As Capital Goes Global, Investors Make Policy
MASSIVE money flows are putting a crimp - sometimes a useful one - in national economic sovereignty.
Countries courting international money find they must behave in their economic policies, or see foreign investors flee with their funds. ''We don't tell governments what to do,'' says Robert Pozen, general counsel for Fidelity Investments, the world's largest mutual-fund group. ''But anybody who raises money in the capital markets has to be subject to market discipline.''
International investors are increasingly putting pressure on both developing and industrialized nations to carry out responsible monetary and fiscal pressures. One reason the French government has held a tough line against strikers in recent days is concern that giving in would weaken the French franc.
The globalization of world capital markets ''rewards good behavior and good economic performance,'' says Anthony Bottrell, deputy managing director of the Institute of International Finance (IIF) in Washington. ''But it punishes mistakes.''
''Globalization'' is a two-dollar word that refers to a long-standing trend in the world's financial markets - one that got a lot more official attention in the past year after the Mexican peso crisis.
In June in Halifax, Nova Scotia, President Clinton and the other leaders of the Group of Seven industrial democracies called for a $50-billion emergency fund to bail out nations caught by a tidal wave of financial flows. The International Monetary Fund endorsed the idea in October and implementation has started.
Globalization can be defined in numbers: It's the almost incomprehensible sum - $1 trillion or more - traded daily on foreign-exchange markets. It's the more than $4 trillion in world trade each year. It's the estimated $170 billion being invested this year in ''emerging markets'' of Latin America, Asia, Europe, Africa, and the Middle East. It's the $33 billion that American companies invested abroad in plant and equipment in the first six months of this year and the smaller sums invested abroad by other industrial countries.
Impact on main street
The trend affects average citizens worldwide. Developed nations such as Sweden, Italy, and Japan have seen the value of their currencies swing sharply in the last few years. In the United States and elsewhere, everything from people's retirement income to jobs and the cost of goods is tied to the global money chase.
Most economists cheer the rapid growth in international flows of money as good for the world, a way to put money to its best use in promoting the overall economic welfare of mankind.
But there can be a negative side to globalization. Just about a year ago, Mexicans and hundreds of thousands of Americans learned this the hard way. The Americans saw their investments in Mexican stocks, high-interest Mexican treasury notes, and certain mutual funds invested in Latin America plunge in value.
On Dec. 21, 1994, with its reserves of foreign currency shrinking dramatically, the Mexican government let the foreign exchange market determine the value of the peso. By the next day, the peso was worth 20 percent less in US dollars. This week it took 7.73 pesos to buy $1, compared with about 3.46 pesos a year earlier.
Mexico, in the throes of an election, had ignored a ballooning international-payments deficit and suffered the consequences. Output will be down almost 4 percent this year, economists estimate.
The impact of globalization still reverberates:
* Nations wanting to attract foreign investment are having to make more economic data available faster.
At its annual meeting in October in Washington, the International Monetary Fund (IMF) announced plans to require more economic information from any of its 180 member nations that borrow on the world's capital markets. They will be asked to put that information promptly on the Internet, where, presumably, it will be available to lenders and anyone else with a computer, a modem, and an on-line service.
Details are still being worked out. But the information is expected to include foreign currency reserves, the balance sheet of the central bank, interest rates, money supply, the current-account balance, budget deficit or surplus, indexes on consumer prices and economic output, foreign debt and the cost of servicing it.
''It is all supposed to be in place by early next year,'' an IMF official says.
* International investors have become more choosy in their investments in developing countries.
The peso crisis, says Fidelity's Mr. Pozen, ''has led to a tiering of the international markets, a more focused and distinguishing type of approach.''
''The capital market is likely to be more discriminating than it was in the early 1990s,'' says William Cline, an economist at the Institute for International Economics, a Washington think tank.
Nations with poor economic policies are less likely to win investors. The total size of world capital markets (including equities and bonds) has been estimated at $35 trillion - another imponderable sum.
* The rapid rise of the private global capital market has shrunk the role of the World Bank and smaller, regional development banks in financing development in third-world nations, at least in nations where the risks are more moderate. In 1994, the emerging nations raised $186 billion in external financing, mostly from rich industrial nations. About $168 billion of this was private finance, according to the IIF. About $18 billion was official money, from governments or such international institutions as the World Bank.
This year, private money flows slipped to about $128 billion. Official creditors are providing about $45 billion, including part of the $40 billion Mexican rescue package, the IIF estimates (see chart).
Mexico prompted another international financial crisis in 1982 when it announced it could not service tens of billions of foreign bank loans. It took nearly a decade for the banks and heavily indebted developing countries to restructure those bank loans to a manageable size.
Banks' role declining
Banks still participate in loaning money to both the developing countries and former communist nations in eastern Europe. But more of the money is portfolio money - purchases of bonds and stocks.
Pension funds and insurance companies often will sink a small amount of their assets - say 1 percent - into the rapidly growing nations of Asia or Latin America, notes Mr. Bottrell of the IIF. That research and information organization has as members about 200 of the world's largest financial institutions, such as commercial and investment banks and mutual-fund groups.
Unlike the banks, which negotiated for years with debtor nations over their unpaid loans, foreign buyers of emerging-market stocks and bonds vote with their feet: They sell when there is trouble.
''It is a totally different and quite new phenomenon,'' says John Heimann, chairman of the global financial institutions group at Merrill Lynch in New York. ''It is pure, passive portfolio investment.''
Governments, if they make the decision to open their economies to the international capital market and attract foreign investors, have to play by the rules, Mr. Heimann adds. They have to make their economies ''transparent,'' providing the financial and economic information that international investors need to make judgments as to the risks involved.
Another difference from 1982: Then, private capital flows to debtor nations dried up for years. After the current Mexican crisis, there was a pause in investment flows. But money is returning already.
In a degree, the discipline of market sentiment on the economic policies of developing countries is replacing the economic leverage held by the multilateral institutions such as the IMF. But dramatic and sudden capital outflows are sometimes the result of ''irrational bandwagons,'' cautions Cline. At other times they are ''judicious discipline.''
Offer you can't refuse?
If governments do ignore the economic advice of IMF officials, they are likely to face higher interest charges and reluctant foreign lenders, says Bottrell.
His organization, the IIF, issues monthly reviews of some 26 main creditor countries and full studies two or three times a year. ''We are urging prompt release of data by authorities of emerging countries,'' he says.
The ability of money to shift suddenly, with the push of some buttons on computers, has prompted concern among IMF officials and others. ''In the past 18 months,'' noted IMF economists in an October report, ''the world economy has witnessed several episodes of turbulence in financial markets as investors have adjusted their portfolios in response to changes in risk evaluation.''
In the Mexican crisis, the government was forced to impose an austerity program to cut the budget deficit, contain inflation, and reduce the nation's dependence on foreign capital. Last March, the crisis reverberated in Argentina. A liquidity crunch in commercial banks forced the government to take measures to bolster savings and reduce the deficit in international payments. Capital flowed out of Latin America and economic real growth this year slowed to about 2 percent, down from 3.7 percent in 1994.
The Bank for International Settlements in Basel, Switzerland, a sort of bank for central bankers of well-to-do countries, noted in its annual report, ''Even if the cause of the [Mexican] crisis can be found in the weakness of certain economic fundamentals, the fact that it could occur so suddenly is nevertheless disquieting.... This suddenness points to the dangers inherent in large upward movements in real exchange rates generated by easily reversible capital flows.''
And Michel Camdessus, managing director of the IMF, spoke at his institution's annual meeting of ''the risk that the crisis would spread in a few days - or even hours - to many other countries, with potentially devastating effect on capital flows and confidence.''