Tag Archives: foreign investment

Venezuela’s first step

Venezuela is a nation is turmoil.  The media, as well as our class blog, have highlighted the on going violence and shortages. Many feel that this is a result of the capital controls put in by the socialist regime of Hugo Chavez. By loosening the capital controls on Monday, the Venezuelan government is taking a step in the right direction.  However Venezuela has a long way to go, and further progress requires further action.

Venezuela is one of the largest petroleum exporters in the world.  It seems absurd to think that there is a food shortage.  Yet the country depends heavily on the imports for its food, and the balance of trade is misleading due the heavy influence of oil exports.  In the past, in order to curb capital flight, the regime of Hugo Chavez put in place strict capital controls to keep money in the country.  The ramifications of these actions are being witnessed today.   Many importers lack the currency to secure imports due to capital controls.

The government of Venezuela has taken action.  As reported in the Wall Street Journal, the currency controls are being removed, allowing the currency to float on the open market.  Lifting the currency controls is hoped to have the effect of clearing up the shortages, alleviating the social unrest.  However it could also devalue the currency, causing inflation.

This can be seen in the short-run international finance diagrams. Upon the removal of the controls, the devaluation would come as a result of a shift in the Net Capital Outflows curve to the right, which has the effect of decreasing the value of the currency relative to the other countries (in this case the US dollar), shown in the currency diagram.

The most obvious way to fight inflation is to raise interest rates.  But raising interest rates enough to counter the inflation may be unfeasible and/or undesirable given the current economic situation.  A similar effect could be achieved if Venezuela had increased foreign investment.  To this, the country should remove laws that limit foreign investment and property rights that where implemented by Chavez.  In addition, Venezuela should consider leasing some of its oil and natural gas resources to foreign companies, as it did before the industry was nationalized in 1973.  By increasing foreign investment, Venezuela can shift the NCO curve back without messing with interest rates, as well as generating some badly needed revenue for a cash-strapped country.

Considering the natural resources that Venezuela has, it is surprising to see the situation as bad as it is.  The situation seems to be largely due to bad economic policy.  Capital controls, nationalization, and weak property rights have not proven to be sustainable economic policies.  Venezuela’s decision to lift its capital controls should be followed by further “free market” policies rectifying the above problems.

(Revised) Foreign Investment in U.S. Assets and Negative Net Export

International finance theory says that intentional purchases of foreign assets lead to an improvement in net export. Here, I am going to look at U.S. data whether or not it suggests the claim.

Perhaps, the most common data to look at to prove the notion is the data of major foreign holder of U.S. Treasury securities where China and Japan for a long time have sat there in the first and second place, consistently the U.S. has been running a negative net export with them along the time (here for China and here for Japan). Policy makers in the U.S. often blame China for piling up U.S. assets in its official reserve and use it to do so-called currency manipulation, according to them, in order to make its export more competitive. And we know that China has been very successful to run trade surplus with the U.S. for a long time. Now, we know that according to this theory, this trade surplus is a direct consequence of an effort to intentionally purchase lots of foreign assets.

Data on federal debt held by foreign and international and net export of good and services also confirms the theory. Starting from around 1970s, foreigners have piled up federal debt; meanwhile, the U.S. has also started running negative net export steadily since around 1982.  Accounted for U.S. claims on foreign assets, the data shows that foreign claims on U.S.  outweigh U.S. claims on foreigners.

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Up to this point, we will accept the notion that, particularly for U.S. case, intentional purchases of foreign assets lead to an increase in net export of the country. The logic behind this is that initially, purchases of foreign assets result inflow of the certificate ownership of foreign assets, compensated by the flow of the currency outside the country.  At the end, the currency flows in the opposite direction through foreign purchases of domestic goods and services, or exports.

US and Foreign claim

Another worth question to ask is that is there a way to flip U.S. position from net importer to net exporter? Honestly, the answer of this question is not easy if not to say no way. I reach to this answer since if we look at the graph above, foreign claims of U.S. assets has risen steadily from the last three decades. As can be seen from the chart below, foreigners increase share of their claim of the dollar as official reserves from only 14% in 2000 to 25 percent in 2010. It is plausible since countries have learned from the East Asian and South East Asian financial crisis in the end of 1990s that had caused the dramatic drop of currencies affected after they run out of reserves on the way to support their fixed exchange rate systems. Thus, as long as the dollar still functions as a vehicle currency, foreign central banks will be continuing to pile up the dollar to back up their currencies. Moreover, foreigners also consider U.S. assets as a safe place to put their money, albeit its low interest rate as the return.

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Considering those facts, I conclude that the U.S. has no choice in order to discourage foreigner from holding its assets, even if it try to lower its interest rate much further since the significant portion of foreign holding of U.S. assets is not driven by an effort to seek high return.

Thus, the rest to do is to shorten the gap by boosting U.S. investments abroad. Thanks to investments in emerging countries and developing countries in general that give a higher return than those in the U.S and other advanced countries.  One way to do so is by increasing the share of U.S. investments in places other than Europe, especially in Africa, where its portion in this place is relatively low compared to that in Europe. By doing so, not only would U.S. benefit from higher return as a result, but also the world will praise the U.S. for boosting the development there since the major portion of U.S investment abroad is in the form of foreign direct investment (look for the graph here), which it will have direct effect to alleviate poverty in those places.

Openness to Foreign Investments

In previous post I argued that it is important to stabilize currency, emerging economies have to attract more durable investments instead of hot money. It is because, in case of external shock such as quantitative easing taper, they would not easily experience foreign capital reversal that often causing vulnerability on their currency. And since they often have to raise domestic interest rate to support the currency, which in turn it can harm domestic economy, thus, measures to prevent such sudden reversal is more crucial to establish rather than to act unprepared when it really happen.

Indonesia, one of five countries so-called the fragile five, had started to experience severe drop in currency by more than 20 percent last year when the Fed announced to paper off its massive asset buying program in last spring. Analysts often blame deficit budget and current account deficit as factors that cause the currency drop most. Although, I think, this is not a solid reason since India also experiences a massive depreciation in the same period, albeit a high current account surplus. One thing that can be seen for sure, its reliance on foreign capital inflow to support economic growth is very vulnerable to any external event that in most cases are uncontrollable.

I have discussed a little about ease of doing business in Indonesia in my earlier post. While it is a good approach to attract more foreign investment, but it cannot fully controlled since like other contest, every country continuously have tried to improve its position to attract as many foreign investments to its country.

Another measure that can be regarded as a path toward encouraging foreign direct investment is the government’s decision in last December to be more open to capital ownership from foreign investment. Indonesia just revise it negative-investment list where under the new regulation foreigner may own business on airport up to 45 percent and up to 100 percent on power plants build through public private partnership.  For information Indonesia has so-called Negative List, list of business field closed to investment that is reconsidered regularly every three year. This limitation is only applied to direct investment, excluding non-direct investment through portfolio transaction in a domestic capital market. Aftermath Asian financial 1997/1998, where Indonesia was regarded as the worst hit by the crisis, it has tried to attract foreign direct investment as shortage in domestic investment. A rapid increase in foreign direct investment can be seen particularly just after 2008’s global financial crisis until currently.

Openness to foreign investment especially in infrastructure provision benefits the country in term of improving economic fundamental which in turn strengthening its position against external shock. Meanwhile, through public-private partnership scheme, the government can provide infrastructure without worrying about debt burden and promote competitiveness in that sector. Through allowing more party to compete one another it will lead to efficiency and quality of the outcome. Finally, allowing foreign investments also improves provision of infrastructures more instantly, which otherwise could not.