Rapid financial globalisation is due not only to financial innovations, but also to choices made by national policymakers, often with naïve expectations, trusting promoters’ promises of steady net inflows of financial resources.
Rapid financialisation has involved fund or asset investment managers operating internationally, managing assets for transnational institutional and retail investors and investing a growing share of transnational financial assets. Even retail investors are attracted by such fund managers offering attractive alternatives for investing in various asset markets, including index funds.
To attract foreign institutional investments interested in capturing more rents, they demand more favourable terms and conditions, thus changing national financial systems. Successfully attracting transnational finance thus limits emerging market economies’ policy space to develop their economies.
The enabling environment to attract capital inflows typically allows them to circumvent regulations and other institutional constraints. Deepening national capital markets by relying on transnational finance typically involves “subordinate” or “dependent” financialisation.
This typically requires modifying national financial systems to better serve transnational finance and transitioning from traditional banking to financial asset markets. Thus, developing countries that open their capital accounts or encourage transnational portfolio investments become especially vulnerable.
In the early 2000s, after the 1997/98 Asian financial crisis, the Group of 8 (G8) major economies — supported by the World Bank, International Monetary Fund (IMF) and Germany’s Bundesbank — promoted local currency bond markets. Soon, local currency bond markets in Asia (ex-Japan) rose tenfold from US$836 billion in 2000 to US$8.3 trillion in 2015.
It was claimed that deeper national securities markets, especially local currency bond markets, would redress both currency and maturity mismatches of short-term foreign currency borrowings by local banks and corporations. Such markets were expected to reduce global imbalances as countries with surpluses would no longer need to recycle savings in the US financial markets.
However, a United Nations Conference on Trade and Development-South Centre study argues that local currency bond markets are “double-edged”, addressing the risks of currency mismatches for individual borrowers while exacerbating the systemic risks associated with the nation’s currency. When developing economies’ equity and bonds are largely foreign held, their currencies are more vulnerable.
Increasing transnational integration of national currency, financial and other asset markets has transformed global finance and its dynamics, including the roles, relations and room for manoeuvre for emerging market and other developing economies:
• Currency markets are now less influenced by international trade flows but increasingly by capital flows and, when substantial enough, by the “carry trade” of those borrowing in low-interest rate currencies to invest in high-interest rate currency assets, taking on exchange rate risk to gain from interest rate arbitrage;
• Inter-bank money markets no longer only reflect the demand for and supply of central bank reserves, but also the effects of central bank interventions in currency markets to prevent excessive appreciation or depreciation of national currencies due to market perceptions of erratic capital flows;
• With domestic financial conditions linked to the vagaries of global finance and US interest rate decisions, subordinate financialisation constrains governments’ capacity to provide macroeconomic stability by trying to stabilise aggregate demand, let alone undertake counter-cyclical policy;
• Subordinate financialisation tends to promote the privatisation of public services by legitimising the notion that public goods — education, health, infrastructure — can be better provided by the private sector with finance from capital markets. Development finance is thus redeployed to ensure profits for private finance, investors and companies.
International financial anarchy unchecked
Efforts to deepen national capital markets have been backed by powerful financial interests, domestic and foreign, especially the major international financial institutions. Multilateral development banks have been urging developing country governments to get private finance to fund development, social and environmental initiatives.
Their message has shifted from “working on finance” to try to ensure more resilient and robust development despite international financial volatility and instability to, thus, “working with finance”. Meanwhile, institutional investment managers are expected to turn to “impact investing” with supposedly beneficial effects, such as green bonds, development impact bonds and infrastructure bonds.
To make matters worse, there is no international financial regulator, as all regulation and regulators are national, even in implementing Bank of International Settlements (BIS) standards. Both the BIS and the IMF acknowledge cross-border transmission of risks, but national regulators focus on their national economies, leaving others more vulnerable than ever.
Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development. He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought, and a member of the Economic Action Council. Dr Lim Mah Hui has been a university professor and banker, in the private sector and with the Asian Development Bank.