The Extent of and Reasons for the Uneven Impact of Global Crisis on Global Capital Movements - Essay Example

?Using the Graph Above and Any Other Material That Is Relevant Examine the Extent of and Reasons for the Uneven Impact of Global Crisis on Global Capital Movements Table of Contents Introduction 3 Trend Before the Global Crisis 4 Current Trend of Global Capital Movements 6 Extent and the Reason for Uneven Impact of Global Crisis on the Capital Movement 9 Conclusion 14 References 16 Bibliography 19 Introduction Over the past few decades, the domestic financial market has expanded rapidly and a greater proportion of financial capital has been traded across the globe. It has been stated that the increase in the global capital movement is primarily due to the augmented integration of the global financial markets. Correspondingly, countries across the world experience capital flows for various reasons. Capital flows are accredited to be the prime factor in the development of the modern day economies by eliminating constraints associated with resources and facilitating technology transfer. On the contrary, the capital flow is also blamed for several external debts and financial crises (Becker & Noone, 2009). The flow of capital is strongly influenced by the regulations of the particular country. It has been observed that when the expected rate of return changes capital can flow in and out of the countries. However, it has been ascertained that expected rate of return depends on many factors that include both exogenous and endogenous to the country which may not reflect the actual returns as determined by the fundamentals within an economy. It can be stated that currently the world is more of an open market and is continuously becoming even more integrated due to the improvement in various aspects such as financial sector and reduction in transaction costs. At the same time, in the changing international financial system large investors possess diversified portfolios. Furthermore, volatility in cross border capital flows is observed to have serious implications. It can be argued that currency crisis is not a new phenomenon. However, with the liberalization in the financial market, the occurrence of financial crisis has become more of a common phenomenon and has often been associated with significant banking crisis. At the same time, it has been contradicted that global capital movement has significantly contributed in the business cycles of both high-income and middle-income countries mostly since 1970 and during the circumstances of financial crisis (Bluedorn & et. al., 2011). Correspondingly, this essay intends to examine the extent of and the reasons for the uneven impact of global crisis on global capital movements. Trend Before the Global Crisis The increasing global and financial liberalisation and innovation along with other developments globally have resulted in increasing cross-border capital flows prior to the global crisis. This outcome can be attributed to both increasing purchase by countries across the world and rising investment. Concerning the euro area, it was observed that since the introduction of euro in 1999 the area has experienced increased cross-border financial flow (Forster & et. al., 2011). Prior to the emergence of recent global crisis, financial flows between the nations across the world were experiencing current account deficits along with surplus. The imbalances in the current account of countries were the major concern for the policy makers (Obstfeld, 2011). Despite the increase in the global capital flow, it has been witnessed that the capital flow from rich countries to poor countries has been negligible. In order to ascertain more generalised understanding, the following trends were identified prior the global crisis: The rise in the cross-border asset possessions revealed a higher portion of foreign assets in portfolios along with rise in the value of assets relative to Gross Domestic Product (GDP) The rise in the global capital movements and cross–border possessions was more profound in the advanced countries as compared to developing countries The increasing international financial ties were associated by an increase in the diffusion of current account stabilities and size of creditor as well as debt position The financial globalisation was widely apparent in the banking sector of developed economies comprising regulatory arbitrage drives International banking integration was involved in both cross-border lending as well as in the operations through foreign affiliates Source: (Milesi-Ferretti & Tille, 2010) It has been further observed that countries before the breakout of the global crisis in 2007 allocated a stable fraction of financial assets. Consequently, the process of financial deepening contributed towards augmenting cross-border capital flows. It was ascertained that investors were more willing to invest in the overseas market. The main driver behind the increasing trend of cross-border flow before the crisis situation was the rise in the fraction of wealth invested by investors in the overseas. As a result of increasing cross-border flow, most of the countries across the world witnessed an increase in the portfolio share by 1 to 2 per cent on an annual basis during the economic boom situation in the year 2000. The impact of the upsurge in the portfolio share reflected fair and even increase in the prices of assets across the globe. This alteration in the portfolio was argued to increase primarily due to the practice of active portfolio management. At the same time, the increasing interest of investors towards the foreign asset also led to the elimination of many restrictions related with international capital movement. The financial globalisation also resulted in the increase in the value of both external assets and liabilities of developed economies at a rapid pace than the emerging economies. Notably, this trend also accompanied with an increase in the movements of regulatory arbitrage drives with international financial institutions along with large and small intermediating shares of cross border capital flows. Current Trend of Global Capital Movements In the recent years, global financial conditions have become stable as a result of new policy initiatives in developed countries, expansion of alternative monetary policies and reduction in the near-term tail risks for the global economy. At the same time, the augmented global liquidity and higher risks desire among investors have steered towards an increase in the assets prices in developed countries while directing capital flows to emergent economies. This capital flow has widely been subjugated by the portfolio investments, particularly in corporate debt. Notably, in the recent times, the large corporations in the emerging economies had been able to take the advantages of the low borrowing costs. Evidently, the bond market in East Asian countries, Mexico and Turkey especially witnessed large inflows in the late 2012 and 2013. At the same time, the Foreign Direct Investment (FDI) flow in emerging countries also fortified during the mid-2012 (United Nations, 2013). The global capital movement including lending, foreign direct investment (FDI) and equity and bond purchase crossed US$4.6 trillion during the year 2012 which was US$0.5trillion during the year 1980. In the recent times, despite the increasing global integration, countries in the west have reduced cross-border lending while capital movement across the world’s developing countries have reinvigorated. It was ascertained that during the year 2012, 32% of total foreign capital flowed into developing countries. On the other hand, the capital flow from the emerging market augmented to US$1.8 trillion. It cannot be denied that most of the outflows were directed towards advanced and developed countries while around US$1.9 trillion is ascertained to flow into emerging markets (International Financial Law Review, 2013). It has been observed that the global FDI fell by 18 per cent in the year 2012. It is expected that recovery of the decline in the global FDI will take longer duration due to the fragility in global economy and uncertainty associated with policy. Inflow of FDI in Africa for the year 2012 increased by 5 per cent while the FDI inflow in the developing countries of Asia dropped by 7 per-cent. Similarly, the inflow of FDI witnessed a decline in Latin American as well as in Central American and Caribbean countries (United Nations Conference on Trade and Development, 2013). The current trend of global cross-border capital movement can be better understood through the graphical presentation depicted below. The graphical presentation below shows the trend of cross-border capital movements since 1980 to 2012. Source: (Chandler, 2013) It is apparent from the above illustrated graphical presentation that the global cross-border capital flows have significantly declined since the year 2007 after the significant rise in its prior years. At the same time, after the dramatic fall in the global cross-border capital flow in the year 2007, the subsequent years have witnessed significant constant fluctuations in the cross-border capital flows. The instability associated with the global cross-border capital movements has significantly hampered the macroeconomic and financial stability of the countries across the world. Extent and the Reason for Uneven Impact of Global Crisis on the Capital Movement It has been observed that the global crisis actually began in mid-2007 which was deeply rooted to the scenario of the housing bubble in the United States. The crisis has had a deep effect not only on the US but has significant implications on the countries across the world. However, Europe was the first to get affected from the global financial crisis originated from the US. The crisis surprised most of the policy makers, agencies and investors across the world. During the outbreak of the global crisis, it has been ascertained that countries across the world were by no means stable. Nonetheless, the crisis took a devastating shape resulting in increasing unemployment and bringing about a significant surge in the rate of poverty. Evidently, the exposure of the lenders and investors was intricate primarily due to the complications associated with the securitisation of mortgages which eventually led towards augmenting uncertainty in the financial market. There are numerous factors that have led to the global crisis. The major factors included global macroeconomics imbalances, feeble financial regulations and inefficient risk management. It can be ascertained that there are various reasons behind the asymmetric distribution of investment. The reasons can be attributed to the desire of the countries to accumulate official exchange reserves, for preventative purposes. In this regard, it can be stated that the USA, Mediterranean countries such as Spain, Italy, Greece, Turkey, Central and East European countries along with the United Kingdom have large current account deficits. On the other hand, countries such as Germany and oil exporting nations including few Asian countries such as Japan, South Korea, Taiwan and Malaysia have surplus. These differences experienced in terms of capital flow resulted in low interest rates in the European and US banks (Kenc & Dibooglu, 2009). Many banks in Europe and the United States witnessed immediate and adverse impacts on the assets, causing the impairment of capital. Precisely stating, the global crisis caused unprecedented collapse of cross-border capital flows after the significant growth in the past decades. It has been ascertained that sharp decline in the cross-border capital flow was primarily due to the financial integration where it is observed that countries suffered due to the adverse situation related with bank flows and domestic macroeconomic condition. During the crisis situation, assets price witnessed significant fall. Since the capital flows are proportional to wealth, such reduction led to the declining flow. The crisis was also associated with the reduction in the share of assets invested in the overseas market which implies that there was an increased degree of home bias in investors’ portfolios. While the most of the countries were seriously impacted by the global crisis, the countries in the East Asian region were able to manage the direct impact of the global financial crisis. On the other hand, the United Kingdom witnessed a serious decline in the capital flow where the inflow of capital was radically dropped to US$939 billion in the initial quarter of the year 2007 to US$464 billion in the second quarter of the same year. Besides, it can be ascertained that decline in the foreign liabilities of the UK was primarily attributed to the retrenchment in the interbank financing by banks in oil exporting countries including Hong Kong, Switzerland and the euro area. This decline was primarily owing to the loans and the deposits. In other words, there was uneven impact of global crisis on the global capital movements (Shirai, 2009). Moreover, it can be better understood with the graphical presentation illustrated below: It can be observed from the above illustrated graphical presentation that the trend of uneven impact of global crisis on the global capital movements. Correspondingly, the capital flow during the early crisis situation i.e.2007 was ascertained to be US$3.3 trillion which declined to US$0.6 trillion in the year 2011. Similarly, the cash flow in Western Europe was observed to be US$9.9 trillion during the year 2007 which fell to US$3.2 trillion in the year 2011. Similar figures were obtained for the rest of the countries with varying decline in the cross border capital flow illustrated in the above graphical presentation. There are various reasons behind this uneven impact of global crisis on the global capital movements (Shirai, 2009). One of the primary reasons behind this was differences in the investment proportion made by the investors of different countries in the US instruments. In this regard, it is stated that countries having greater proportion of investment in US instruments and other countries with considerable impact of global crisis had suffered steadier declines in the cross-border capital while those countries with relatively less investment were able to manage less decline in their global capital movement. Moreover, the key reason behind countries which were able to manage relatively less decline can be attributed to risk-aversion attitude adopted by the investors of these countries. Another reason can be associated with the book value of the structured product held by the national banks of the countries including major and regional banks as well as cooperative banks. Correspondingly, it can be ascertained that countries with significant book value of structured credits held by the national banks of the respective countries amounted greater loss while on the other hand the countries with relatively low book value of structured credit had to sustain little losses. Thus, the differences in the loss acquired by the country also resulted in the uneven decline of global capital movement. At the same time, the differences in the bank’s write downs associated with assets is also identified as one of the reasons behind the uneven decline in the global capital movement as a consequence of global crisis. Accordingly, the banks of the countries with smaller write downs have less impact on their capital movement than those banks of the countries with significant write downs. It has been identified that there lays several factors behind the uneven impact of global crisis on the global capital flow. In this regard, regulations associated with commercial banks of the countries can also be attributed to the uneven impact of global crisis on global capital flow. Responsively, the countries such as Japan which have removed the barriers associated with banking insurances and securities experienced fewer declines on their capital flow while the regions such as the USA and Europe where the removal of restrictions was not fully implemented had experienced greater impact of global crisis on their capital movement. At the same time, the intensity of competition amid the commercial and investment banks prevailing during the global crisis has also radically impacted the global capital movements. Responsively, the intensity of competition between the commercial and the investment banks in the USA and Europe was significant which caused these countries to experience greater decline in the cross-border capital flow while the other countries which have less intensity of competition had witnessed relatively less decline in the cross border capital flow. Notably, the banks of the countries with large pool of deposited household savings have experienced lower impact of global crisis in relation to global capital movements. Moreover, the value of the stock held by the banks of the countries also had implications on the degree of impact of global crisis on the capital movements. Correspondingly, the countries experiencing higher level of decline in the value of share owed by the banks of the country had witnessed significant decline in the capital movement, on the other hand the countries experiencing lesser decline in the value of share held by the banks have limited impacts on the cross border capital movement (Shirai, 2009). Thus, it has been explicitly identified from the above discussion that there are various reasons behind the uneven impact of global crisis on the global capital movement. Conclusion It has been ascertained from the foregoing discussion that there has been significant flow of cross-border capital prior to the eruption of global crisis in the year 2007. This increase in the cross-border capital flow can be primarily attributed to the increase in the financial integration of the international financial market. Cross-border capital movement is an important factor and has a radical impact on the growth and development of the economy. The observation of the recent trends related with the cross-border capital movements revealed that developing economies are able to attract considerable amount of capital flow. Nonetheless, it has been ascertained that capital flows in developing countries are more appreciable than the capital flow in the developed countries. The current trend of global capital movements has strong affinity with the global crisis witnessed in the year 2007. It is worth mentioning that the global crisis has significantly influenced the global capital movement. Accordingly, the countries across the world have varying impacts on their cross-border capital movements. Accordingly, it has been observed that the United Kingdom, Western Europe and the USA have experienced serious falls in the cross-border capital movement while Africa, China, Japan and other developing nations have limited impacts on their cross border capital movements. The differences in the impact of global crisis on the global capital movement can be attributed to several reasons. Correspondingly, the uneven impact of global crisis on global capital movement was primarily due the differences in the investment made to the US instruments. In this regard, the risk aversion attitude of investors of most of the countries has emerged from extensive decline in their cross-border capital movements. At the same time, the differences in the book value of the structured product owned by the national banks of the many countries can be associated with varying impact of global crisis on the global capital movement. Moreover, various other reasons such as differences in write downs by the banks of the respective countries, varying degree of regulations relative to commercial banks of the countries and the degree competition amid the commercial and investment are ascertained to be major reasons behind the uneven impact of global crisis on the global capital movement. References Becker, C. & Noone, C., 2009. Volatility in International Capital Movements. Research Discussion Paper, pp. 1-32. Bluedorn, J. & et. al.,2011. Capital Flows are Fickle: Anytime, Anywhere. IMF Working Paper, pp. 1-32. Chandler, M., 2013. Great Graphic: Cross Border Capital Flows. EconoMonitor. [Online] Available at: http://www.economonitor.com/blog/2013/02/great-graphic-cross-border-capital-flows/ [Accessed January 04, 2014]. Forster, K. & et,al., 2011. Euro Area Cross-Border Financial Flows and the Global Financial Crisis. Occasional Paper Series, pp. 4-39. International Financial Law Review, 2013. 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