Brad Setser

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Showing posts for "emerging economies"

Russia’s waning appetite for dollars

by Brad Setser

If Russia were China — or if Russia’s reserves were growing at the same pace as in late 2007 or early 2008 – today’s revelation that Russia cut the dollar share of its reserves over the course of 2008 would be big news.

The dollar share of Russia’s reserves is now (or at least was in January) a lot closer to 40% than 50%. Reuters (via the Moscow Times, and other sources):

The euro’s share in Russia’s forex reserves, the world’s third-largest, overtook that of the dollar last year as the country pressed on with a gradual diversification, the Central Bank’s annual report showed. The euro’s share increased to 47.5 percent as of Jan. 1 from 42.4 percent a year ago, according to the report, which was submitted to the State Duma on Monday. The dollar’s share fell to 41.5 percent from 47 percent at the start of 2008 and 49 percent at the start of 2007.

It is often asserted that the dollar is the global reserve currency. It would be more accurate to say the dollar is the globe’s leading reserve currency.* The dollar is the dominant reserve currency in Northeast Asia. And the two big economies of Northeast Asia both happen to both hold far more reserves than either really needs. The dollar is also the reserve currency of the Gulf. And Latin America.**

But the dollar isn’t the dominant reserve currency along the periphery of the eurozone. Most European countries that aren’t part of the euro area now keep most of their reserves in euros. That makes sense. Most trade far more with Europe than the US – and some, especially in Eastern Europe, ultimately want to join the eurozone.

Russia has long traded far more with Europe than with the United States. By increasing the euro share of its reserves, Russia is in some sense just converging with the norm among other countries on the periphery of the eurozone.

Russia’s announcement also settles one mystery — or at least one little thing that I have spent a bit of time pondering. The following chart shows the Setser/ Pandey estimates of Russia’s dollar holdings relative to Russia’s foreign exchange reserves.

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Sovereign bailout funds, sovereign development funds, sovereign wealth funds, royal wealth funds …

by Brad Setser

The classic sovereign wealth fund was an institution that invested a country’s surplus foreign exchange (whether from the buildup of “spare” foreign exchange reserves at the central bank or from the proceeds of commodity exports) in a range of assets abroad. Sovereign funds invested in assets other than the Treasury bonds typically held as part of a country’s reserves. They generally were unleveraged, though they might invest in funds –private equity funds or hedge funds – that used leverage. And their goal, in theory, was to provide higher returns that offered on traditional reserve assets.

To borrow slightly from my friend Anna Gelpern, sovereign wealth funds argued that they were institutions that claimed to invest public money as if it was private money, and thus that they should be viewed as another private actor in the market place. Hence phrases like “private investors such as sovereign wealth funds”

This characterization of sovereign funds was always a bit of an ideal type. It fit some sovereign funds relatively well but the fit with many funds was never perfect. Norway’s fund generally fits the model for example, except that it seeks to invest in ways that reflect Norway’s values, and thus explicitly seeks to promote non-financial goals.

And over time, the fit seems to be getting worse not better.

Governments with foreign assets have often turned to their sovereign wealth fund to help finance their domestic bailouts – and thus investing in ways that appear to be driven by policy rather than returns. Bailouts are driven by a desire to avoid a cascading financial collapse – or a default by an important company – rather than a quest for risk-adjusted returns. That is natural: Foreign exchange reserves are meant to help stabilize the domestic economy and it certainly makes sense for a country that has stashed some of its foreign exchange in a sovereign fund rather than at the central bank to draw on its (non-reserve) foreign assets rather than run down its reserves or increase its external borrowing.

Of course, a country doesn’t need foreign exchange reserves to finance a domestic bailout. Look at the US.

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Greenish shoots in East Asia

by Brad Setser

In early January, data showing a sharp fall in Asian exports — a couple of Asian countries, led by Korea, tend to report trade data faster than anyone else — signaled a much broader slump in global trade.

The trade data for q1 is now in for most of the world, and it is (predictably) grim. China’s exports were up close to 20% y/y in q3 2008. They were down 20% y/y in q1 2008. Japan’s exports are now, stunningly, down close to 50% y/y. Germany isn’t doing much better. In February — the last monthly data point — exports were down by 23%, but in April German auto exports were down 48%. Turkey’s exports are down 33%.

Trade contracted exceptionally sharply almost everywhere. A sudden deceleration global demand growth — probably augmented by an inventory correction and in some case a shortfall of trade finance — is undoubtedly the main reason for the very sudden fall in global trade.

On the other hand, there is now some evidence that the contraction has ended, at least in Asia. Korea’s April exports, for example, topped its March exports. A chart showing Korea’s monthly exports and imports isn’t as scary now as it was a few months ago.

Korea’s April 2009 exports are about equal to its April 2007 exports. The y/y fall in Korea’s exports is now similar to the fall in 2001 — when the tech bust hit Korea hard. That counts as good news these days, as for a while it looked like the current fall would be far larger.

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How much “capital flow reversal” insurance should the world offer?

by Brad Setser

That isn’t a question that is usually asked in the debate about the “right” size of the IMF. But it strikes me as a question worth asking.

Back in 2006, US growth slowed relative to growth in the world. Private demand for US assets fell.* But the US didn’t have to “adjust” — that is to say bring its trade deficit down to reflect the reduced availability of private financing. Why not? Emerging economies, who received most of the influx of private money not going to the US, generally used this influx to build up their reserves. A rise in financing from central banks and sovereign funds offset the fall in (net) private demand for US assets.** The US trade deficit fell a bit relative to US GDP, but not by all that much.

Thanks to a generous supply of credit from the emerging world’s central banks, the party kept going long after private investors ceased to be willing to finance it.

Suffice to say that when emerging economies running comparable deficits to the US encounter a comparable fall off in private financial flows, the amount of financing that gets recycled back their way by the US and EU (through institutions like the IMF) is far smaller. Between 1997 and 1999, “volatile” private capital flows (bank loans and portfolio flows, I left FDI out) swung from a $100 billion inflow to a $100 billion outflow. The net increase in IMF’s lending over this time by contrast was only around $30b — not all that much relative to the $200 billion swing.

The current crisis isn’t all that different. Between 2007 and 2009, volatile capital flows are expected to fall from a positive $250 billion to a negative $400 billion — a swing over over $650 billion. IMF lending — based on all existing programs — will increase by close to $120 billion (see this chart by my colleague Paul Swartz). That is more than in the past, but not enough to offset the fall in capital flows, and certainly not enough to offset the combined impact of lower capital flows and lower commodity prices on the commodity exporting region.

Scaled to world GDP, the current swing in private capital flows and the (projected) rise in official lending looks roughly similar to the swing back in 97-98.

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Give the IMF credit (literally, and figuratively)

by Brad Setser

One issue to watch over the next few days, as the world’s finance ministers gather for the IMF’s spring meetings: whether or not the G-20 (and other) countries carry through on their pledge to expand the resources available to the IMF.

The IMF cannot supply credit to a host of troubled emerging markets unless it gets credit (via its supplementary credit line, or a bond issue sold to key central banks with excess reserves) from a bunch of countries in a (somewhat) stronger financial position.

But also give the IMF credit for producing analysis that has become an essential guide to the current crisis. Like Dr. Krugman, I am eagerly awaiting the release of first few chapters of the WEO tomorrow. That is something that I couldn’t have credibly said all that often in the past. The detailed WEO will provide a baseline, among other things, for assessing whether the fall in the world’s macroeconomic imbalances in the first quarter can be expected to persist for this year, and for the next.

The IMF’s Global Financial Stability Report – released today – already provides a baseline for assessing the scale of the losses that the last credit cycle will generate (gulp, over $4 trillion, with $2.8 trillion from the US – two times as much as the IMF forecast in October) and thus, in broad terms, the scale of the new capital the financial sector needs.

This crisis challenged the IMF. A truly global crisis calls out for a global response, underpinned by high-quality global analysis. A few years back, the IMF’s surveillance wasn’t perhaps as focused on the underlying risks of an unbalanced and highly leveraged world as it should have been. Just look at the IMF’s 2007 economic health check for the US , which declared – a minus a caveat or two – that the core of the US financial sector was well capitalized and “relatively protected from credit risk” (see paragraph 5, on p 10 of the staff report/ and paragraph 5 of the PIN/ ). Oops.

Of course, the IMF’s assessment of the US financial sector echoed the conventional wisdom of the time. And, in other areas, the IMF can credibly argue that it highlighted risks that others wanted to ignore. It, for example, consistently called attention to the build-up of balance sheet risk in emerging Europe.

Suffice to say that the IMF didn’t risk making the same mistake in its current Global Financial Stability Report. Chapter 1 of the Global Financial Stability Report makes for sobering reading.

The IMF paints a picture of a global economy where neither large financial institutions in the world’s economic and financial core nor those emerging market governments with large external financing needs can count on financing themselves in private markets. Both sets of borrowers, in effect, now rely on the support of official institutions, whether the IMF, the the world’s large central banks or taxpayers. The financial sector relies on official support for the money it can no longer raise in the “wholesale” funding market*, and emerging markets to offset the withdrawal of cross-border bank lending.

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Still plenty to worry about …

by Brad Setser

Macroman reports that there is a bit of optimism in the air about China right now. Loan growth was strong in January. Steel prices have picked up a bit. The latest Chinese purchasing managers survey wasn’t as bad as the last one. The fall in the pace of contraction in activity has generated hope that China’s economy will rebound later in the year. China’s stimulus will help, as will the fact that China’s state banks are liquid and have clear instructions to lend …

Everyone looks at China through their own lens. My lens is the trade data. And there I still don’t find much basis for optimism. China’s January trade data isn’t out, but Korea’s data is — and it was awful. The sheer scale of the fall in Korean and Taiwanese exports shows up most cleanly if monthly exports are plotted over time.

A plot of the y/y change confirms that the current slowdown is sharper than past slowdowns, and given the strong growth in exports over the past several years, a bigger percentage change interacts with a bigger base to produce a far bigger absolute fall.*

I share Paul Krugman’s and Kevin Drum’s assessment of the “Buy American” provisions in the stimulus package: the impulse behind these provisions is understandable, but their likely costs exceed their likely benefits.** But I do wish that there was a bit more recognition on the part of those bankers highlighting the risks poised by protectionism of the scale of the collapse in trade that has ensued from the collapse of the financial sector. Not all risks to the flow of goods across borders emanate from Washington DC.

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Not guilty as charged. The banking crisis, not the budget deficit, is sucking funds out of the emerging world …

by Brad Setser

The US clearly failed to recognize the risks associated with highly leveraged households and an over-leverage and under-capitalized financial sector. The resulting implosion has reverberated globally.

But I don’t quite see the basis for arguing that the US fiscal deficit is siphoning funds from the rest of the world. It may in the future. But right now it isn’t.

The amount the US borrows from the world is a function of the trade deficit (really the current account deficit, but the trade deficit is a good proxy), not the budget deficit. And the trade deficit is coming down. Calculated Risk estimates that the January deficit could be as low as $30 billion, or only about 1/2 its peak level. Thank the fall in oil prices. Put simply, the US is borrowing a lot less from the rest of the world now than a year ago, two years ago or three years ago.

Moreover, the US doesn’t magically attract funds from the rest of the world. In order to pull in savings from the rest of the world, the US has to offer a higher (risk-adjusted) return than other borrowers do. The ten year Treasury has sold off (see Jansen). It no longer yields 2%, but it still yields less than 3%. And that isn’t exactly a high rate. The way the US pulls in funds from the rest of the world is by offering a higher interest rate than the rest of the world. That ends up driving up interest rates globally and forcing other countries to pay more to borrow. Today though US rates are well below there levels a year ago. If anything that should create incentives for US investors to send funds abroad — not incentives to pull in funds from the rest of the world.

And well, I don’t think anyone can argue that high short-term rates in the US are sucking savings out of the world. If anything, low policy rates in the US should make it easier for other countries to raise funds. It isn’t hard to offer a yield pickup over the US right now. Last fall when the Fed was cutting rates and other countries weren’t, private money was flowing out of the US …

This isn’t to say that the problems emerging economies now face trying to raise funds originated in the emerging world. They didn’t. Not really. They are suffering from the collapse of the US — and European — financial sector. Hedge funds are pulling back. And more importantly, capital constrained banks are pulling back. That — not the fiscal deficit — is what is pulling funds out of the emerging world. Emerging economies in that sense are no different than any other borrower facing difficulties getting a bank loan.

The fact that the financial sector now depends on a government backstop may have prompted the banks to pull back more from foreign markets than their home markets, though they are clearly doing both. Deglobalization — particularly financial deglobalization — isn’t going to be pretty.

But a few emerging economies are also suffering from self-inflicted wounds …

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It wasn’t just the market …

by Brad Setser

James Saft of Reuters worries that the crisis will lead to a shift away from the “Davos consensus,” especially as the market’s power had pulled so many out of poverty.

“the stuff underlying the Davos consensus really was pretty good at doing lots of things, not least raising living standards in huge swathes of the developing world. States aren’t traditionally all that great at allocating resources either”

Reasonable point.

But the narrative of the past six years isn’t really one defined solely by the retreat of the state and a greater role for markets in allocating resources in the developing world. In both China and many fast-growing (until recently) oil-exporters, the state played an active role in guiding investment decisions. It thus was helping to determine how resources were allocated across sectors.

— Most Chinese investment, as Nick Lardy and Morris Goldstein pointed out a while ago, is financed domestically. And a lot of that investment is financed by the retained earnings of state firms or by loans from state banks. Perhaps all of these investments were done on a purely commercial basis, but there was certainly scope for the state to guide the allocation of resources.

— Most oil exporters have powerful national oil companies that control the oil revenue stream. And a lot of “private” investment in Gulf came from banks and firms that were either owned by the state or by the “palace.” A host of firms borrowed not on the basis of the strength of their own balance sheet but on the perception that they were too close to the state to fail. Dubai is often presented as a model of free-wheeling capitalism. But Dubai, inc remains closely tied to the palace.

Simeon Kerr and Roula Kalaf of the FT:

“Dubai’s sprawling business empire spans government institutions and private companies owned directly by Sheikh Mohammed but acting as quasi-government bodies. The ruler has instituted a culture of competition among state-backed companies and insisted they run themselves as private sector entities. In their quest to satisfy his ambitions, the business groups have come to rely heavily on debt – leveraging myriad commercial ventures, from domestic property developments to international acquisitions. Along the way, Dubai’s finances have become complicated and the line between ruler and government assets blurred.

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Asia’s two recessions

by Brad Setser

During the good times, both exports and investment boomed. Indeed, the fact that China ran a large current account surplus even as Chinese domestic investment soared — something only possible because of a large increase in China’s national savings rate — was one of the global economy’s core puzzles. Investment booms generally lead to current account deficits (setting aside investment booms financed by spare petrodollars) not large surpluses.

The risk always was that exports and investment might turn down at the same time. And, alas, that indeed is what seems to be happening. The Economists’ analysis this week was spot on:

many of Asia’s tiger economies seem to have been hit harder than their spendthrift Western counterparts. In the fourth quarter of 2008, GDP probably fell by an average annualised rate of around 15% in Hong Kong, Singapore, South Korea and Taiwan; their exports slumped more than 50% at an annualised rate … .


In the fourth quarter of 2008, real GDP fell by an annualised rate of 21% in South Korea and 17% in Singapore, leaving output in both countries 3-4% lower than a year earlier. Singapore’s government has admitted the economy may contract by as much as 5% this year, its deepest recession since independence in 1965. In comparison, China’s growth of 6.8% in the year to the fourth quarter sounds robust, but seasonally adjusted estimates suggest output stagnated during the last three months.

Asia’s richer giant, Japan, has yet to report its GDP figures, but exports fell by 35% in the 12 months to December. In the same period, Taiwan’s dropped by 42% and industrial production was down by a stunning 32%, worse than the biggest annual fall in America during the Depression.

Note the scale of the fall in Taiwanese production. There is a big difference between “worse since the Depression” and “worse than the Depression.” Hopefully the fall in Taiwanese production reflects a one-off inventory adjustment in the global electronics supply chain. Japanese industrial production is also down significantly.

Asia’s slowdown isn’t just a magnified reflection of the fall in US (and European) consumption. The Economist notes in its leader: “Most of the slowdown in regional economic growth so far stems not from a fall in net exports but from weaker domestic demand.”

More details are provided in the longer analysis piece:

Asia’s export-driven economies had benefited more than any other region from America’s consumer boom, so its manufacturers were bound to be hit hard by the sudden downward lurch …. Shocking as the export figures are, they are not entirely to blame for Asia’s woes. A closer look at the numbers reveals that in most countries imports have fallen by even more than exports, and that weaker domestic demand explains a larger part of the slump.

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A truly global slump. Do not look to the emerging economies for good news …

by Brad Setser

Only a few months ago it was common to argue that growth in the emerging world would prevent a global recession. That forecast looks increasingly wide of the mark. The slowdown in the emerging world now looks to be as severe – and potentially more severe – than the slowdown in the advanced economies.

Morgan Stanley’s currency team recently observed that “Brazil’s growth collapsed in 4Q08, with several activity indicators displaying the worst decline on record.” Earlier this year Brazil was growing strongly on the back of both strong domestic demand and strong global demand for its commodities. The domestic growth dynamic (and the improved state of the balance sheet of Brazil’s government) made me think it might be able to ride out this crisis relatively well. Guess not.

Russia is in even worse shape. Output is poised to fall sharply. Danske Bank expects a 3% fall. That might be optimistic. Moving from a budget that balances at $70 oil to a budget based on $41 a barrel isn’t fun even if Russia uses its fiscal reserve to adjust gradually. Eastern European economies that relied on large capital inflows rather than high commodity prices to support their growth aren’t doing any better.

The Gulf is in better shape than Russia, but that isn’t saying all that much. $40 a barrel oil requires the Gulf to dip into its foreign assets, but most countries still have plenty of spare cash (though not as much as before). Still, all of the Gulf is slowing. And the most exuberant bits of the Gulf – Dubai in particular – are in real trouble. Most of the Gulf’s sovereign funds under-estimated their countries need for emergency liquidity. They aren’t quite in the same position as Dubai’s Istithmar (looking to sell Barneys for cash as demand for luxury goods falls), but they presumably do wish that they had more liquid assets — and more assets that weren’t correlated with oil.

The commodity-importing BRICs aren’t doing much better. India is slowing. And China is really slowing. Stephen Green of Standard Chartered has constructed an indicator of Chinese economic activity that isn’t based on the government’s reported GDP data. It suggests a far bigger fall in Chinese output than in 1998.*

Chinese output shrank in the fourth quarter. The first quarter isn’t going to be any better.

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