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Dubai

Financial Market -02

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Published in: Finance | Finance: Banking | Finance: Corporate
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International finance is a branch of economics that studies how money flows between countries and affects global economies and businesses. Financial markets are platforms where people and institutions trade assets like stocks, bonds, currencies, and commodities, playing a crucial role in moving funds from savers to those who need them for productive uses.

Namal I / Dubai

10 years of teaching experience

Qualification: BA(Economics)Special (Hons)(2nd Class). MA(Economics), MA(Financial Economics),M.Econ, MBA, PGD in Information Technology, MIT-Master of Information Technology, NVQ Level 4: Diploma in Computer Networking.

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  1. INTERNATIONAL FINANCE AND FINANCIAL MARKETS
  2. OBJECTIVES •To understand Nature of Funds Flowing across National Borders International Monetary System and Institutions International Financial System, Financial Institutions and Financial markets International Financial Centres and Exchanges
  3. PRESENTATION OUTLINE 1. 2. 3. Foreign Trade in Goods and Capital Financial Globalization Recent Experience of Capital Account Liberalization
  4. IN GOODS AND FLOW OF CAPITAL The case for free trade in goods and services applies also to capital Trade in capital helps countries to specialize according to comparative advantage, exploit economies of scale, and promote competition Exporting securities — e.g., equity in domestic firms - earns foreign exchange, and also grants access to capital, ideas, know-how, technology But financial capital is volatile
  5. TRADE IN GOODS AND CAPITAL FLOWS IN EXTERNAL BALANCE SHEET Balance of payments AR = X -M + FX-FM=X-M+F DR = change in foreign reserves exports of goods and services M = imports of goods and services FX _ FM = net exports of capital Foreign direct investment Portfolio investment Foreign borrowing
  6. TRADE IN GOODS AND SERVICES DEPENDS ON... Relative prices at home and abroad Exchange rates - elasticity National incomes at home and abroad Geographical distance from trading partners - gravity models Trade policy regime - tariffs and other barriers to trade
  7. or CAPITAL DEPENDS ON.. Interest rates at home and abroad Exchange rate expectations Geographical distance from trading partners Capital account policy regime-exchange controls and other barriers to free flows
  8. IN GOODS AND FLOW OF CAPITAL Since 1945, trade in goods and services has been gradually liberalized -GATT, WTO Since 1980s, trade in capital has also been freed up Capital inflows (i.e., foreign funds obtained by the domestic private and public sectors) have become a large source of financing for many emerging market economies
  9. Going Strng CAPITAL FLOWS Globalization Trends, 1870-2015 Paradoxically, emerging market countries are a key provider of capital to mature markets. (global caøital billion Oollars)' Emerging markets Share of emerging markets - Nom America Advanced Asia (øercent) 1995 99
  10. Globalization Is Increasing (So Far) While flows of information show the most growth over time. the percentages of trade, capital, and people flows crossing national borders all increased between 2016 and 2017 as WAI. Depth Of global connectedness, Figtre 1.9. Ernerging Market Economies: Capital Flows hvztus irureæed nurut botul md e.ity in earty X)19. 40 - Net in "Jars) relative to 2001 2001 '09 '13 Information Capital People Trade 20 - 10- -10.- 12- eq.iw muket 13 14 15 — EWWY elætion 2010 11 12 16 15 - 2. Cap" IMIows — EnzÄ Eurq)e (Percat of kia excluding mina 2m 7 08 10 12 13 14 15 18 Feb 19 04
  11. IMPORTANCE or CAPITAL Facilitate borrowing abroad to smooth consumption over time Dampen business cycles Reduce vulnerability to domestic economic disturbances Encourage saving, investment, and economic growth • Increase welfare
  12. CAPITAL FLOWS: CONCEPTUAL FRAMEWORK Emerging countries save a little Saving Borrowin Investment Loanable funds Industrial countries save a lot Lendi Saving Investment Loanable funds Financial globalization encourages investment in emerging countries and saving in industrial countries
  13. PUSH AND PULL FACTORS Capital flows result from interaction between supply and demand Capital is pushed away from investor countries • Investors supply capital to recipients Capital is pulled into recipient countries • Recipients demand capital from investors
  14. PUSH FACTORS External factors pushed capital from industrial countries to LDCs Cyclical conditions in industrial countries Recessions in early 1990s Decline in world interest rates Structural changes in industrial countries Developments in the financial structure • Demographic changes
  15. PUSH FACTORS... Institutional investors, banks, and firms in mature markets increasingly invest in emerging markets assets to diversify and enhance risk-adjusted returns (i.e., to reduce "home bias"), due to • low interest rates at home, high liquidity in mature markets, stimulus from "yen" carry trade demographic changes, rise in pension funds in mature markets changes in accounting and regulatory environment allowing more diversification of assets
  16. PUSH FACTORS... Sovereign wealth funds (e.g., future generations funds) need to invest abroad as the domestic financial market is too small or too risky • Need to invest the windfall gains accruing to commodity producers, in particular oil producers (e.g., Norway)
  17. PULL FACTORS • Internal factors "pulled" capital into LDCs from industrial countries Macroeconomic fundamentals Reduction in barriers to capital flows Private risk-return characteristics Creditworthiness Productivity
  18. PULL FACTORS... Structural changes in emerging markets Better financial market infrastructure • Improved corporate and financial sector governance More liberal regulations regarding foreign portfolio inflows Stronger macroeconomic fundamentals Solid current account positions (except in emerging European countries) • Improved debt management Large accumulation of reserve assets
  19. BENEFITS CAPITAL n Improved allocation of global savings allows capital to seek highest returns Greater efficiency of investment More rapid economic growth Reduced macroeconomic volatility through risk diversification which dampens business cycles • Income smoothing Consumption smoothing
  20. RISKS or CAPITAL FLOWS Open capital accounts may make receiving countries vulnerable to foreign shocks Magnify domestic shocks and lead to contagion Limit effectiveness of domestic macroeconomic policy instruments Countries with open capital accounts are vulnerable to Shifts in market sentiment • Reversals of capital inflows May lead to macroeconomic crisis Sudden reserve losses, exchange rate pressure Drastic balance of payments adjustment, with severe macroeconomic consequences Financial crisis
  21. RISKS or CAPITAL FLOWS. Overheating of the economy Excessive expansion of aggregate demand with inflation, real currency appreciation, widening current account deficit Increase in consumption and investment relative to GDP Quality of investment suffers Construction booms - count the cranes! Monetary consequences of capital inflows and accumulation of foreign exchange reserves depend on exchange regime Fixed exchange rate: Inflation takes off Flexible rate: Appreciation fuels spending boom
  22. FINANCIAL GLOBALIZATION: RECENT TRENDS AND CRISES Global cross-border asset and liabilities accumulation has risen dramatically, reflecting Financial Globalization • Financial crises 1997-98 and 2008-09
  23. RISKS or CAPITAL FLOWS... Capit• Asian Private Capital Flows Prior to the Crisis US$ billions 50 25 USSb 40 20 portfolio -20 1990 1991 1992 source: IMF 1998. (LHS) Per cent of GDP (RHS) Other 1993 1994 FDI 1995 1996 6 3 US$b 40 20 1997
  24. courtnes' Waysia 2 wnezueä sweæn Aab Enü&s 2 3% Countries That Export Capialt Out kama 242% Ulited SMtes 2008 Countries That Import Capital' Otter cow'triesd 30.7% Australia Frau 290/0 LIMed Kingdom Greæe 33% $ajn g 8%
  25. TRENDS IN NET CAPITAL FLOWS TO EMERGING MARKETS Emerging markets, as a group, have become net exporters of capital and an important investor class in mature markets Emerging markets' outflows mirror the U.S. external financing gap Flow of capital from emerging to mature markets is channeled in large part through Asian central bank reserves and sovereign wealth funds
  26. RISK FACTORS Large deficits Current account deficits Government budget deficits Poor bank regulation Government guarantees (implicit or explicit) Moral hazard Stock and composition of foreign debt • Ratio of short-term liabilities to foreign reserves (Giudotti- Greenspan Rule) Mismatches • Maturity mismatches (borrowing short, lending long) Currency mismatches (borrowing in foreign currency, lending In domestic currency)
  27. RECENT EXPERIENCE or CAPITAL ACCOUNT LIBERALIZATION External or financial crisis followed capital account liberalization e.g., Mexico, Sweden, Turkey, Korea, Paraguay Response Rekindled support for capital controls Focus on sequencing of reforms Sequencing makes a difference Strengthen financial sector and prudential framework before removing capital account restrictions Remove restrictions on FDI inflows early Liberalize outflows after macroeconomic imbalances have been addressed
  28. RISKY CAPITAL FLOWS Ostry et al (2010), for example, propose the following decreasing order of riskiness for capital flows (with short-term instruments riskier than long-term ones within each category): foreign-currency debt, local-currency debt (with CPI- linkers being riskier than nominal bonds; no mention of interest-rate linkers), portfolio equity investment, and foreign direct investment
  29. High degree of risk sharing No risk sharing RISKY CAPITAL FLOWS Portfolio equity Short term debt Foreign direct investment Long term debt (bonds) Permanent In general, FDI is assumed to be good and more stable, while portfolio flows are assumed to be more volatile - particularly debt, as opposed to equity, flows. Tansitory
  30. SEQUENCING or CAPITAL ACCOUNT LIBERALIZATION Pre-conditions for liberalization Sound macroeconomic policies Strong domestic financial system Strong and autonomous central bank Timely, accurate, and comprehensive data disclosure
  31. VOLATILITY or CAPITAL FLOWS AND YIELDS •Capital flows exhibit volatility and a "boom-bust" pattern •The pattern reflects in part waves of privatization (FDI) and liberalization in emerging market economies •But it can at times reflect contagion effects from a financial crisis across markets
  32. MARKET CLOSURES •High volatility episodes can be associated with temporary loss of access to capital markets and high yields on emerging markets bonds •The loss of access often reflects adverse political or economic developments in emerging market economies •The loss of access is sometimes linked to developments in mature markets (e.g., tightening of liq uidity)
  33. EVOLUTION or IN CRISIS EPISODES •Foreign Direct Investment (FDI) is considered the most stable capital flow to emerging markets •Experience shows that FDI in general continued to grow through capital account crisis episodes
  34. FINANCIAL CRISES IN 1990S CALLED CAPITAL LIBERALIZATION IN DOUBT •Financial globalization is often blamed for crises in emerging markets •It was suggested that emerging markets had dismantled capital controls too hastily, leaving themselves vulnerable •More radically, some economists view unfettered capital flows as disruptive to global financial stability •These economists call for capital controls and other curbs on capital flows (e.g., taxes) •Others argue that increased openness to capital flows has proved essential for countries seeking to rise from lower income to middle-income status
  35. ROLE OF CAPITAL CONTROLS •Capital controls aim to reduce risks associated with excessive inflows or outflows •Specific objectives may include •Protecting a fragile banking system •Avoiding quick reversals of short-term capital inflows following an adverse macroeconomic shock •Reducing currency appreciation when faced with large inflows •Stemming currency depreciation when faced with large outflows •Inducing a shift from shorter- to longer-term inflows
  36. IMF ANNUAL REPORT ON EXCHANGE ARRANGEMENTS AND EXCHANGE RESTRICTIONS •IMF (which has jurisdiction over current account, not capital account, restrictions) maintains detailed compilation of member countries' capital account restrictions •The information in the AREAER has been used to construct measures of financial openness based on a 1 (controlled) to 0 (liberalized) classification •They show a trend toward greater financial openness during the 1990s •But these measures provide only rough indications because they do not measure the intensity or effectiveness of capital controls (de jure versus de facto measures)
  37. Figure I .2. Countries with Capital Controls I or total IMF 85 980 82 All 84 94 96 9B 2000 Source: A Report on Exchange Arrangements Exchange (AREAER). •Based o" a one or zero (not all as by the AREAER. There a definitional change 1997 to 1998.
  38. Figure 4.7. Capital Controls and Flows to Emerging Markets 250 — 150 — too — 50 _ Capita/ controls (right scale) Gross capital flows (in billions of U_S_ dollars; left scale) — 0.70 — 0.65 — 0.60 — 0.55 — 0.50 — 0.45 — 0.40 0:35 1982 84 86 88 90 92 94 96 98 2000 02 Sources: IMF. Annual Report on Exchange Arrangements and Exchange Restrictions; and World Economic Outlook.
  39. CAPITAL CONTROLS: PROBLEMS • Implementation and circumvention Controls distort behavior, as parties try to evade them • Controls reduce competition, and may promote cronyism •Higher capital costs, esp. for small firms • Controls may reduce FDI as well as other inflows •Hard to sustain controls over long periods • Investors learn how to evade them
  40. CAPITAL CONTROLS: EFFECTIVENESS •There is some evidence that •Capital controls can help preserve some degree of monetary autonomy •Some countries have succeeded in using capital controls to alter the maturity of capital flows •There may be a case for imposing controls as an emergency measure during a limited period if the administrative capacity to manage controls is there •E.g., Iceland 2008 •Market-based controls, such as unremunerated required reserves, are preferable to administrative measures
  41. Mosr OECD COUNTRIES LIBERALIZED •In OECD countries, legacy of controls from 1930s and from World War Il took long to disappear •In France, it took until late 1980s to abolish capital controls, and in the UK, capital controls were abandoned only in early 1980s •It took long in part because of fear that any change in the system would be destabilizing •However, it was understood within the European common market and later EU that capital mobility was essential to economic integration
  42. THE IMF'S ROLE •Since 1944, IMF has had full surveillance jurisdiction over the current account • IMF moved close to reaching an agreement in 1997 on an amendment to its Articles of Agreement giving the Fund full surveillance jurisdiction over the capital account as well •After Asian crisis, the move to amend the Articles weakened, and was shelved • IMF today follows an eclectic and integrated approach toward capital account liberalization, emphasizing proper sequencing and phasing combined with several concomitant reforms • IMF's approach is flexible, recognizing specific country circumstances
  43. CAPITAL ACCOUNT LIBERALIZATION AND FINANCIAL STABILITY •Experience has shown that a country with a poor macroeconomic situation, or a weak financial system, should not liberalize •It is necessary to create a reasonably stable banking and financial system before implementing a meaningful liberalization •As this takes a lot of time and effort, capital account liberalization should be gradual
  44. CAPITAL ACCOUNT LIBERALIZATION AND FINANCIAL STABILITY •Experience suggests •Sequencing by type of capital flow by liberalizing .. •Inflows before or at the same time as outflows •Long-term capital flows before short-term flows •FDI before portfolio investment •Sequencing by sector by liberalizing . •First, the business sector, •Second, individuals, •Third, financial sector •However, not easy to devise an operational plan that puts these principles in practice
  45. Figure 3. Capital Controls by Financial Openness and Income Group, 1975—2005 Non-Iberalized countries All [hralized c ountries 1975 1977 1979 1983 1989 1991 1993 199' F)97 1999 2003
  46. High "come Source: Annual Report on Exchange Arrangements and El-change Restrictions (AREAER), IMF; and Staff calculations. Notes: Based on a sample of74 countries for which data on de facto globalization and de jure capital controls are available for the entire sample period. The graph depicts unweighted averages of countries' capital controls,
  47. COVID-19 AND TRADE IMPACT •Self study exercise
  48. CONCLUSION •Capital flows can play an important role in economic growth and development •But they can also create macroeconomic vulnerabilities •Recipient countries need to manage capital flows so as to avoid hazards •Need sound policies as well as effective institutions, including financial supervision, and good timing

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