FX International Payments
By Frances Coppola
Generally, the easier it is to move money across borders, the easier it is to trade with other countries. Technological improvements in international payments, the removal of capital and exchange controls, and liberalisation of financial markets – all of these help to encourage international trade and finance, and lubricate the flow of goods, services and money around the world.
Allowing foreign financial institutions access to domestic markets encourages cross-border trade and investment. It reduces complexity in correspondent banking networks and enables businesses to use global payment systems to pay international suppliers and receive payments from overseas customers. Opening financial borders also enables businesses to raise funds on international capital markets, driving down their cost of funding. Financial integration and access to global financial markets also attracts foreign direct investment, a key driver of business growth and economic prosperity.
Historically, though, international trade and finance have been problematic for developing market economies, tending to cause unstable capital inflows and abrupt reversals – what are known as “sudden stops.”1 The petrodollar boom of the 1970s ended in the Latin American debt crisis and some of the largest government debt defaults in history. In the 1990s, large inflows to Asian economies caused a real estate and construction boom, an overvalued stock market and excessive bank lending;2 when the flows reversed abruptly in 1997, the result was the Asian debt crisis.3
Both of these collapses shared the same feature. The countries that suffered the most were those that had large current account deficits. They had been importing far more than they were exporting; because they had to pay for their imports in foreign currency, they had borrowed heavily in foreign currencies to finance the difference, a phenomenon known as “original sin.”4 When the capital flows reversed, they were unable to pay for their imports. The result in many cases was a wrenching adjustment to the current account, a deep recession and debt default. Some countries needed financial assistance from the International Monetary Fund;5 others went through international debt restructuring via the Paris Club,6 a group of creditor nations, or the Brady Bond program for local government relief.7
Since the Asian crisis, many developing markets have eschewed current account deficits funded by external borrowing. Instead, they have gone for an export-led growth model. Developing markets share of global trade rose fast during the 2000s, reaching 35 percent by 2010, though it has stagnated since.8
This is a radical reshaping of international trade and finance. In the past, advanced economies exported to developing ones, funding those exports with cross-border lending. Now, developing economies export to advanced ones, building up foreign currency reserves in the process. The reserve strength and current account surpluses of many developing markets, particularly in Asia, mitigate the effects of a sudden stop. This has enabled them to pursue global financial integration while limiting the risk of wrenching adjustment and debt default as have happened in the past.9
Developing markets weathered the 2008 financial crisis better than advanced economies but are now suffering from a general contraction in international trade and finance. Developing markets that depend on oil and commodities exports are particularly exposed to experiencing severe falls in their terms of trade due to dropping prices – though those that have built up reserves are doing better than those that have spent the money.
This contraction in international trade and finance arises in large part from damage that advanced economies experienced, first in the Great Recession of 2008-9 and subsequently in the eurozone crisis of 2011-12. Concurrently with the growing strength of developing markets, advanced economies were becoming highly indebted and fragile: as developing market trade surpluses grew, so too did the trade deficits of advanced economies.10 The crises exposed their weaknesses.
In response to the crises, financial institutions in advanced countries – under pressure from regulators to reduce their risks, and from governments to help restore their local economies – retreated back behind their borders, reducing access to international trade finance for businesses. Investors pulled back from developing markets to traditionally safer locales, causing an investment chill that dampened business growth. Demand for developing market exports in advanced countries slumped due to falling real wages, government spending cuts and, in some countries, high unemployment.
The fall in demand from advanced countries rippled back to developing markets. As businesses in these markets found the demand for their exports falling, their own demand for imports fell. Chinese businesses, particularly, reduced their demand for imports from suppliers in other Asian countries.11 The result is a general economic slowdown, not just in Asia but worldwide. When international trade declines, the whole world slows down.
After the 1997 Asian crisis, developing market countries found a way of benefiting from international trade and finance integration without the risk of “sudden stops” and debt crises. However, crises in advanced economies then ensued, contributing to slowing global demand, rising protectionism and falling commodity prices – opening another chapter in the story of international trade and finance.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. Capital Flows and Capital Market Crises: The Simple Economics of Sudden Stops, Journal of Applied Economics; http://www.columbia.edu/~gc2286/documents/ciecpp5.pdf
2. What Caused the Asian Currency and Financial Crisis?, Japan and the World Economy; https://www.newyorkfed.org/medialibrary/media/research/economists/pesenti/whatjapwor.pdf
3. Lecture 12: Benefits of International Financial Integration, Harvard University; https://www.hks.harvard.edu/fs/jfrankel/ITF-220/ls/L12-IntlBorrowing.pdf
4. Currency Mismatches, Debt Intolerance, and Original Sin: Why They Are Not The Same and Why It Matters, National Bureau of Economic Research; http://www.nber.org/papers/w10036.pdf
5. "Recovery from the Asian Crisis and the Role of the IMF", International Monetary Fund; https://www.imf.org/external/np/exr/ib/2000/062300.htm
6. "Celebrating the 50th Anniversary of the Paris Club", European Central Bank; https://www.ecb.europa.eu/press/key/date/2006/html/sp060614.en.html
7. Brady Bonds and Other Emerging Markets Bonds, The Federal Reserve; https://www.federalreserve.gov/boarddocs/supmanual/trading/4000p2.pdf
8. Who Catches a Cold When Emerging Markets Sneeze?, World Bank; http://pubdocs.worldbank.org/en/100601452034670440/Global-Economic-Prospects-January-2016-Spillovers-from-major-emerging-markets.pdf
9. ADB Working Paper Series on Regional Economic Integration, Asian Development Bank; https://www.adb.org/sites/default/files/publication/28809/wp79-financial-integration-emerging-asia.pdf
10. "The Global Saving Glut and the U.S. Current Account Deficit", The Federal Reserve; https://www.federalreserve.gov/boardDocs/Speeches/2005/200503102/default.htm
11. "South-South’ Trade Falters", The Wall Street Journal; http://www.wsj.com/articles/south-south-trade-falters-1446133209