960s to over $13 billion by 1979, and had a significant impact on growth and capital stocks. The outstanding amount of foreign direct investment in developing countries, which increased at an average annual rate of 11.4 percent in 1973–83 to reach a total of $138 billion, grew more slowly than total external debt, which expanded at a rate of almost 18 percent per annum to reach $669 billion in 1983. As with international bank lending, these foreign direct investment flows to non-oil developing countries have been concentrated on a small number of recipients. Brazil, Malaysia, Mexico, Singapore, and South Africa accounted for nearly one half of the stock of foreign direct investment for non-oil developing countries at the end of 1983 (Table 18). In part, this concentration was due to the positive attitude of these developing countries toward foreign investment.
The primary source of foreign direct investment has been the United States, but its relative importance as a source has declined in recent years along with that of the United Kingdom and France, while flows from the Federal Republic of Germany and Japan have grown rapidly. The stock of U.S. direct investment in developing countries grew at an average annual rate of less than 10 percent in the period 1970-82, compared with growth rates of 17 and 21 percent for Germany and Japan. The United Kingdom and France saw the stocks of their investment expand at roughly 9 percent per annum.
Income payments50 by developing countries on foreign direct investment rose from $9.5 billion in 1973 to over $25 billion in 1981 but then declined to about $16 billion in 1983, when profits fell sharply as a result of the world recession and a decline in oil prices. In contrast, interest payments on external debt of non-oil developing countries grew significantly, especially after 1979, primarily reflecting high rates of borrowing. The variability of payments on direct investment is clearly an advantageous element for the recipient country, but it would be negated to the extent that foreign investors increase the proportion of these investments in the form of intercompany loan claims.
Table 19 contrasts the roles of foreign direct investment and external borrowing in the financing of the current account deficits and reserve accumulations of the non-oil developing countries and the 25 largest debtors among these countries. In 1973, net foreign direct investment inflows were equivalent to 20 percent of the current account deficits and reserve accumulations of the non-oil developing countries, whereas borrowing from financial institutions and other creditors equaled 27 percent of the financing requirement. The relative importance of both flows then changed. By 1977 foreign direct investment accounted for only 13 percent of financing needs and the share of private borrowing had risen to 44 percent. While both foreign direct investment and private borrowing grew rapidly in the period after the second oil price increase in 1977, private borrowing expanded much more sharply. In 1981, just prior to the emergence of external payments difficulties for a growing number of developing countries, the share of foreign direct investment had fallen to 11 percent, whereas the share of private external borrowing had risen to 62 percent. As the debt crisis developed, the share of foreign direct investment rose to 14 percent in 1982 and to 13 percent in 1983; while the share of private credit flows fell to 46 percent in 1982 and to 32 percent in 1983, with much of the flow from financial institutions in late 1982 and 1983 taking the form of concerted lending. For the 25 largest developing country debtors, the relative importance of private credit flows in comparison to foreign direct investment was even greater. In 1977 foreign direct investment accounted for 12 percent and external borrowing from private creditors for 63 per-cent of the financing needs of the 25 developing countries with the largest external debt. By 1980, the share of foreign direct investment had declined to 10 percent, but that of external borrowing had reached 94 percent. In 1983, however, the share of foreign direct investment rose slightly to 11 percent, but that of external borrowing fell sharply to 49 percent, with most of this lending taking the form of concerted lending. Thus, the role of foreign direct investment in financing the current account deficits and reserve accumulations of the non-oil developing countries remained relatively stable in the 10-12 percent range, but the share of net external borrowing initially rose dramatically between 1977 and 1980 before diminishing just as sharply between 1981 and 1983.
Table 17.Gross Foreign Direct Investment Flows, 1960–79(In millions of U.S. dollars)
Recipient Regions
1960 315 749 2,150 1,806 3,956 46
1961 311 1,573 2,815 1,839 4,654 39
1962 346 1,598 2,790 1,469 4,259 35
1963 231 1,819 2,836 1,659 4,495 38
1964 322 2,255 3,412 1,819 5,231 35
1965 415 2,652 4,227 2,488 6,715 37
1966 425 2,878 4,504 2,159 6,663 33
1967 698 2,893 4,791 2,103 6,894 30
1968 807 2,646 4,735 2,900 7,635 38
1969 1,263 3,300 5,928 2,804 8,732 32
1970 1,464 4,200 7,522 3,689 11,211 33
1971 367 4,892 7,523 3,307 10,830 31
1972 949 5,925 8,702 4,234 12,936 33
1973 2,800 8,054 11,688 4,719 16,407 29
1974 4,760 9,962 16,695 1,123 18,088 6
1975 2,603 7,244 11,153 10,494 21,647 49
1976 4,347 5,611 10,791 7,824 18,615 42
1977 3,338 8,972 13,851 9,500 23,351 40
1978 7,900 10,470 20,978 11,154 32,132 35
1979 9,730 9,403 22,098 13,491 35,589 38
Sources: United Nations Center of Transnational Corporations; and the Group of Thirty.
1 Besides flows into the United States and Europe, other flows went mainly into Canada and Australia. Flows into Japan averaged well below $100 million a year throughout.
2 Average for period.
Flows of foreign direct investment have been influenced by a variety of economic and political factors. In a recent survey conducted by the Group of Thirty,51 for example, 52 major international corporations re-ported on the factors that they regarded as most important in determining their level of foreign direct investment in developing countries. According to these corporations, the primary considerations determining their level of foreign direct investment were the shrinking investment opportunities in their domestic markets, the need to compete more efficiently in the recipient countries, the need to overcome tariff or nontariff barriers in recipient countries, the desire to gain access to particular regional markets, and the general prospects for current and future economic conditions in the recipient country. In general, these investors stated that they were not as influenced by considerations relating to political stability, labor costs, or exchange rate and interest rate fluctuations. Most firms also indicated that official incentives played a somewhat limited role in their decisions where to locate foreign direct investment on a worldwide basis. These official incentives have been offered by the governments of both the supplier and the recipient countries. In many of the major industrial countries, for example, there are programs that provide investment guarantees covering a variety of political risks. There are also fiscal measures that, in general, provide preferential treatment for capital invested in developing countries through some type of tax deferral. Official financial support can sometimes be obtained to finance either some portion of the investment or the imports of certain types of goods to be used in the investment process.
Table 18.Stocks of Foreign Direct Investment in Selected Developing Countries, 1973–83(In billions of U.S. dollars)
growth rate, 1973–83
end of 1983 2
Argentina 2.5 5.7 8.6 40.7
Brazil 7.5 23.6 12.1 87.4
Chile 0.5 3.0 19.6 17.4
Colombia 1.0 2.4 9.1 10.7
India 1.8 2.5 3.3 26.2
Indonesia 1.7 6.9 15.0 32.6
Korea 0.7 1.4 7.2 40.4
Malaysia 1.2 7.1 19.5 13.4
Mexico 3.1 12.8 15.2 90.0
Nigeria 2.3 3.8 5.1 17.1
Philippines 0.9 3.0 12.8 24.9
Singapore 0.6 7.3 28.4 0.6
South Africa 8.4 17.1 7.4 17.4
Thailand 0.5 1.4 10.8 13.7
Turkey 0.4 1.3 12.5 17.5
All non-oil developing countries 47.0 138.0 11.4 668.6
1 The 1983 end-of-year stock figures equal the estimated book value of the stock of direct investment from industrial countries at the end of 1978 plus total direct investment flows during 1979–83.
2 Includes short-term debt.
Table 19.Non-Oil Developing Countries: Financing of Current Account Deficit and Reserve Accumulation, 1973–83(In billions of U.S. dollars)
(1) Current account deficit 11.0 37.1 46.3 31.7 30.4 42.3 62.0 87.7 109.1 82.2 56.4
(2) Reserve accumulation 9.7 1.6 –1.6 14.5 11.5 16.3 11.8 6.8 5.4 –3.8 6.1
Financing: Sum of (1) and (2) 20.7 38.7 44.7 46.2 41.9 58.6 73.8 94.5 114.5 78.4 62.5
(3) Direct investment, net 4.2 5.1 5.3 5.3 5.4 7.1 9.3 9.4 13.1 11.2 7.9
(4) Official transfers 5.5 8.8 7.1 7.4 8.3 8.3 11.5 12.8 13.5 12.9 13.2
(5) Long-term borrowing from official creditors, net 5.7 6.8 11.0 12.3 13.1 13.8 17.0 20.0 22.6 21.6 22.6
(6) Net external borrowing from private creditors 5.6 17.9 23.0 19.2 18.4 32.8 36.5 60.6 70.5 36.2 20.2
(7) Other sources1 1 –0.3 0.1 –1.7 2.0 –3.3 –2.4 –0.5 –8.3 –5.2 –3.5 –1.4
Source: International Monetary Fund, World Economic Outlook, Occasional Paper No. 27 (Washington, April 1984).
1 Includes errors and omissions.
Developing countries’ policies toward foreign direct investment have combined some elements of regulation and control designed to improve the benefits received by the host country with incentives that attract such investment. Some developing countries, with large domestic markets and thereby the potential to attract foreign investment for import substitution, have established restrictions in an attempt to limit the share of foreign ownership in certain industries or to increase the net contribution of direct investment to the domestic economy. These measures have included such policies as restrictions on foreign portfolio investment, limits on capital repatriation, minimum investment periods, and high taxes on dividends. At the same time, there have also been a variety of incentives for foreign investment that have included tax concessions, official financial support, and special measures pertaining to exchange controls, labor agreements, and environmental standards. In examining the influence of these incentives, the study by the Group of Thirty found that, over time, foreign direct investment tended to respond primarily to economic and financial conditions created by an appropriate mix of fiscal, financial, trade, and exchange rate policies. Although fiscal incentives and the removal of restrictions on foreign direct investments could enhance the attractiveness of such investments, they could not offset the effects of overvalued exchange rates, large and continuous fiscal imbalances, and inappropriate relative price signals in both the goods and financial markets. In this regard, protectionism in both developed and developing countries could have an adverse effect on flows of foreign direct investment to developing countries. The establishment of protectionist barriers in developed countries against imports from developing countries directly reduces the incentives to undertake production of export goods in developing countries. While protectionism in developing countries might encourage foreign investment in relatively inefficient import substitution industries, the general rise in production costs often associated with such a strategy made investment in export industries in developing countries less attractive. The response of foreign direct investment to appropriate incentives was likely to develop gradually. Thus, while foreign direct investment could play an important medium-term role as a source of development finance, in the immediate future it was unlikely to be a major source of balance of payments financing.
The recent World Economic Outlook exercise and the survey by the Group of Thirty provide information on the medium-term outlook for foreign direct investment in non-oil developing countries. If the investment plans of the large corporations included in the Group of Thirty survey were carried out, then the growth of foreign direct investment is likely to slow somewhat during the coming five-year period relative to that in the two preceding five-year periods, when real foreign direct investment increased by 25 percent or more in each period. However, a substantial amount of real investment would still take place.
For 1984 and 1985, the World Economic Outlook forecasts that foreign direct investment will account for 14 and 15 percent, respectively, of the current account deficit and reserve accumulations of the non-oil developing countries. During 1986-90, the medium-term scenario described in the World Economic Out-look assumes that foreign direct investment to the non-oil developing countries would increase by nearly 5 percent per annum in real terms. In contrast, these flows grew at only 3½ percent a year from 1973 to 1981. This rate of growth implies that the 1981 peak flow of direct investment would again be attained in 1988. As bank exposure is assumed to grow less rapidly, the share of foreign direct investment in financing the current account deficit and reserve accumulation of the non-oil developing countries would rise from nearly 11 percent in 1979-81 to 15 percent in 1988-90. As foreign direct investment flows have traditionally focused on a relatively narrow set of developing countries, not all developing countries will benefit from these larger flows unless there are changes in their policies regarding foreign investment. In this regard, the most important policies are those fiscal and financial policies that lead to greater domestic stability and more manageable external positions. Appropriate relative prices, especially for exchange rates and interest rates, will also encourage such inflows. While specific incentive programs can play a role in attracting direct investment flows, they are not likely to offset inappropriate macroeconomic policies.
Official transfers and lending have been important sources of financing for the non-oil developing countries throughout the 1973-83 period, but their relative contribution to the financing of current account deficits and reserve accumulations of this group of countries has varied considerably, especially during periods when these countries came to rely heavily on external borrowing from private creditors. As shown in Table 19, official transfers and lending accounted for more than 40 percent of the sum of current account deficits and reserve accumulations of the non-oil developing countries in the period 1973-77. As borrowing from private markets expanded during 1978-81, how-ever, the relative share of official inflows was consistently below 40 percent and reached a low of 32 percent in 1981. In contrast, the slowdown in the growth of private credit in 1982 and 1983 raised the share of official transfers and lending to 57 percent by 1983.
The share of official lending has always been more important than that of official transfers, but both have followed somewhat similar trends over the 1973-83 period. Official transfers accounted for 27 percent of the financing needs of the non-oil developing countries in 1973, but fell to only 14 percent in 1980 before recovering to 21 percent in 1983. The share of official lending declined from 28 percent in 1973 to 20 percent in 1981 before increasing to 36 percent in 1983.
The role of official transfers and lending can also be evaluated in terms of the real resources made available through these programs. One measure of the flow of real resources from world markets which could be obtained through the use of these funds is to deflate the nominal flows by the unit value of imports of the non-oil developing countries. By this measure, the real value of official transfers fell from $8.9 billion in 1973 to $8.1 billion in 1983. In addition, the real level of official transfers remained constant at approximately $8 billion between 1981 and 1983, which represented a period of considerable difficulty for the non-oil developing countries. The real level of official lending totaled $8 billion in 1973, increased to $11-12 billion in 1977-80, and then rose to $13-14 billion in 1981-83. Together, the real value of official transfers and lending increased from $16 billion in 1973 to a peak of $22 billion in 1983. Thus, in real terms, the resources provided to the non-oil developing countries through official lending and transfers increased during the 1981-83 period, but there was a shift away from official transfers toward official lending. The real value of official transfers in 1983 was not significantly different from that in 1979, while the real value of official lending had increased from $12 billion to $14 billion in the same period.
It is unlikely that official transfers and lending will show significant real growth in the near future in view of the difficulties in obtaining additional funds during periods of restraint on public expenditures, as now exist in many donor countries. The World Economic Outlook medium-term scenarios assumed that official development assistance was likely to remain constant in real terms throughout the 1985-90 period at the level projected for 1984.
International bonds consist of foreign and Eurocurrency bonds. Foreign bonds are issued by a borrower who is of a nationality different from the country in which the bonds are issued. Such issues are usually underwritten and sold by a group of banks of the market country and are denominated in that country’s currency. In contrast, Eurocurrency bonds are those underwritten and sold in various national markets simultaneously, usually through international syndicates of banks.
Issues net of redemptions and bank purchases of bonds.
This relationship may not be an exact equality because of capital controls and market or political risks.
For a detailed discussion of this experience, see Appendix II, International Monetary Fund, International Capital Markets: Developments and Prospects, 1983, Occasional Paper No. 23 (Washington, July 1983).
For a detailed discussion of this experience, see ibid.
In April 1984, the OECD and the BIS published jointly the first of a series of semiannual reports combining statistics on the external claims of banks in the BIS reporting area with OECD data on official and officially guaranteed buyers’ and suppliers’ credits. This report showed the component of external bank claims that could be identified as guaranteed claims, which accounted for approximately 12 percent of total bank claims of $521 billion as of June 30, 1983. It also showed trade-related credits provided by nonbanks, where such claims were officially guaranteed; these amounted to $132 billion on the same date. This latter figure includes credits in the form of intercompany transactions, where these are officially guaranteed in the lending country.
Dividends and net interest payments on borrowings from parent companies or affiliates (net of host country taxes) plus the investor’s share of reinvested earnings.
The Group of Thirty, Foreign Direct Investment, 1973-87 (New York, 1984).