Faculty of Economics

Cambridge Working Papers in Economics

CWPE #1539

Why corporations in developing countries are likely to be even more susceptible to the vicissitudes of international finance than their counterparts in the developed world: A Tribute to Ajit Singh

José Gabriel Palma

All things considered, anything up to US $7 trillion of so-called quantitative easing (QE) funds has flooded emerging markets since the 2008 global financial crisis. These funds, created to stimulate a recovery in the OECD and to stabilise international financial markets, ended up mostly as emerging markets’ corporate bonds and loans (often after being leveraged into many multiples of their original value). They were then either mainly invested (Asia), or used (as in Latin America and South Africa) at best to finance economic activities which do not enhance productive capacities, such as residential construction, or used to finance deficits, M&A, capital flight and all sorts of financial deeds - including as fuel for any conceivable asset bubble. The enquiries of these issues, especially how corporations financed their investment, and how much of it took place, were subjects that fascinated Ajit. He was the first to find out that corporations in emerging markets relied much more on external finance than those in the OECD (where retained profits played a major role). The implication was that they were likely to be even more susceptible to the vicissitudes of financial markets - and as these became ever more weird (the almost inevitable outcome of hasty deregulation cum excess liquidity), the financial balances of corporate sectors north and south of the Equator ended up moving in opposite directions further than ever before. This is a key (if not the key) difference between current global financial fragilities and those at the onset of the current global financial crisis in 2007. This highly asymmetric corporate balance scenario is part and parcel of such a low interest rate and highly financialised environment, as now (among other things) so-called “investors” in search for elusive yields, inevitably have to take on more risk, leverage and illiquidity. And emerging markets have always been their markets of last resort. This is a vital (yet only implicit) ingredient of the peculiar ideas behind super-accommodative monetary policy; but the downside is the risk of more volatile asset prices (including commodities), and unchartered financial fragilities all over. Closer regulatory scrutiny worldwide, therefore, should have been an intrinsic part of such risky reflationary and monetary policies. But try to get speculators, traders and rentiers (or politicians in need of donations) to understand something, when their (shortterm) earnings, bonuses, share options and corporate-sponsored retirement plans depended on them not understanding it. The stakes for emerging markets’ corporations, their economies, financial markets and wider society (and everybody else in the world for that matter) could scarcely be higher - but unfortunately these huge new challenges occur at the worst possible time, as our social imagination has seldom been so barren.

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