Asset Accumulation By Emerging Countries

By M. Isi Eromosele

The evolution of accumulation of external assets by emerging countries is significant. In recent years, their asset accumulation has picked up strongly and has been remarkably broad-based. Combined with changes in liabilities, the net result is that emerging countries have become net capital exporters to the developed world, running a hefty current account surplus. The upsurge in the acquisition of foreign assets by emerging nations can be evaluated through three dimensions:

An increase in FDI. As globalization is leading developed countries to invest in emerging nations, many emerging country companies are also investing both in high-income countries as well as other emerging companies
An increase in private investment in other assets. This includes outward investment flows from the resident private sector
A hefty increase in foreign exchange reserves. The gross foreign exchange reserves of emerging nations has risen by an average of $70 billion a year in recent years

The acquisition of substantial foreign assets by individuals, companies and governments from emerging countries have some positive implications. Most prominent is the opportunity for them to diversify away from local business cycles, reducing their risks. By maintaining high levels of foreign exchange reserves, governments in emerging countries establish a financial cushion that enables them to better ride out shocks in the global financial system.

The high level of East Asian foreign exchange reserves built up in the aftermath of the 1997-1998 Asian financial crisis illustrates why these countries were able to avoid much of the stresses and strains suffered by many other countries during the most recent global financial downturn.

However, there are other troubling aspects to be considered in the acquisition of substantial foreign assets by the private as well as public sectors in emerging countries.

Emerging countries need to mobilize their savings. Leakage of capital abroad diminishes the savings available to fund domestic economic activities. It should be noted that high external reserve holdings come with a significant interest rate carrying cost. While most countries invest their foreign exchange reserves in safe short term assets, such as U. S. Treasury bills. However, the yields on these instruments are relatively low, well below the interest rates emerging countries pay on their debt.
High foreign exchange reserves imply a fear of floating. The move from pegged exchange rates to floating exchange rates has given emerging nations a greater flexibility. While a floating rate system does offer many advantages, it has been accompanied by an increased precautionary demand for foreign exchange reserves.

Living With Less Debt

Emerging countries, in aggregate, have been net lenders to developed countries. They have remained heavily reliant on FDI to finance both their debt repayments to private creditors and their acquisition of foreign assets, both private and official. This is not necessarily desirable. Key flows have to adjust to shifts that have occurred since 2008.

The stock adjustments expressed by the change in capital flows, notably the pay down of private sector debt need to be taken into consideration. When they are completed, capital flows will surely move to a different pattern, probably one that again favors higher debt flows relative to equity flows. This shift is likely to begin in 2013, with net debt flows to the emerging world from private sources turning modestly positive once again.

Meanwhile, a change in global policy will have to be implemented that ensures that current shifts involve the least pain possible, and that the pattern of flows that emerges from the process of stock adjustment is one to put development finance on a more solid footing than it has been during recent years.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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