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If financial openness is morecostly for developing countries,

why have so many undertakenliberalisation in recent years?

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Financial liberalisation in the developing world

0

25

50

75

100

125

150

175

200

225

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

East Asia & Pacific (developingonly)

Europe & Central Asia(developing only)

Latin America & Caribbean(developing only)

Middle East & North Africa

(developing only)

OECD members

Total value of stocks traded (% GDP)

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0

5

10

15

20

25

30

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

East Asia & Pacific (developingonly)

Europe & Central Asia(developing only)

Latin America & Caribbean(developing only)

Middle East & North Africa(developing only)

South Asia

Financial liberalisation in the developing worldInterest rate spreads (lending rate minus deposit rate)

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Financial liberalisation in the developing worldNet inflows of portfolio equity (in current US$)

-20

-10

0

10

20

30

40

50

60

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Billion

s

East Asia & Pacific(developing only)

Europe & CentralAsia (developing only)

Latin America &Caribbean(developing only)

Middle East & NorthAfrica (developingonly)

South Asia

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Good news, bad news?Financial liberalisation is more costly for developing countries

Domestic financial liberalisation Capital account liberalisation

Greater fluctuation in output gap in developing country compared to developedcountry note that variation is muchlarger in developing country after t = 0.

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Costs of financial liberalisationFinancial fragility and vulnerability to crisis

-15

-10

-5

0

5

10

15

20

25

-4

-2

0

2

4

6

8

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985

Millions

Annual GDP growth: LatinAmerica and Caribbean

World annualGDP growth

Portfolio equity in Latin America& Caribbean (developing only)

Portfolio equity (current US$)Annual GDP Growth (%)

0

10

20

30

40

50

60

70

80

-15

-10

-5

0

5

10

15

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Annual GDP Growth (%)

Value of stocks traded(% GDP): Thailand

Annual GDP growth: Thailand

Value of stocks traded (% GDP)

In 1996, five Asian economies(South Korea, Indonesia,Malaysia, Thailand and thePhillipines) received net privatecapital inflows amounting toUS$93.0 billion. One year later

in 1997, they experienced anestimated outflow of US$12.2billion.

Access to foreign capital flowsas a means of financing lead toa leveraging process in thepublic and private sector, which

in turn led to questions aboutthe sustainability of the crisis.

Increased dependence onforeign investment.

Crowding out effects?

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Costs of financial liberalisationConstraints on policy flexibility

Inflows 1992-97

avg.

2003-08

avg.

Current account balancealldeveloping countries ex. China,

Russia, Middle East

-96.7 -38.9

Net external financingalldeveloping countries ex. China,

Russia, Middle East

225.6 470.0

Increase in reservesalldeveloping countries ex. China,

Russia, Middle East

39.7 218.6

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Gains from financial liberalisationFinancial repression

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Removal of capital controls allow risk sharing, through global diversificationof portfolios.

This allows higher-yield (higher-risk) investment to be undertaken for thesamelevel of risk, i.e. more projects can be considered (Obstfeld, 1994).

Gains from financial liberalisationImproved risk sharing mechanisms

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Gains from financial liberalisationAlleviation of capital scarcity

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Is it worth it?Empirical evidence of gains

Have developing countries experienced faster economic growth?

Not significant!

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Is it worth it?Empirical evidence of gains

Have developing countries experienced increased investment?

Not significant!

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Is it worth it?Empirical evidence of gains

Have developing countries experienced lower inflation?

Not significant!

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Then, why liberalise?Are the costs exaggerated?

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Then, why liberalise?Political economy considerations

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Then, why liberalise?Political economy considerations

Fiscal policy discipline

Redirection of public spendingfrom subsidies

Tax reform

Interest rates that marketdetermined

Competitive exchange rates

Trade liberalisation

Liberalisation of inward foreign

direct investmentPrivatisation of state enterprises

Deregulation

Legal security for property rights

The Washington Consensus

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Current account convertibility and capitalaccount convertibility are two completelydifferent concepts, with different

implications altogether.

ConclusionTo liberalise ornot to liberalise?

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Discussion