Download Capital Flows (1)

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International Capital Flows
Session 10
--Hilla Shahpur Maneckji
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Introduction (1)
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The integration of the financial markets across the globe and
the increase in the quantum of international trade had caused
the capital to flow from one part of the globe to the other.
In a world, characterized by liberalization and globalization,
firms are looking for places to invest that offer specific
advantages.
Till recently, the global capital flows were determined by
factors like favorable investment climate, market growth
prospects, natural resources, labor markets, etc.,
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Introduction (2)
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But now, the macroeconomic factors like good monetary
policies, tax policies, exchange rate policies, etc., have taken
precedence over the factors stated above.
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CAPITAL FLOWS
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Capital Flows (1)
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As many countries are moving towards globalization and
liberalization, many global firms are showing great interest in
investment in communications, services, marketing networks,
infrastructure, etc.
The flows of capital-debt, portfolio equity, and direct and real
estate investment between one country and others are recorded
in the capital account of its Balance of Payments.
Outflows include residents purchases of foreign assets and
repayment of foreign loans; inflows include foreigners
investments in home country financial markets and property
and loans to home country residents.
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Capital Flows (2)
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Freeing transactions like these from restrictions, that is,
allowing capital to flow freely in or out of a country without
controls or restrictions is known as Capital Account
Liberalization.
Classic economic theory argues that international capital
mobility, allows countries with limited savings to attract
financing for productive domestic investment projects,
enables investors to diversify their portfolios that spreads
investment risk more broadly, and promotes inter-temporal
trade—the trading of goods today for goods in the future.
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Capital Flows (3)
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1.
More specifically:
Capital mobility means that households, firms or even
countries can smoothen consumption by borrowing
money from abroad when incomes are low in the home
country and repaying when incomes are high.
The ability to borrow abroad can thus dampen business
cycles by allowing households and firms to continue
buying and investing when domestic production and
incomes have fallen.
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Capital Flows (4)
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By lending money abroad, households and firms can reduce
their vulnerability to domestic economic disturbances.
Companies can protect themselves against sudden cost
increases in the home country, for example, by investing in
branch plants in several countries.
Capital mobility thus enables investors to achieve higher riskadjusted rates of return. In turn, higher rates of return can
encourage saving and investment that deliver faster economic
growth.
Thus capital flows result in a free flow of capital throughout
the globe from one sector to another.
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Capital Flows (5)
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Free flow of capital is necessary for the welfare of the society.
The international flows of capital have become everyday fact of
life in the international economy, and because of their
enormous size, are important.
Capital flows can affect lot of factors like exchange rates, forex
rates, interest rates and monetary policy.
Various factors such as the level of human capital, political
stability, and the depth of domestic financial markets, define a
country’s ability to attract foreign capital.
Most of the capital flows are in the form of Foreign Direct
Investments (FDIs) in different countries. International Banking
Capital Flows (6)
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This happens when a domestic firm acquires ownership or
control over the operations of a foreign subsidiary firm.
A firm is said to directly invest abroad if it has a direct or
indirect ownership interest of 10% or more in a foreign
business enterprise.
Today, FDI has become the single most important source of
private development financing for the developing countries and
plays an important role in the economic growth and
development of the developing countries.
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FOREIGN DIRECT
INVESTMENTS (FDIS)
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Reasons for FDIs
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Reasons (1)
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Individual firms may not maximize profits, keeping in view the
interest of the stockholders, but, instead, they maximize growth
in terms of firms size.
In such cases, FDI is preferred because firms cannot depend on
foreign managed firms to operate in their best interests.
Other reasons are based on the superior skills, knowledge, or
information of the domestic firms as compared to the foreign
firms.
Such advantages would allow the foreign subsidiary of the
domestic firm to earn a higher return than is possible by a
foreign-managed firm.
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Reasons (2)
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FDI may involve new technologies and expertise not
available in the domestic economy.
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FDIs In Pakistan
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FDIs In Pakistan (1)
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The fact that FDI helps accelerate the process of economic
development in host countries made Pakistan realize the
importance of new technologies for economic growth.
Of late the Government of Pakistan is also recognizing the
fact that it has to overcome some past practices and adopt
the emerging ones in order to make Pakistan compete
globally.
In the process, it has brought about major changes in its
national policies on FDI.
In the recent past, it has dramatically reduced barriers to
FDI, and is wooing multinational firms. International Banking
FDIs In Pakistan (2)
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The Government of Pakistan started promoting FDI
through various means such as direct subsidies,
extension of tax holidays, and exemptions from import
duties.
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Determinants of FDIs In
Pakistan
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Determinants of FDI (1)
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1.
In a developing country like Pakistan, certain factors like
regulations and effective administration, infrastructure, labor
costs and taxes playa vital role in determining the quality and
quantity of FDI.
For promoting FDI in a country, the investment community
always calls for a transparent system and efficient practices in
business, administration, and prospects for profits in the
country. Therefore the Government of Pakistan is taking
relevant steps to create a favorable climate for FDI in the
country.
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Determinants of FDI (2)
2.
Another area of strategic significance is the infrastructure.
It is well known that infrastructure is crucial for aiding growth
and in turn development of economy. Reliability on power,
transport, and communication is vital as they are the engines of
economic growth. Many nations give due importance to FDI
involvement in the infrastructure owing to its role in the
economy. In the absence of FDI in infrastructural
development, it is very difficult for a large developing country
like Pakistan to finance solely. Apart from the above social
sector, investment in education and wealth will take an active
role in increasing the per capita and quality of life, which the
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government has to finance on its own.
Determinants of FDI (3)
3.
4.
Location is strategic not only for attaining profits, and lower
costs but can also make sense in exporting those goods back to
investing nation. Reducing tariffs and barriers are often done to
boost trade. Export Processing Zones (EPZs) are created by
the Government of Pakistan to promote exports and facilitate
the exporters to become globally competitive.
Labor costs, and tax rates also influence FDI investment. Per
unit labor cost of the final output is vital in a developing
country like Pakistan. The labor laws in Pakistan are being
made flexible and are tuned in accordance with the developed
economies.
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Issues Relating to FDIs In
Pakistan
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Issues Relating to FDIs (1)
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1.
Some of major issues, which make Pakistan less attractive for
FDI compared to other countries, are its poor infrastructure,
and productivity of labor.
Apart from the above two issues, some of the major obstacles
are:
Lack of Transparency in FDI Policy:
This is evident from actual investment being made into sectors
compared to committed FDI. Red-tapism has often curtailed
the interest of some of the companies and they have eventually
cancelled or dropped out of the projects due to delays caused
in approvals.
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Issues Relating to FDIs (2)
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3.
FDI Regime:
No doubt, there has been an improvement regarding policies,
clearances but still there are restrictions on foreign ownership
in certain sectors like defense and railways. It also takes a lot of
time for government approval. Deregulation in infrastructure
sector would be welcome sign.
High Tariff Rates:
Despite reduction of the tariffs, they are still high compared to
global economy standards. Though the post-WTO regime is
still on its course, the high tariff rates is one of deterrents for
major MNCs to invest in Pakistan.
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Issues Relating to FDIs (3)
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5.
Financial Sector:
In spite of an improvement in terms of opening insurance
sector, and banking sector, the ownership issue still needs
clarification in terms of 100% FDI into these sectors. The
Pakistani financial sector had its own share of debacles in terms
of crisis and scams from 1991. Accordingly, transparency has
become a crucial issue now.
Labor Laws:
The labor laws in Pakistan give companies reasonable hedge in
terms of hiring and firing employees without seeking the
permission of the state government, unlike inInternational
India. Banking
Issues Relating to FDIs (4)
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7.
Decisions from the State Government:
The state governments were passive to the reform process as
most of reform process was concentrated in substantial
initiative in attracting FDI, and they still have to depend on
central government in terms of freedom, with respect to certain
infrastructure areas.
Export Processing Zones (EPZs):
We need more EPZs in terms of scale, government initiative in
terms of incentives, labor reforms, regulations so as become
real export houses for the nation.
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Issues Relating to FDIs (5)
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1.
So considering all these issues, the major areas that require
improvement are:
Bureaucracy:
Bureaucracy has been a bugbear for the clearance of FDI. The
delays due to multiple agencies at both center and state
governments hinder processes. This is where Pakistan lags behind
China despite being a democratic country where decisions are
expected to be taken on time. Systems have to be fine tuned so as
minimize delays in getting necessary clearances. A lot of
improvement needs to be done with respect to consolidation of
various regulatory agencies, and single window clearances
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procedures.
Issues Relating to FDIs (6)
2.
Tax and Tariffs:
The complex tax & tariff structure has been a major
issue not only for the foreign businessmen but also
domestic businessman. Though central taxes are in right
direction, other areas call for a major overhaul. Tax &
tariff structure is very perplexing, and the amount of
time taken to clear issues is enormous.
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Issues Relating to FDIs (7)
3.
Leveraging the Labor Force:
Though there is no dearth for skilled labor in Pakistan, educated
and English speaking sections forms a small part of economy.
Owing to this factor, we have seen the reasonable growth in the
IT and Pharmaceutical sectors. The thrust on export based and
knowledge intensive products along with traditional products can
provide the extra growth. Recently automobile industry is one of
the sectors reaching global standards. The thrust on domestic
market and also reliance of the MNCs on Pakistan as an export
base is enabling us to place ourselves on the global map, as well as
provide jobs and investments needed for development of ancillary
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industries.
Issues Relating to FDIs (8)
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On the flipside, FDIs also do not come free of cost.
They are definitely required but excessive use may
lead to turmoil as happened in East-Asia, Mexico and
Chile.
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Costs Associated With FDIs
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Costs Associated With FDIs (1)
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Foreign capital inflows can work both ways for a country.
We have seen that from many economies like Mexico, SouthEast Asian countries which had economic crisis.
Thus certain economies are small and have structural
deficiencies, which are not conducive for FDI.
Entry of MNCs in capital-intensive sector would reduce the
demand for labor, thereby intensifying the unemployment.
In other case, reduction in tariffs can reduce the revenue for
the government.
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Costs Associated With FDIs (2)
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Without proper competition policy, MNCs over time can reduce
competitors through their power, which can affect domestic
economy in terms of job losses, reduction in consumer welfare
society at large.
The domination of MNCs in global market is a huge concern
for the developing countries which have sizable population.
These countries have own reasons to develop economy due to
huge population, backwardness, for want of capital and
technology.
The MNC can drive out domestic players once they get a
foothold in a market, monopolizing the market
in future.
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Costs Associated With FDIs (3)
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FDI affects the domestic entrepreneurship adversely as
competition and cost structure can become huge barriers for the
infant industries.
The larger social issues pertaining to culture and values are taken
care of.
So, given the distractions in most of the developing countries in
terms of economic, infrastructure, and government policies,
attracting FDI can worsen the overall development due to
further disparity between rich and poor in the society.
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THE EAST-ASIAN
CRISIS
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The East-Asian Crisis (1)
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The East-Asian miracle economies became a major attraction for
foreign investors during the 1990s.
These economies were well managed, had been growing rapidly,
their exports were internationally competitive, governments were
well disposed to foreign investment, and labor was hardworking,
well-trained, and motivated.
With stock markets expanding, and privatization of several public
enterprises underway, these were ideal emerging markets,
promising high returns with relatively low perceived risk.
The East-Asia region as a whole received almost US$ 500 billion
(or a little under 40% of the world total) in net capital inflows
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during the five-year period 1993-97.
The East-Asian Crisis (2)
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About 60% of the inflows consisted of FDI and portfolio
investment.
The macroeconomic fundamentals of the East-Asian economies
remained strong on the whole right up to the outbreak of the crisis
with the devaluation of the Thai baht.
For instance, Indonesia, Korea, Malaysia and Thailand had all
enjoyed strong economic growth for many years and their inflation
rates were in single figures.
Their domestic savings rates were among the highest in the world
and their levels of investment were very high.
Government fiscal balances were either in surplus or showed only
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small sustainable deficits.
The East-Asian Crisis (3)
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All had the ability to service their debts in the long-term.
GDP growth for Indonesia, Malaysia and Thailand during the 1990s
averaged at rates higher than those prevailing in the previous two
decades, though in Korea’s case it was a little lower, but still an
impressive 7.5% a year.
But the other side of the coin was that each of these countries
started to run high current account deficits, though at least in the
case of Korea and Indonesia not quite as large as those witnessed in
the earlier Latin American crises.
With government accounts more or less in balance, it was the
private sector in each of these countries that was rapidly
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accumulating foreign liabilities.
The East-Asian Crisis (4)
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A number of observers have explained the East-Asian crisis in
terms of misguided investments in real estate, “crony capitalism” in
which governments and private enterprise engage in reciprocal
favors, lack of prudential regulation of domestic financial
institutions, and various other failures.
While each of these explanations had some factual basis, and
cannot be dismissed offhand, they give rise to awkward questions.
Why were these weaknesses not evident to foreign investors
before it was too late?
Or, if they were evident, why were they not taken into account in
their investment decisions?
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The East-Asian Crisis (5)
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The close government/business relationship in East-Asia, though
widely denoted in the press as corruption, had been applauded as an
example of successful partnership in economic management, which
other countries needed to follow.
The soft prudential regulation and other weaknesses of the financial
sector were also well known, and noted by the World Bank in its
country reports.
But granting that these weaknesses already existed points only to
one conclusion, that the opening up of the capital account and
financial deregulation in the East-Asian economies was premature
and should have been undertaken only after the correction of the
weaknesses that are now held to explain the crisis.
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The East-Asian Crisis (6)
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It was the rapid opening up of the capital accounts and deregulation
of the financial sectors that attracted the massive capital inflow
(especially short-term loans) into the region’s economies, and should
be considered as the major cause of the crisis.
In any case, the purveyors of foreign capital once again
demonstrated their inability, or unwillingness, to see the financial
strains and avoid another financial collapse.
Perhaps the problem of “moral hazard”, which had been noted in the
context of the Mexico crisis, is real: private lenders from the north
shared the expectation born out of past experience that they would
be bailed out by governments or international public agencies in
time of trouble.
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The East-Asian Crisis (7)
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The IMF responded with policy prescriptions that it had
applied in other countries with altogether different conditions
and circumstances.
It also insisted on a broad range of socio-political institutional
measures, to deal with labor market reforms, corporate
governance, government/business relations and corruption,
among other things, and to further open up to foreign
investors.
In prescribing a regime of sharp demand compression,
accompanied by steep increases in interest rates, the IMF may
have deepened instead of alleviating the East-Asian
crisis.
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The East-Asian Crisis (8)
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In the event, the steep rise in interest rates failed to prevent the
currency collapse, but the two together raised the burden of
external and internal debt to unsustainable levels, resulting in the
technical bankruptcy of major segments of the domestic private
sector.
Industrial disruption has been widespread, with declining domestic
output and sharply rising unemployment.
The resolution of a serious financial crisis is bound to inflict the
pain of adjustment; on an economy.
But a situation where adjustment reduces, rather than enhances,
the economy’s ability to cope with the crisis can hardly be regarded
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as a remedy.
The East-Asian Crisis (9)
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The IMF has therefore come under considerable criticism, and
not only from the quarters generally hostile to the institution.
Recently, certain well-known mainstream economists, including
some in the World Bank, have questioned the soundness of the
IMF’s diagnosis and the standard remedies prescribed for the
countries in deep trouble.
These comments are a welcome addition to the more longstanding critiques of the Washington consensus, which so far
has been unshakable.
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CHILE & MEXICAN
CRISIS
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Chile’s Experience in Regulating
Capital Flows (1)
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Chile should be studied for lessons in tackling Asia’s present
problems.
Unlike other Latin American countries in the 1980s, its crisis was
created in the private sector, and it took action to stem shortterm capital inflows.
The fixed exchange rate had encouraged heavy borrowing in US$.
With peso devaluation, debt repayments faltered and the
government bailed out the banks by taking over loans to foreign
creditors.
Assistance totaled about 20% of GDP, setting off a major
recession.
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Chile’s Experience in Regulating
Capital Flows (2)
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Several steps were taken by Chile.
A 1986 banking law, set strict operational guidelines, applied by an
independent supervisor, that prohibit banks from holding shares in
companies or other banks, prevent build-up of currency mismatches
in borrowing and lending, and establish firm provisioning
requirements for loans.
In addition, since 1991 foreign lenders must deposit 30% of the loan
amount with the Central Bank, which holds it for one year without
interest.
To reduce volatility this measure was extended to stock-market
inflows; under another regulation, FDI requires Central Bank
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approval.
Chile’s Experience in Regulating
Capital Flows (3)
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Chile also adopted a strong macroeconomic framework that led
to surpluses of 1% - 3% of GDP.
Monetary policy, under an independent Central Bank, responded
quickly to signs of overheating.
A flexible exchange rate policy has kept the current account
deficit in check.
The system may have flaws and be hard to replicate elsewhere,
but one exportable lesson is that well-regulated banks are
absolutely essential for financial stability.
The regulations also encourage long-term rather than short-term
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capital.
Chile’s Experience in Regulating
Capital Flows (4)
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Statistics of outflows (not controlled) indicate that speculative
inflows could still occur: high interest rates make loopholes
profitable, and export advances or FDI can be used for shortterm inflows.
In addition, large companies with access to foreign capital have
issued new shares or borrowed abroad.
Policymakers do not appear to be concerned about this because
the banking system is not exposed, depositors funds are safe,
and the broad objective of dampening the volatility of shortterm flows has been achieved.
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Mexican Crisis & Comparison
With Thailand (1)
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Private capital inflows financed a boom in private consumption
in Mexico, but private investment in Thailand.
Both countries experienced a pre-crisis surge in private capital
flows, a sharp increase in credit to the private sector, and
concerns about sustainability of rising current account deficits
and loss of competitiveness (exchange rates and inflation).
The banking systems were weak, especially in Thailand (higher
private sector external debt).
Thailand’s investment rate rose steadily after 1983 (28% of
GDP 1983-89, 40% in 1990 and onward).
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Mexican Crisis & Comparison
With Thailand (2)
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Domestic savings increased (32%-36% in the 90s) but the
shortfall was financed by foreign capital, generating current
account deficits of 5%-9%.
Investment was both public (infrastructure) and private
(industrial and real estate).
In Mexico, stabilization programs of 1987 were aimed at
reducing inflation (then 160%).
By 1993, it fell to a single digit (first time in two decades).
Real interest rates turned positive, and access to credit increased,
unleashing private consumption while private saving fell from
about 20% in 1988 to 13% in 1990 and 11%International
in 1994.Banking
Mexican Crisis & Comparison
With Thailand (3)
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Pre-crisis investment was only about 21% of GDP (half
Thailand’s rate).
Private sector spending widened the current account deficit
from around 2.5% of GDP in 1988-89 to 7% in 1994, financed
(as in Thailand) by private inflows.
Growth of export demand, needed to sustain Thailand’s
increasing industrial capacity, faltered in 1996; a decline in
inflated real estate (collateral for loans), along with sharp
currency devaluation, hit commercial banks balance sheets and
their ability to repay foreign borrowings (some of which was
channeled into property).
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Mexican Crisis & Comparison
With Thailand (4)
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Mexican crisis also affected its financial sector.
Higher interest, devaluation, and economic slowdown (reducing
borrowers ability to repay loans) hurt banks balance sheets though
asset values declined relatively little compared to Thailand, where
the impact on the financial sector was more widespread and called
for deeper restructuring.
The explosive growth of international financial transactions and
capital flows is one of the most far-reaching economic
developments of the late twentieth century.
Net private capital flows to developing countries tripled to more
than $150 billion a year during 1995-97 from roughly $50 billion a
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year during 1987-89.
Mexican Crisis & Comparison
With Thailand (5)
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At the same time, the ratio of private capital flows to domestic
investment in developing countries increased to 20% in 1996
from only 3% in 1990.
Powerful forces have driven the rapid growth of international
capital flows, including the trend in both industrial and
developing countries toward economic liberalization and the
globalization of trade.
Revolutionary changes in information and communications
technologies have transformed the financial services industry
worldwide.
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Mexican Crisis & Comparison
With Thailand (6)
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Computer links enable investors to access information on asset
prices at minimal cost on a real-time basis, while increased
computing power enables them to rapidly calculate correlations
among asset prices and between asset prices and other variables.
At the same time, new technologies make it increasingly difficult
for governments to control either inward or outward
international capital flows when they wish to do so.
All this means that the liberalization of capital markets and, with
it, the likely increases in the volume and the volatility of
international capital flows is an ongoing and to some extent,
irreversible process.
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Mexican Crisis & Comparison
With Thailand (7)
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It has contributed to higher investment, faster growth, and
rising living standards in many countries.
But financial liberalization—both domestic and international has
also been associated with costly financial crises in several cases.
This underscores that liberalization carries risks as well as
benefits and has major implications for the policies that
governments will find it feasible and desirable to follow.
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OTHER SOURCES OF
CAPITAL INFLOWS
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Introduction (1)
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Apart from the FDIs and FIIs, capital flows in Pakistan are
entertained through the Non-Resident Pakistan (NRP)
deposits, Foreign Currency Non-Resident (Bank) Account, and
External Commercial Borrowings (ECBs).
NRPs can freely invest in government securities or company
shares or debentures with repatriation rights.
They are also allowed to park their funds in shares/debentures
of Pakistani companies through stock exchange under portfolio
investment scheme with repatriation rights.
An NRP can acquire any immovable property in Pakistan other
than agricultural land/farm house/plantationInternational
property.
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Introduction (2)
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1.
2.
They are allowed to hold Resident Foreign Currency (RFC)
Account to keep their foreign currency assets.
The funds in RFC accounts can be freely used without any
restrictions including investments outside Pakistan.
Deposits—NRPs and Persons of Pakistani Origins (PPOs) can
open, hold and maintain the following two types of accounts
with an authorized dealer in Pakistan, that is, a bank authorized
to deal in foreign exchange.
Foreign Currency Non-Resident (Bank) Account—
FCNR(B) Account.
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Non-Resident (External) Rupee Account—NRE
Account.
Foreign Currency NonResident Bank Account—
FCNR(B) Account
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Foreign Currency Non-Resident Bank
Account—FCNR(B) Account (1)
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Only NRPs and Overseas Corporate Bodies (OCBs) can
open this type of account.
Accounts can be denominated in Pound Sterling, US
Dollar, Japanese Yen or Euro.
This account is of time deposit nature.
The duration of these accounts varies between 1 year and 3
years.
Both principal and interest can be repatriated.
Nomination is permitted.
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Foreign Currency Non-Resident Bank
Account—FCNR(B) Account (2)
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Regarding interest rates, the banks are free to determine the rates,
however within the ceiling prescribed by the RBP.
At present, the interest rates on FCNR(B) deposits are subject to a
ceiling of LIBOR rates for the corresponding maturities minus 25
basis points.
In respect of deposits of one year and above, interest shall be paid
within the ceiling rate of LIBOR/SWAP rates for the respective
currency/corresponding maturities minus 25 basis points.
On floating rate deposits, interest shall be paid within the ceiling of
SWAP rates for the respective currency/maturity minus 25 basis
points.
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Foreign Currency Non-Resident Bank
Account—FCNR(B) Account (3)
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For floating rate deposits, the interest-reset period shall be sixmonths.
However, in respect of Yen deposits, banks have the freedom to
set the FCNR(B) deposit rates, which may be equal or less than
LIBOR.
Loans and overdraft facilities are available to the account
holders.
Since the FCNR(B) account is denominated in foreign currency,
the account holder is protected against changes in Pakistani
Rupee value against the currency in which the account is
denominated.
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Non-Resident (External)
Rupee Account—NRE
Account
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Non-Resident (External) Rupee
Account—NRE Account (1)
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Like FCNR(B) Account, NRE Account is also open to
only NRPs and OCBs.
This type of account can be in any form, that is, savings,
current or term deposits account.
The account is denominated in Pakistani Rupees only.
Deposit accepting banks have enough discretion regarding
the duration of the fixed deposit.
There is normally no ceiling on interest rates, that is, banks
are free to determine the interest rates.
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Non-Resident (External) Rupee
Account—NRE Account (2)

Under the NRE scheme, deposits are received in foreign
currency and converted into rupees, and converted back
into foreign currency on maturity loans and overdraft
facilities are available to the account holders.
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External Commercial
Borrowings (ECB)
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External Commercial Borrowings
(ECB) (1)

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
External Commercial Borrowings (ECB) are borrowings from
lenders and investors outside Pakistan, who are permitted by the
Government as a source of finance for Pakistani corporates for
expansion of existing capacity as well as for fresh investment.
These include commercial bank loans, buyers credit, suppliers
credit, securitized instruments such as Floating Rate Notes and
Fixed Rate Bonds, etc., credit from official export credit
agencies and commercial borrowings from the private sector
window of Multilateral Financial Institutions.
The RBP seeks to keep an annual cap or ceiling on access to
ECB, consistent with prudent debt management.
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External Commercial Borrowings
(ECB) (2)




The Government has decided to place fresh ECB approvals up
to US$ 50 millions under the automatic route.
Under this scheme, Pakistani companies are allowed to raise
ECBs up to $50 million without any approval from the
Government or the RBP.
The advantages of ECBs route to the Pakistani corporates is
obvious: it provides a source of the foreign currency funds,
which will be cheaper than the rupee funds.
The average maturity for ECB is less than or equal to US $20
million is 3 years, above that it is 5 years except 100% Export
Oriented Units which is three years.
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External Commercial Borrowings
(ECB) (3)



Though Pakistan’s FDIs are not attractive compared to other
countries it is increasingly being recognized due to its
democracy, size resilience, stability, growing economy and
financial system with its vast educated, well-trained man power,
entrepreneurial capabilities and institutional set-up.
However, the huge government deficit has been a problem.
But Pakistan has been growing at a stable rate and this is a
promise, which international investors cannot ignore.
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SOURCES OF
INTERNATIONAL
CAPITAL INFLOWS
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Introduction


1.
2.
Sources of capital inflows are associated with forex
risks since they deal in foreign currencies.
Therefore, many banks and corporates are resorting to
the following two instruments to raise foreign capital.
Global Depository Receipts (GDRs)
American Depository Receipts (ARDs)
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Global Depository Receipts
(GDRs)
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Global Depository Receipts
(GDRs) (1)




The advent of GDRs in Pakistan has been mainly due to the
Balance of Payments crisis in the early 90s.
At this time Pakistan did not have enough foreign exchange
balance to meet even the requirements of a fortnight's imports.
International institutions were not willing to lend because of noninvestment credit rating of Pakistan.
Out of compulsion, rather than by choice, the government
(accepting the World Bank suggestions on tiding over the financial
predicament) gave the permission to allow fundamentally strong
private corporates to raise funds in international capital markets
through equity or equity-related instruments.
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Global Depository Receipts
(GDRs) (2)



The Foreign Exchange Regulation Act (FERA) was
modified to facilitate investment by foreign investors up to
51% of the equity-capital of the companies.
Investment even beyond this limit is also being permitted
by the government in certain sectors.
Prior to this, the companies in need of the foreign
exchange component or resources for their projects had to
rely on the Government of Pakistan or otherwise rely
partly on the government and partly on the financial
institutions.
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Global Depository Receipts
(GDRs) (3)



These foreign currency loans utilized by the companies (whether
through the financial institutions or through the government
agency) were paid from the government allocation from the IMF,
World Bank or other governments credits.
This, in turn, created liability for the remittance of interest and
principal, in foreign currencies which was to be met by way of
earnings through exports and other grants received by the
government.
However, with a rapid deterioration in the foreign exchange
reserves consequent to Gulf War and its subsequent oil crisis, the
companies were asked to get their own foreign currencies which
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led to the advent of the GDRs.
GDR Instruments (1)



GDRs are essentially those instruments which possess certain
number of underlying shares in the custodial domestic bank
of the company.
That is, a GDR is a negotiable instrument which represents
publicly traded local currency equity share.
By law, a GDR is any instrument in the form of a depository
receipt or certificate created by the Overseas Depository
Bank outside Pakistan and issued to non-resident investors
against the issue of ordinary shares or foreign currency
convertible bonds of the issuing company.
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GDR Instruments (2)



Usually, a typical GDR is denominated in US$ whereas the
underlying shares would be denominated in the local currency
of the issuer.
GDRs may be, at the request of the investor, converted into
equity shares by cancellation of GDRs through the
intermediation of the depository and the sale of underlying
shares in the domestic market through the local custodian.
GDRs, are considered as common equity of the issuing
company and are entitled to dividends and voting rights since
the date of its issuance.
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GDR Instruments (3)


The company effectively transacts with only one entity—
the Overseas Depository—for all the transactions.
The voting rights of the shares are exercised by the
Depository as per the understanding between the issuing
company and the GDR holders.
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American Depository
Receipts (ADRs)
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American Depository Receipts
(ADRs) (1)



Until 1990, companies had to issue separate receipts in the US
(ADRs) and in Europe (IDRs) to access both the markets.
The weakness was that there was no cross-border trading
possible as ADRs had to be traded, settled and cleared through
the Depository Trust Company (DTC) in the US, while the
IDRs could be traded and settled via Euroclear in Europe.
It was in April, 1990 when changes in Rule 144A and
Regulations of the SEC of the US allowed non-US companies to
raise capital in the US market without having to register the
securities with the SEC or changing the financial statements to
reflect the US accounting principles.
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American Depository Receipts
(ADRs) (2)

Rule 144A is designed to facilitate certain investment bodies
called Qualified Institutional Buyers (QIBs) to invest in overseas
(non-US) companies without those companies needing to go
through the SEC registration process.
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ADR Instrument (1)



1.
2.
3.
ADR is a Dollar Denominated Negotiable Certificate, which
represents non-US company’s publicly traded equity.
It was devised in the late 1920s to help Americans invest in
overseas securities and to assist non-US companies wishing to
have their stock traded in the American markets.
ADRs are divided into three levels based on the regulation and
privilege of each company's issue.
ADR Level-I
ADR Level-II
ADR Level-III
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ADR Instrument (2)

ADR Level-I:
It is often the first step for an issuer into the US public equity
market. Issuer can enlarge the market for existing shares and
thus diversify the investor base. In this instrument only
minimum disclosure is required to the SEC and the issuer need
not comply with the US GAAP (Generally Accepted
Accounting Principles). This type of instrument is traded in the
US OTC market. The issuer is not allowed to raise fresh capital
or list on anyone of the national stock exchanges.
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ADR Instrument (3)


ADR Level-II:
Through this level of ADR, the company can enlarge the investor
base for existing shares to a greater extent. However, significant
disclosures have to be made to the SEC. The company is allowed to
list in the American Stock Exchange (AMEX) or New York Stock
Exchange (NYSE) which implies that the company must meet the
listing requirements of the particular exchange.
ADR Level-III:
This level of ADR is used for raising fresh capital through public
offering in the US capital markets. The company has to be registered
with the SEC and comply with the listing requirements of
AMEXINYSE while following the US-GAAP.International Banking
ADR Instrument (4)
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
The reason for this may be attributed to the stiff disclosure
requirements and accounting standards as per the US GAAP.
Intermediaries that are involved in an ADR issue perform the
same work as in the case of a GDR issue.
Additionally, the intermediaries involved will liaison with the
QIBs for investing in ADRs.
Some of the well known intermediaries for ADRs/GDRs are,
Merrill Lynch International Ltd., Goldman Sachs & Co., James
Capel & Co., Lehman Brothers International, Robert Fleming
Inc., Jardine Fleming, CS First Boston, JP Morgan, etc.
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CAPITAL FLIGHT
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Capital Flight (1)




Capital flight refers to the large capital outflows resulting
from unfavorable investment conditions in a country.
The expected risk and return are the determinants of the
foreign investment.
When the risk of investment in a country rises sharply
and/or expected return falls, large outflows of investment
funds take place, and the country experiences massive
current account deficits.
Such outflows are descriptively referred to as Capital Flight.
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Capital Flight (2)



The change in the risk-return relationship that gives rise to
capital flight may be due to political or financial crisis,
tightening capital controls, tax increases, or fear of domesticcurrency devaluation.
One of the most important aspects of the capital flight is that
fewer resources are available at home to service the debts,
and more borrowing is required.
Also, capital flight may be associated with a loss of
international reserves and greater pressure for devaluation of
the domestic currency.
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Capital Flight (3)


The capital flight serves the importance of political and
economic stability for encouraging domestic investment.
A stable, growing developing country faces little, if any,
capital flight and attracts foreign capital to aid in
expanding its productive capacity.
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INTERNATIONAL
LIQUIDITY
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International Liquidity (1)




International liquidity refers to the generally accepted means of
international payments available for the settlement of the
international transactions.
International liquidity encompasses the international reserves and
the facilities for international borrowing for financing the Balance of
Payments deficit.
The international reserves include official holdings of gold, foreign
exchange, Special Drawing Rights (SDRs), and reserve position in
the IMF.
International reserves do not include private holdings of gold,
private holdings of foreign exchange and long-term international
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financing.
International Liquidity (2)



The IMF provides international liquidity in accordance with the
purpose of the fund specified in the Articles of Agreement.
Part of the liquidity takes the form of reserve assets that can be
used for Balance of Payments financing (unconditional
liquidity), while the other part takes the form of credit to
members that is generally subject to certain conditions
(conditional liquidity).
Unconditional liquidity is supplied through allocation of SDRs
and also in the form of reserve positions in the fund which are
claims corresponding to the resources that countries have made
available to the fund.
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International Liquidity (3)




Members holding SDRs and reserve positions in the fund can
use them to finance Balance of Payments deficits without
having to enter into policy commitments with the fund.
Conditional liquidity is provided by the IMF under its various
lending activities.
Most of the fund’s credit extended under these arrangements
requires an adjustment program that is intended to promote a
sustainable external position for the member.
In addition, it is often the case when the member obtains fund
financing under agreed conditions, its access to capital markets
is enhanced.
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International Liquidity (4)

This kind of a catalytic role of the fund has become more
important in recent times when private lending institutions have
been less willing to engage in international lending.
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The End
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