TRADE AND CAPITAL FLOWS

Trade

After the recovery of world trade in 1997 from its relatively muted performance in 1996, a sharp fall in imports by the developing countries, led by the Asian economies affected by the crisis, saw a major deceleration of world trade in 1998. Growth in the volume of world trade is expected to fall to 3.7 per cent in 1998 from 9.7 per cent in 1997. Global merchandise trade in dollar values is actually expected to register a decline in 1998 compared to 1997 because of sharply lower commodity prices. Between October 1997 and October 1998, the dollar price index for all commodity groups declined by 7.4 per cent, following a decline of 3.7 per cent in the previous 12 months.

The expected rapid growth in exports from the countries experiencing large currency depreciations did not materialize. The major factor behind this phenomenon, perhaps initially underrated to some extent, was the high cost of imported inputs and the shortage of finance available to the real economy. The chronic weakness of the Japanese economy was another negative factor in so far as the ESCAP region was concerned.

Some deceleration of world trade had been expected in 1998 on the presumption that growth in North America could begin to taper off during the year and this might not be offset by recovery in the EU. Against this, it was assumed that, if developing and transition economies were able to maintain their rate of expansion of imports, the decline in the overall rate of growth of world trade in 1998 might be only marginal. In the event, North American imports remained unexpectedly buoyant for most of 1998, but developing country imports declined by far more than had been forecast, thus causing the slowdown in world trade growth.

It is worth emphasizing that in many developing countries imports and exports, have a circular relationship. Many of the newer exports, on which much of the export buoyancy in the early 1990s was built, including those generated by FDI, have a high import content of raw materials and components. Exchange rate depreciations made imports more expensive. This, in turn, produced an adverse knock-on effect on exports. However, the latest indications are that exports from some of the worst-affected Asian economies have risen modestly in volume terms but not yet in dollar values to a commensurate degree. Nevertheless, rising export volumes have served to partially mitigate severe cash flow problems in several economies and to counter the effects of shrinking domestic sales.

In terms of merchandise trade, while the broad parameters do not look very optimistic, the worldwide demand for semiconductors is expected to bounce back in 1999.⁽⁶⁾ Overcapacity and weakness in semiconductor prices was a major factor in the trade slowdown of several countries in the ESCAP region in 1996. A pick-up of demand in that industry could have more than just symbolic significance in the present context.

Capital flows

Trends in capital flows are shown in table I.2. Virtually all forms of private capital flows show a fairly sustained rise in the period 1990 to 1996. There was a slowdown between 1993 and 1994 in the aftermath of the Mexican crisis and a further deceleration in 1997, reflecting the beginning of the financial crisis in Asia in the latter half of 1997. Preliminary indications for 1998 suggest a sharp deceleration across the board, with the exception of ODA flows. Overall, private flows to emerging markets are estimated to have declined by some 35 per cent compared with 1997, with a particularly dramatic fall in commercial bank lending. ODA flows have obviously risen only temporarily in response to the expanded emergency assistance provided by IMF, the World Bank and other multilateral and bilateral sources to several countries in 1998.⁽⁷⁾

As already mentioned, in the wake of the Asian crisis and subsequent problems elsewhere, financial market contagion spread beyond the Asian region. With the unilateral debt freeze in the Russian Federation, an intensified risk aversion emerged, leading to a more generalized flight to quality during 1998. Prime quality bond prices rose to unprecedented heights during the year. Simultaneously, yield differentials between the best-rated bonds, such as United States Treasury bonds, and others such as those issued by emerging markets or lesser-known corporate names widened. This phenomenon made it virtually impossible for emerging market governments or corporate entities to raise finance at an acceptable cost.

There is some fear that this flight to quality may not be easily reversible in the short term. One critical feature of the phenomenon is the state of the balance sheets of emerging market financial institutions. All capital flows, other than FDI, require intermediation by financial institutions. Impaired asset quality of many financial institutions has forced many of them to cut back on new lending, especially to less creditworthy customers, creating the anomalous situation in which interest rates are tending downwards, yet there is an overall shortage of credit. Many developing country financial institutions, saddled with bad debts, are thus unable to access outside sources of capital.

Generally speaking, investors appear to be eschewing, at least for the time being, emerging markets in favour of developed countries. Likely rates of return in emerging markets may not be considered high enough to compensate for the currently heightened risk perceptions associated with these economies.

It should be borne in mind that international capital movements in the 1990s have become more supply-driven than in the past, reflecting continued growth in the size of the international asset management industry. The latter, which exceeds the aggregate GDP of developed countries,⁽⁸⁾ has had a major bearing on financial indicators such as liquidity, ease of issuance of debt, the volume and pattern of international capital flows, the development of new instruments and new markets, and on market volatility.

In the years 1994-1996, developing countries benefited from rising volumes of capital flows as developed country financial institutions sought to diversify portfolios and improve rates of return; 1997 and 1998 effectively saw a complete reversal of this pattern, creating severe problems for countries relying on private capital inflows. In the latter part of 1998, capital flows appear to have been redirected once again to the developed countries. This is reflected in the upsurge of merger activity across a range of sectors which is keeping equity markets unusually buoyant, despite the likelihood of a slowdown in growth in the coming months. Indeed, corporate mergers have not only kept developed country capital markets relatively buoyant but may also suggest a more long-term need for consolidation in order to defend market shares in what might be more difficult trading conditions in the future. All these developments raise important issues relating to the stability, international oversight, regulation and management of cross-border capital movements, some of which are discussed later in this chapter.

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Table I.2. Net long-term resource flows to developing countries, 1990-1997

(Billions of US dollars)

Footnotes:

^6. Bangkok Post, 13 November 1998.
^7. Financial Times, 20 October 1998.
^8. Bank for International Settlements, 68th Annual Report (1998), p. 83.