Financing the transition: Risks and benefits of integrating into the international capital market

This paper surveys the theoretical and empirical evidence on capital account convertibility and assesses its relevance for the reform states of Central and Eastern Europe. Its major findings are that domestic investment conditions matter and that domestic policies can reduce the risk of an abrupt reversal of capital flows. Policymakers must stand ready to adjust the exchange rate but also their fiscal and monetary policies once signs of overheating appear. The effectiveness of controls on capital flows is highly questionable. Moreover, capital controls raise the irreversibility of investment projects and may cause the postponement of investment decisions. The countries under review have made substantial progress towards capital account convertibility and should continue on this track as they strive for membership in the EU.

European financial integration and corporate governance

The paper studies the link between the integration of European financial markets and corporate governance in Europe. The focus of the paper is on how integration affects the interplay of ownership structures, capital structures, and monitoring, all of which can be used to govern agency problems at the firm level. Integration is a process which comprises the abolition of capital controls, the harmonization of institutions, and the creation of a common currency area. These elements, in turn, affect the liquidity of markets, the cost of monitoring, and the cost of debt. Based on these considerations, implications for changes in the structure of corporate governance systems are derived. --corporate governance,complementarity,financial integration

The end of the Czech miracle? Currency crisis reveals need for institutional reforms

After years of high growth, low unemployment and low inflation, the Czech economy has suffered a sudden setback. Speculative attacks on the currency have forced the Central Bank to abandon its fixed exchange rate. The government has now announced austerity measures to reduce the massive current account deficit. In the short run, these measures will lead to lower growth and higher unemployment. Moreover, the devaluation of the Czech Koruna will make it more difficult to further reduce inflation. The crisis is due in part to the previous boom in domestic absorption. The expansion of absorption has been fuelled by massive capital inflows which helped to maintain the fixed exchange rate. At the same time, productivity growth has been sluggish despite high investment-to-GDP ratios, and wages have increased substantially despite sluggish productivity growth. These developments have contributed to the overvaluation of the exchange rate. As a result, the competitiveness of the tradables sector has been weakened, and the current account deficit has widened dramatically. The policy measures now announced aim at reducing domestic demand by cutting fiscal expenditure, raising taxes, devaluing the currency, and containing wage growth in the public sector. However, the government has so far failed to address the microeconomic issues that are at the heart of these supply-side problems. These include inefficiencies in financial intermediation, ineffective bankruptcy procedures, and weaknesses in the corporate governance of enterprises resulting from mass privatization. Solutions to the problems in the banking and financial sector should comprise tax incentives for banks to provision for loan losses, decentralized debt restructuring, the streamlining of bankruptcy proceedings, upgrading of the court system's resources, and a greater political will to enforce the existing bankruptcy legislation. Opening up for foreign banks more decisively and in particular allowing foreign banks to participate in the privatization of the large commercial banks can help to improve the efficiency of the banking system and the corporate governance role of banks. In order to encourage funds to manage their portfolios for the benefit of investors, funds should be encouraged to register as open-end unit trusts rather than as joint stock companies. On the macroeconomic level, the government is moving in the right direction. As regards the medium term outlook, fundamentals of the Czech economy remain strong. However, decisive and timely action to improve the institutional framework is needed if the economy is to overcome the present crisis and to reach a new, sustainable growth path. --

The value of waiting: Russia's integration into the international capital markets

Capital flight has characterized the transformation process in Russia. Inflows of foreign direct investment have been minor and have been preceeded by inflows of portfolio capital. The paper shows that uncertainty about macroeconomic stabilization exhibits a strong negative effect on the volume of capital inflows when investment decisions are irreversible. Reducing uncertainty may but must not necessarily lead to more investment. The fact that monetary stabilization policies have not been accompanied by comprehensive institutional reforms can explain the pattern of Russia's capital flows in general and the dismal performance in attracting foreign direct investment in particular.

Taxing short-term capital flows - An option for transition economies?

This paper discusses whether the implementation of a tax on short-term capital flows can make the transition economies of Central and Eastern Europe less vulnerable to adverse external shocks and to sudden withdrawals of foreign capital. The following section outlines the main arguments which are advanced by the supporters and opponents of a transactions tax on foreign capital flows. We also develop a simple theoretical framework which allows us to study the effects of a tax on capital inflows. The model reveals that it is important to distinguish between two effects of a transactions tax. On the one hand, a transactions tax might be a useful tool to discourage destabilizing trading strategies on the foreign exchange market. On the other hand, it should be taken into account that a tax on foreign capital flows pushes the economy to a new steady state. This induces an overshooting of the exchange rate if super efficient financial markets react faster than goods markets. Thus, the implementation of a transactions tax by itself can be viewed as a source of additional (excess) volatility of the exchange rate. Section 3 briefly discusses the experience of Chile which maintains a deposit requirement for short-term capital inflows. Section 4 gives an account of the structure of capital flows of the transition economies and of the restrictions which currently pertain to the capital account of the balance of payments. We restrict our analysis to four of the more advanced reform countries – i.e., the Czech Republic, Estonia, Hungary, and Poland – because the policy issues of high capital inflows are most relevant for these countries. Section 5 concludes. -- Die Währungskrise, die in den letzten Monaten Asien erschütterte, zeigte einmal mehr, wie riskant es sein kann, aufstrebende Marktwirtschaften in den internationalen Markt mit einzubeziehen. Der vorliegende Diskussionsbeitrag befaßt sich mit der Frage, ob es sinnvoll wäre, den Kapitalzufluß in Transformationsländer durch Steuern zu regeln. Anhand von Grafiken und Tabellen werden die Entwicklung und der Verlauf von Finanzströmen verdeutlicht.

Southern enlargement of the European Union and capital account liberalization: Lessons for Central and Eastern Europe

The integration of the central and eastern European countries into the international capital markets has been and will be determined by the process of European Union (EU) integration. Our analysis shows that southern and eastern European countries already appear to be surprisingly similar regarding FDI flows from EU members. The central and eastern European countries, however, are likely to attract increased portfolio flows in the years to come. We argue that membership alone in a regional arrangement like the EU is neither sufficient for sustained capital inflows nor is it the guarantee for increased investment activities. Rather, domestic economic policy has to change in accordance: Liberalization matters, not only membership.Capital Account Liberalization,European Union Enlargement,Capital Flows,Eastern Europe,Economic Growth

Globalisierung der Finanzmärkte: Freier Kapitalverkehr oder Tobin-Steuer?

Freier internationaler Kapitalverkehr kann eine Reihe von positiven Effekten auf die wirtschaftliche Entwicklung haben. Kapital wird in die produktivsten Investitionsprojekte gelenkt, Investitionsrisiken werden gestreut, neue Technologien verbreitet, und effiziente Finanzsysteme können sich entwickeln. Dies macht eine Integration in die internationalen Kapitalmärkte attraktiv – nicht zuletzt auch für Länder in einem relativ frühen Entwicklungsstadium. Allerdings stehen diesen Vorteilen auch Risiken gegenüber. Eine Öffnung für internationales Kapital kann dazu führen, Zahlungsbilanz- und Währungskrisen über den internationalen Kapitalverkehr auf eigentlich unbeteiligte Drittländer zu übertragen. Zudem kann eine vergleichsweise schnelle Anpassung der Finanzmärkte zu einer Fehlleitung von realwirtschaftlichen Ressourcen führen. Häufig wird daher eine stärkere Besteuerung kurzfristiger Kapitalströme als Abwehrmaßnahme gegen diese Risiken gefordert. Vielfach beruft man sich dabei auf einen Vorschlag von James Tobin, der in den siebziger Jahren dafür plädiert hatte, durch eine Steuer auf Devisenmarkttransaktionen „Sand in das Getriebe der internationalen Geldmärkte zu streuen“. Allerdings ergeben empirische Untersuchungen kein klares Bild darüber, wie sich Steuern auf internationale Kapitalströme auswirken und ob sie nicht sogar unerwünschte Nebenwirkungen entfalten können. Grundsätzlich können durch diese Steuern spekulative Angriffe auf überbewertete Währungen nicht verhindert, sondern bestenfalls aufgeschoben werden. Zudem ist es angesichts der technologischen Entwicklung auf den internationalen Kapitalmärkten relativ einfach, einer solchen Steuer auszuweichen. Inwieweit die Vorteile des freien Kapitalverkehrs tatsächlich genutzt und die Gefahren eingegrenzt werden können, hängt in entscheidendem Maße von der inländischen Wirtschaftspolitik ab. Kernelemente einer erfolgreichen Integrationsstrategie sollten strukturelle Reformen sein, die auf makroökonomischer Ebene überbewertete Währungen und zu hohe Außenhandelsdefizite vermeiden helfen. Im mikroökonomischen Bereich sollten die Anreize so gesetzt werden, dass eine hohe Verschuldung in ausländischer Währung vermieden wird. In vielen sich entwickelnden Volkswirtschaften müssen hierzu das Bankensystem und die Bankenaufsicht reformiert werden. Zudem sollte eine klare und transparente Informationspolitik gegenüber den Märkten betrieben werden. --

Russia's Debt Crisis and the Unofficial Economy

Russia's foreign debt problems worsened substantially after the financial crisis of 1998. The paper focuses on the key role of the government in servicing foreign debt and promoting institution building by showing how foreign debt influences the choice between official and unofficial taxation. The enterprise sector is assumed to reallocate its resources between domestic investment and capital flight. It is discussed under which conditions debt rescheduling may create incentives for the government to promote institution building. The results of this paper shed light on the conditions under which the recent agreement with the London Club to write off substantial amounts of former Soviet debt can be successful.Foreign debt, debt restructuring, Russian Federation