Thursday, 18 August 2011

Swiss National Bank might have a look at Chile's 'encaje'

With North Atlantic sovereign debt crises frightening investors around the world and with resource-backed currencies weakening as well, the only place to hide in the industrialised world seems Japan and Switzerland these days. Since late 2007, the Swiss franc has thus been rising relentlessly - up to some 60% against the Euro, the currency used by the bulk of its trading partners. Watchmakers, pharma and tourism are reeling.

While Japan is a big economy and thus relatively closed, Switzerland is a typical small open economy of which the emerging-markets sphere abounds. In a world of full capital mobility, small economies in particular confront the problem of the 'impossible trinity': they must give up on one of three policy goals - monetary independence (price stability, that is); stable exchange rates (that allow the real economy to compete); or free capital markets. They cannot have all three at once.

I understand that currently the SNB is debating the idea to peg the Swiss franc to the Euro. That policy has repeatedly proven quite dangerous. The central bank would give up monetary control as it would have to buy up foreign exchange to defend the exchange rate; sterilising those inflows so as to avoid an unfettered rise of the monetary base would starve the local economy of domestic credit. Worse, the peg would amount to a one-way bet to currency speculators should the Eurozone disintegrate further (which cannot be excluded after this week's disappointing Franco-German summit at the Elysée) until a two-speed Europe is fully put in place. So what should the Swiss do?

Once again, the North can learn from the South. In 1991, Chile's central bank imposed a one-year unremunerated reserve requirement (encaje) on foreign loans. Subsequently, the rate of the encaje was increased to 30 per cent and its coverage extended to cover virtually all foreign inflows except foreign direct investment. The one-year minimum holding period effectively implied a tax on inflows, inversely tied to their maturity. Prudential regulation complemented these curbs on inflows. Except for trade credits, banks could not lend domestically in foreign currency. And maximum open foreign exchange positions were set at 20 per cent of banks’ capital and reserves. As short-term flows dried up in 1998, the encaje was reduced to 0 per cent, but not abolished. As it is difficult to quantify the intensity of inflow restrictions and to control for prudential regulations, macroeconomic policies and other conditions that impact on capital inflows, the effectiveness of Chile’s measures was hotly debated then. Banco Central de Chile (thanks to Klaus Schmidt-Hebbel, then Head of Research) provided the OECD Development Centre in 1999 with a set of unpublished internal studies on the impact of the encaje*. These authoritative studies did show that the encaje had been effective in providing some monetary autonomy and in influencing the mix of capital inflows. The Swiss should try.

* Helmut Reisen (1999), After the Great Asian Slump: Towards a Coherent Approach to Global Capital Flows, OECD Development Centre Policy Brief #16.

Friday, 12 August 2011

Indicators of Hard and Soft Infrastructure in China-Heavy Africa

The New Structural Economics developed and promoted by  World Bank Chief Economist Justin Jifu Lin grants an important role of the government in growth facilitation, through the provision of hard (adequate networks of road, rail and air transport and communications, electricity grids and other public utilities) and soft (basic governance including competitive market institutions, financial  system and regulation, basic health, and primary and secondary education services including vocational training) infrastructure. Because of externalities and their public good character, this is indeed the core legitimate domain of the government. The adequacy of physical facilities and the cost-effectiveness of operation and delivery of corresponding public services cut down transaction costs for the private sector and strengthen its competitiveness.

Variation of Indicators of Hard and Soft Infrastructure in China-Heavy Africaa                                                                                                
Country Group
WORLD BANK GOVERNANCE INDICATORS, change 2008vs2005                                                                           

IFC Cost of Doing Business,
2010 vs 2006   

Regulatory quality
Government effectiveness
Rule of law
Corruption control 
Days to export
Days to import
Average variation China-heavy Africa






Average variation






a) Countries where China dominated foreign investment in the mid 2000s (Benin, Congo DR, Ethiopia, Guinea, Libya, Niger, Rwanda, Sudan, Zambia) according to the Heritage investment tracker.

The Table focuses on identifying possible differences in ‘soft’ (governance) and ‘hard’ (the ease of foreign trading, as a proxy for transport infrastructure)  between country groups with heavy Chinese investment and an averag for all-Africa. The data are derived by the World Bank World Governance Indicators and the IFC Cost of Doing Business Indicators. Note that the underlying averages are unweighted and hide a lot of country variation;  they should not be taken as  statistically significant results. Yet they serve to put into context pronouncements such as by the US Secretary of State Hillary Clinton at a recent state visit to Zambia who warned again ‘new colonialism’ in Africa, refering to China:

“We don’t want them to undermine good governance in Africa.”

The Table shows that African countries qualified as China-heavy (where China dominated foreign investment in the mid 2000s according to the Heritage investment tracker) did clearly better in terms of changes in  ‘soft’ infrastructure:  regulatory quality; government effectiveness; rule of law; and corruption control. Also the IFC Cost of Doing Business data that are not distorted by US dollar variations and can be taken to at least partly represent changes in transport infrastructure, namely days needed to import, resp. export, indicate greater improvements in countries where China engaged more strongly than elsewhere. While this does not tell us anything about causation, it can be assumed that these data reflect the impact of China’s development cooperation.

A new OECD Development Centre Working Paper (#302) by Myriam Dahman Saidi and Christina Wolf analyses the Asian mode of development co-operation that is progressively gaining momentum in poor countries. Asian mode development co-operation usually relies on project rather than programme aid and targets infrastructure and industrial rather than social sectors. Chinese ‚Aid‛ is in fact perceived more as one of several tools aiming at laying the ground for enhanced bilateral trade and private-sector activity, enabling governments to reduce the risk of market entry for companies and to provide the necessary infrastructure to reduce operational costs.

Being largely complementary to the actions of established donors, this new philosophy is associated to a range of new opportunities for African countries, notably with respect to filling the infrastructure gap, the development of the rural hinterland, finance modalities that combine the longer-term horizon of public actors with the profit-oriented private sector and the possible spill-over effects from the new entrepreneurial diaspora.

Saturday, 6 August 2011


Some noteworthy comments:

FT Lex stays calm...

and already in June 2009:

Monday morning US Treasury futures update. The market reacts as perversely as could be expected as the 10-year yield tumples from 2.60 to 2.50%.

Monday night: Obama says we will always be AAA (Hey teacher, leave us all alone...!)
It is true that the US can print $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$...indefinitely.

Tuesday, 9th August: $ weakens against safe haven currencies (the result of the prospect of the Fed printing $$$$$$$$$$$$$$$$$$$$$$$$$$$$ - or QE3), and two statements that are noteworthy:

Paola Subacchi (Chatham)

Prof Willem Buiter (Citi), in a note 9th August (no hyperlink here), pronounces
The US sovereign downgrade was both expected and appropriate, in our view.
The roots of US fiscal unsustainability date back to 2001.
Absolutely safe assets no longer exist.
The other AAA-rated G7 sovereigns are all at risk of a downgrade, with the markets focusing particularly on France.In the emerging Brave New World without AAA G7 sovereigns, relative safety guides portfolio allocation decisions.

The ABC of the US Triple-A Downgrade and of Others to Come