Toward a New Foreign Policy.

It is increasingly recognized that both development and debt repayment depend upon stable and long-term capital inflows. Reliability assures realistic cash-flow assumptions and repayment schedules. As crises in the 1980s and 1990s illustrated, private bank loans funded by short-term deposits are not a suitable source of financing for development.

Foreign portfolio investments could provide an expanding source of long-term capital in developing countries if surges in capital flows could be moderated to prevent the boom/bust cycles that have characterized the use of this channel to date. U.S. policymakers should consider promoting measures that limit the destabilizing impact of portfolio investments in foreign markets.

Establishing a closed-end investment fund for emerging markets would be an effective way to address the problems associated with foreign portfolio investment. Closed-end funds contain stabilizing features that make them preferable to open-end funds. The typical, open-end mutual fund issues and redeems its shares on demand, buying and selling assets to accommodate purchases and redemptions. A closed-end fund would provide stable, patient capital to emerging markets. Although shares in the closed-end fund could be traded, share price fluctuations would not prompt purchases or sales of the underlying investments in emerging markets. A closed-end fund would, thereby, help countries avoid problems accompanying surges in either inflows (e.g., rising exchange rates and inflated asset prices) or outflows (e.g., collapsing asset prices and exchange rates).

The fund should be adequately capitalized. Between 10-20% of the value of shares sold to investors should be used to purchase and hold government securities of major industrial countries in amounts roughly proportional to the closed-end fund shares owned by residents of those countries. Thus, the fund would provide a channel for retirement investments and other pooled funds to diversify their holdings and earn a basic, guaranteed return in addition to dividends and interest on investments in emerging market securities.

The fund would issue its own liabilities to private investors. In consultation with developing country governments and citizen groups, it would then buy stocks and debt obligations of private enterprises and public agencies in developing countries. Both the number of countries and the size of the pool should be large enough to ensure diversification.

The creation of one or more public international investment funds would reduce the need for capital controls, especially in countries that choose to accept foreign portfolio investment solely through the proposed fund. The proposed fund would also build the capacity of public and private institutional investors in developing countries to manage their own pension funds. Working together, developing country investors and public international funds could share the cost of investment information and collectively combat the lack of disclosure by domestic issuers in these emerging markets.

Governments must take the lead in laying the groundwork for a closed-end fund. The U.S. government has initiated other public-purpose market innovations, beginning with the Reconstruction Finance Corporation in the 1930s and culminating in the development of the secondary mortgage market in the 1970s. In today's globalized market, it makes sense to devise similar investment and development instruments on an international level.

Management of the proposed fund would be consistent with the charter of the World Bank Group, which facilitates private investment in developing countries and issues its own liabilities in global capital markets. The World Bank or its affiliate, the International Finance Corporation, could be encouraged to partner with governments and civil society organizations to ensure that needs are met for long-term investment and socially and environmentally sustainable development. Given the shifts in channels for international capital flows and their destabilizing impacts on the economies of emerging market countries, a review of current methods and programs for extending assistance to these countries is long overdue. Rather than blindly staying the course of financial liberalization, the U.S. government should promote a new role for public institutions in managing international financial flows and advancing sustainable development.

Key Recommendations

* Establishing a closed-end investment fund for emerging markets would eliminate surges in foreign portfolio investment while harnessing the potential of this foreign investment to provide long-term capital for development.

* Managed by a public international agency, such a fund would focus on the economic performance of enterprises and countries rather than seeking short-term financial returns.

* Holdings of government securities of industrialized countries would provide a capital cushion and guarantee for pension funds and other beneficiaries whose savings are currently at risk.

Sources for More Information

Organizations

Center of Concern
1225 Otis St. NE
Washington, DC 20017
Voice: [phone]
Fax: [phone]
Email: [e-mail]
Website: http://www.igc.org/coc/

Economic Policy Institute
1660 L St. NW, Ste. 1200
Washington, DC 20036
Voice: [phone]
Fax: [phone]
Email: [e-mail]
Website: http://www.epinet.org

Financial Markets Center
Box 334
Philomont, VA 20131
Voice: [phone]
Fax: [phone]
Email: [e-mail]
Website: http://www.fmcenter.org

Globalization Challenge Initiative
9703 Hedin Drive
Silver Spring, MD 20903
Voice: [phone]
Fax: [phone]
Email: [e-mail]

New School for Social Research
Center for Economic Policy Analysis
80 Fifth Ave., 5th Floor
New York, NY 10011-8002
Voice: [phone]
Fax: [phone]
Email: [e-mail]
Website: http://www.newschool.edu/cepa

Overseas Development Council
1875 Connecticut Ave. NW, Ste. 1012
Washington, DC 20009
Voice: [phone]
Fax: [phone]
Email: [e-mail]
Website: http://www.odc.org

Oxfam America
26 West St.
Boston, MA 02111
Voice: (800) 77OXFAM
Fax: [phone]
Email: [e-mail]
Website: http://www.oxfamamerica.org
Contact: Lucy Nichols

Publications

Robert A. Blecker, Taming Global Finance (Washington, DC: Economic Policy Institute, 1999).

Jane D'Arista, "Financial Regulation in a Liberalized Global Environment," available at: http://www.newschool.edu/cepa

Jane D'Arista, "The Debt Trap and a Way Out," available at: http://www.fmcenter.org

John Eatwell and Lance Taylor, Global Finance at Risk (New Press, forthcoming, January 2000).

Susan Strange, Mad Money (Manchester, U.K.: University of Manchester Press, 1998).

World Wide Web

Bank for International Settlements http://www.bis.org

International Monetary Fund http://www.imf.org

World Bank http://www.worldbank.org

Jane D'Arista is Director of Programs at the Financial Markets Center.