IV. Current Macroeconomic Environment
- R. Williams
- Published Date:
- September 1980
In assessing the broad prospects for the international banking markets, even for a relatively short period, it is necessary to examine the underlying macro-economic factors which largely determine the demand for market finance and the terms on which it will be met. Important among these is the pattern of payments imbalances, which continue to be heavily influenced by developments in oil prices. For 1980 there is perhaps less uncertainty than in 1979 about the prospects for oil prices and their impact on the pattern of payments imbalances. However, other aspects of the macroeconomic environment are changing rapidly; the long awaited recession in the United States may be developing more severely than many observers had thought, while U.S. dollar interest rates have fallen more rapidly from their recent high rates than many would have expected. Such developments, like changing oil prices, have consequences both for the demand for market finance and for the willingness of banks to provide it. Likewise, prospects for the international bond markets are relevant in assessing financing flows through the banking sector as, to some extent, bond market activity can substitute for financing flows through the money market.
Current Account Prospects and Demand for International Market Finance
The prospective pattern of current account balances and some aspects of their financing in 1980, from the projections in the 1980 World Economic Outlook, are set out in Tables 4 and 5. As in 1974 (compare Table 24) the large deficits which are the counterpart of oil surpluses will need to be financed; the projected oil surplus of US$115 billion is about 70 per cent higher than in 1974, rather larger in real terms.12 While the large statistical discrepancy between current account surpluses and deficits in 1974 makes it difficult to make comparisons of the pattern of deficits then and now, broadly speaking this time around the prospective deficits initially are much more heavily concentrated in the seven largest industrial countries, at about six times that recorded in 1974. The prospective deficits of the smaller industrial countries are somewhat more than twice as large as in 1974, while for the non-oil developing countries the deficits are projected to increase above the 1974 level by about 85 per cent. The industrial countries, particularly the larger ones, are likely to finance much of their deficits through means other than the international capital markets, so that such a pattern implies a relatively modest increase in the aggregate demand on international capital markets for financing current account deficits in relation to the earlier period.
|Oil exporting developing countries||32||5||68||115|
|Non-oil developing countries||–28||–36||–55||–68|
|Balance of current accounts||–28||–36||–55||–68|
|Accumulation of reserves (increase—)||–12||–18||–12||–9|
|Nondebt-creating flows and long-term borrowing from official sources (net)||28||31||35||40|
|Use of reserve-related credit facilities (net)||1||1||1||2|
|Other borrowing (net)1||11||22||31||35|
Including errors and omissions.
Including errors and omissions.
Although the financing of non-oil developing country deficits through mechanisms not giving rise to debt and through long-term borrowing from official sources has increased almost proportionately to the increase in current account deficits between 1974 and 1980 (Table 34), the residual amount requiring financing by use of reserves, reserve-related credit facilities, or commercial borrowing is projected to increase by some 20 per cent in real terms. To provide a more recent perspective, if non-oil developing countries neither accumulated reserves nor made use of reserve-related credit facilities in 1980, their prospective borrowing requirement from other sources would be US$28 billion, somewhat less than they borrowed in 1979 (Table 5).
Most observers do not expect that moderation in real oil prices and absorption by the oil producing countries over the next few years will proceed nearly as rapidly as in 1974–78, so that even with further progress in oil conservation the oil surpluses will not decline rapidly as they did in the earlier period.13 The slowdown in economic activity in the industrial countries suggests a reduction in aggregate industrial country deficits and a further increase in those for the non-oil developing countries beyond 1980, as was the case in 1975. In these circumstances, considerable importance attaches to the extent to which the market borrowers among the developing countries are able—with assistance from international agencies as necessary—to reorient their economic policies to the new conditions in a manner which will maintain their market credibility for sustained private financing flows.
Macroeconomic Environment for International Lending
The aggregate demand for capital market finance is not, of course, limited to the financing of current account deficits, although for many developing countries balance of payments considerations predominate. Much of the demand for international bank finance is directly related to international trade, so that increases in trade, even if there were no increase in current account imbalances, would imply an increased demand. For 1980, the major factor in the increase in the value of world trade, the price of oil, is also the major factor in the increase in current account deficits, and the impact on demand for market finance is already largely captured in the latter. The 1980 World Economic Outlook suggests the value of world trade in 1980 may increase by about 20 per cent in current U.S. dollar terms, slightly less than in 1979 but considerably more than in any other year since 1974, when the rate of increase was more than twice as high. In general, much of the increase in trade finance relates to developed country borrowers and is of relatively short maturity so that increased demand for such financing is not likely to pose any significant problem for the banking system from the prudential point of view.
Among the major industrial countries, the largest incremental demand for trade finance denominated inforeign currencies is likely to come from Japan, which finances a large proportion of its imports through foreign currency borrowing abroad, to a large extent by Japanese commercial banks. This tendency is reinforced this year by the termination of programs under which Japanese commercial banks were able to obtain trade-related refinancing from the Bank of Japan. (The increase in foreign funding of trade financing by Japanese banks has been facilitated to some extent by the decline in funding requirements associated with the deceleration in their medium-term foreign lending.)
The economic slowdown in the industrial countries (the 1980 World Economic Outlook projects an increase in output of 1.0 per cent, down from 3.4 per cent in 1979), which, as noted above, could turn out to be somewhat greater than expected a few months ago, will reduce demand for bank credit within the industrial countries. As in 1974 and 1975, this should facilitate an increase in aggregate bank lending to the non-oil developing countries. The general level of interest rates (and, more generally, the stance of monetary policy in the industrial countries) is also subject to a rapidly changing outlook. After rising sharply earlier this year, U.S. dollar interest rates have fallen back even more sharply; interest rates on other currencies have yet to decline significantly from their recent peaks. Other things being equal, declines in real interest rates will stimulate demand for international credit.
Financial flows resulting from the factors mentioned so far have their counterpart in real transactions. Transactions of a more purely financial character, however, such as switches from one currency to another in response to changing interest rate differentials and exchange rate expectations, are also reflected in flows through the international financial markets. When currencies come under speculative pressure, the volume of international lending tends to increase as hedgers and speculators borrow to finance their currency positions. An upsurge in international bank lending relating to speculative pressure against the U.S. dollar was particularly noticeable in the last quarter of 1978 and the third quarter of 1979, but subsequently was reversed as foreign exchange positions were unwound. While such transactions are important in explaining the overall volume of bank lending, they probably have only minor implications for the ability of the markets to carry out their more fundamental functions.
Many observers expect that gradual diversification of foreign exchange positions (including official reserve holdings) into currencies other than the U.S. dollar will continue in 1980. Where such diversification merely involves changing the currency of denomination of a bank asset or liability, the impact on international lending is minor. In some cases, however, the change involves a switch in financial instruments as well. In the past, such diversification has tended to expand the supply of funds to the international banking markets, as the authorities of some alternative currencies, such as the deutsche mark, the yen, and the Swiss franc, were reluctant to accept inflows of funds to their domestic markets. To the extent that those countries are now more willing to permit direct placements of funds, including off-market transactions, the expansionary effect of currency diversification on the international banking markets should be more limited. Similar considerations apply to any switching of financial instruments. Insofar as oil surplus countries place a higher proportion of their funds in instruments other thaa international bank deposits, for example, the cost of bank loans to borrowers will be increased. Under normal circumstances, however, the impact of such shifts is minor relative to other factors influencing the terms and volume of international lending.
Outlook for International Bond Markets
Early in 1980, the Organization for Economic Cooperation and Development (OECD) published a forecast14 of US$30 billion for the volume of gross inter-national bond issues in 1980, almost 20 per cent below that recorded in 1979. Nevertheless, in view of a further weakening of the bond market during the first quarter of the year, many observers at the time regarded even that forecast as optimistic. Over the period January–March 1980, total new international issue volume fell to an annual rate of only US$23 billion, almost 40 per cent below the amount recorded in 1979; the fixed interest rate dollar sector was particularly weak. High long-term interest rates deterred borrowers, while the possibility of even further rises and the additional rapid increases in short-term rates dampened investor interest in longer-term financial assets.
Toward mid-April, however, a marked turnaround occurred, which was precipitated by a sharp decline in U.S. short-term interest rates. Subsequently, there has been a spate of new issues; in the April-May period the volume of international bond issues was at an annual rate of US$36 billion. Moreover, the secondary market has rebounded strongly.15 The U.S. dollar sector of the Eurobond market was the first segment of the international market to record substantial gains. In April–May new issues amounted to about US$4 billion, and secondary market activity was reportedly the highest in over two years. Over the same period, coupon interest rates fell sharply, and the Eurodollar inverse yield curve was largely eliminated. In the deutsche mark sector, the volume of new issues in April (US$660 million) exceeded that in any previous month this year, although the pace slowed in May. The Swiss franc sector has also benefited from investors moving their funds out of money market instruments into longer-term paper, and there has been an acceleration in the flow of new issues; in May, the volume of foreign issues approached US$750 million—equivalent to the record average monthly volume in 1979. In Japan, also, there has been a modest pickup in issue volume, although the issue calendar is likely to continue to be constrained.
In view of the recent bond market developments and the trends in interest rates and in the foreign exchange markets, it is not unreasonable to assume that new international bond issues will reach, or even exceed somewhat, the OECD forecast level of US$30 billion. The strengthening of the international bond markets should help accommodate part of the financing requirements of the smaller-deficit industrial countries and perhaps some of the higher-income developing countries, thus reducing somewhat their demand for international bank credit below the level which was in prospect earlier in the year. Nevertheless, the relative share of deficits financed through the bond markets in 1980 will be well below that recorded in 1975, when international issues doubled.
One broad measure of inflation, the gross national product (GNP) deflator in the United States, is projected to have increased by some 56 per cent, 1974–80, a rate of 7.6 per cent per annum; the increase for most other industrial countries is rather less.
The outlook for oil-related payments imbalance and, inter alia, the implications for the deficit developing countries, were analyzed in some detail by the Managing Director of the Inter-national Monetary Fund in his address before the International Monetary Conference in New Orleans on “Energy and the World Economy: A Medium-Term Perspective” (IMF Survey, June 3, 1980).
OECD, Financial Market Trends, No. 13 (Paris), February 1980.
The London Financial Times index for medium-term Eurobonds, which was at its low point for the year on April 2 (86.32), increased to 92.26 by May 30 (its high point thus far for the year), and the index for long-term issues rose from a low of 71.54 on February 29 to 81.72 on May 30.