Brazil, China, Commodities, Corporate Finance, Economics, Emerging Markets, Emerging markets, global economy, International Trade, Latin America, Long term finance, Uncategorized

Global Imbalances on the Rise

Capital Finance International, winter 2016-2017 

Discussions around large current account imbalances among systemically relevant economies as a direct threat to the stability of the global economy vanished in the aftermath of the global financial crisis. As the crisis originated in the U.S. financial system – followed by a second dip in the Eurozone – and global imbalances diminished in following years the issue has faded into the background.

More recently, some signs of a possible resurgence of rising imbalances have returned attention to the issue. We argue here that, while not a threat to global financial stability, the resurgence of these imbalances reveals a sub-par performance of the global economy in terms of foregone product and employment, i.e. a post-crisis global economic recovery below its potential. In addition, we approach how the re-orientation of the U.S. economic policy already announced by president-elect Trump suggests risks of new bouts of tension around global current account imbalances.

Are global imbalances rising again?

For five years now, the International Monetary Fund (IMF) has produced an annual report on the evolution of global external imbalances – current account surpluses and deficits – and the external positions – stocks of foreign assets minus liabilities – of 29 systemically significant economies. Results for 2015 have pointed out a moderate increase of global imbalances, after they had narrowed in the aftermath of the global financial crisis (GFC) and stabilized later (IMF, 2016a) – see Chart 1.

The evolution of imbalances in 2015 depicted in Chart 1 as explained by the IMF is reflective of three major drivers:

First, the recovery among advanced economies proceeded in an asymmetric fashion. Stronger recoveries in the U.S. and the U.K. relative to the euro area and Japan led to divergence in expected paths for monetary policies and appreciation of the dollar and sterling (pre-Brexit). The deficits of the U.S. and U.K. widened, together with increased surpluses in Japan and both debtor and creditor countries of the euro area (Chart 2).

Second, the fall of commodity prices – especially oil – transferred income from commodity exporters to importers. Overall however, it made only a moderate contribution to the narrowing of imbalances.

Third, prospects of monetary policy normalization in the U.S., as well as bouts of fears about the softness of China’s rebalancing, contributed to a slowdown of capital inflows and depreciation pressures in emerging markets (Canuto, 2016a).

All in all, larger U.S. deficits and augmented surpluses in Japan, the Euro area and China more than compensated for smaller surpluses in oil exporters and smaller deficits in deficit emerging markets and Euro area debtor countries. Hence, global current account imbalances widened last year, even if “moderately”.

However, a picture of higher global imbalances emerges if one focuses on the rising surpluses of two systemically relevant groups of economies. Chart 2 exhibits how in the euro area deficits in debtor countries have shrunk in tandem with the maintenance of surpluses in creditor countries (slightly increasing in the case of Germany). While the net foreign asset position (liabilities) of debtors has not diminished as much, their current account adjustment has added to the soaring surpluses the euro area as a whole runs with the rest of the world. Setser (2016) in turn has called attention to how the six major East Asian surplus economies – China, Japan, South Korea, Taiwan (China), Hong Kong (China), and Singapore – have reverted their post-GFC decline of surpluses and are currently topping even the euro area (Chart 3).

Such double trajectory of rising surpluses gives credence to those who have expressed concerns about a revival of rising current account imbalances as a source of risks to the global economy. While Eichengreen (2014) had declared “the era of global imbalances” to be over, more recently others believe they are “back” and claim that “rising global imbalances should be ringing alarm bells” (HSBC, according to Verma and Kawa (2016). To address this issue, however, it is worth first reviewing how the profile of current imbalances differs from the one prior to the GFC.

Global imbalances have evolved

The “era of global imbalances” up to the GFC (Chart 1) had two distinctive-yet-combined processes at its core:

On the one hand, credit-driven, asset bubble-led growth in the U.S., along with wealth effects, intensified the existing trend of domestic absorption (particularly consumption) growing faster than GDP. This resulted in falling personal saving rates and increasing current account deficits (Chart 4) (Canuto, 2009; 2010).

On the other hand, the accelerated structural transformation and rapid growth in China, led to high and rising savings and investments and producing ever larger current account surpluses (Chart 5) (Canuto, 2013a).

Two caveats about these distinctive-yet-combined processes are needed. First, the bilateral U.S. deficit with China in the period decreases by a third when measured in terms of value added,  as China became a “hub or a stroke” of value chains with intermediate stages supplied from abroad  (Canuto, 2013b). The U.S.-China bilateral imbalance therefore constituted outlets for production beyond China.

Second, while often linked as mirror images of each other – as in the hypothesis of an Asian “savings glut” causing low interest rates and asset price hikes in the U.S. (Bernanke, 2005) – the U.S. asset bubbles were more strongly associated to the “excess elasticity of the international monetary and financial system”, rather than to Asian current account surpluses (Borio and Disyatat,2011) (Borio, James, and Chin, 2014). Global current account imbalances cannot be blamed for the U.S.-originated GFC. As stressed by Eichengreen (2014):

“…the flows that mattered were not the net flows of capital from the rest of the world that financed America’s current-account deficit. Rather, they were the gross flows of finance from the US to Europe that allowed European banks to leverage their balance sheets, and the large, matching flows of money from European banks into toxic US subprime-linked securities.”

Asset bubbles in the U.S. to a large extent were blown by European banks through their balance sheets, by channeling U.S. money market funds into toxic assets. From the U.S.-Europe balance of payments standpoint, short-term outflows from the latter to the former were netted out by simultaneous long-term flows in the opposite direction. Close-to-zero net capital flows hid a lot of financial intermediation and asset-bubble blowing via banks’ balance sheets.

A parallel to that China-U.S. relationship can be traced within the euro area, including its later experience with a second dip of the GFC. The entry of the euro as a common currency was followed by a risk premium convergence toward German levels and to cross-border banking flows at extremely easy conditions. Consequent asset bubbles originated wealth effects and excess domestic absorption – besides inflated financial intermediation – in southern Europe and Ireland, leading to the subsequent debt crisis. The pattern of intra-euro area current account imbalances exhibited in Chart 2 was primarily a consequence of the euphoria taking place under conditions of “excess elasticity” of the euro area’s financial system.

The commodity super-cycle also helped shape global imbalances in this period seen in Chart 1. However, it was to a large extent a consequence of extraordinary global growth prior to the crisis, one in which commodity-intensive emerging market economies maintained growth trends above those of advanced economies (Canuto, 2010).

While such a pattern of global imbalances was unfolding prior to the GFC, much discussion took place about its potential to spark a crisis on its own when faced with a sudden stop. China’s current account surpluses were boosted by depreciated levels of the exchange rate sustained mainly by a piling up of foreign reserves. The same evolution was interpreted by some as an expression of a savings glut unmatched by enough domestic availability of safe-and-liquid assets like U.S. Treasuries.

Regardless of the emphasis of causality one might establish between export-led strategies and saving-glut-cum-safe-asset-scarcity, analysts were split into two camps, as described by Eichengreen (2014). Some analysts feared a possible crisis of confidence in the dollar bringing capital flows to a sudden halt, while others saw imbalances as an exchange of cheap Asian goods for safe and liquid U.S. assets. In the latter case, imbalances might gradually unwind as export-led strategies reached exhaustion and/or the desire for asset accumulation approached satiation.

In any case, the GFC happened before that dispute was settled and global imbalances started to unwind in its aftermath. U.S. personal saving rates began to climb, borrowers reduced leverage, the dollar devalued and the U.S. current account deficit shrank from almost 6% of GDP in 2006 to much lower levels from 2009 onwards. At the same time, as shown in Chart 5, China initiated its rebalancing from an exports and investment-led growth model towards higher domestic consumption and services, including an appreciation of the RMB and lower growth rate targets. This has not meant a straightforward change of trajectory, as caution against a post-GFC hard landing favored continued high investment in domestic housing and infrastructure as a component of the transition (Canuto, 2013a).

As we have already seen, deficits also diminished in the euro area in the aftermath of its debt crisis. The decline in commodity prices also helped global imbalances to shrink.

So, global imbalances did not spark a crisis and have returned in different configuration. Since current account balances are neither expected nor desired to be zero, how to make an assessment of whether the recent “moderate” uptick detected by the IMF might be a bad omen? Do those who have voiced concern over rising surpluses in East Asia and the euro area have a point? To answer these questions, it will be useful to look at the IMF exercise of judgement on whether global imbalances have been “in excess”, i.e. inconsistent with “fundamentals and desirable policies” (IMF, 2016a, Box 1).

How misaligned with fundamentals have current account imbalances been?

National economies are not expected to exhibit zero current-account balances and stocks of net foreign assets. At any period of time, domestic absorption – consumption and investment – can be larger or smaller than the local GDP, triggering inflows or outflows of capital, due to “fundamental” factors:

  • Differences in intertemporal preferences and age structures of their populations mean different ratios of domestic consumption to GDP;
  • Differences in opportunities for investment also tend to lead to capital flows;
  • Differences in institutional development levels, reserve currency statuses and other idiosyncratic features also generate capital flows and imbalances;
  • Cyclical factors – including fluctuations in commodity prices – may also cause transitory increases and declines in balances; and
  • Countries’ outstanding stocks of net foreign assets also have a counterpart in terms of service payments in their current accounts.

When global imbalances – and corresponding real effective exchange rates (REERs) – reflect such fundamentals, economies are in a better place than they would be in autarky (isolated with zero balances). There are situations, however, in which such imbalances may be gauged as in excess and countries should reduce them – as approached in Blanchard and Milesi-Ferretti (2010; 2011).

There is the straightforward case of imbalances being magnified by domestic distortions, the removal of which would directly benefit the economy. For instance, this is the case when deficits are higher because of lax financial regulation fueling unsustainable credit booms or excessively loose fiscal policies. It is also the case of surpluses that reflect extremely high private savings due to lack of social insurance or investments being curbed because of a lack of efficient financial intermediation. It is worth noticing that, while excessive deficits eventually face a shortage of external finance, surpluses suffer less automatic pressures to dissipate and can therefore persist for longer.

Furthermore, as pointed out by Blanchard and Milesi-Ferretti, there are also situations in which the multilateral interdependence of economies calls for restricting current-account deficits or surpluses. Unsustainable deficits of large, financially integrated economies are such a case, as a crisis associated to them may trigger cross-border effects.

Blanchard and Milesi-Ferretti additionally point out two conceivable situations in which surpluses can be deemed as in excess:

  • When current-account surpluses are the result of deliberate strategies of curbing domestic demand and deliberate exchange rate undervaluation, crowding out foreign competitors. On the other hand, given the simultaneous determination of savings and current account balances, it is always hard to disentangle such a strategy from other determinants of the current-account balance.
  • When an increase of one economy’s surplus takes place while others face difficulties to absorb it without suffering adverse, durable effects on their demand and output. This is the case when part of the world is caught in a “liquidity trap”, unable to resort to lowering domestic interest rates as an adjustment policy, or face obstacles to use countervailing fiscal policies.

The IMF “External Sector Report” aims to gauge to what extent current account balances and corresponding REERs are out of line with “fundamentals and desirable policies”, as well as whether stocks of net foreign assets are evolving within sustainable boundaries. What did the latest issue show?

Chart 6 displays its assessment of how intensively individual economies have exhibited current accounts – and REERs – that are out of line with their “fundamentals”, i.e. those features that would normally lead them to feature current account imbalances within certain estimated country-specific ranges. Stronger (weaker) corresponds to REER “undervaluation” (“overvaluation”). Stronger (weaker) also means that a current account balance is actually larger (smaller) than that “consistent with fundamentals and desirable policies” (IMF, 2016a, Box 1).

The report notices that the evolution toward less excess imbalances after the GFC has stopped and recent movements have given cause for concern (IMF, 2016a, p. 23):

First, those economies with external positions considered “substantially stronger” (Germany, Korea, Singapore) or “stronger” (Malaysia, Netherlands) have remained as such for the last 4 years. Also noticeable has been the shift toward stronger positions in the cases of Thailand and Japan.

Second, at the bottom of the distribution, while some countries reduced – or suppressed – degrees of “weakness” (Russia, Brazil, Indonesia, South Africa, and France), others remained (Spain, Turkey, United Kingdom) – with the addition of Saudi Arabia to this group after the oil price decline.

Third, on-going trends of current account imbalances are bound to lead to a further widening of some external stock imbalances accumulated since the GFC. While China’s external stock position is expected to stabilize, other large economies are projected to exacerbate their debtor (U.S., UK) and creditor (Japan, Germany, Netherlands) positions. Furthermore, the net foreign asset position of some euro-crisis countries remain highly negative despite years of flow adjustment with high unemployment and low growth.

In our view, although not giving ground to fears of a collapse in major financial flows, global imbalances have not gone away as an issue, as they reveal that the global economic recovery may have been sub-par because of asymmetric excess surpluses in some countries and output below potential in many others. The end of the “era of global imbalances” may have been called too early. Lord Keynes’ argument about the asymmetry of adjustments between deficit and surplus economies remains stronger than ever.

The IMF report has a point in calling for a “recalibration” of macroeconomic policies from demand-diverting to demand-supportive measures. This would be particularly the case for countries – or the Eurozone as a whole – currently able to resort to expansionary fiscal policies that have instead relied mainly on unconventional monetary policy – which has become increasingly ineffective at the margin. On the other hand, one must acknowledge that there are limits to which national fiscal policies can deliver cross-border demand-pull effects. Huge savings flows – like German or U.S. corporate profits – may also not be easy to redeploy.

Hence specific priority should be given to country-specific structural reforms addressing obstacles to growth and rebalancing. Which could be aided by cross-border dislocation of pools of savings currently parked in low-return assets. Paradoxically, global imbalances demand more globalization in a moment when the latter faces hurdles (Canuto, 2016b).

Implications of U.S. future trade and macroeconomic policies for global imbalances

Given the weight of the U.S. economy, global imbalances may undergo new shocks in the coming years as a result of the policy reorientation already announced by president-elect Donald Trump. Although at a preliminary stage, it is possible to devise two possible scenarios, the choice of which will depend on the options assumed by trade policies accompanying the macroeconomic reorientation.

President-elect Trump and his team have announced a macroeconomic platform with a likely strong potential impact: a major fiscal boost via infrastructure spending, corporate tax cuts, and a (financial and environmental) deregulation agenda (Canuto & Cavallari, 2016). Such platform underlies the announced goal of raising the U.S. economic growth to 4% a year, well above the potential 2% estimated by the IMF (IMF, 2016b).

Important details are yet to be filled out. For example, how much of the US$ 1 trillion of infrastructure investment pledged will be borne by the public sector or by public-private partnerships, and therefore how much of it will contribute to public sector deficits and debt. As suggested by different experiences around the world, including the United States, sudden increases in public investment are not easily implemented. The increase in investments in infrastructure will take some time to implement and there will be a lag in their effects, on both the demand and supply side.

Similarly, given that U.S. corporations currently display already high liquidity reserve buffers and low levels of acquisition of new fixed assets, the results of corporate tax reduction on their expenditures will depend significantly on the terms of conditions of local investment that may be attached. Such type of conditionality has already been alluded to in the case of profit repatriation.

There are also doubts as to the extent of the impacts of deregulation. In the case of finance, given the favorable climate in Congress and beyond to reforming the Dodd-Frank regulation, one can expect a relief from the regulatory burden that has been inhibiting bank credit in recent years. Environmental deregulation may also facilitate investment in the energy sector, particularly on shale oil and gas.

Assuming that, in fact, aggregate demand is stimulated, there remain doubts as to the current capacity of the response of domestic supply. After all, low rates of involuntary unemployment and upbeat levels of economic activity at the end of the Obama administration will be part of the latter’s legacy. In the event of binding supply limits, the macroeconomic effect will be largely directed to higher inflation and import growth. The frenetic appreciation of the dollar in the weeks following the initial announcements of Mr. Trump’s program reinforces the possibility of greater demand leaks via foreign purchases of goods and services.

In any case, a drastic change in the current regime of fiscal and monetary policies is likely to occur. The normalization of monetary policy by the Federal Reserve toward higher interest rates and smaller balance sheets tends to accelerate, while fiscal policy will definitely leave the consolidation path forced by Congress to the Obama administration in recent years. In effect, the U.S. is one of those cases in which the IMF – and others (Canuto, 2014) – have long advised a shift from monetary easing to expansionary fiscal policies. The appetite in the markets for Treasury bonds has been far from satiated and larger public deficits would be easily absorbed, for which it would suffice to issue signs of future reforms toward some smoothing of the public debt path.

It is in trade policy and in dealing with current account imbalances that two scenarios emerge: a “soft” scenario is the one in which the Trump government limits its campaign promises to occasional “arm twists” with corporations, like moral suasion and tax concessions in exchange for local investments or import substitution within value chains. The “hard” scenario would be to establish extraordinary tariffs and other restrictions on imports – China and Mexico were frequent targets of such threats during the election campaign.

In the “soft” scenario, there will be a demand stimulus for the rest of the world, albeit at the cost of greater current US imbalances which would not likely face financing difficulties. The “hard” scenario, in turn, contains high risks of substantial price increases in the domestic basket of goods and services, as well as of having a negative impact on the profitability of U.S. corporations. In addition, if followed by “trade wars” with countries directly affected, a “lose-lose” result in the global economy – as in the 1930s – could materialize (Canuto, 2016b). After all, the US economy nowadays has levels of trade and financial integration with the rest of the world sufficient to generate significant feedback loops.

Bottom line

Current account imbalances in the global economy have returned to the spotlight, albeit with a different configuration from the one that marked the trajectory prior to the global financial crisis. Not as a particular threat to global financial stability, but mainly because they reveal asymmetries in adjustment and post-crisis recovery between surplus and deficit economies and, in the coming years, for the risk of sparking waves of trade protectionism.

Otaviano Canuto is an Executive Director at the World Bank (WB). All opinions expressed here are his own and do not represent those of the institution or of those governments he represents at the WB Board.

Brazil, Corporate Finance, Emerging Markets, Emerging markets, Latin America, Long term finance

Latin American Corporate Finance: Is There a Dark Corner?


Since last year there has been much talk of possible financial stress stemming from increased debt leverage in non-financial corporates of emerging markets economies. A recent study has brought to light some key evidence on the Latin American case (Bastos et al, 2015).

Read here:

or here:

Best regards



My Articles in 2014 (with links)

Bear and bull dancing

Global Economy – Crisis Recovery and Secular stagnation Hypotheses

1. Macroeconomics and Stagnation – Keynesian-Schumpeterian Wars
Policy makers in the advanced economies at the core of the global financial crisis can make the claim that they prevented a new “Great Depression”. However, recovery since the outbreak of the crisis more than five years ago has been sluggish and feeble. Since these macroeconomic outcomes have to some extent been shaped by policy […]
May 6, 2014 | By Capital Finance International

2. Sluggish Postcrisis Growth: Policies, Secular Stagnation, and Outlook

(with Raj Nallari, and Breda Griffith)
Economic Premise n.139, April 2014.

3. Calibrating 2014
 Huffington Post – Posted January 2, 2014 | 12:35 PM
The global economy looks poised to display better growth performance in 2014. Leading indicators are pointing upward — or at least to stability — in major growth poles. However, for this to translate into reality policymakers will need to be nimble enough to calibrate responses to idiosyncratic challenges.

Emerging Markets

4. Liquidity Glut, Infrastructure Finance Drought and Development Banks
The world economy faces huge infrastructure financing needs that are not being matched on the supply side. Emerging market economies, in particular, have had to deal with international long-term private debt financing options that are less supportive of infrastructure finance. While unconventional monetary policies in advanced countries in the aftermath of the global financial crisis […]
September 19, 2014 | By Capital Finance International

5. Long-Term Finance in EMEs: Navigating between Risks and Policy Choices
(with Anderson Caputo Silva, and Catiana García-Kilroy)
Economic Premise n. 152, June 2014

6. China and Emerging Markets: Riding Wild Horses
Huffington Post Posted February 3, 2014 | 8:08 PM
One month ago, I discussed some major risks to a slight upturn in the global economic scenario for 2014. Among those risks, concerns with the growth slowdown and challenges with shadow banking in China have already come to the fore as the Chinese Year of the Horse approached…
Read Post

7. Sovereign Wealth Funds Are Coming Home
Huffington Post Posted January 15, 2014 | 5:30 PM
Followers of this blog have read several recent pieces on the changing landscape of investment finance in developing countries, particularly in natural resource-rich countries. We have approached the rise of development banks partially filling the void left by the retrenchment of international banking. We have also highlighted how…
Read Post

8. Commodity Super Cycle to Stick Around a Bit Longer
Some analysts have predicted that the commodity price boom has played itself out. However, natural resource-based commodity prices (with the exception of shale gas and its downward pressure on US natural gas prices) have remained relatively high over the last few years, despite the feeble global economic recovery (Canuto, 2014). The commodity price spike that […]
August 22, 2014 | By Capital Finance International


9. The High Density of Brazilian Production Chains
Huffington Post Posted November 13, 2014 | 12:50 PM
International trade has undergone a radical transformation in the past decades as production processes have fragmented along cross-border value chains. The Brazilian economy has remained on the fringes of this production revolution, maintaining a very high density of local supply chains. This article calls attention to the rising opportunity costs…
Read Post

10. Navigating Brazil’s Path to Growth
Huffington Post Posted November 9, 2014 | 10:01 PM
Brazil’s macroeconomic management will face four major immediate challenges in the near future. The response to them will be strengthened if we could have some indication of how to steer the Brazilian economy back to a growth route.
A first major challenge will be the upward realignment of domestic regulated…
Read Post

11. Three Perspectives on Brazilian Growth Pessimism
(with Philip Schellekens)
Economic Premise n.148, June 2014
It has become increasingly evident over the last two years that the growth engine of the Brazilian economy has run out of steam. Despite relative resilience during the global financial crisis and following a quick recovery, economic growth registered just 1 percent in 2012 and…

12. What’s Holding Back Brazil?

Project Syndicate,February 21, 2014

One often hears that Brazil’s economy is stuck in the “middle-income trap,” having failed to revive the structural transformation and per capita income growth that it enjoyed before the debt crisis…

13. Clogged Metropolitan Arteries
Huffington Post Posted February 10, 2014 | 3:45 PM
Bad conditions of mobility and accessibility to jobs and services in most metropolitan regions in developing countries are a key development issue. Besides the negative effects on the wellbeing of their populations associated with traffic congestion and time spent on transportation, the latter mean economic losses in terms of waste…

Middle-Income Trap

14. Access to Finance, Product Innovation and Middle-Income Traps
(with Pierre-Richard Agenor)
World Bank Policy Research Working Paper Series 6767, February 2014

15.  Access to Finance, Product Innovation, and Middle-Income Growth Traps

(with Pierre-Richard Agenor and Michael Jelenic)

Economic Premise n.137, March 2014.)

Debt Restructuring

16. Orderly Sovereign Debt Restructuring: Missing in Action! (And Likely To Remain So)
(with Brian Pinto and Mona Prasad)
The World Bank Research Observer 01/2014; 29:109-135.
(Accessible in and

Economics, Emerging Markets, Emerging markets, Long term finance

Long-Term Finance in Emerging Market Economies: Navigating between Risks and Policy Choices

Emerging market economies (EMEs) are making important strides in developing long-term finance capital market vehicles to support investment in strategic areas such as infrastructure. However, since last year, EMEs have suffered from big shifts in terms of market sentiment. While EMEs’ prospects were clearly overhyped in the wake of the crisis, the bleak forecasts that dominated headlines in the second half of last year were similarly exaggerated. There are still a number of factors indicating that EMEs’ role in the global economy will continue to grow—just not as rapidly or dramatically as previously thought.

Click here: Economic Premise 152


Clogged Metropolitan Arteries

Bad conditions of mobility and accessibility to jobs and services in most metropolitan regions in developing countries are a key development issue. Besides the negative effects on the wellbeing of their populations associated with traffic congestion and time spent on transportation, the latter mean economic losses in terms of waste of human and material resources.

That led me to read with much interest a recent book – available on Google Play – on the impact of rail-based networks in São Paulo and Mumbai written by Jorge Rebelo, a transport specialist who worked for more than 25 years at the World Bank. São Paulo and Mumbai are both mega-metropolitan regions with about 20 million inhabitants and in dire need of quick solutions for better mobility and accessibility for their populations. As their population and income grew, auto and motorcycle ownership and their use also increased in both cities. Their mass transport systems are overloaded and traveling conditions are reaching their limit or are above their limit at peak-hours. Congestion is becoming unbearable in these two megacities and any new infrastructure requires relocation of houses and businesses, a very sensitive issue which in turn demands careful planning and heavy investment.

Both Mumbai and São Paulo metropolitan regions have extensive suburban railway networks dating from the 19th century that are now serving primarily a huge number of mostly low-income commuters every day. Built initially for transportation of freight and intercity passengers, these railways are now major commuter networks which are used by millions of passengers every day. According to Rebelo, both mega-metropolitan regions have delayed too long the substantial extension of their subways and other rail based systems either because of lack of coordination between levels of government and/or unreliable financing mechanisms which did not allow the required continuity to ensure annual additions to their rail based systems. The price for having procrastinated in facing those challenges has been huge!

Increasing challenges with mobility are of course not unique to those two mega-metropolises. Nineteen of the twenty-six largest metropolitan areas in the world are in non-advanced economies and most of them have suffered from a mismatch between, on the one hand, the fast dynamics of densification and transformation of space use and, on the other, the slower pace of institutional adaptation and/or investment finance to cope with the evolution of transportation needs. Mobility difficulties have become more intense even where population dynamics and rural-urban migration are not major factors, like in Russia, as approached by JungEun Oh and Kenneth Gwilliam in a recent World Bank review of the urban transport sector in the Russian Federation:

 “Russian cities are undergoing critical economic and social changes that affect the performance and condition of their urban transport systems. While the population of most large cities in Russia (over one million residents) has remained relatively unchanged over the last decade, the average income of the urban dwellers has sharply increased. The number of private cars per capita has increased rapidly, generating a demand for urban mobility which is increasingly difficult to meet.”

Through the long series of projects and analyses with which the World Bank has been supporting urban transport improvements in developing countries over the years – openly accessible on – one can notice how challenges associated with the mismatch between evolution of urban transport needs and institutional and investment finance responses are widespread in the developing world. One can also see how far ago those challenges had already become significant. For instance, a World Bank appraisal report on a project in Rio de Janeiro more than 20 years ago stated the following:

 “Urban Transportation is in a crisis in Brazil. Although the nation has invested heavily in the sector over the past 15 years, the effective demand for urban transport services particularly in major metropolitan regions (MRs), increased by about 82% in the last decade, and under present pricing policies, exceeds the existing peak hour supply in most MRs. To add to this capacity shortage, the Brazilian urban transport sector suffers from institutional problems due to a lack of coordination between the three levels of government responsible for urban transport in the MRs.

Not by chance, the issue of coordination between levels of government is highlighted in a set of policy proposals argued in Rebelo’s book – one that certainly serves as a reference for most metropolitan areas in developing countries. First and foremost, it is fundamental to establish some sort of real, effective Metropolitan Authority as a coordinator of long-term planning, evaluation and prioritization of new investments and coordination of their tariff and subsidy policy. This has also been pinpointed in a recent World Bank report – Institutional Labyrinth:

 “Typically, multiple agencies, at different levels of government, are involved in the management and delivery of urban transport infrastructure and services. More often than not, there is little or no coordination among them. This results in duplication and inefficiency in the use of resources and poor-quality services. The need for institutional coordination across space and function is increasingly being recognized as critical to developing an integrated and comprehensive urban transport system.”

The rapid transformation of space use and densification of connections between urban areas tends to turn previous transport- and urban-related political and administrative mandates obsolete and dysfunctional. Natural political inertia or resistance then often becomes a hindrance to building some sort of new, effective authority able to cope with the evolving metropolitan reality.

Some other recommendations follow in Rebelo’s book. For instance, there should be a search for financing mechanisms that are less dependent on floating government general budgets. A greater use of Public-Private Partnerships seems to be a trend in many parts of the world, and that might require operating subsidies. Therefore, financing mechanisms to guarantee the payment on time of those subsidies must be in place to avoid situations where concessions risk failing when operating subsidies are not paid on time. Revenues from advertising, use of station space, real estate developments around stations and urban operations can also be carefully planned.

Another key consideration is to strongly encourage the transparency of the bidding and evaluation process to foster international competitiveness and decrease costs. It also seems advisable to create an inventory of projects contained in the long-term strategy well beyond preliminary design stages. That would cut in the implementation schedule and make projects more attractive from a political standpoint. Finally, in most cases probably with the help of the judiciary, an effort must be made to find ways to simplify and accelerate expropriation/resettlement processes that may be deemed as necessary. All these recommended procedures require a definition of lines of authority appropriate to the evolving metropolitan reality.

The reality is some of the developing world’s transport infrastructures are beyond simple congestion; they are in danger of complete collapse or paralysis. There is reason to believe, however, that authorities in many countries have got the message and started to act more decisively. For instance, Mumbai just had its first monorail inaugurated and there are other rail and metro projects underway under the leadership of the Mumbai Metropolitan Region Development Authority. Sao Paulo and Rio are also undertaking substantial programs to try to address their mobility issues, and it’s high time they do it. Pay-offs from adjusting institutions and finance to the urban dynamics are clearly huge. It’s time to unclog the arteries of urban transport now to prevent stroke and paralysis tomorrow!

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Sovereign Wealth Funds Are Coming Home

Followers of this blog have read several recent pieces on the changing landscape of investment finance in developing countries, particularly in natural resource-rich countries. We have approached the rise of development banks partially filling the void left by the retrenchment of international banking. We have also highlighted how  less tax avoidance on extractive industries can be obtained and how that would make a huge difference in terms of resources available for local investment in those countries, provided that appropriate policies are put into place. Furthermore, we have pointed out the emergence of new forms and contracts of resource-backed investment finance, including a redirection toward home in asset acquisition made by developing countries’ Sovereign Wealth Funds.

I have invited three colleagues who have been studying the subject more closely to write the short piece below. Hope you will enjoy it as much as I did.


Sovereign Wealth Funds Investing at Home: Opportunity Fraught with Risks

Håvard Halland, Alan Gelb, Silvana Tordo

Traditionally, economists have advised countries where oil, gas or mineral reserves are discovered to invest extractives revenues abroad, ensuring a continuous future revenue stream from the return on accumulated foreign assets. The structure to do this became known as a Sovereign Wealth Fund (SWF). More recently, it has become accepted policy for resource-rich developing countries to invest a larger share of resource revenues at home, through the national budget. Now, some of these countries are turning the concept of the SWF on its head by using SWFs directly for national investment, particularly in infrastructure. For many public finance experts, such intentions cause warning lights to flash, and for good reason – the risks are substantial. As several countries push ahead with this new role for SWFs, what can be done to minimize the risks, and could there be potential advantages? A recent Economic Premise by Gelb, Tordo and Halland addresses these important questions.

The Evolving Agenda of Sovereign Wealth Fund Policy

SWFs have become so common that it is easy to forget that the term has been in use for less than a decade. However, there has already been a paradigmatic shift in the way SWFs are expected to be used for development. Until three or four years ago, oil and mineral producing countries were advised to save resource revenues abroad according to some version of the permanent income hypothesis, which posits accumulation of foreign savings until returns on accumulated capital are sufficient to provide an even future revenue stream. For many developing countries, this always seemed like an outrageous idea, given urgent needs to expand infrastructure investment at home. Eventually, economists arrived at the same conclusion, considering domestic investments a potentially beneficial complement to foreign savings in cases where they contribute to increased economic productivity. For example, a new power plant can provide reliable access to electricity where power cuts previously hampered firms’ output.

SWFs that Invest at Home

Several recent and upcoming oil and mineral producing countries, such as Tanzania, Uganda, Mozambique, and Sierra Leone, as well as Zambia, are now considering the use of their SWFs for direct domestic investment, outside of the national budget. In fact, this role for SWFs is not as new as it sounds, and Gelb and others (forthcoming) count fourteen SWFs that invest domestically, including well-established funds such as Singapore’s Temasek and New Zealand’s Superannuation Fund. These two funds, and several others, are commercial investors on par with pension funds and other privately owned funds, where the composition of the domestic investment portfolio is determined on the basis of expected financial returns. For other SWFs, including Malaysia’s Kazanah, several funds in the Gulf States, and more recently the Nigeria Infrastructure Fund, the investment mandate goes beyond financial returns to include development objectives.

Why Resource Revenues Might be Safer Abroad

Using SWFs for national development purposes carries significant risks. From a macroeconomic perspective, there is the risk of exacerbating damaging boom-bust spending cycles. On the investment side, quality, productivity and integrity of investments may suffer, particularly in contexts where there is a high risk of investment decisions being affected by political and lobbying pressure, and the risk of low-productivity, badly selected and poorly implemented “white elephant” projects is high.

It could be argued that, in the light of such risks, SWFs investing domestically should make domestic investments based purely on financial returns. However, equity markets in developing countries tend to be underdeveloped, and new infrastructure projects are frequently considered too risky to be bankable on purely commercial terms. Under such circumstances, SWFs’ opportunities for domestic investment could be very limited, and their contribution to development marginal.

Addressing the Risks of Domestic Investment

How can the integrity of SWF’s investment processes be ensured, reducing opportunities for corruption and politicization while bringing additional expertise to the investment process? In their forthcoming piece, Gelb, Tordo and Halland propose three main avenues to address such challenges.

Firstly, they suggest that domestic investment projects should compete for funding with foreign assets, rather than be fixed at a certain portfolio share. In periods of low domestic returns, or when there are indications of asset bubbles, investments would be channelled abroad. If the investment project has a clearly defined development objective, it would still be benchmarked against the financial return on foreign assets, but allowance could be made for a limited mark-down from the benchmark rate. Determining an acceptable “home bias” of this kind is challenging, and there are few examples to draw on. Gelb, Tordo and Halland discuss this issue in a forthcoming paper and suggest possible solutions. Investments that cannot be expected to yield a competitive return, such as for example public schools, would be undertaken through the national budget.

Secondly, partnering with experienced international investors can strengthen the integrity of the investment process and the quality of investments, by bringing additional oversight and expertise. The Nigeria Infrastructure Fund provides an example of this, having signed cooperation agreements with General Electric, the Africa Finance Corporation and the International Financial Corporation.

Third, SWF governance structures must ensure that investment decisions will be made independently of political and other pressures. Operational independence of professional management from the Board needs to be solidly embedded in the SWF governance structure, as well as an arms-length relationship between Board and the government as owner of the SWF.  Additionally, if the SWF is large relative to the rest of the economy, coordination with overall macroeconomic policy is needed to avoid exacerbating macroeconomic cycles. Coherence with investments funded through the budget needs to be ensured by coordinating with the overall national investment program.

Looking for the Upside: Potential Opportunities and Advantages

The use of SWFs for domestic investments carries significant risks. But can there be an upside too? An SWF that invests domestically on a commercial or quasi-commercial basis could act as an expert investor that shares risk and crowds in private investment to projects that would otherwise not be bankable but have an important development impact. Where necessary the SWF could boost its capacity by involving foreign majority investors. The first paradigmatic shift in developing countries’ resource revenue policy changed the emphasis from a focus on foreign savings to include a larger share of domestic investments. The next shift may see an expanded role for SWFs as active domestic investors. However, the risks are high, and the level of success will depend on the establishment of strong checks, balances and governance structures.

Alan Gelb is a Senior Fellow at the Center of Global Development in Washington, DC. Silvana Tordo is Lead Energy Economist for the Sustainable Energy Department, Extractive Industries. Håvard Halland is a Natural Resource Economist for the Poverty Reduction and Economic Management (PREM) Network of the World Bank.

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