Sunday, January 04, 2009

The Rise of Capital Market Protectionism

A new one to me is talk of "capital market protectionism", and how forcing our banks to prioritise domestic lending will limit their ability to invest in developing nations. I wonder about this, because I'm highly skeptical of the benefits of banks lending to developing nations. My belief is that developing nations should as much as possible limit their exposure to foreign loans.

A huge danger of foreign loans is something called "locational mismatch" it works as follows:
  • Let's say a firm in Nation A borrows $1 million US dollars and that it uses for investment, it borrows at 8% interest so the monthly payment is around $7,718.
  • Now lets assume that inlation in Nation A causes the currency to depreciate by 50%
  • The result is that the firm is now saddled with debt that will be more expensive to service.

Another danger is that of "maturity mismatch", this occurs when a long term project is being financed on short term debt, if the foreign financing dries up the project could end up being abandoned. Funilly enough, this is exactly what could potentially happen given the change

As much as possible, governments of developing nations should encourage their nations firms to seek domestic lending this means developing a banking system that is responive to the needs of domestic businesses as well as encouraging saving. Developing nations should certainly act to control (directly or through incentives) the level of foreign debt available for it's firms, the only really good use for foreign loans is the purchase of resources not available domestically.

In terms of the potential crisis that could result from a shortage of future foriegn loans, it should be looked upon as an opportunity for developing nations to reduce foreign loan obligations, as much possible, foreign loans should be abandoned in favour of domestic loans.

The talk of protectionism in this sense is strange and to me, since the whole thing is the result the banks' own incompetence. The banks engaged in foreign lending for their own gain rather than some altruistic motive, now that they are forced to prioritise owing to to overstretching themselves it seems more than a little rich that they are attempting to use their supposed commitment to overseas development as a way of avoiding their domestic responsibilities.

NOTE: Much of what is written here owes itself to ideas in Reclaiming Development, An Alternative Economic Policy Manual by Ha-Joon Chang (for it is he) and Ilene Grabel. It's an excellent book and well worth a read.

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