Managing foreign finance

Managing foreign capital
Sound economic policies can raise the expected return from international borrowing and the risks involved can be reduced by adaptable policymaking and flexible economic structures. The capital flows arising from such borrowing must, however, be effectively managed - that is, a country's external liabilities and assets must be organized from the technical and institutional aspect so as to choose the best possible combination of risk and return consistent with supply conditions in the capital surplus countries. Such effective management of foreign capital is an essential part of sound macroeconomic management, since neither lending nor borrowing decisions can be made independently of macroeconomic policy. It is therefore necessary for debt managers to have a clear understanding of expected macroeconomic developments and for policymakers to have a good grasp of expected new borrowing requirements and debt service payments. However, in many countries poor communications exist between debt managers (usually in the Ministry of Finance), reserves managers (usually in the central bank) and macroeconomic planners (often in the Ministry of Planning). Often governments treat the level of capital inflows as a residual and frame their fiscal and monetary policies independently of their effect on debt level and structure.

There are two sets of issues to consider:

(a) Assuming they ensure their economic policies are sound, what further efforts should governments make to regulate inflows of foreign capital ? In fact, because decisions are made on factors other than market forces, governments need to be involved in deciding how much their countries should borrow, both because the public sector tends to be the largest borrower and because the prices with which private companies are faced may be distorted by government policies, encouraging the private sector to borrow too much or too little. Private companies would clearly try to ensure that their investments generate enough domestic currency to repay a loan, but it is the responsibility of the monetary authorities to ensure the availability of enough foreign exchange.

(b) What composition of capital inflow and debt is appropriate ? Although every individual loan has to be justified on its own merits, it is still necessary to monitor the overall level of inflow and debt. For a sustainable rate of borrowing, the rate of growth of a nation's income (particularly its exports) must in the long-term grow faster than the rate of interest; and to avoid liquidity problems, it is necessary for the rate of growth of exports to exceed the rate of interest so as to ensure that there will not be a continual rise in the proportion of export revenues required to service the debt. There can be no simple rule adequate in all circumstances because of the number of factors determining a country's ability to sustain any particular debt ratio. These include export outlook, probable future terms of trade and interest rates and the flexibility with which a country adjust rapidly. A country which has proved itself capable of responding to difficulties may be able to sustain a debt service ratio of 30 percent, while less than 20 percent may prove too much to a country which is less flexible.

An IMF study of twenty countries showed that only one-fifth of developing countries were explicitly managing their debt systematically, although several countries have brought or are now arranging to bring debt management into the mainstream of economic decision making.

In general, controls on foreign borrowing increased in the 1980s, often because of inadequate economic policy. In fact, the need for such control lessens the more governments adhere to fiscal and monetary policies consistent with a sustainable balance of payments position and the more prices, interest rates and exchange rates are set to reflect opportunity costs. Some developing countries have statutory rules on how much borrowing can be done by the public sector and by the country as a whole, but a large, though diminishing, minority have no clear borrowing guidelines, judging each investment on its own economic, commercial and political merits and on the availability of foreign funds. Generally a country will have a policy somewhere between these two extremes, announcing overall guidelines either for the absolute value of new commitments for a given year or in terms of some debt or debt service ratio. Although target levels of public debt may be approved they are frequently not observed and non-guaranteed debt is not usually included in the guidelines. The existence of formal borrowing rules cannot guarantee avoidance of debt-servicing difficulties. Even the Philippines, which had a most systematic approach, had to have a debt service moratorium in 1983. Nevertheless, borrowing limits have been found to be a useful complement to macroeconomic decisionmaking in some countries. Certainly it is useful to have a formal ceiling on borrowing, as it encourages discipline and helps to focus official attention on central macroeconomic questions. It also can be particularly helpful to have official borrowing rules if they cover military expenditure and projects that are politically difficult to control.

While over tight controls on level of borrowing may be undesirable, control of borrowing structure or composition may be necessary. Central government control on foreign borrowing as a whole and even procedures for approving and monitoring government borrowing differ among countries. Official borrowing is normally through the Ministry of Finance unless the purpose is to support the exchange rate or to build up reserves, in which case the official borrower may be the central bank. It is rare for other government departments to borrow independently from abroad, and when they do it is usually short term. Public enterprises in most developing countries may negotiate foreign loans themselves, although such loans must usually be registered with central government and increasingly its prior approval is required.

Effective management of foreign capital is not a substitute for sound macroeconomic management; it is an essential part of it.
Counter Claim:
Formal rules can create an unjustified sense of security and they neglect some kinds of borrowing, such as short-term debt which, if uncontrolled, may rise dangerously. Again, partial controls can bias the overall debt structure. One example was Thailand, where foreign borrowing by the public sector had a defined ceiling but not domestic borrowing. This results in heavy borrowing from the domestic market by the public sector, crowding out the private sector so that it is forced to borrow abroad - where it often has to pay higher interest rates and is offered shorter maturities than could have been obtained by the government.
Type Classification:
C: Cross-sectoral strategies