Long-Term Capital Flows to Developing Countries

Figure 11.5(a) shows that long-term capital flows to developing countries have declined since
1998, mainly due to the Asian financial crisis of 1997–8 and the recent slowdown of the global
economy. New long-term flows totaled $261 billion in 2002, $83 billion below the peak in 1997.
Sharp declines in private capital market flows in recent years – bank loans, bonds, and portfolio
equity flows – account for nearly all of this decline. As a result, the share of emerging markets
in global capital market financing fell to 3 percent in 2002, compared to 6.4 percent in 1998
and 11 percent in 1997. Figure 11.5(b) shows that even foreign direct investment (FDI), which
tends to be more resilient than capital market flows, has slowly but steadily declined since 1999.
 Rotation from debt to equity
The weakness in the growth of private-sector debt flows is unprecedented in the post-1965
period. In the decade of the 1970s, developing-country debt posted a compound annual growth



                                                                      
rate of 24 percent. The Latin American debt crisis of the early 1980s slowed this growth but did
not end it. Since the middle of 1998, however, the whole context for development financing has
shifted. As borrowers have chosen, or been required by their creditors, to pay down their debts,
the external debt of developing countries has fallen in dollar terms. As debt is being repaid to
private-sector creditors, net equity flows to developing countries remain significant, mainly
though the route of FDI.
The shifting pattern of private flows – debt down, equity up – has had an important impli-
cation for the associated stock of debt (see table 11.6). While the stock of developing country
external debt outstanding from all sources has fallen since 1998, the stock of equity capital owned
and controlled by foreigners has risen over the past decade. Table 11.6 shows that the drop in
the external debt-to-equity ratio, from 316 percent in 1997 to 196 percent in 2002, has been
spread across all regions of the developing world. The World Bank highlighted three aspects of
the shift in its 2004  Global Development Finance . First, the shift is partly driven by investor
preferences. Debt investors have become more wary of holding debt claims on developing coun-
tries, while MNCs have increasingly come to believe that the developing world offers significant
growth opportunities. Second, the shift is privately driven by the preferences of developing
country policy-makers. To protect against debt crises, such as the Asian financial crisis of 1997–8,
countries have strengthened their precautionary reserve holdings and shifted their liabilities to
more stable form of investment, especially FDI. Finally, on balance, the shift is a positive devel-
opment. This rotation from debt to equity is best seen as a constructive development, because it
puts development finance on a stable footing.

The International Equity Market

Besides debt instruments such as the Eurodollar and bond markets, the equity capital market is
another important source of financing. Evidence indicates that the final decade of the twentieth
century will go down in history as the period in which much of the world discovered the stock
market as a major source of funds for their global expansion. Companies will increasingly turn
to the stock market to raise money. This section focuses on how ownership in publicly owned
corporations is traded throughout the world. The stock market consists of the primary market
and the secondary market. The  primary market is a market in which the sale of new common
stock by corporations to initial investors occurs. The  secondary market is a market in which the
previously issued common stock is traded between investors.
 New trends in the stock markets
In   recent years, a number of new trends have begun to emerge in the stock markets around the
world: (1) alliance, (2) crosslisting, and (3) concentration.
STOCK MARKET ALLIANCES There are some 150 stock exchanges in the world. Within the past
10 years, these stock exchanges have scrambled to align with each other. Markets in Paris,
Amsterdam, and Brussels have agreed to form Euronext, while a group of Scandinavian markets
has agreed to form Norex. Those deals prompted the London Stock Exchange and Frankfurt’s
Deutsche Bourse to consider a merger into a new market, but that deal fell through in Septem-
ber 2000. In 2001, the Lisbon Exchange decided it would join Euronext. NASDAQ has joint
ventures and alliances in Japan, Hong Kong, Australia, Canada, the UK, and Germany. In Sep-
tember 2002, Euronext and the Tokyo Stock Exchange signed an alliance for cooperation and
investor protection. In November 2002, the New Zealand Stock Exchange and the Hong Kong
Stock Exchange signed an information-sharing agreement. The New York Stock Exchange has
recently discussed alliances with markets in Canada, Latin America, Europe, and Asia.
There is a variety of reasons for this consolidation of stock exchanges: the growing speed and
power of telecommunication links, big and small investors’ keen interest in stocks from all parts
of the world, and the fear of being left behind. Moreover, if national exchanges do not take the
initiative, they could be bypassed by new electronic trading systems. These same forces have
caused the burgeoning of online trading and have pushed national securities firms to expand
their business overseas.
In   addition, these same factors have caused another wave of stock markets becoming publicly
traded on the different stock exchanges. In 2001, the London Stock Exchange and the Deutsche
Bourse went public and are traded on their markets, while the Toronto Stock Exchange and
Spain’s four regional stock exchanges went public in 2002. In December 2002, the Chicago
Mercantile Exchange, the world’s second largest futures market, became publicly traded on the
New York Stock Exchange.
CROSSLISTING With the rise of cross-border mergers during the 1990s and the early 2000s,
there arises a need for companies to crosslist their stocks on different exchanges around the world.
By  crosslisting its shares on foreign exchanges, an MNC hopes to:
1 Allow foreign investors to buy their shares in their home market.
2Increase the share price by taking advantage of the home country’s rules and regulations.
3Pro vide another market to support a new issuance.
4 Establish a presence in that country in the instance that it wishes to conduct business there.
5Increase its visibility to its customers, creditors, suppliers, and the host government.
6 Compensate local management and employees in the foreign affiliates.
Companies are obligated to adhere to the securities regulations of all countries where their
shares are listed. A decision to crosslist in the USA means that any company, domestic or foreign,
must meet the accounting and disclosure requirements of the US Securities and Exchange Com-
mission. Rules for listing requirements differ markedly from country to country, but analysts
regard US requirements as the most restrictive in the world. Reconciliation of a company’s finan-
cial statements to US standards can be a laborious process. Some foreign companies are reluc-
tant to disclose hidden reserves and other pieces of company information. It might not appear
too difficult for US companies to crosslist on certain foreign exchanges because their listing
requirements are not that restrictive, but certain barriers still exist, such as a foreign country’s
specific rules and reporting costs.
STOCK MARKET CONCENTRATION European stock markets have become more integrated since
the European Union’s decision to switch their monetary union from the European Currency Unit
to the euro, which was launched in 1999. Increasing integration, as reflected in converging price
dynamics across markets, results from various structural changes in European stock markets.
There is already a large amount of crosslisting and trading among exchanges. Competition among

                                     exchanges for listing and order flow has long characterized European securities markets. In addi-
tion, exchanges have become subject to competition for order flow from alternative trading
systems. Because there are benefits from achieving large size and attracting liquidity, another
important response to competitive pressures has consisted of mergers among exchanges.
The concentration of stock market capitalization is not an “EU phenomenon,” but reflects a
worldwide trend toward a single global market for certain instruments. Figure 11.3 shows the
share of the three, five, and 10 largest stock exchanges of total world stock market capitalization.
The three largest stock markets accounted for 60 percent of the total market capitalization in
1995 and 2001. Furthermore, the share of the five and 10 largest stock markets has increased
from 1995 to 2001. These statistics indicate a trend toward concentration of the world stock
markets.
                                                      Privatization
In   Nove mber 1996, Deutsche Telekom – a government-owned telecommunications company in
Germany – raised $13.3 billion through its initial public offering. During the 1990s, the rolling-
back of state ownership in the economy through privatization gathered considerable pace both
in OECD countries and outside the OECD arena. The OECD – the Organization for Economic
Cooperation and Development – is an organization of 29 countries and most of these countries
are industrialized.
Privatization is a situation in which government-owned assets are sold to private individuals
or groups. In recent years, even many developing countries have been selling government-owned
enterprises to private investors. For example, the amount of money raised through privatization
by   the Indian government increased from $100 million in 1996 to $1,234 million in 1999. In
May 2000, the Indian government announced that it would privatize most of the government-
owned enterprises, including Air India, which is the international flag carrier for India. Figure
11.4 shows that the global amount of money raised through privatization by developing coun-
tries surged from almost nothing in the early 1980s to $67 billion in 1997, before decreasing to
$42 billion in 1999. The World Bank estimates that cumulative privatization revenues world-
wide have exceeded $1 trillion by 2000. Privatization could play an important role in the ongoing
transformation of emerging capital markets: due to its high profile, privatization may facilitate a
switch from investment in bonds to investment in equities.
Why privatize? First, governments try to assist the development of capital markets by increas-
ing market capitalization and liquidity. Second, a closely related motive is to widen share own-
ership and to create a “shareholder culture” in the population at large. Third, governments use
privatization to raise money. Fourth, by replacing public-sector decision-making and control with
those of the private sector, privatization is inducing notable changes in the corporate governance
structure in important segments of the economy. Finally, privatization enables governments to
use their resources more efficiently. By 1990, state-owned enterprises (SOEs) consumed nearly
20 percent of gross domestic investment in developing economies, while producing just more
than 10 percent of gross domestic product: “Overall, privatization has dramatically improved the
performance of former SOEs” (The World Bank 2003b, p. 96).
How is it done? Privatization takes many forms. First, a government sells state-owned com-
panies directly to a group of ultimate investors. Second, the government divests itself of a
company it owns through public offerings of equity in the primary market. The primary market
is a market in which the sale of new securities occurs. Third, the government may sell residual
                      stocks of partly privatized companies in the secondary market. The secondary market is a
market for securities that have already been issued and sold. Finally, other privatization methods
include leasing, joint ventures, management contracts, and concessions. In 1998, direct sales of
government-owned enterprises by developing countries accounted for almost 75 percent of
privatization revenues and public offerings contributed to most of the remaining sales.
What are the essential elements for a successful privatization? Any successful privatization
involves at least three elements. First, a government needs a political agreement to sell all or part
of a company it owns. Second, the company should have the potential to transform itself into a
profit-making entity rather than a government-subsidized burden. Third, the government has to
find underwriters who will distribute and market the shares domestically and internationally.