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st.invest.

Spanish translation: ST. INVEST. = INVERSIÓN A CORTO PLAZO - ST/LT

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GLOSSARY ENTRY (DERIVED FROM QUESTION BELOW)
English term or phrase:st.invest.
Spanish translation:ST. INVEST. = INVERSIÓN A CORTO PLAZO - ST/LT
Entered by: sil rodriguez
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14:54 Nov 1, 2007
English to Spanish translations [PRO]
Law/Patents - Finance (general)
English term or phrase: st.invest.
Hola! Alguin puede decirme si este termino podria llegar a significar Short term investment?
El texto habla sobre inversiones, forex, comercio de metales, etc.
sil rodriguez
Local time: 18:33
ST. INVEST. = INVERSIÓN A CORTO PLAZO - ST/LT
Explanation:
3.4 Short-term debt as a precommitment deviceAn important possible objection is that ST debt plays no useful role in the analysis thus far.But in reality, there are some reasons why the possibility of borrowing short can be sociallybene…cial: ST loans may help share risk between borrowers and lenders, or give lenders morecontrol over borrowers’ actions and hence help reduce the risk of default. The point is notjust academic, for if some kinds of ST debt are socially bene…cial, policies that discouragesuch borrowing may have costs as well as bene…ts.Consider, for illustration, a case in which default is possible, and ST debt acts as akind of precommitment device that ameliorates the default problem.9Assume that thereare two kinds of governments: orthodox governments that always repay foreign debt andpermit private debtors to do the same, regardless of circumstance; and populist governmentsthat may choose to repudiate their debts or impose exchange controls that prevent privatedebtors from repaying their foreign loans. A populist government behaves opportunistically,repaying debts only if it is in its short-term interest (or that of the local borrower) to do it.To make the story interesting, in the sense that populists do not always cause a default,7Notice that this expectation includes only the consumption level if there is no run, for in the event of arun consumption is zero: all resources go to paying foreign creditors.8There is a second possible, though very implausible, equilibrium. Suppose that the investor expectsrS= rL, so that her expected consumption is independent of d. Suppose also (implausibly) that, since d isnot determined, she sets d = 0. Then, the expectation rS= rLturns to have been correct, and we have anequilibrium with no ST debt. The problem, of course, is that the investor is very unlikely to set d = 0. If sherandomized, for instance, across all possible d 2 [0;k], the probability associated with hitting zero exactlywould also be zero.9Jeanne (1998) has built a model with a similar mechanism.9
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assume that default is costly. If in period 2the government defaults on its outstanding loans,a portion ® < R¡1of the income produced by the project is lost. Default costs may includesanctions, litigation and other transactions costs, etc. Hence, in the event of a default theinvestor ends up with R(k¡ `)(1 ¡ ®)units of consumption.Timing is as follows. Between periods 0 and 1 an orthodox government is always in o¢ce.Late in period 1 there is an election. With probability ¼ a populist wins, and with probability1 ¡ ¼an orthodox leader is elected. Election results become known before lenders choosewhether to rollover their debts at the end of period 1. Then a run occurs with probability pif d is large enough to make a run feasible. But even if a run does not occur, rational lendersmay choose not to roll over ST debts if a populist has been elected. Quite crucially, rolloverdecisions are made once election results are known but before the new government takesover, so that ST debts will always be repaid to the extent that available resources permit.10The interesting case occurs if a populist is elected and no generalized run or panic occurs.In that situation, whether lenders refuse to roll over loans depends on whether they expectthe government will cause a default; and the default incentives faced by the governmentdepend crucially on the maturity structure of debt. It is in this context that ST debt canhave desirable incentive e¤ects.To see this, consider the options faced by a newly elected populist government if no runtakes place. If it can assure lenders that loans will be repaid (by causing project income, forinstance, to be deposited in an international escrow account), ST debts will be rolled over,and consumption by the representative local borrower is Rk¡ (1 + rS)d ¡ (1 + rL)(k ¡ d).If the newly elected government cannot (or does not want to) reassure investors, holders ofST debts will refuse to roll them over and some early liquidation of the project will takeplace. Having nothing to lose, the government will indeed decree a default when it comes too¢ce. In that case, consumption by the representative local borrower is R³k ¡d½(1 ¡ ®).The newly elected government will choose the escrow account option if consumptionby the representative individual is larger in that case. The choice depends on how muchST debt there is.11For the sake of brevity, consider just the polar cases of d = 0 andd = k. If d = 0, then no runs can take place and rs= 0. Will a default take place?10This is a very realistic assumption. There is often a “bunching” of amortizations in the window betweenelections and the corresponding transfer of power.11To evaluate which consumption level is higher one must pin down the value of the relevant interest rates;they, in turn, depend on the size of d. One could readily compute, as we did in an earlier section, rS, rLand expected borrower consumption for each d, and then use the results to identify the socially optimal levelof ST debt.10
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With default the representative borrower consumes Rk (1¡ ®), and without it consumes(R ¡ 1)k. Since we have assumed ® < R¡1, consumption is higher under no payment, andthe opportunistic government will prefer a default. With rational expectations, d = 0 willcause 1 + rL= (1 ¡ ¼)¡1, since after a populist triumph in the elections, holders of LTdebt get nothing. If no ST debt is chosen in period 0, then expected consumption by therepresentative borrower is (R¡ 1)k ¡ ¼®k.If only ST debt is chosen and d = k, on the other hand, default can never take placein equilibrium: the expectation of a default would cause all debt to be redeemed in period1, and early liquidation of the whole investment would leave nothing for the borrower toconsume. But runs can clearly occur in equilibrium, so that 1 + rL= (1 ¡ p)¡1and rSisgiven by equation 6 evaluated at d = k. With that information it is easy to compute expectedconsumption by the representative borrower, which is equal to (R¡ 1)k ¡ p(R ¡ ½)k.Comparing the two expressions for expected consumption we see that having no ST debtis better ex ante if and only if the probability of electing a populist and the cost of thepotentially associated default are su¢ciently small: ¼® < p(R¡ ½). The intuition is clear:the positive incentive e¤ect of ST debt is most useful in countries prone to populist policies.This bene…t shows up in lower contractual interest rates, since debt that is su¢ciently shortin maturity reduces the risk of default. In such an environment, eliminating all ST borrowingwould be socially harmful.3.5 ImplicationsThe model sketched out in this section has several important implications:²Runs can only occur when investors take on su¢ciently large amounts of ST debt.²The larger the stock of ST debt, the larger the size of a run..²The larger the stock of ST debt, the larger the real consequences (in terms of costlyliquidation and reduced output and consumption) of a run.²Distorted incentives can cause investors to take on ST debt, even if doing so is sociallycostly. Hence, there may be a case for discouraging short maturities through publicpolicy.²But ST debt can play a useful role (for instance, by serving as a precommitment device).Hence, policies that sharply reduce ST ‡ows can have costs as well as bene…ts.11
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4 Short-term external debt: an empirical analysisShort-term capital ‡ows comprise a wide array of …nancial transactions: trade credits, com-mercial bank loans with a maturity of less than one year, and short-term private and publicdebt (both in local and foreign currencies) issued abroad or sold to non-residents.The statistical coverage of these transactions and of outstanding stocks is imperfect.The OECD, BIS, World Bank, and the IMF all provide some data on short-term debt fordeveloping and transition countries, but do so with some gaps.12In what follows, we usedata from the Institute of International Finance (IIF 1998). These data have been collectedlargely from national sources, and have the advantage that in principle they include allforms of suppliers’ credits as well as non-residents’ holdings of government bills (includingdebt issued in local currency), in addition to liabilities to commercial banks and other foreign-currency denominated borrowing.13The IIF presentation of the data allows us to distinguishbetween medium- and long-term debt and short-term debt, and in the latter category betweendebt owed to banks and other debt. The main shortcoming of the IIF source is that thecoverage is limited to 37 emerging-market economies. For our purposes, however, this is nota major concern, as these countries constitute the relevant sample for the analysis.A caveat is that, because comparable data are not currently available, we have notincluded short-term domestic public debt in our work even though a run on such public debtcan also cause illiquidity and crises. In the Asian crisis, this is not likely to be an importantomission. Around the time of the collapse there does not seem to have been much shortterm public debt in the strongly a¤ected countries of Indonesia, Korea and Thailand (seeTable 3 of Ito, 1998).14However, public debt probably played a role in other episodes. We12These international organizations have recently pooled their resources to provide a uni…ed set of quarterlystatistics on external debt The data are available at http://www.oecd.org/dac/debt/. The short-term debtstocks reported by these agencies cover liabilities to non-resident banks, o¢cial or o¢cially guaranteed tradecredits, and debt securities (i.e., money market instruments, bonds and notes) issued abroad. Their dataare put together largely from creditor and market sources. Coverage is poor or non-existent in the followingareas: (i) non-o¢cially guaranteed suppliers’ credit not channeled through banks; (ii) private placementsof debt securities; (iii) domestically issued debt held by non-residents; and (iv) deposits of non-residents indomestic institutions.13We are grateful to William Cline of the IIF for making the data available, as well as for clari…cations onsources and coverage.14Except for Brazil, public debt has not been a major problem recently for comparable Latin Americancountries either. Mexico managed to extend the maturity of its public debt after the 1994 collapse. At theend of September 1994, short term domestic federal debt was equivalent to US $26.1 billion; by the end of12
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know that the Mexican government’s inability to roll over its large stock of short term debt(in particular, the infamous Tesobonos) was to prove key in triggering the …nancial crisis inDecember 1994. More dramatically, Brazil’s internal debt situation seems to be crucial forunderstanding its current predicament.4.1 Debt maturity and crisesEven though short-term debt exposure …gures prominently in the long list of culprits forthe Asian …nancial crisis, few empirical studies have been able to draw a tight empiricalconnection between currency or balance-of-payments crises and short-term debt. Kaminsky,Lizondo and Reinhart’s (1998) comprehensive survey of the empirical literature uncoversessentially no evidence that the maturity pro…le of external debt matters for crises. Thevariables highlighted by this literature as leading indicators of currency crises are the level ofreserves, the real exchange rate, credit growth, credit to the public sector, and in‡ation, butnot short-term debt (Kaminsky et al. 1998). One reason, as noted by Furman and Stiglitz(1998, 51), is that not many of these studies have focussed on the composition of foreigndebt. Three exceptions are Sachs, Tornell and Velasco (1996); Frankel and Rose (1996) andEichengreen and Rose (1998). The …rst of these papers …nds weak evidence that the shareof short term capital ‡ows in total ‡ows helps predict which countries were a¤ected by thetequila e¤ect in 1995. The second …nds no statistically signi…cant relationship between theshare of short-term debt and the incidence of currency crises, while the third concludes thata higher share of short-term debt actually decreases the probability of banking crises.A recent paper by Radelet and Sachs (1998) is, to our knowledge, the only paper thatpresents systematic evidence on the culpability of short-term debt. These authors provide aprobit analysis for 19 emerging markets covering the years 1994-1997. Their crisis indicatoris a binary variable that takes the value of 1 when a country experiences a “sharp shift fromcapital in‡ow to capital out‡ow between year t¡ 1and year t” (Radelet and Sachs 1998, p.23). They classify nine cases as such: Turkey and Venezuela in 1994, Argentina and Mexicoin 1995, and Indonesia, Korea, Malaysia, the Philippines, and Thailand in 1997. Radelet andSachs measure short-term debt exposure by taking the ratio of short-term debt to foreignbanks (from BIS) to central bank reserves. They …nd that this ratio is associated positivelyand statistically signi…cantly with crises (as is the increase in the private credit/GDP ratio inJune 1997 this …gure was down to less than US $8.5 billion. Argentina, Chile and Peru have not issueddomestic short term debt in any substantial magnitude.13
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the previous three years). They …nd no evidence that crises are associated with corruption.They …nd only weak evidence on the current-account de…cit and, even more surprisingly, noevidence on the role of real exchange rate appreciation.We present here an exercise in the spirit of Radelet and Sachs (1998), extending theiranalysis in two directions. First, we use the IIF database (IIF 1998), and can thus distinguishconsistently between short-term debt owed to foreign banks and other short-term debt, aswell as between short-term and medium- and long-term debt. By contrast, the BIS statisticson which most recent analyses have relied provide information only on short-term debt owedto foreign banks.15Second, the IIF database allows us to expand the scope of the empiricalanalysis: we cover the period 1988-1998 and 32 emerging-market economies, giving us amuch larger sample of observations as well as more crises.16In de…ning a …nancial crisis, we focus on the proximate cause: a sharp reversal in capital‡ows. Hence we follow the de…nition of Radelet and Sachs (1998) rather than that of theearlier literature, which emphasized currency depreciations and/or reserve reductions. Weassume there is a crisis when there is a turn-around in net private foreign capital ‡ows (Bt)of 5 percentage points of GDP or more.17Operationally, our crisis variable is a 0¡1variablewhich takes the value 1 in any year in which Bt¡1> 0 and (Bt¡1¡ Bt)=Yt¡1> 0:05. Thevalue of crisis is set to missing for the two successive years following a year in which crisis= 1 (again following Radelet and Sachs).18This exercise yields 16 instances of crises, listed in Table 2. The sample includes all buttwo of the cases identi…ed by Radelet and Sachs (1998) as well as many others. The two in-stances of crisis in Radelet and Sachs that do not meet the 5 percent threshold are Argentina(1995) and Malaysia (1997). Note that Malaysia is listed instead as having had a “crisis”in 1994, with a whopping turnaround in private capital ‡ows of 20 percent of GDP (which15The correlation between the statistics on short-term debt to commercial banks provided by the twosources is very high, typically of the order of 0.9 (with some exceptions).16The IIF database includes an additional …ve oil-exporting countries, which we have excluded from theanalysis.17Private capital ‡ows are loans from commercial banks and other private credit, excluding equityinvestments.18Also, we have excluded from the sample a few data points with extremely high values of short-termdebt to reserves (greater than 5). Russia (in 1991) and Cote d’Ivoire (in 1992), for example, had short-termdebt (to banks)/reserves ratios of 312 and 217, respectively. Since short-term debt is our focus, leaving suchobservations in would result in outliers in the probit analysis that would cloud the interpretation of theresults.14
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followed the imposition of capital controls on in‡ows in January 1994 as discussed below).19Additional crises include Bulgaria, Hungary, and the Philippines (all in 1990), Uruguay (1990and 1993), and Ecuador (1996). Some of these cases are arguably not instances of crisis inthe sense of …nancial collapse, and seem related to idiosyncratic developments (such as thetransition from socialism in the cases of Bulgaria and Hungary in 1990). But rather thanexercise discretion, which leaves the empirical results open to interpretation, we have decidedto follow the 5 percent rule rigidly. One exception is that we have included Russia (1998)in the crisis sample, even though we did not have data on private capital ‡ows for all of1998 at the time of this writing. The results reported below are robust to the exclusion ofRussia or of any of the other cases from the sample, as well as to changes in the de…nitionof a crisis. We are fairly con…dent that our …ndings on the importance of short-term debtare not an artifact of arbitrary decisions regarding thresholds, sample coverage, and othermethodological choices.As Table 2 reveals, countries experiencing sharp reversals in capital ‡ows tend to havehigher shares of short-term debt in total, but where they really stand apart is in termsof short-term debt/reserves ratios. On average, crisis cases have short-term debt/reservesratios that are twice the level that obtains in other cases (1.49 versus 0.76 for debt owed tobanks, and 1.59 versus 0.71 for other debt). At the same time, the table reveals instances ofcrises in the presence of quite low levels of short-term exposure as well (e.g., Ecuador 1996;Venezuela 1994)The relationship between short-term capital ‡ows and …nancial crises is examined moresystematically in Table 3, which presents probit regressions. Columns (1) and (2) are bi-variate probits, where crisis is regressed solely on an indicator of short-term debt exposure.The …rst indicator is a dummy variable which takes on a value of 1 whenever the (lagged)value of short term debt to foreign banks/reserves exceeds unity. The estimated coe¢cientis statistically highly signi…cant, indicating that countries where this ratio is higher thanunity have a 10 percentage points higher probability of experiencing a crisis (compared tocountries where the ratio is below one). Since the average probability of crisis in our sampleis 0.06, this corresponds roughly to a tripling of the crisis probability (0.16 versus 0.06).Column (2) shows that there is a tight bivariate relationship between crisis and the share ofshort-term debt in total debt as well.In the remaining regressions of Table 3, we introduce simultaneously the ratios of three19The capital controls were meant to stem the ‡ow of large amounts of short-term speculative fundsgambling on the appreciation of the Malaysian currency.15
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di¤erent types of debt to reserves (all in continuous form rather than as a dummy): (a) shortterm debt owed to banks; (b) other short-term debt; and (c) medium- and long-term debt.Both types of short-term debt enter with positive and statistically signi…cant coe¢cients(with the exception of other short-term debt in column (8)). The point estimates reveal thatthe impact of short-term borrowing from banks is larger. Interestingly, medium- and long-term debt enters with a small, negative, and statistically signi…cant coe¢cient, indicatingthat longer term borrowing is associated with a lower probability of crisis (even when holdingthe short-term debt stock constant). One interpretation is that the medium- and long-termdebt stock is correlated with omitted country attributes that increase creditworthiness andreduce the propensity to crises.The probit estimates also indicate that crisis probabilities are increasing in the overalldebt burden (measured by the debt-GDP ratio), the current account de…cit (as a percentageof GDP), and the appreciation of the real exchange rate (measured over the previous threeyears). These results are consistent with previous empirical work. On the other hand, budgetde…cits, the ratio of M2 to reserves, and the change in credit-GDP ratios do not appear tohave a statistically signi…cant relationship with crises. Indeed, once the debt ratios areincluded, all three of these variables enter with the “wrong” sign.We note that these results remain essentially unchanged when we exclude the 1997 and1998 observations from the sample, restricting attention to reversals in capital ‡ows prior tothe Asian crisis and the Russian meltdown. In particular, short-term debt/reserves ratioscontinue to enter with highly signi…cant coe¢cients. It does not appear therefore that theperils of short-term capital ‡ows are of very recent vintage. Moreover, substituting BIS dataon short-term debt (to commercial banks) for the IIF data yields results that are virtuallyidentical.In short, these results provide strong support for the idea that potential illiquidity —inparticular, the ratio of short-term foreign debt to reserves— is an important precursor of…nancial crises triggered by reversals in capital ‡ows. Our evidence is consistent with the ideathat illiquidity makes emerging-market economies vulnerable to panic. At the same time, itbears repeating that such crises remain highly unpredictable. The overall “…t” of the probitsis poor, and certainly of not much use for predictive purposes, even when applied in-sample.For instance, the in-sample predicted probabilities of crisis for South Korea, Thailand, andIndonesia in 1997 are 0.54, 0.24, and 0.19, respectively. The corresponding out-of-sampleprobabilities are 0.31, 0.17, and 0.13. Empirically, a high ratio of short-term debt to reservesis neither a necessary nor a su¢cient condition for …nancial panic.16
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4.2 Short-term debt and the severity of crisesWe have analyzed so far the relationship between short-term capital ‡ows and the onset ofcrisis. As the model in section 3 suggested, short-term debt exposure is also likely to a¤ectthe severity of the shock once a crisis does erupt. When con…dence disappears and debtrollovers become di¢cult, the entire stock of a country’s short-term foreign debt may haveto be paid back within a year. A country with a short-term debt/GDP ratio of, say, 15percent, could in principle have to pay 15 percent of its GDP to its creditors in a single year.Generating an external transfer of this magnitude is likely to be quite costly, not only tolevels of domestic absorption, but also to real activity. The latter e¤ects can come aboutthrough a costly liquidity squeeze, through the e¤ects on balance sheets of the drop in assetvalues and the currency depreciation that accompany the crisis, and through traditionalKeynesian multiplier channels.One might then expect the costs incurred, conditional on having a crisis, to be propor-tional to the pre-existing stock of short-term foreign debt. In this section, we present a rangeof evidence that suggests that this is indeed the case.We …nd that it is the ratio of pre-existing short-term foreign debt to reserves that seemsto matter to the severity of the crisis, and not the ratio in relation to GDP. A reason whythe former ratio may be the relevant ratio has to do with within-country contagion. Imaginethat in a crisis the holders of all short-term debt in the economy —including M1, short-term domestic debt of the public sector— come to fear that international reserves will beexhausted by the service of short-term foreign debt. Then they will attempt to ‡ee as well,and will succeed in doing so as long as there are dollars in the Central Bank, or as long asthe capital account remains open. So with low reserves, the turnaround in capital ‡ows asa proportion of GDP can be much higher in a panic.Figure 3 shows that there is a tight relationship between the magnitude of the collapsein growth, conditional on having experienced a capital-‡ows crisis as de…ned previously, andthe pre-existing short-term foreign debt exposure (measured in relation to reserves). In oursample of 16 crises, the average reduction in the growth rate in the year of crisis (relative tothe previous year) is 4.1 percent. But countries like Turkey (1994) and Mexico (1995), withvery high levels of short-term debt have su¤ered much greater collapses in real economicactivity than Malaysia (1994) or Venezuela (1994). The statistical regularity in our sampleis that an increase, say, from 0.5 to 1.5 in the short-term debt owed to foreign banks inrelation to reserves is associated with a reduction in growth of 2.3 percentage points (the17
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associated t-statistic being a highly signi…cant -3.8).Part of the explanation for this relationship has to do with the greater downward pressureon the exchange rate in highly illiquid economies. A collapse of the exchange rate caused by…nancial panic wreaks havoc with private-sector balance sheets and absorption, impartingstrong recessionary e¤ects in the short run. In the case of East Asia, there was indeed astrong correlation between short-term debt and the extent of currency depreciation followingthe collapse of the Thai peg in July 1997 (see Figure 4). During the second half of 1997, cur-rencies plummeted to greater depths in Korea, Indonesia, and Thailand, the countries withthe highest short-term debt-reserves ratios in the region, than they did in the Philippines,Malaysia, or Thailand. The …rst set of countries also su¤ered greater reductions in economicactivity.As we discussed earlier, the buildup of short-term debt in East Asia is a relatively recentphenomenon. Therefore another way of illustrating the downside of short-term debt exposureunder crisis conditions is to compare the recent experience of East Asia with previous episodesof balance-of-payments crisis in the region. For this purpose, Table 4 shows the evolutionof macroeconomic indicators in Korea during the recent crisis as well as during the crisis of1980. Indonesia and Thailand did not experience external crises of a comparable magnitudeduring the last two decades and therefore do not allow a similar comparison.Begin by noting that the external shocks experienced by Korea in 1979-1980, while orig-inating mostly on the current account rather than the capital account, were quite severe byany measure. There was the second oil price hike, the Volcker shock of higher world interestrates, and the worldwide recession, which reduced foreign demand for Korean exports. Thebalance-of-payments cost of the …rst two alone amounted to 6 percent of GDP (Aghevli andMarquez-Ruarte 1985, p. 5). In addition, the economy was faced with a large reduction inagricultural output (amounting to a loss of more than 4 percent of GNP) and considerablepolitical turbulence due to the assassination of President Park.During the second half of the 1970s, South Korea had borrowed heavily from foreigncommercial banks to …nance an ambitious investment program, implemented via close col-laboration between the government and the chaebol. In many ways, the current crisis bears alot of resemblance to the 1980 crisis. In both cases, prior to the crisis we have a debt buildup,limited exchange rate ‡exibility, some real appreciation of the currency, deceleration of ex-port growth, real wage increases, negative terms-of-trade shocks (the oil shock in 1979-80;the fall in the price of semiconductors in 1996-97), and other adverse external shocks (worldinterest rate increases and slowdown of world economic activity in the …rst case; contagion18
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from Thailand and the slump in Japan in the second)–all against a background of politicalinstability. The structural problems a-icting the Korean economy in the late 1970s weresaid to be chronic excess demand for bank loans, rapid credit expansion, excessive invest-ment in certain sectors, an in‡ationary environment, duplication of investment and build-upof excess capacity (due to availability of cheap loans and overly optimistic assessment of theprospects in the domestic and world economy), and a rapid expansion of housing. Exceptfor the in‡ationary environment (and maybe substituting general property and asset priceboom for the housing boom), all the other factors have been mentioned in relation to thecurrent crisis. The current-account de…cit was 2.2 percent of GDP in 1978 and 6.4 percentin 1979–similar to the de…cits of 1.9 percent in 1995 and 4.7 percent in 1996.However, the debt that Korea piled on during the 1970s was mostly medium- and-longterm, and this sharply limited the potential magnitude of capital-‡ow reversals at the timeof crisis. On the eve of the stabilization program of January 1980, total short-term debtstood at 8.4 percent of GDP and 97 percent of reserves. These …gures are much lower thanthe numbers that prevailed on the eve of the most recent crisis. In late 1997, when Koreawas forced to respond to the forces of contagion emanating from Thailand, short-term debtstood at around 15 percent of GDP and more than 300 percent of reserves.The key di¤erence between the two episodes therefore is that Korea became illiquid in1997 and subject to creditors’ panic. Unable to roll over its short-term debt, the countryhad to generate a huge current account surplus at substantial real cost to the economy.In 1980, the Korean economy faced no such di¢culty. Korea was able to run in 1980 aneven larger current-account de…cit than in previous years. It accomplished this by relyingheavily on short-term borrowing. The tilt towards short-term borrowing was due in part tothe hesitation of creditors to commit long-term funds in the face of political and economicuncertainty. As a consequence, during 1980-81 Korea’s short-term debt ratios increasedsubstantially and the maturity structure of its debt shortened signi…cantly (see Table 4).In 1997, short-term liabilities were an instigator of the crisis and could hardly play therole of savior. Korea had to generate a mammoth current account surplus of 13 percent ofGDP instead (compared to a de…cit of 8.5 percent in 1980). The currency depreciation wascommensurately larger, as was the decline in economic growth.The moral of the Korean comparison is quite clear. Regardless of fundamentals, a largeexposure to short-term debt intensi…es the costs of a crisis because it magni…es the current-account adjustment and currency depreciation that have to be undertaken.19
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4.3 Determinants of the maturity structure of debtIn 1997, 58 percent of Uruguay’s total foreign debt (according to IIF statistics) was short-term. In Morocco, meanwhile, only 3 percent of debt was short-term. Are there systematicfactors that account for the maturity structure of foreign debt across countries as well asover time within countries?A plausible list of possible determinants includes the following. First, as we emphasizein the theoretical model in section 3, short-term debt can have a useful role to play infostering e¢cient …nancial intermediation –and, indirectly, investment and growth. Forthis and other (potentially less benign) reasons, we would expect both the demand andsupply for maturity-transformation services to increase with …nancial sophistication. As theproductivity of an economy and its …nancial depth increase, the ratio of short-term debtshould therefore increase, ceteris paribus credits and other types of credit to importers aretrade-related. Consequently, the volume of short-term debt should also increase with theopenness of an economy. Third, corruption and cronyism in the debtor countries, generatingexpectations of bailouts, can result in inadequate internalization of the risks of short-termborrowing. Hence, we might expect short maturities to be associated with high levels ofcorruption.Finally, governments have at their disposal a whole range of …nancial and regulatorypolicies that in‡uence the maturity structure of capital ‡ows. Often, regulatory policies havethe e¤ect of stimulating short-term capital ‡ows. The Basle capital adequacy standards, forexample, encourage short-term cross-border lending to non-OECD economies by attachinga lower risk weight to short-term loans than to long-term loans. The Bangkok InternationalBanking Facility (BIBF) set up by the Thai government in early 1993 was speci…cally aimedat attracting short-term funds from abroad. And the Korean government is often blamedfor having encouraged short-term in‡ows by making longer-term investments in Korea (suchas equity investment or purchase of government bonds) di¢cult for foreigners. On the otherhand, limits on the short-term foreign liabilities of domestic banks, deposit requirements oncapital in‡ows, and restrictions on the sale of short-term securities to foreigners are examplesof the types of policies that can reduce short-term capital in‡ows. We will discuss the Chileanand Malaysian examples below.Table 5 presents some econometric evidence on the determinants of the maturity of ex-ternal debt. The table shows cross-country and panel regressions (with …xed e¤ects) usingthe sample of 32 emerging-market economies on which we have been focussing. The depen-20
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dent variable is the share of short-term debt in total debt. The results support some of theabove hypotheses, but not all. There is indeed a consistent and robust relationship betweenper-capita income levels and M2/GDP ratios, on the one hand, and short maturities, on theother. This relationship holds both across countries and within countries over time. Thatis, as economies get richer and …nancial markets become deeper (through …nancial liberal-ization or other channels), the external debt pro…le gets tilted towards short-term liabilities.We …nd also that the overall debt burden (debt/GDP ratio) is positively correlated withshort-term borrowing in the time-series (but not in the cross-section). One interpretationis that countries that go on a borrowing binge are forced to shorten the maturity of theirexternal liabilities in the short run.To gauge the e¤ect of corruption we use Transparency International’s index of corrup-tion. We …nd that the relationship between levels of short-term borrowing and corruption ispositive, but not statistically signi…cant (column 3).Most surprisingly, we …nd no relationship between trade and short-term debt. In fact,the estimated coe¢cient on the imports/GDP ratio is negative, suggesting that if anythingmore open economies tend to do less short-term borrowing. This is puzzling in view ofthe idea that short-term borrowing is driven in part by trade credits. One possibility isthe following.20Suppose that more open economies tend to be more creditworthy (becausethey have more to lose from defaulting on their debt and/or can provide greater collateralto their creditors). They will be less credit-rationed in the market for long-term …nance.Hence, they will have higher ratios of long-term debt to GDP. Even if such economies alsohave higher levels of short-term debt, the net e¤ect on the maturity composition of the debtwould still be ambiguous. The evidence provides partial support for this interpretation.In our sample, increases in openness (measured by import-GDP ratios) are associated ina statistically signi…cant way with higher ratios of long-term debt to GDP, but not withhigher ratios of short-term debt to GDP. The inescapable conclusion is that the levels ofshort-term debt that we observe in the real world are only weakly, if at all, related to trade‡ows. Whatever it is that drives short-term capital ‡ows, it is not international trade.The regressions in Table 5 leave a lot of the variance in the maturity composition ofexternal debt unexplained. One reason is that it is di¢cult to quantify the myriad policiesand regulations that directly a¤ect short-term capital ‡ows.2120We thank Aaron Tornell for suggesting this possibility.21See Montiel and Reinhart (1997) for an e¤ort to do so. Focusing on capital ‡ows of di¤erent types in asample of 15 countries, these authors …nd that capital controls tend to reduce the share of short-term ‡ows21
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5 Conclusions and Policy ImplicationsWe have to live with …nancial markets that are prone to herding, panics, contagion, andboom-and-bust cycles. This is as true of domestic …nancial markets–where they can domore limited damage– as it is of international ones. The world has seen banking crises in69 countries since the late 1970s, and 87 currency crises since 1975.22And the frequencyof such crises has risen sharply over the last decade. After the recent series of meltdownsin Asia, Eastern Europe and Latin America, no observer can be surprised at the apparentinstability of …nancial markets.The debate on the causes of these crashes will undoubtedly go on for a long time. Badluck, in the form of exogenous shocks from abroad and from mother nature, and bad policy,in the shape of poor regulation and imprudent macro policies, doubtlessly carry some of theblame. But that cannot be the end of the story. The main message of this paper is thatthe potential for illiquidity was at the center of recent crises, and that short-term debt is acrucial ingredient of illiquidity. The empirical evidence is clear in that respect.In the aftermath of the crises, the reaction, particularly from multilateral lenders butalso from Wall Street, has been to call for more prudent monetary and …scal policies, andgreater supervision and transparency in local …nancial markets. This is all …ne. Who can beagainst prudence and transparency? But appropriate macroeconomic policies and …nancialstandards can go only so far in reducing the risks.There is limited agreement on what macro policies are “appropriate” in this context.Analysts of the Asian episodes, for instance, seem to be evenly divided between those whothink that countries like Thailand and Indonesia held on to …xed exchange rates for too longand those who claim that the defense of the peg was insu¢ciently …erce.The current emphasis on strengthening domestic …nancial systems also glosses over thepractical di¢culties. Putting in place an adequate set of prudential and regulatory controlsto prevent moral hazard and excessive risk-taking in the domestic banking system is a loteasier said than done. Even the most advanced countries fall considerably short of the ideal,as their bank regulators will readily tell you. Indeed, banking crises have recently takenwhile sterilized intervention increases it.22The bank crises number comes from Caprio and Klingebiel (1996). A banking crisis occurs, in theirde…nition, when the banking system has zero or negative new worth. The …gure excludes transition economieswhich, by their estimate, would add at least 20 crises in the period. The currency crisis …gure is from Frankeland Rose (1996), who de…ne such a crisis as a year in which the currency depreciates by more than 25 percent,and this depreciation is at least 10 percentage points larger than the previous year’s.22
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place in countries as well o¤ as Sweden and Japan. The collapse of Long Term Capital inthe summer of 1998 revealed a gaping hole in the regulatory arrangements of U.S. …nancialmarkets. If this happens at the heart of the OECD, one can imagine the scale of problemsfacing bank regulators in Ecuador, India or Turkey.The moral of the story, then, is that …nancial crises are as di¢cult to avoid as theyare to understand. There is no magic …x that will make them go away. Our incompleteunderstanding of how …nancial markets work, along with changing fads and disagreementson what constitutes “sound” economic policy in developing economies, should make us verycautious of attempts to impose a one-size-…ts-all recipe on borrowing countries (Rodrik 1999).What is called for is a pragmatic and ‡exible approach that works on several fronts at once.And one of those fronts, undoubtedly, is increasing liquidity and discouraging short termdebt.5.1 Crisis preventionOne obvious, if not very useful, answer is to require …nancial systems to be always liquid.But liquidity is costly to maintain, and countries attempting to prevent crises face someunpleasant trade-o¤s. Chang and Velasco (1999b) and Feldstein (1999) discuss some ofthe options. On the asset side, using …scal policy to build a “war chest,” and securingcontingent credit lines abroad –both to be used in times of trouble– are useful but notwithout problems. On the liability side, increasing required foreign-currency reserves onbanks’ liquid liabilities (perhaps making the size of the requirement an inverse function ofmaturity) can help discourage short term bank debt. Lengthening the average maturity ofpublic debt, as Mexico did after the 1995 tequila crisis, is also crucial to prevent illiquidity.In addition, there is a case for instituting across-the-board disincentives to short-termforeign borrowing, such as those used by Chile, Colombia and Malaysia among many others.Their potential role in preventing a possible liquidity crisis should be clear from our earliertheoretical analysis. Three objections are often raised against such controls: that they areine¤ective, costly, and that they fail to protect an economy from panic by all relevant players.We consider each in turn.Ine¤ectiveness: Any claim about the ine¤ectiveness of capital controls must be tempered bythe observation that such policies are vehemently opposed by the very markets participantswhose actions the controls are supposed to in‡uence. Perhaps bankers and arbitrageursdenounce the taxes and ceilings they can presumably avoid with the stroke of a key out of23
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simple public-mindedness, or because of a deep-seated reluctance to break the law. We donot claim to know.Furthermore, there is an obvious contradiction between emphasizing, on the one hand,improved prudential regulation and transparency as an important part of the solution, andmaintaining, on the other, that capital controls cannot work because they can be easilyevaded through corruption, …nancial engineering or other mechanisms. If …nancial marketscan evade controls of the latter kind, they can surely evade controls of the former kind as well.Regulatory ine¤ectiveness may undercut the argument for capital controls, but it undercutseven more seriously the emphasis on …nancial standards that pervades the G7’s approach tothe international …nancial architecture.But aside from these apparent logical inconsistencies, there is growing evidence thatcontrols can be indeed e¤ective. We illustrate this by drawing on the experiences of twocountries–Chile and Malaysia–that at some point successfully managed short-term capitalin‡ows.Chile’s capital-account regime appears to represent a canonical case of successful fending-o¤ of short-term capital ‡ows, and for that reason has been studied extensively.23In June1991, the Chilean authorities imposed a non-interest bearing reserve requirement of 20 per-cent on all external credits. Equity investments were exempt. The reserves had to be heldat the Central Bank for a minimum of 90 days and a maximum of one year. As an alterna-tive to the reserve requirement, medium-term creditors were allowed to make a payment tothe Central Bank equivalent to the …nancial cost of the reserve requirement. In May 1992,the reserve requirement was raised to 30 percent and extended to time deposits in foreigncurrency and to Chilean stock purchases by foreigners. In addition, the deposit period waslengthened to one year (see Agosin and Ffrench-Davis 1998). The authorities eventuallybegan to closely monitor DFI ‡ows to ensure that short-term ‡ows were not disguised asequity investments. In 1998, faced with capital out‡ows, Chile relaxed and eventually setthe required reserve to zero. While it was in force, the reserve requirement had the e¤ect ofcreating a severe disincentive for short-term capital in‡ows. At a LIBOR of 5 percent, forexample, the annualized cost of the policies in place was 3.9 percent on a one-year loan, but11.0 percent on a three-month loan (Agosin and Ffrench-Davis 1998, Table 3).The data on the composition of Chile’s external debt suggests quite strongly that thepolicies had the intended e¤ect. The top panel of Figure 5 shows the share of short-term23See, for instance, Valdes Prieto and Soto 1996; Larrain, Laban and Chumacero 1997; Budnevich andLefort 1997; Agosin and Ffrench-Davis 1998; and Edwards 1998.24
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debt in total for Chile. We note a sharp dip in 1991, the year that the deposit require-ment was …rst imposed. The ratio bounces back in 1992, but following the tightening ofthe reserve requirement, it steadily falls throughout 1992-1997. By 1997, short-term debtconstituted only 7.6 percent of total debt. This informal conclusion is con…rmed by moresystematic evidence in a number of papers. Valdes-Prieto and Soto (1996), Larrain, Labanand Chumacero (1997), Budnevich and Lefort (1997), and Montiel and Reinhart (1997) all…nd that the restrictions have a¤ected the maturity composition of ‡ows, though not theiroverall volume or the course of the real exchange rate.The case of Malaysia in 1994 is less well known. The country is notorious (in somecircles) for the sweeping currency and capital out‡ow controls that its government imposedon September 1st, 1998. It is too early to evaluate the consequences of these recent controls,but we do have some evidence on a set of temporary controls that were implemented someyears earlier in 1994. In January 1994, the Malaysian government imposed a prohibitionon the sale to non-residents of a wide range of short-term securities (including banker’sacceptances, negotiable instruments of deposit, Bank Negara bills, treasury bills or othergovernment securities with a remaining maturity of one year or less). These restrictions werewidened in February (to cover swap transactions in the currency market), and complementedby an interest charge on short-term deposit accounts placed in domestic commercial banksby foreigners. The restrictions began to be lifted in August 1994, and were largely eliminatedby the end of the year.The background to these restrictions was that there had been a huge surge of short-term speculative capital in‡ows in late 1993 following a surprise 6 percent depreciation ofthe ringgit. Hedge funds and others expecting a quick recovery in the currency ‡ooded theMalaysian market. As the bottom panel in Figure 5 shows, the result was a sharp increasein short-term liabilities, which reached a peak of 37 percent of total debt at the end of1993. The …gure also reveals that the restrictions imposed at the beginning of 1994 wereremarkably e¤ective. (So e¤ective in fact that the colossal turnaround in short-term capital‡ows in 1994 led us above to classify Malaysia in 1994 as a case of “crisis”.) The ratio ofshort-term debt in the total fell sharply to 26 percent in 1994 and to 23 percent in 1995,beginning to recover only in 1996. The overall debt burden fell as well, from 59 percent ofGDP in 1993 to 41 percent in 1995.As we know too well by now, these policies did not prevent Malaysia from getting intoserious trouble a few years later. One possible explanation is that the controls were liftedtoo soon: Figure 2 reveals that the ST debt-to-reserves ratio rose between 1994 and 1997,25
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and Figure 5 reveals that the same happened to the share of ST debt in total debt.The cases of Chile and Malaysia illustrate the importance of the policy regime in in‡u-encing the maturity structure of foreign debt. But policy is not all-powerful. One constraintcomes from the growing role of derivatives in international capital ‡ows. As Garber (1998)has stressed, derivatives can help circumvent controls and they render interpretation of stan-dard balance of payments categories problematic. But it is not clear that derivatives canalways undo the intended e¤ects of policy. As Garber writes: “Market sources ... reportserious, though as yet unsuccessful, …nancial engineering research e¤orts to crack directlythe Chilean tax on capital imports in the form of an uncompensated deposit requirement.”Costliness: What about the costs presumably involved? In theory, capital controls preventrisk-spreading through global diversi…cation of portfolios. They result in an ine¢cient globalallocation of capital. And they encourage irresponsible macroeconomic policies at home. Isthere evidence to support such presumptions?One of us has examined this issue systematically (Rodrik 1998), relating capital accountliberalization to three indicators of economic performance: per-capita GDP growth, invest-ment (as a share of GDP), and in‡ation. The indicator of capital account liberalization usedwas the proportion of years for which the capital account was free of restrictions (according toIMF classi…cations). The exercise covered a post-1975 sample of around 100 countries. Thestudy found no evidence that countries without capital controls have grown faster, investedmore, or experienced lower in‡ation.24Furthermore, speci…c episodes of capital controls do not reveal signi…cant real costs either.Chile is a success case of the 1990s, in no small part because it has managed to avoid thede-stabilizing in‡uence of short-term capital ‡ows. Even in Malaysia, where the impositionof restrictions in January 1994 resulted in a massive turnaround in capital ‡ows, growth wasuna¤ected (in fact, the Malaysian economy grew faster in 1994 and 1995 than in 1993).Other claimants: The other very important caveat is that foreigners are not the only short-term creditors. Hence, imposing controls and reducing external short term debt is neither anecessary nor a su¢cient condition for ruling out crises. As Krugman (1999) has stressed,in‡ow controls still leave all holders of domestic claims on the commercial and central banksready to run. There is one important distinction, however, between this type of capital ‡ight24Policy choices regarding the capital account are endogenous, so there is a potential for reverse causation.But to the extent that this is a problem, it biases the results in the direction of …nding a positive relationshipbetween open capital accounts and good performance: countries are more likely to remove capital controlswhen their economies are doing well.26
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and the reversal of short-term external ‡ows. Governments are allowed under the existingrules of the IMF (Art. VI) to close the foreign-exchange window so as to prevent capitalout‡ows by domestic residents. Hence a run on a country’s domestic short-term liabilitiescan in principle be prevented by legal means. But refusal to pay back short-term foreigndebt would abrogate existing debt contracts and would put the country into default. In anycase, we view this argument not as one against capital controls per se, but rather as a pleato complement them with other policies. Bank regulation and the exchange rate regime arecentral in this regard. Again, Chang and Velasco (1999b) and Feldstein (1999) analyze theavailable options.5.2 Crisis managementThe presence of short-term debt makes a coordination failure among lenders possible. Hence,a main task of crisis management is to attempt to coordinate their behavior on the “good”outcome. In the model presented above, the key is to avoid the real costs (liquidation andothers) imposed by early repayment. Hence, a simple suspension of payments that preservesthe present value of the creditors’ claims makes everyone better o¤. In practice, of course,lenders are wary of such responses. From New York or London it is hard to distinguish thepayments moratoria that are justi…ed by liquidity considerations from those that are thinlyveiled attempts at default. When in doubt, lenders are likely to suspect the latter. There isalso the logistical problem of coordinating the actions of many bond-holders.But the fact that the task is hard should not keep policymakers from trying. Paymentsreprogrammings that are accompanied by serious macroeconomic policies and signals ofcreditworthiness (such as …scal retrenchment) may prove more palatable. In Korea, forinstance, American, European and Japanese banks jointly agreed in December 1997 to anorderly rollover of existing short-term loans. Major creditor countries helped by anticipatingthe disbursement of a fraction of the bailout package the IMF had just approved. Those twomeasures e¤ectively ended the …nancial panic that had gripped Korea for several months.25Multilateral lenders can also help. Just as after appropriate surveillance and conditional-ity they place their seal of approval on countries that follow sound macroeconomic policies,IFIs could publicly endorse temporary payments suspensions or reschedulings in situations25This description follows Corsetti, Roubini and Pesenti (1998b). These authors also note that therescheduling of loans was a much more daunting task in Indonesia, where there were large numbers both onthe lenders’ and borrowers’ sides.27
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where these are justi…ed. Such an endorsement could overcome the perception of illegit-imacy that surrounds changes in debt repayment terms, however justi…ed. Multilaterallenders could also lend “into arrears” when appropriate in order to strengthen con…dence inthe borrower’s prospects. They could also encourage the adoption of clauses in internationalbond covenants that facilitate negotiations between debtors and creditors even when debtservice is suspended. As Kenen (1999) points out, such proposals were endorsed by the G-10back in 1995, but have yet to be implemented in full.Encouraging other kinds of capital ‡ows may also be useful in times of trouble. In themodel above, a good part of the problem comes from the local investor’s inability to sellrather than liquidate its illiquid assets in the event of a squeeze. That assumption is realisticinsofar as, in a crisis situation, there are few domestic agents with the cash in hand to buythe real capital. But foreigners are in a di¤erent position. In principle, everyone could bebetter o¤ if liquidation could be avoided through foreign direct investment –even if the priceis that of a …re sale, below the present value of capital’s real yield in the future.26Therefore,FDI could be encouraged for these purposes. Debt-equity swaps involving foreign creditorsplayed an important role in the resolution of the 1980s debt crisis, and could be useful againin the current context as part of a broader strategy that includes the elements discussedabove. At the same time, a series of …nancial crises that become the occasion for the sale ofnational assets to foreigners at bargain-basement prices is unlikely to do much to enhancethe legitimacy of the international …nancial system.26In the model above, because the world rate of interest is zero and one unit of healthy capital yields Runits of the tradeable good in period 2, the “fundamental”price of capital in period 1 is R. But any pricesmaller than R and bigger than ½ makes the borrower better o¤ (relative to liquidation), while giving theforeign investor an abnormally high rate of return.28
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References[1] Aghevli, Bijan, and Jorge Marquez-Ruarte. 1985. “A Case of Successful Adjustment:Korea’s Experience During 1980-84.” Occasional Paper 39. Washington DC: Interna-tional Monetary Fund.[2] Agosin, Manuel R., and Ricardo Ffrench-Davis. 1998. “Managing Capital In‡ows inChile.” Paper prepared for UNU/WIDER project on Short-Term Capital Movementsand Balance of Payments Crises. Sussex, May 1-2, 1997.[3] Budnevich, Carlos and Guillemo Le Fort. 1996. “Capital Account Regulations andMacroeconomic Policy: Two Latin American Experiences,” Working Paper No. 6, BancoCentral de Chile.[4] Calvo, Guillermo. 1995. “Varieties of Capital Market Crises.” Working Paper 15, Centerfor International Economics, University of Maryland.[5] Cárdenas, M. and F. Barrera 1997. “On the E¤ectiveness of Capital Controls: TheExperience of Colombia during the 1990s,” Journal of Development Economics 54(1),pp. 27-57.[6] Chang, Roberto and Andrés Velasco. 1998. “Financial Crises in Emerging Markets: ACanonical Model” NBER Working Paper No. 6606, June.[7] Chang, Roberto and Andrés Velasco. 1999a. “Banks, Debt Maturity, and FinancialCrises,” unpublished manuscript, Federal Reserve Bank of Atlanta and NYU.[8] Chang, Roberto and Andrés Velasco. 1999b. “Illiquidity and Crises in Emerging Mar-kets: Theory and Policy.” Paper prepared for the 1999 NBER Macroeconomics Annual,Cambridge, Mass.[9] Harold L. Cole, Timothy J. Kehoe. 1996. “A self-ful…lling model of Mexico’s 1994–1995debt crisis.” Journal of International Economics (41) 3-4, pp. 309-330[10] Corsetti, Giancarlo, Paolo Pesenti and Nouriel Roubini. 1998a. “What Caused the AsianCurrency and Financial Crises? Part I: The Macroeconomic Overview” NBER WorkingPaper 6833, December.29
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[11] Corsetti, Giancarlo, Paolo Pesenti and Nouriel Roubini. 1998b. “What Caused the AsianCurrency and Financial Crises? Part II: The Policy Debate” NBER Working Paper6834, December.[12] Edwards, Sebastian. 1998.“Capital Flows, Real Exchange Rates and Capital Controls:Some Latin American Experiences,” Working paper 6800. Cambridge, Mass: NationalBureau of Economic Research, November.[13] Eichengreen, Barry, and Andrew Rose. 1998. “Staying A‡oat When the Wind Shifts:External Factors and Emerging Market Banking Crises.” Working paper 6370. Cam-bridge, Mass: National Bureau of Economic Research (January).[14] Feldstein, Martin. 1999. “A Self-Help Guide for Emerging Markets,” Foreign A¤airs,March-April.[15] Frankel, Je¤rey A., and Andrew K. Rose. 1996. “Currency Crashes in Emerging Markets:Empirical Indicators.” Journal of International Economics (41) 3-4, pp. 351-367.[16] Furman, Jason and Joseph E. Stiglitz. 1998. “Economic Crises: Evidence and Insightsfrom East Asia.” Brookings Papers on Economic Activity (1998:2): 1-135.[17] Garber, Peter M. 1998. “Derivatives in International Capital Flow.” Working paper6623. Cambridge, Mass: National Bureau of Economic Research (June).[18] Institute of International Finance, Inc. 1998. Comparative Statistics for Emerging Mar-ket Economies. Washington DC: IIF.[19] Jeanne, Olivier. 1998. “The International Liquidity Mismatch and the New Architec-ture,” manuscript, International Monetary Fund.[20] Kaminsky, Graciela, Saul Lizondo, and Carmen M. Reinhart. 1998. “Leading Indicatorsof Currency Crises.” International Monetary Fund Sta¤ Papers 45 (1): 1-48.[21] Kenen, Peter. 1998. “Coment on Radelet and Sachs” in the forthcoming NBER Confer-ence Volume, based on the Conference on Currency Crises held in Cambridge, Mass.,February 6 and 7.[22] Krugman, Paul. 1999. “Balance Sheets, the Transfer Problem and Financial Crises,”paper prepared for the festchrift volume in honor of Rober Flood, January.30
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[23] Larrain, Felipe, Raul Laban and Romulo Chumacero. 1997. “What Determines CapitalIn‡ows? An Empirical Analysis for Chile,” Development Discussion Paper No. 590,HIID.[24] Montiel, Peter, and Carmen M. Reinhart. 1997. “Do Capital Controls In‡uence theVolume and Composition of Capital Flows: Evidence from the 1990s.” Paper preparedfor UNU/WIDER project on Short-Term Capital Movements and Balance of PaymentsCrises. Sussex, May 1-2.[25] Obstfeld, Maurice. 1994. “The Logic of Currency Crises,” Cahiers Economiques etMonétaires No. 34.[26] Radelet, Steven, and Je¤rey Sachs. 1998. “The East Asian Financial Crisis: Diagno-sis, Remedies, Prospects.” Paper prepared for the Brookings Panel. Washington D.C.,March 26-27.[27] Rodrik, Dani. 1998. “Who Needs Capital Account Convertibility?” Essays in Interna-tional Finance 207, International Finance Section, Department of Economics, PrincetonUniversity, May.[28] Rodrik, Dani. 1999. “Governing the World Economy: Does One Architectural Style FitAll?” paper prepared for the Brookings Institution Trade Policy Forum conference onGoverning in a Global Economy, April 15-16.[29] Sachs, Je¤rey, Aaron Tornell and Andres Velasco. 1996. “Financial Crises in EmergingMarkets: The Lessons from 1995,” Brookings Papers on Economic Activity, No. 1.[30] Valdés-Prieto, S. and C. Soto. 1996. “The E¤ectiveness of Capital Controls in Chile,”manuscript, Catholic University of Chile.31
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Figure 1Source: IIF (1998)01002003004005006001988 1989 1990 1991 1992 1993 1994 1995 1996 1997M< debt0501001502002503001988 1989 1990 1991 1992 1993 1994 1995 1996 1997ST debt (all)0501001502002501988 1989 1990 1991 1992 1993 1994 1995 1996 1997Africa/Middle EastAsia/PacificEuropeLatin AmericaST debt to commercial banks
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Figure 2Short-term debt/reserves ratios 00.511.522.533.5199219931994199519961997IndonesiaMalaysiaPhilippinesSouth KoreaThailand
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Figure 3Note: Short-term debt exposure is lagged one year. Each observation corresponds to a year of sharp reversal in capital flows, as defined in text:Bulgaria1990Hungary1990Philippines1990Uruguay1990Uruguay1993Malaysia1994Turkey1994Venezuela1994Mexico1995Ecuador1996Hungary1996Indonesia1997Philippines1997South Korea1997Thailand1997Russian Federation 1998change in growth rateshort-term debt to banks/reserv01234-15-10-50BulgariaEcuadorHungaryHungaryIndonesiMalaysiaMexicoPhilippiPhilippiRussian South KoThailandTurkeyUruguayUruguayVenezuel
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Figure 4Short term debt and currency collapse00.511.522.5KoreaIndonesiaThailandPhilippinesMalaysiaTaiwan0%20%40%60%80%100%120%140%short-term bank debt/reserves, end-June 1997 (left axis)depreciation of currency, second half of 1997 (right axis)
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Figure 5Share of debt that is STChileYear198819911997.05.1.15.2deposit requirements imposedShare of debt that is STMalaysiaYear198819941997.095559.373698temporary restrictions on ST capital inflows
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Table 1Composition of foreign debt by region1988198919901991199219931994199519961997Asia/PacificST (commercial banks)13.6%14.8%18.7%20.3%22.0%21.8%22.4%26.0%29.2%23.8%ST (other)6.8%6.6%6.0%6.0%5.4%6.4%4.7%4.3%4.2%4.0%M<79.6%78.6%75.2%73.7%72.5%71.8%72.9%69.8%66.6%72.2%Latin AmericaST (commercial banks)9.3%8.0%8.9%8.5%10.3%11.1%12.4%13.9%15.0%15.2%ST (other)3.1%9.6%9.4%12.5%12.7%14.0%12.4%8.3%6.9%4.9%M<87.6%82.4%81.7%79.0%77.0%75.0%75.2%77.8%78.1%79.9%EuropeST (commercial banks)9.7%10.0%9.4%9.9%9.5%10.3%6.4%7.9%10.0%11.9%ST (other)5.3%4.6%7.4%7.9%7.8%7.0%5.6%6.6%8.7%11.0%M<85.1%85.5%83.2%82.2%82.7%82.7%88.0%85.5%81.2%77.1%Africa/Middle EastST (commercial banks)19.0
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josemarrase
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5ST. INVEST. = INVERSIÓN A CORTO PLAZO - ST/LTjosemarrase


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19 hrs   confidence: Answerer confidence 5/5
ST. INVEST. = INVERSIÓN A CORTO PLAZO - ST/LT


Explanation:
3.4 Short-term debt as a precommitment deviceAn important possible objection is that ST debt plays no useful role in the analysis thus far.But in reality, there are some reasons why the possibility of borrowing short can be sociallybene…cial: ST loans may help share risk between borrowers and lenders, or give lenders morecontrol over borrowers’ actions and hence help reduce the risk of default. The point is notjust academic, for if some kinds of ST debt are socially bene…cial, policies that discouragesuch borrowing may have costs as well as bene…ts.Consider, for illustration, a case in which default is possible, and ST debt acts as akind of precommitment device that ameliorates the default problem.9Assume that thereare two kinds of governments: orthodox governments that always repay foreign debt andpermit private debtors to do the same, regardless of circumstance; and populist governmentsthat may choose to repudiate their debts or impose exchange controls that prevent privatedebtors from repaying their foreign loans. A populist government behaves opportunistically,repaying debts only if it is in its short-term interest (or that of the local borrower) to do it.To make the story interesting, in the sense that populists do not always cause a default,7Notice that this expectation includes only the consumption level if there is no run, for in the event of arun consumption is zero: all resources go to paying foreign creditors.8There is a second possible, though very implausible, equilibrium. Suppose that the investor expectsrS= rL, so that her expected consumption is independent of d. Suppose also (implausibly) that, since d isnot determined, she sets d = 0. Then, the expectation rS= rLturns to have been correct, and we have anequilibrium with no ST debt. The problem, of course, is that the investor is very unlikely to set d = 0. If sherandomized, for instance, across all possible d 2 [0;k], the probability associated with hitting zero exactlywould also be zero.9Jeanne (1998) has built a model with a similar mechanism.9
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assume that default is costly. If in period 2the government defaults on its outstanding loans,a portion ® < R¡1of the income produced by the project is lost. Default costs may includesanctions, litigation and other transactions costs, etc. Hence, in the event of a default theinvestor ends up with R(k¡ `)(1 ¡ ®)units of consumption.Timing is as follows. Between periods 0 and 1 an orthodox government is always in o¢ce.Late in period 1 there is an election. With probability ¼ a populist wins, and with probability1 ¡ ¼an orthodox leader is elected. Election results become known before lenders choosewhether to rollover their debts at the end of period 1. Then a run occurs with probability pif d is large enough to make a run feasible. But even if a run does not occur, rational lendersmay choose not to roll over ST debts if a populist has been elected. Quite crucially, rolloverdecisions are made once election results are known but before the new government takesover, so that ST debts will always be repaid to the extent that available resources permit.10The interesting case occurs if a populist is elected and no generalized run or panic occurs.In that situation, whether lenders refuse to roll over loans depends on whether they expectthe government will cause a default; and the default incentives faced by the governmentdepend crucially on the maturity structure of debt. It is in this context that ST debt canhave desirable incentive e¤ects.To see this, consider the options faced by a newly elected populist government if no runtakes place. If it can assure lenders that loans will be repaid (by causing project income, forinstance, to be deposited in an international escrow account), ST debts will be rolled over,and consumption by the representative local borrower is Rk¡ (1 + rS)d ¡ (1 + rL)(k ¡ d).If the newly elected government cannot (or does not want to) reassure investors, holders ofST debts will refuse to roll them over and some early liquidation of the project will takeplace. Having nothing to lose, the government will indeed decree a default when it comes too¢ce. In that case, consumption by the representative local borrower is R³k ¡d½(1 ¡ ®).The newly elected government will choose the escrow account option if consumptionby the representative individual is larger in that case. The choice depends on how muchST debt there is.11For the sake of brevity, consider just the polar cases of d = 0 andd = k. If d = 0, then no runs can take place and rs= 0. Will a default take place?10This is a very realistic assumption. There is often a “bunching” of amortizations in the window betweenelections and the corresponding transfer of power.11To evaluate which consumption level is higher one must pin down the value of the relevant interest rates;they, in turn, depend on the size of d. One could readily compute, as we did in an earlier section, rS, rLand expected borrower consumption for each d, and then use the results to identify the socially optimal levelof ST debt.10
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With default the representative borrower consumes Rk (1¡ ®), and without it consumes(R ¡ 1)k. Since we have assumed ® < R¡1, consumption is higher under no payment, andthe opportunistic government will prefer a default. With rational expectations, d = 0 willcause 1 + rL= (1 ¡ ¼)¡1, since after a populist triumph in the elections, holders of LTdebt get nothing. If no ST debt is chosen in period 0, then expected consumption by therepresentative borrower is (R¡ 1)k ¡ ¼®k.If only ST debt is chosen and d = k, on the other hand, default can never take placein equilibrium: the expectation of a default would cause all debt to be redeemed in period1, and early liquidation of the whole investment would leave nothing for the borrower toconsume. But runs can clearly occur in equilibrium, so that 1 + rL= (1 ¡ p)¡1and rSisgiven by equation 6 evaluated at d = k. With that information it is easy to compute expectedconsumption by the representative borrower, which is equal to (R¡ 1)k ¡ p(R ¡ ½)k.Comparing the two expressions for expected consumption we see that having no ST debtis better ex ante if and only if the probability of electing a populist and the cost of thepotentially associated default are su¢ciently small: ¼® < p(R¡ ½). The intuition is clear:the positive incentive e¤ect of ST debt is most useful in countries prone to populist policies.This bene…t shows up in lower contractual interest rates, since debt that is su¢ciently shortin maturity reduces the risk of default. In such an environment, eliminating all ST borrowingwould be socially harmful.3.5 ImplicationsThe model sketched out in this section has several important implications:²Runs can only occur when investors take on su¢ciently large amounts of ST debt.²The larger the stock of ST debt, the larger the size of a run..²The larger the stock of ST debt, the larger the real consequences (in terms of costlyliquidation and reduced output and consumption) of a run.²Distorted incentives can cause investors to take on ST debt, even if doing so is sociallycostly. Hence, there may be a case for discouraging short maturities through publicpolicy.²But ST debt can play a useful role (for instance, by serving as a precommitment device).Hence, policies that sharply reduce ST ‡ows can have costs as well as bene…ts.11
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4 Short-term external debt: an empirical analysisShort-term capital ‡ows comprise a wide array of …nancial transactions: trade credits, com-mercial bank loans with a maturity of less than one year, and short-term private and publicdebt (both in local and foreign currencies) issued abroad or sold to non-residents.The statistical coverage of these transactions and of outstanding stocks is imperfect.The OECD, BIS, World Bank, and the IMF all provide some data on short-term debt fordeveloping and transition countries, but do so with some gaps.12In what follows, we usedata from the Institute of International Finance (IIF 1998). These data have been collectedlargely from national sources, and have the advantage that in principle they include allforms of suppliers’ credits as well as non-residents’ holdings of government bills (includingdebt issued in local currency), in addition to liabilities to commercial banks and other foreign-currency denominated borrowing.13The IIF presentation of the data allows us to distinguishbetween medium- and long-term debt and short-term debt, and in the latter category betweendebt owed to banks and other debt. The main shortcoming of the IIF source is that thecoverage is limited to 37 emerging-market economies. For our purposes, however, this is nota major concern, as these countries constitute the relevant sample for the analysis.A caveat is that, because comparable data are not currently available, we have notincluded short-term domestic public debt in our work even though a run on such public debtcan also cause illiquidity and crises. In the Asian crisis, this is not likely to be an importantomission. Around the time of the collapse there does not seem to have been much shortterm public debt in the strongly a¤ected countries of Indonesia, Korea and Thailand (seeTable 3 of Ito, 1998).14However, public debt probably played a role in other episodes. We12These international organizations have recently pooled their resources to provide a uni…ed set of quarterlystatistics on external debt The data are available at http://www.oecd.org/dac/debt/. The short-term debtstocks reported by these agencies cover liabilities to non-resident banks, o¢cial or o¢cially guaranteed tradecredits, and debt securities (i.e., money market instruments, bonds and notes) issued abroad. Their dataare put together largely from creditor and market sources. Coverage is poor or non-existent in the followingareas: (i) non-o¢cially guaranteed suppliers’ credit not channeled through banks; (ii) private placementsof debt securities; (iii) domestically issued debt held by non-residents; and (iv) deposits of non-residents indomestic institutions.13We are grateful to William Cline of the IIF for making the data available, as well as for clari…cations onsources and coverage.14Except for Brazil, public debt has not been a major problem recently for comparable Latin Americancountries either. Mexico managed to extend the maturity of its public debt after the 1994 collapse. At theend of September 1994, short term domestic federal debt was equivalent to US $26.1 billion; by the end of12
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know that the Mexican government’s inability to roll over its large stock of short term debt(in particular, the infamous Tesobonos) was to prove key in triggering the …nancial crisis inDecember 1994. More dramatically, Brazil’s internal debt situation seems to be crucial forunderstanding its current predicament.4.1 Debt maturity and crisesEven though short-term debt exposure …gures prominently in the long list of culprits forthe Asian …nancial crisis, few empirical studies have been able to draw a tight empiricalconnection between currency or balance-of-payments crises and short-term debt. Kaminsky,Lizondo and Reinhart’s (1998) comprehensive survey of the empirical literature uncoversessentially no evidence that the maturity pro…le of external debt matters for crises. Thevariables highlighted by this literature as leading indicators of currency crises are the level ofreserves, the real exchange rate, credit growth, credit to the public sector, and in‡ation, butnot short-term debt (Kaminsky et al. 1998). One reason, as noted by Furman and Stiglitz(1998, 51), is that not many of these studies have focussed on the composition of foreigndebt. Three exceptions are Sachs, Tornell and Velasco (1996); Frankel and Rose (1996) andEichengreen and Rose (1998). The …rst of these papers …nds weak evidence that the shareof short term capital ‡ows in total ‡ows helps predict which countries were a¤ected by thetequila e¤ect in 1995. The second …nds no statistically signi…cant relationship between theshare of short-term debt and the incidence of currency crises, while the third concludes thata higher share of short-term debt actually decreases the probability of banking crises.A recent paper by Radelet and Sachs (1998) is, to our knowledge, the only paper thatpresents systematic evidence on the culpability of short-term debt. These authors provide aprobit analysis for 19 emerging markets covering the years 1994-1997. Their crisis indicatoris a binary variable that takes the value of 1 when a country experiences a “sharp shift fromcapital in‡ow to capital out‡ow between year t¡ 1and year t” (Radelet and Sachs 1998, p.23). They classify nine cases as such: Turkey and Venezuela in 1994, Argentina and Mexicoin 1995, and Indonesia, Korea, Malaysia, the Philippines, and Thailand in 1997. Radelet andSachs measure short-term debt exposure by taking the ratio of short-term debt to foreignbanks (from BIS) to central bank reserves. They …nd that this ratio is associated positivelyand statistically signi…cantly with crises (as is the increase in the private credit/GDP ratio inJune 1997 this …gure was down to less than US $8.5 billion. Argentina, Chile and Peru have not issueddomestic short term debt in any substantial magnitude.13
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the previous three years). They …nd no evidence that crises are associated with corruption.They …nd only weak evidence on the current-account de…cit and, even more surprisingly, noevidence on the role of real exchange rate appreciation.We present here an exercise in the spirit of Radelet and Sachs (1998), extending theiranalysis in two directions. First, we use the IIF database (IIF 1998), and can thus distinguishconsistently between short-term debt owed to foreign banks and other short-term debt, aswell as between short-term and medium- and long-term debt. By contrast, the BIS statisticson which most recent analyses have relied provide information only on short-term debt owedto foreign banks.15Second, the IIF database allows us to expand the scope of the empiricalanalysis: we cover the period 1988-1998 and 32 emerging-market economies, giving us amuch larger sample of observations as well as more crises.16In de…ning a …nancial crisis, we focus on the proximate cause: a sharp reversal in capital‡ows. Hence we follow the de…nition of Radelet and Sachs (1998) rather than that of theearlier literature, which emphasized currency depreciations and/or reserve reductions. Weassume there is a crisis when there is a turn-around in net private foreign capital ‡ows (Bt)of 5 percentage points of GDP or more.17Operationally, our crisis variable is a 0¡1variablewhich takes the value 1 in any year in which Bt¡1> 0 and (Bt¡1¡ Bt)=Yt¡1> 0:05. Thevalue of crisis is set to missing for the two successive years following a year in which crisis= 1 (again following Radelet and Sachs).18This exercise yields 16 instances of crises, listed in Table 2. The sample includes all buttwo of the cases identi…ed by Radelet and Sachs (1998) as well as many others. The two in-stances of crisis in Radelet and Sachs that do not meet the 5 percent threshold are Argentina(1995) and Malaysia (1997). Note that Malaysia is listed instead as having had a “crisis”in 1994, with a whopping turnaround in private capital ‡ows of 20 percent of GDP (which15The correlation between the statistics on short-term debt to commercial banks provided by the twosources is very high, typically of the order of 0.9 (with some exceptions).16The IIF database includes an additional …ve oil-exporting countries, which we have excluded from theanalysis.17Private capital ‡ows are loans from commercial banks and other private credit, excluding equityinvestments.18Also, we have excluded from the sample a few data points with extremely high values of short-termdebt to reserves (greater than 5). Russia (in 1991) and Cote d’Ivoire (in 1992), for example, had short-termdebt (to banks)/reserves ratios of 312 and 217, respectively. Since short-term debt is our focus, leaving suchobservations in would result in outliers in the probit analysis that would cloud the interpretation of theresults.14
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followed the imposition of capital controls on in‡ows in January 1994 as discussed below).19Additional crises include Bulgaria, Hungary, and the Philippines (all in 1990), Uruguay (1990and 1993), and Ecuador (1996). Some of these cases are arguably not instances of crisis inthe sense of …nancial collapse, and seem related to idiosyncratic developments (such as thetransition from socialism in the cases of Bulgaria and Hungary in 1990). But rather thanexercise discretion, which leaves the empirical results open to interpretation, we have decidedto follow the 5 percent rule rigidly. One exception is that we have included Russia (1998)in the crisis sample, even though we did not have data on private capital ‡ows for all of1998 at the time of this writing. The results reported below are robust to the exclusion ofRussia or of any of the other cases from the sample, as well as to changes in the de…nitionof a crisis. We are fairly con…dent that our …ndings on the importance of short-term debtare not an artifact of arbitrary decisions regarding thresholds, sample coverage, and othermethodological choices.As Table 2 reveals, countries experiencing sharp reversals in capital ‡ows tend to havehigher shares of short-term debt in total, but where they really stand apart is in termsof short-term debt/reserves ratios. On average, crisis cases have short-term debt/reservesratios that are twice the level that obtains in other cases (1.49 versus 0.76 for debt owed tobanks, and 1.59 versus 0.71 for other debt). At the same time, the table reveals instances ofcrises in the presence of quite low levels of short-term exposure as well (e.g., Ecuador 1996;Venezuela 1994)The relationship between short-term capital ‡ows and …nancial crises is examined moresystematically in Table 3, which presents probit regressions. Columns (1) and (2) are bi-variate probits, where crisis is regressed solely on an indicator of short-term debt exposure.The …rst indicator is a dummy variable which takes on a value of 1 whenever the (lagged)value of short term debt to foreign banks/reserves exceeds unity. The estimated coe¢cientis statistically highly signi…cant, indicating that countries where this ratio is higher thanunity have a 10 percentage points higher probability of experiencing a crisis (compared tocountries where the ratio is below one). Since the average probability of crisis in our sampleis 0.06, this corresponds roughly to a tripling of the crisis probability (0.16 versus 0.06).Column (2) shows that there is a tight bivariate relationship between crisis and the share ofshort-term debt in total debt as well.In the remaining regressions of Table 3, we introduce simultaneously the ratios of three19The capital controls were meant to stem the ‡ow of large amounts of short-term speculative fundsgambling on the appreciation of the Malaysian currency.15
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di¤erent types of debt to reserves (all in continuous form rather than as a dummy): (a) shortterm debt owed to banks; (b) other short-term debt; and (c) medium- and long-term debt.Both types of short-term debt enter with positive and statistically signi…cant coe¢cients(with the exception of other short-term debt in column (8)). The point estimates reveal thatthe impact of short-term borrowing from banks is larger. Interestingly, medium- and long-term debt enters with a small, negative, and statistically signi…cant coe¢cient, indicatingthat longer term borrowing is associated with a lower probability of crisis (even when holdingthe short-term debt stock constant). One interpretation is that the medium- and long-termdebt stock is correlated with omitted country attributes that increase creditworthiness andreduce the propensity to crises.The probit estimates also indicate that crisis probabilities are increasing in the overalldebt burden (measured by the debt-GDP ratio), the current account de…cit (as a percentageof GDP), and the appreciation of the real exchange rate (measured over the previous threeyears). These results are consistent with previous empirical work. On the other hand, budgetde…cits, the ratio of M2 to reserves, and the change in credit-GDP ratios do not appear tohave a statistically signi…cant relationship with crises. Indeed, once the debt ratios areincluded, all three of these variables enter with the “wrong” sign.We note that these results remain essentially unchanged when we exclude the 1997 and1998 observations from the sample, restricting attention to reversals in capital ‡ows prior tothe Asian crisis and the Russian meltdown. In particular, short-term debt/reserves ratioscontinue to enter with highly signi…cant coe¢cients. It does not appear therefore that theperils of short-term capital ‡ows are of very recent vintage. Moreover, substituting BIS dataon short-term debt (to commercial banks) for the IIF data yields results that are virtuallyidentical.In short, these results provide strong support for the idea that potential illiquidity —inparticular, the ratio of short-term foreign debt to reserves— is an important precursor of…nancial crises triggered by reversals in capital ‡ows. Our evidence is consistent with the ideathat illiquidity makes emerging-market economies vulnerable to panic. At the same time, itbears repeating that such crises remain highly unpredictable. The overall “…t” of the probitsis poor, and certainly of not much use for predictive purposes, even when applied in-sample.For instance, the in-sample predicted probabilities of crisis for South Korea, Thailand, andIndonesia in 1997 are 0.54, 0.24, and 0.19, respectively. The corresponding out-of-sampleprobabilities are 0.31, 0.17, and 0.13. Empirically, a high ratio of short-term debt to reservesis neither a necessary nor a su¢cient condition for …nancial panic.16
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4.2 Short-term debt and the severity of crisesWe have analyzed so far the relationship between short-term capital ‡ows and the onset ofcrisis. As the model in section 3 suggested, short-term debt exposure is also likely to a¤ectthe severity of the shock once a crisis does erupt. When con…dence disappears and debtrollovers become di¢cult, the entire stock of a country’s short-term foreign debt may haveto be paid back within a year. A country with a short-term debt/GDP ratio of, say, 15percent, could in principle have to pay 15 percent of its GDP to its creditors in a single year.Generating an external transfer of this magnitude is likely to be quite costly, not only tolevels of domestic absorption, but also to real activity. The latter e¤ects can come aboutthrough a costly liquidity squeeze, through the e¤ects on balance sheets of the drop in assetvalues and the currency depreciation that accompany the crisis, and through traditionalKeynesian multiplier channels.One might then expect the costs incurred, conditional on having a crisis, to be propor-tional to the pre-existing stock of short-term foreign debt. In this section, we present a rangeof evidence that suggests that this is indeed the case.We …nd that it is the ratio of pre-existing short-term foreign debt to reserves that seemsto matter to the severity of the crisis, and not the ratio in relation to GDP. A reason whythe former ratio may be the relevant ratio has to do with within-country contagion. Imaginethat in a crisis the holders of all short-term debt in the economy —including M1, short-term domestic debt of the public sector— come to fear that international reserves will beexhausted by the service of short-term foreign debt. Then they will attempt to ‡ee as well,and will succeed in doing so as long as there are dollars in the Central Bank, or as long asthe capital account remains open. So with low reserves, the turnaround in capital ‡ows asa proportion of GDP can be much higher in a panic.Figure 3 shows that there is a tight relationship between the magnitude of the collapsein growth, conditional on having experienced a capital-‡ows crisis as de…ned previously, andthe pre-existing short-term foreign debt exposure (measured in relation to reserves). In oursample of 16 crises, the average reduction in the growth rate in the year of crisis (relative tothe previous year) is 4.1 percent. But countries like Turkey (1994) and Mexico (1995), withvery high levels of short-term debt have su¤ered much greater collapses in real economicactivity than Malaysia (1994) or Venezuela (1994). The statistical regularity in our sampleis that an increase, say, from 0.5 to 1.5 in the short-term debt owed to foreign banks inrelation to reserves is associated with a reduction in growth of 2.3 percentage points (the17
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associated t-statistic being a highly signi…cant -3.8).Part of the explanation for this relationship has to do with the greater downward pressureon the exchange rate in highly illiquid economies. A collapse of the exchange rate caused by…nancial panic wreaks havoc with private-sector balance sheets and absorption, impartingstrong recessionary e¤ects in the short run. In the case of East Asia, there was indeed astrong correlation between short-term debt and the extent of currency depreciation followingthe collapse of the Thai peg in July 1997 (see Figure 4). During the second half of 1997, cur-rencies plummeted to greater depths in Korea, Indonesia, and Thailand, the countries withthe highest short-term debt-reserves ratios in the region, than they did in the Philippines,Malaysia, or Thailand. The …rst set of countries also su¤ered greater reductions in economicactivity.As we discussed earlier, the buildup of short-term debt in East Asia is a relatively recentphenomenon. Therefore another way of illustrating the downside of short-term debt exposureunder crisis conditions is to compare the recent experience of East Asia with previous episodesof balance-of-payments crisis in the region. For this purpose, Table 4 shows the evolutionof macroeconomic indicators in Korea during the recent crisis as well as during the crisis of1980. Indonesia and Thailand did not experience external crises of a comparable magnitudeduring the last two decades and therefore do not allow a similar comparison.Begin by noting that the external shocks experienced by Korea in 1979-1980, while orig-inating mostly on the current account rather than the capital account, were quite severe byany measure. There was the second oil price hike, the Volcker shock of higher world interestrates, and the worldwide recession, which reduced foreign demand for Korean exports. Thebalance-of-payments cost of the …rst two alone amounted to 6 percent of GDP (Aghevli andMarquez-Ruarte 1985, p. 5). In addition, the economy was faced with a large reduction inagricultural output (amounting to a loss of more than 4 percent of GNP) and considerablepolitical turbulence due to the assassination of President Park.During the second half of the 1970s, South Korea had borrowed heavily from foreigncommercial banks to …nance an ambitious investment program, implemented via close col-laboration between the government and the chaebol. In many ways, the current crisis bears alot of resemblance to the 1980 crisis. In both cases, prior to the crisis we have a debt buildup,limited exchange rate ‡exibility, some real appreciation of the currency, deceleration of ex-port growth, real wage increases, negative terms-of-trade shocks (the oil shock in 1979-80;the fall in the price of semiconductors in 1996-97), and other adverse external shocks (worldinterest rate increases and slowdown of world economic activity in the …rst case; contagion18
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from Thailand and the slump in Japan in the second)–all against a background of politicalinstability. The structural problems a-icting the Korean economy in the late 1970s weresaid to be chronic excess demand for bank loans, rapid credit expansion, excessive invest-ment in certain sectors, an in‡ationary environment, duplication of investment and build-upof excess capacity (due to availability of cheap loans and overly optimistic assessment of theprospects in the domestic and world economy), and a rapid expansion of housing. Exceptfor the in‡ationary environment (and maybe substituting general property and asset priceboom for the housing boom), all the other factors have been mentioned in relation to thecurrent crisis. The current-account de…cit was 2.2 percent of GDP in 1978 and 6.4 percentin 1979–similar to the de…cits of 1.9 percent in 1995 and 4.7 percent in 1996.However, the debt that Korea piled on during the 1970s was mostly medium- and-longterm, and this sharply limited the potential magnitude of capital-‡ow reversals at the timeof crisis. On the eve of the stabilization program of January 1980, total short-term debtstood at 8.4 percent of GDP and 97 percent of reserves. These …gures are much lower thanthe numbers that prevailed on the eve of the most recent crisis. In late 1997, when Koreawas forced to respond to the forces of contagion emanating from Thailand, short-term debtstood at around 15 percent of GDP and more than 300 percent of reserves.The key di¤erence between the two episodes therefore is that Korea became illiquid in1997 and subject to creditors’ panic. Unable to roll over its short-term debt, the countryhad to generate a huge current account surplus at substantial real cost to the economy.In 1980, the Korean economy faced no such di¢culty. Korea was able to run in 1980 aneven larger current-account de…cit than in previous years. It accomplished this by relyingheavily on short-term borrowing. The tilt towards short-term borrowing was due in part tothe hesitation of creditors to commit long-term funds in the face of political and economicuncertainty. As a consequence, during 1980-81 Korea’s short-term debt ratios increasedsubstantially and the maturity structure of its debt shortened signi…cantly (see Table 4).In 1997, short-term liabilities were an instigator of the crisis and could hardly play therole of savior. Korea had to generate a mammoth current account surplus of 13 percent ofGDP instead (compared to a de…cit of 8.5 percent in 1980). The currency depreciation wascommensurately larger, as was the decline in economic growth.The moral of the Korean comparison is quite clear. Regardless of fundamentals, a largeexposure to short-term debt intensi…es the costs of a crisis because it magni…es the current-account adjustment and currency depreciation that have to be undertaken.19
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4.3 Determinants of the maturity structure of debtIn 1997, 58 percent of Uruguay’s total foreign debt (according to IIF statistics) was short-term. In Morocco, meanwhile, only 3 percent of debt was short-term. Are there systematicfactors that account for the maturity structure of foreign debt across countries as well asover time within countries?A plausible list of possible determinants includes the following. First, as we emphasizein the theoretical model in section 3, short-term debt can have a useful role to play infostering e¢cient …nancial intermediation –and, indirectly, investment and growth. Forthis and other (potentially less benign) reasons, we would expect both the demand andsupply for maturity-transformation services to increase with …nancial sophistication. As theproductivity of an economy and its …nancial depth increase, the ratio of short-term debtshould therefore increase, ceteris paribus credits and other types of credit to importers aretrade-related. Consequently, the volume of short-term debt should also increase with theopenness of an economy. Third, corruption and cronyism in the debtor countries, generatingexpectations of bailouts, can result in inadequate internalization of the risks of short-termborrowing. Hence, we might expect short maturities to be associated with high levels ofcorruption.Finally, governments have at their disposal a whole range of …nancial and regulatorypolicies that in‡uence the maturity structure of capital ‡ows. Often, regulatory policies havethe e¤ect of stimulating short-term capital ‡ows. The Basle capital adequacy standards, forexample, encourage short-term cross-border lending to non-OECD economies by attachinga lower risk weight to short-term loans than to long-term loans. The Bangkok InternationalBanking Facility (BIBF) set up by the Thai government in early 1993 was speci…cally aimedat attracting short-term funds from abroad. And the Korean government is often blamedfor having encouraged short-term in‡ows by making longer-term investments in Korea (suchas equity investment or purchase of government bonds) di¢cult for foreigners. On the otherhand, limits on the short-term foreign liabilities of domestic banks, deposit requirements oncapital in‡ows, and restrictions on the sale of short-term securities to foreigners are examplesof the types of policies that can reduce short-term capital in‡ows. We will discuss the Chileanand Malaysian examples below.Table 5 presents some econometric evidence on the determinants of the maturity of ex-ternal debt. The table shows cross-country and panel regressions (with …xed e¤ects) usingthe sample of 32 emerging-market economies on which we have been focussing. The depen-20
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dent variable is the share of short-term debt in total debt. The results support some of theabove hypotheses, but not all. There is indeed a consistent and robust relationship betweenper-capita income levels and M2/GDP ratios, on the one hand, and short maturities, on theother. This relationship holds both across countries and within countries over time. Thatis, as economies get richer and …nancial markets become deeper (through …nancial liberal-ization or other channels), the external debt pro…le gets tilted towards short-term liabilities.We …nd also that the overall debt burden (debt/GDP ratio) is positively correlated withshort-term borrowing in the time-series (but not in the cross-section). One interpretationis that countries that go on a borrowing binge are forced to shorten the maturity of theirexternal liabilities in the short run.To gauge the e¤ect of corruption we use Transparency International’s index of corrup-tion. We …nd that the relationship between levels of short-term borrowing and corruption ispositive, but not statistically signi…cant (column 3).Most surprisingly, we …nd no relationship between trade and short-term debt. In fact,the estimated coe¢cient on the imports/GDP ratio is negative, suggesting that if anythingmore open economies tend to do less short-term borrowing. This is puzzling in view ofthe idea that short-term borrowing is driven in part by trade credits. One possibility isthe following.20Suppose that more open economies tend to be more creditworthy (becausethey have more to lose from defaulting on their debt and/or can provide greater collateralto their creditors). They will be less credit-rationed in the market for long-term …nance.Hence, they will have higher ratios of long-term debt to GDP. Even if such economies alsohave higher levels of short-term debt, the net e¤ect on the maturity composition of the debtwould still be ambiguous. The evidence provides partial support for this interpretation.In our sample, increases in openness (measured by import-GDP ratios) are associated ina statistically signi…cant way with higher ratios of long-term debt to GDP, but not withhigher ratios of short-term debt to GDP. The inescapable conclusion is that the levels ofshort-term debt that we observe in the real world are only weakly, if at all, related to trade‡ows. Whatever it is that drives short-term capital ‡ows, it is not international trade.The regressions in Table 5 leave a lot of the variance in the maturity composition ofexternal debt unexplained. One reason is that it is di¢cult to quantify the myriad policiesand regulations that directly a¤ect short-term capital ‡ows.2120We thank Aaron Tornell for suggesting this possibility.21See Montiel and Reinhart (1997) for an e¤ort to do so. Focusing on capital ‡ows of di¤erent types in asample of 15 countries, these authors …nd that capital controls tend to reduce the share of short-term ‡ows21
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5 Conclusions and Policy ImplicationsWe have to live with …nancial markets that are prone to herding, panics, contagion, andboom-and-bust cycles. This is as true of domestic …nancial markets–where they can domore limited damage– as it is of international ones. The world has seen banking crises in69 countries since the late 1970s, and 87 currency crises since 1975.22And the frequencyof such crises has risen sharply over the last decade. After the recent series of meltdownsin Asia, Eastern Europe and Latin America, no observer can be surprised at the apparentinstability of …nancial markets.The debate on the causes of these crashes will undoubtedly go on for a long time. Badluck, in the form of exogenous shocks from abroad and from mother nature, and bad policy,in the shape of poor regulation and imprudent macro policies, doubtlessly carry some of theblame. But that cannot be the end of the story. The main message of this paper is thatthe potential for illiquidity was at the center of recent crises, and that short-term debt is acrucial ingredient of illiquidity. The empirical evidence is clear in that respect.In the aftermath of the crises, the reaction, particularly from multilateral lenders butalso from Wall Street, has been to call for more prudent monetary and …scal policies, andgreater supervision and transparency in local …nancial markets. This is all …ne. Who can beagainst prudence and transparency? But appropriate macroeconomic policies and …nancialstandards can go only so far in reducing the risks.There is limited agreement on what macro policies are “appropriate” in this context.Analysts of the Asian episodes, for instance, seem to be evenly divided between those whothink that countries like Thailand and Indonesia held on to …xed exchange rates for too longand those who claim that the defense of the peg was insu¢ciently …erce.The current emphasis on strengthening domestic …nancial systems also glosses over thepractical di¢culties. Putting in place an adequate set of prudential and regulatory controlsto prevent moral hazard and excessive risk-taking in the domestic banking system is a loteasier said than done. Even the most advanced countries fall considerably short of the ideal,as their bank regulators will readily tell you. Indeed, banking crises have recently takenwhile sterilized intervention increases it.22The bank crises number comes from Caprio and Klingebiel (1996). A banking crisis occurs, in theirde…nition, when the banking system has zero or negative new worth. The …gure excludes transition economieswhich, by their estimate, would add at least 20 crises in the period. The currency crisis …gure is from Frankeland Rose (1996), who de…ne such a crisis as a year in which the currency depreciates by more than 25 percent,and this depreciation is at least 10 percentage points larger than the previous year’s.22
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place in countries as well o¤ as Sweden and Japan. The collapse of Long Term Capital inthe summer of 1998 revealed a gaping hole in the regulatory arrangements of U.S. …nancialmarkets. If this happens at the heart of the OECD, one can imagine the scale of problemsfacing bank regulators in Ecuador, India or Turkey.The moral of the story, then, is that …nancial crises are as di¢cult to avoid as theyare to understand. There is no magic …x that will make them go away. Our incompleteunderstanding of how …nancial markets work, along with changing fads and disagreementson what constitutes “sound” economic policy in developing economies, should make us verycautious of attempts to impose a one-size-…ts-all recipe on borrowing countries (Rodrik 1999).What is called for is a pragmatic and ‡exible approach that works on several fronts at once.And one of those fronts, undoubtedly, is increasing liquidity and discouraging short termdebt.5.1 Crisis preventionOne obvious, if not very useful, answer is to require …nancial systems to be always liquid.But liquidity is costly to maintain, and countries attempting to prevent crises face someunpleasant trade-o¤s. Chang and Velasco (1999b) and Feldstein (1999) discuss some ofthe options. On the asset side, using …scal policy to build a “war chest,” and securingcontingent credit lines abroad –both to be used in times of trouble– are useful but notwithout problems. On the liability side, increasing required foreign-currency reserves onbanks’ liquid liabilities (perhaps making the size of the requirement an inverse function ofmaturity) can help discourage short term bank debt. Lengthening the average maturity ofpublic debt, as Mexico did after the 1995 tequila crisis, is also crucial to prevent illiquidity.In addition, there is a case for instituting across-the-board disincentives to short-termforeign borrowing, such as those used by Chile, Colombia and Malaysia among many others.Their potential role in preventing a possible liquidity crisis should be clear from our earliertheoretical analysis. Three objections are often raised against such controls: that they areine¤ective, costly, and that they fail to protect an economy from panic by all relevant players.We consider each in turn.Ine¤ectiveness: Any claim about the ine¤ectiveness of capital controls must be tempered bythe observation that such policies are vehemently opposed by the very markets participantswhose actions the controls are supposed to in‡uence. Perhaps bankers and arbitrageursdenounce the taxes and ceilings they can presumably avoid with the stroke of a key out of23
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simple public-mindedness, or because of a deep-seated reluctance to break the law. We donot claim to know.Furthermore, there is an obvious contradiction between emphasizing, on the one hand,improved prudential regulation and transparency as an important part of the solution, andmaintaining, on the other, that capital controls cannot work because they can be easilyevaded through corruption, …nancial engineering or other mechanisms. If …nancial marketscan evade controls of the latter kind, they can surely evade controls of the former kind as well.Regulatory ine¤ectiveness may undercut the argument for capital controls, but it undercutseven more seriously the emphasis on …nancial standards that pervades the G7’s approach tothe international …nancial architecture.But aside from these apparent logical inconsistencies, there is growing evidence thatcontrols can be indeed e¤ective. We illustrate this by drawing on the experiences of twocountries–Chile and Malaysia–that at some point successfully managed short-term capitalin‡ows.Chile’s capital-account regime appears to represent a canonical case of successful fending-o¤ of short-term capital ‡ows, and for that reason has been studied extensively.23In June1991, the Chilean authorities imposed a non-interest bearing reserve requirement of 20 per-cent on all external credits. Equity investments were exempt. The reserves had to be heldat the Central Bank for a minimum of 90 days and a maximum of one year. As an alterna-tive to the reserve requirement, medium-term creditors were allowed to make a payment tothe Central Bank equivalent to the …nancial cost of the reserve requirement. In May 1992,the reserve requirement was raised to 30 percent and extended to time deposits in foreigncurrency and to Chilean stock purchases by foreigners. In addition, the deposit period waslengthened to one year (see Agosin and Ffrench-Davis 1998). The authorities eventuallybegan to closely monitor DFI ‡ows to ensure that short-term ‡ows were not disguised asequity investments. In 1998, faced with capital out‡ows, Chile relaxed and eventually setthe required reserve to zero. While it was in force, the reserve requirement had the e¤ect ofcreating a severe disincentive for short-term capital in‡ows. At a LIBOR of 5 percent, forexample, the annualized cost of the policies in place was 3.9 percent on a one-year loan, but11.0 percent on a three-month loan (Agosin and Ffrench-Davis 1998, Table 3).The data on the composition of Chile’s external debt suggests quite strongly that thepolicies had the intended e¤ect. The top panel of Figure 5 shows the share of short-term23See, for instance, Valdes Prieto and Soto 1996; Larrain, Laban and Chumacero 1997; Budnevich andLefort 1997; Agosin and Ffrench-Davis 1998; and Edwards 1998.24
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debt in total for Chile. We note a sharp dip in 1991, the year that the deposit require-ment was …rst imposed. The ratio bounces back in 1992, but following the tightening ofthe reserve requirement, it steadily falls throughout 1992-1997. By 1997, short-term debtconstituted only 7.6 percent of total debt. This informal conclusion is con…rmed by moresystematic evidence in a number of papers. Valdes-Prieto and Soto (1996), Larrain, Labanand Chumacero (1997), Budnevich and Lefort (1997), and Montiel and Reinhart (1997) all…nd that the restrictions have a¤ected the maturity composition of ‡ows, though not theiroverall volume or the course of the real exchange rate.The case of Malaysia in 1994 is less well known. The country is notorious (in somecircles) for the sweeping currency and capital out‡ow controls that its government imposedon September 1st, 1998. It is too early to evaluate the consequences of these recent controls,but we do have some evidence on a set of temporary controls that were implemented someyears earlier in 1994. In January 1994, the Malaysian government imposed a prohibitionon the sale to non-residents of a wide range of short-term securities (including banker’sacceptances, negotiable instruments of deposit, Bank Negara bills, treasury bills or othergovernment securities with a remaining maturity of one year or less). These restrictions werewidened in February (to cover swap transactions in the currency market), and complementedby an interest charge on short-term deposit accounts placed in domestic commercial banksby foreigners. The restrictions began to be lifted in August 1994, and were largely eliminatedby the end of the year.The background to these restrictions was that there had been a huge surge of short-term speculative capital in‡ows in late 1993 following a surprise 6 percent depreciation ofthe ringgit. Hedge funds and others expecting a quick recovery in the currency ‡ooded theMalaysian market. As the bottom panel in Figure 5 shows, the result was a sharp increasein short-term liabilities, which reached a peak of 37 percent of total debt at the end of1993. The …gure also reveals that the restrictions imposed at the beginning of 1994 wereremarkably e¤ective. (So e¤ective in fact that the colossal turnaround in short-term capital‡ows in 1994 led us above to classify Malaysia in 1994 as a case of “crisis”.) The ratio ofshort-term debt in the total fell sharply to 26 percent in 1994 and to 23 percent in 1995,beginning to recover only in 1996. The overall debt burden fell as well, from 59 percent ofGDP in 1993 to 41 percent in 1995.As we know too well by now, these policies did not prevent Malaysia from getting intoserious trouble a few years later. One possible explanation is that the controls were liftedtoo soon: Figure 2 reveals that the ST debt-to-reserves ratio rose between 1994 and 1997,25
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and Figure 5 reveals that the same happened to the share of ST debt in total debt.The cases of Chile and Malaysia illustrate the importance of the policy regime in in‡u-encing the maturity structure of foreign debt. But policy is not all-powerful. One constraintcomes from the growing role of derivatives in international capital ‡ows. As Garber (1998)has stressed, derivatives can help circumvent controls and they render interpretation of stan-dard balance of payments categories problematic. But it is not clear that derivatives canalways undo the intended e¤ects of policy. As Garber writes: “Market sources ... reportserious, though as yet unsuccessful, …nancial engineering research e¤orts to crack directlythe Chilean tax on capital imports in the form of an uncompensated deposit requirement.”Costliness: What about the costs presumably involved? In theory, capital controls preventrisk-spreading through global diversi…cation of portfolios. They result in an ine¢cient globalallocation of capital. And they encourage irresponsible macroeconomic policies at home. Isthere evidence to support such presumptions?One of us has examined this issue systematically (Rodrik 1998), relating capital accountliberalization to three indicators of economic performance: per-capita GDP growth, invest-ment (as a share of GDP), and in‡ation. The indicator of capital account liberalization usedwas the proportion of years for which the capital account was free of restrictions (according toIMF classi…cations). The exercise covered a post-1975 sample of around 100 countries. Thestudy found no evidence that countries without capital controls have grown faster, investedmore, or experienced lower in‡ation.24Furthermore, speci…c episodes of capital controls do not reveal signi…cant real costs either.Chile is a success case of the 1990s, in no small part because it has managed to avoid thede-stabilizing in‡uence of short-term capital ‡ows. Even in Malaysia, where the impositionof restrictions in January 1994 resulted in a massive turnaround in capital ‡ows, growth wasuna¤ected (in fact, the Malaysian economy grew faster in 1994 and 1995 than in 1993).Other claimants: The other very important caveat is that foreigners are not the only short-term creditors. Hence, imposing controls and reducing external short term debt is neither anecessary nor a su¢cient condition for ruling out crises. As Krugman (1999) has stressed,in‡ow controls still leave all holders of domestic claims on the commercial and central banksready to run. There is one important distinction, however, between this type of capital ‡ight24Policy choices regarding the capital account are endogenous, so there is a potential for reverse causation.But to the extent that this is a problem, it biases the results in the direction of …nding a positive relationshipbetween open capital accounts and good performance: countries are more likely to remove capital controlswhen their economies are doing well.26
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and the reversal of short-term external ‡ows. Governments are allowed under the existingrules of the IMF (Art. VI) to close the foreign-exchange window so as to prevent capitalout‡ows by domestic residents. Hence a run on a country’s domestic short-term liabilitiescan in principle be prevented by legal means. But refusal to pay back short-term foreigndebt would abrogate existing debt contracts and would put the country into default. In anycase, we view this argument not as one against capital controls per se, but rather as a pleato complement them with other policies. Bank regulation and the exchange rate regime arecentral in this regard. Again, Chang and Velasco (1999b) and Feldstein (1999) analyze theavailable options.5.2 Crisis managementThe presence of short-term debt makes a coordination failure among lenders possible. Hence,a main task of crisis management is to attempt to coordinate their behavior on the “good”outcome. In the model presented above, the key is to avoid the real costs (liquidation andothers) imposed by early repayment. Hence, a simple suspension of payments that preservesthe present value of the creditors’ claims makes everyone better o¤. In practice, of course,lenders are wary of such responses. From New York or London it is hard to distinguish thepayments moratoria that are justi…ed by liquidity considerations from those that are thinlyveiled attempts at default. When in doubt, lenders are likely to suspect the latter. There isalso the logistical problem of coordinating the actions of many bond-holders.But the fact that the task is hard should not keep policymakers from trying. Paymentsreprogrammings that are accompanied by serious macroeconomic policies and signals ofcreditworthiness (such as …scal retrenchment) may prove more palatable. In Korea, forinstance, American, European and Japanese banks jointly agreed in December 1997 to anorderly rollover of existing short-term loans. Major creditor countries helped by anticipatingthe disbursement of a fraction of the bailout package the IMF had just approved. Those twomeasures e¤ectively ended the …nancial panic that had gripped Korea for several months.25Multilateral lenders can also help. Just as after appropriate surveillance and conditional-ity they place their seal of approval on countries that follow sound macroeconomic policies,IFIs could publicly endorse temporary payments suspensions or reschedulings in situations25This description follows Corsetti, Roubini and Pesenti (1998b). These authors also note that therescheduling of loans was a much more daunting task in Indonesia, where there were large numbers both onthe lenders’ and borrowers’ sides.27
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where these are justi…ed. Such an endorsement could overcome the perception of illegit-imacy that surrounds changes in debt repayment terms, however justi…ed. Multilaterallenders could also lend “into arrears” when appropriate in order to strengthen con…dence inthe borrower’s prospects. They could also encourage the adoption of clauses in internationalbond covenants that facilitate negotiations between debtors and creditors even when debtservice is suspended. As Kenen (1999) points out, such proposals were endorsed by the G-10back in 1995, but have yet to be implemented in full.Encouraging other kinds of capital ‡ows may also be useful in times of trouble. In themodel above, a good part of the problem comes from the local investor’s inability to sellrather than liquidate its illiquid assets in the event of a squeeze. That assumption is realisticinsofar as, in a crisis situation, there are few domestic agents with the cash in hand to buythe real capital. But foreigners are in a di¤erent position. In principle, everyone could bebetter o¤ if liquidation could be avoided through foreign direct investment –even if the priceis that of a …re sale, below the present value of capital’s real yield in the future.26Therefore,FDI could be encouraged for these purposes. Debt-equity swaps involving foreign creditorsplayed an important role in the resolution of the 1980s debt crisis, and could be useful againin the current context as part of a broader strategy that includes the elements discussedabove. At the same time, a series of …nancial crises that become the occasion for the sale ofnational assets to foreigners at bargain-basement prices is unlikely to do much to enhancethe legitimacy of the international …nancial system.26In the model above, because the world rate of interest is zero and one unit of healthy capital yields Runits of the tradeable good in period 2, the “fundamental”price of capital in period 1 is R. But any pricesmaller than R and bigger than ½ makes the borrower better o¤ (relative to liquidation), while giving theforeign investor an abnormally high rate of return.28
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References[1] Aghevli, Bijan, and Jorge Marquez-Ruarte. 1985. “A Case of Successful Adjustment:Korea’s Experience During 1980-84.” Occasional Paper 39. Washington DC: Interna-tional Monetary Fund.[2] Agosin, Manuel R., and Ricardo Ffrench-Davis. 1998. “Managing Capital In‡ows inChile.” Paper prepared for UNU/WIDER project on Short-Term Capital Movementsand Balance of Payments Crises. Sussex, May 1-2, 1997.[3] Budnevich, Carlos and Guillemo Le Fort. 1996. “Capital Account Regulations andMacroeconomic Policy: Two Latin American Experiences,” Working Paper No. 6, BancoCentral de Chile.[4] Calvo, Guillermo. 1995. “Varieties of Capital Market Crises.” Working Paper 15, Centerfor International Economics, University of Maryland.[5] Cárdenas, M. and F. Barrera 1997. “On the E¤ectiveness of Capital Controls: TheExperience of Colombia during the 1990s,” Journal of Development Economics 54(1),pp. 27-57.[6] Chang, Roberto and Andrés Velasco. 1998. “Financial Crises in Emerging Markets: ACanonical Model” NBER Working Paper No. 6606, June.[7] Chang, Roberto and Andrés Velasco. 1999a. “Banks, Debt Maturity, and FinancialCrises,” unpublished manuscript, Federal Reserve Bank of Atlanta and NYU.[8] Chang, Roberto and Andrés Velasco. 1999b. “Illiquidity and Crises in Emerging Mar-kets: Theory and Policy.” Paper prepared for the 1999 NBER Macroeconomics Annual,Cambridge, Mass.[9] Harold L. Cole, Timothy J. Kehoe. 1996. “A self-ful…lling model of Mexico’s 1994–1995debt crisis.” Journal of International Economics (41) 3-4, pp. 309-330[10] Corsetti, Giancarlo, Paolo Pesenti and Nouriel Roubini. 1998a. “What Caused the AsianCurrency and Financial Crises? Part I: The Macroeconomic Overview” NBER WorkingPaper 6833, December.29
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[11] Corsetti, Giancarlo, Paolo Pesenti and Nouriel Roubini. 1998b. “What Caused the AsianCurrency and Financial Crises? Part II: The Policy Debate” NBER Working Paper6834, December.[12] Edwards, Sebastian. 1998.“Capital Flows, Real Exchange Rates and Capital Controls:Some Latin American Experiences,” Working paper 6800. Cambridge, Mass: NationalBureau of Economic Research, November.[13] Eichengreen, Barry, and Andrew Rose. 1998. “Staying A‡oat When the Wind Shifts:External Factors and Emerging Market Banking Crises.” Working paper 6370. Cam-bridge, Mass: National Bureau of Economic Research (January).[14] Feldstein, Martin. 1999. “A Self-Help Guide for Emerging Markets,” Foreign A¤airs,March-April.[15] Frankel, Je¤rey A., and Andrew K. Rose. 1996. “Currency Crashes in Emerging Markets:Empirical Indicators.” Journal of International Economics (41) 3-4, pp. 351-367.[16] Furman, Jason and Joseph E. Stiglitz. 1998. “Economic Crises: Evidence and Insightsfrom East Asia.” Brookings Papers on Economic Activity (1998:2): 1-135.[17] Garber, Peter M. 1998. “Derivatives in International Capital Flow.” Working paper6623. Cambridge, Mass: National Bureau of Economic Research (June).[18] Institute of International Finance, Inc. 1998. Comparative Statistics for Emerging Mar-ket Economies. Washington DC: IIF.[19] Jeanne, Olivier. 1998. “The International Liquidity Mismatch and the New Architec-ture,” manuscript, International Monetary Fund.[20] Kaminsky, Graciela, Saul Lizondo, and Carmen M. Reinhart. 1998. “Leading Indicatorsof Currency Crises.” International Monetary Fund Sta¤ Papers 45 (1): 1-48.[21] Kenen, Peter. 1998. “Coment on Radelet and Sachs” in the forthcoming NBER Confer-ence Volume, based on the Conference on Currency Crises held in Cambridge, Mass.,February 6 and 7.[22] Krugman, Paul. 1999. “Balance Sheets, the Transfer Problem and Financial Crises,”paper prepared for the festchrift volume in honor of Rober Flood, January.30
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[23] Larrain, Felipe, Raul Laban and Romulo Chumacero. 1997. “What Determines CapitalIn‡ows? An Empirical Analysis for Chile,” Development Discussion Paper No. 590,HIID.[24] Montiel, Peter, and Carmen M. Reinhart. 1997. “Do Capital Controls In‡uence theVolume and Composition of Capital Flows: Evidence from the 1990s.” Paper preparedfor UNU/WIDER project on Short-Term Capital Movements and Balance of PaymentsCrises. Sussex, May 1-2.[25] Obstfeld, Maurice. 1994. “The Logic of Currency Crises,” Cahiers Economiques etMonétaires No. 34.[26] Radelet, Steven, and Je¤rey Sachs. 1998. “The East Asian Financial Crisis: Diagno-sis, Remedies, Prospects.” Paper prepared for the Brookings Panel. Washington D.C.,March 26-27.[27] Rodrik, Dani. 1998. “Who Needs Capital Account Convertibility?” Essays in Interna-tional Finance 207, International Finance Section, Department of Economics, PrincetonUniversity, May.[28] Rodrik, Dani. 1999. “Governing the World Economy: Does One Architectural Style FitAll?” paper prepared for the Brookings Institution Trade Policy Forum conference onGoverning in a Global Economy, April 15-16.[29] Sachs, Je¤rey, Aaron Tornell and Andres Velasco. 1996. “Financial Crises in EmergingMarkets: The Lessons from 1995,” Brookings Papers on Economic Activity, No. 1.[30] Valdés-Prieto, S. and C. Soto. 1996. “The E¤ectiveness of Capital Controls in Chile,”manuscript, Catholic University of Chile.31
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Figure 1Source: IIF (1998)01002003004005006001988 1989 1990 1991 1992 1993 1994 1995 1996 1997M< debt0501001502002503001988 1989 1990 1991 1992 1993 1994 1995 1996 1997ST debt (all)0501001502002501988 1989 1990 1991 1992 1993 1994 1995 1996 1997Africa/Middle EastAsia/PacificEuropeLatin AmericaST debt to commercial banks
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Figure 2Short-term debt/reserves ratios 00.511.522.533.5199219931994199519961997IndonesiaMalaysiaPhilippinesSouth KoreaThailand
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Figure 3Note: Short-term debt exposure is lagged one year. Each observation corresponds to a year of sharp reversal in capital flows, as defined in text:Bulgaria1990Hungary1990Philippines1990Uruguay1990Uruguay1993Malaysia1994Turkey1994Venezuela1994Mexico1995Ecuador1996Hungary1996Indonesia1997Philippines1997South Korea1997Thailand1997Russian Federation 1998change in growth rateshort-term debt to banks/reserv01234-15-10-50BulgariaEcuadorHungaryHungaryIndonesiMalaysiaMexicoPhilippiPhilippiRussian South KoThailandTurkeyUruguayUruguayVenezuel
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Figure 4Short term debt and currency collapse00.511.522.5KoreaIndonesiaThailandPhilippinesMalaysiaTaiwan0%20%40%60%80%100%120%140%short-term bank debt/reserves, end-June 1997 (left axis)depreciation of currency, second half of 1997 (right axis)
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Figure 5Share of debt that is STChileYear198819911997.05.1.15.2deposit requirements imposedShare of debt that is STMalaysiaYear198819941997.095559.373698temporary restrictions on ST capital inflows
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Table 1Composition of foreign debt by region1988198919901991199219931994199519961997Asia/PacificST (commercial banks)13.6%14.8%18.7%20.3%22.0%21.8%22.4%26.0%29.2%23.8%ST (other)6.8%6.6%6.0%6.0%5.4%6.4%4.7%4.3%4.2%4.0%M<79.6%78.6%75.2%73.7%72.5%71.8%72.9%69.8%66.6%72.2%Latin AmericaST (commercial banks)9.3%8.0%8.9%8.5%10.3%11.1%12.4%13.9%15.0%15.2%ST (other)3.1%9.6%9.4%12.5%12.7%14.0%12.4%8.3%6.9%4.9%M<87.6%82.4%81.7%79.0%77.0%75.0%75.2%77.8%78.1%79.9%EuropeST (commercial banks)9.7%10.0%9.4%9.9%9.5%10.3%6.4%7.9%10.0%11.9%ST (other)5.3%4.6%7.4%7.9%7.8%7.0%5.6%6.6%8.7%11.0%M<85.1%85.5%83.2%82.2%82.7%82.7%88.0%85.5%81.2%77.1%Africa/Middle EastST (commercial banks)19.0

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