UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT DEBT VULNERABILITIES IN DEVELOPING COUNTRIES: A NEW DEBT TRAP? Volume II: Policy Options and Tools UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT DEBT VULNERABILITIES IN DEVELOPING COUNTRIES: A NEW DEBT TRAP? Volume II: Policy Options and Tools Layout and Printing at United Nations, Geneva 1801793 (E) October 2018 635 UNCTAD/GDS/MDP/2017/4 (Vol. II) UNCTAD Volume II DEBT VULNERABILITIES IN DEVELOPING COUNTRIES: A NEW DEBT TRAP? UNITED NATIONSUNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT DEBT VULNERABILITIES IN DEVELOPING COUNTRIES: A NEW DEBT TRAP? Volume II: Policy Options and Tools New York and Geneva, 20182 DEBT VULNERABILITIES IN DEVELOPING COUNTRIES: A NEW DEBT TRAP? VOLUME II: POLICY OPTIONS AND TOOLS UNCTAD/GDS/MDP/2017/4 (Vol II) © 2017, United Nations This work is available open access by complying with the Creative Commons licence created for intergovernmental organizations, available at creativecommons/licenses/by/3.0/igo/. The findings, interpretations and conclusions expressed herein are those of the authors and do not necessarily reflect the views of the United Nations or its officials or Member States. The designation employed and the presentation of material on any map in this work do not imply the expression of any opinion whatsoever on the part of the United Nations concerning the legal status of any country, territory, city or area or of its authorities, or concerning the delimitation of its frontiers or boundaries. Photocopies and reproductions of excerpts are allowed with proper credits. This publication has not been formally edited. United Nations publication issued by the United Nations Conference on Trade and Development.3 ABOUT THE AUTHORS ABOUT THE AUTHORS David Bicchetti is an Economic Affairs Officer at UNCTAD. He joined UNCTADs Macroeconomic Branch in 2010 where he focuses his interest on the interactions between financial markets and information flows and their influence on price discovery mechanisms. Before joining the United Nations in 2009, he worked as a researcher at the Swiss Institute of Technology in Lausanne and is the co-author of several studies on post-Kyoto protocol mechanisms and their impacts on the world economy. David Neto is a Researcher at the Institute of Economics and Econometrics at the Geneva School of Economics and Management, University of Geneva. He has published in leading economics and science journals, including the Oxford Bulletin of Economics and Statistics, Economic Notes and Physica A. Martin Guzman is an Associate Research Scholar at Columbia University Graduate School of Business, and an Associate Professor at the Department of Economics at University of Buenos Aires. He is also a member of the Institute for New Economic Thinking Research Group on “Macroeconomic Efficiency and Stability” (chaired by Prof. Joseph Stiglitz), a co-chair of Columbia Initiative for Policy Dialogues T askforce on Debt Restructuring and Sovereign Bankruptcy, and a non-resident Senior Fellow at the Centre for International Governance Innovation. His research fields are Macroeconomics, Sovereign Debt, and Economic Development. Jan Kregel is director of research at the Levy Economics Institute, Director of the Levy Institute masters program in economic theory and policy, and Head of the Institutes Monetary Policy and Financial Structure program. He also holds the position of professor of development finance at Tallinn University of Technology. In 2009, Kregel served as Rapporteur of the President of the UN General Assemblys Commission on Reform of the International Financial System. He previously directed the Policy Analysis and Development Branch of the UN Financing for Development Office and was deputy secretary of the UN Committee of Experts on International Cooperation in Tax Matters. His major works include a series of books on economic theory, among them, Rate of Profit, Distribution and Growth: Two Views (1971); The Theory of Economic Growth (1972); Theory of Capital (1976); and Origini e sviluppo dei mercati finanziari (1996). In 2011, Kregel was elected to the Accademia Nazionale dei Lincei, also known as the Lincean Academy, the oldest honorific scientific organization in the world. He is a life fellow of the Royal Economic Society (UK) and an elected member of the Società Italiana degli Economisti. 5 CONTENTS About the authors 3 Introduction 7 References 13 MONITORING FINANCIAL STABILITY IN EMERGING AND FRONTIER MARKETS DAVID BICCHETTI AND DAVID NETO . 15 Introduction 16 I Literature review of financial/economic composite indexes 17 A. Existing FCI/FSI for emerging and frontier markets . . 18 B. Existing FCI/FSI for developed markets . . 18 II Methodology 19 III Data and summary statistics 20 VI Estimation method 20 V Results 21 VI Conclusion 22 Acknowledgments 22 Notes 29 References 30 CONTINGENT INSTRUMENTS IN SOVEREIGN LENDING MARKETS MARTIN GUZMAN. 33 Introduction 34 I Sovereign Credit Default Swaps 35 A. Market completion and efficiency gains . 36 B. Interpretation of SCDS contracts . 36 C. Argentinas litigation dispute and the opaque SCDS markets . 37 D. The EU ban of naked SCDS . 38 II GDP indexed bonds 43 A. The current debate . 43 B. The case of Argentina . 44 III Conclusions 46 Appendix 47 Notes 52 References 53 CONTENTS6 DEBT VULNERABILITIES IN DEVELOPING COUNTRIES: A NEW DEBT TRAP? VOLUME II: POLICY OPTIONS AND TOOLS THE CLEARING UNION PRINCIPLE AS THE BASIS FOR REGIONAL FINANCIAL ARRANGEMENTS IN DEVELOPING COUNTRIES JAN KREGEL . 57 Introduction 58 A. Evolution of the International Financial System . 58 B. Developing Countries and the International Financial System . 59 C. National and International Monetary Systems . 60 I Bretton Woods and its problems 62 A. The Bretton Woods System and Developing Countries . 63 II The Banking Principle and Financial Institutions 66 III The Banking System at the International Level: Keyness Clearing Union 68 IV The Experience of the European Payments Union 71 A. The Return to Multilateral Settlement in Europe under the Marshall Plan . 71 B. The European Payments Union as Part of the ERP . 74 C. A Central American Payments Union and Proposals for Asia . 76 D. Payments and Settlements Systems for Development: UNCTAD . 78 V Representation of Trade Flows between Various Regional Groupings, 19952014 79 A. BRICS . 80 B. Mercosur .82 C. Latin American Integration Association (LAIA) . 83 D. ASEAN . 84 E. ASEAN + China, Japan, Korea . 85 VI Dealing with Capital Flow 87 VII Relations between Regional Unions and the Rest of the World and the Multilateral Organisations 88 VIII Other Logistical Matters 89 Statistical Appendix 90 Notes 91 References 917 INTRODUCTION Yet again, unsustainable international debt burdens haunt the developing world and are fast becoming a core obstacle to the international community delivering on its repeated promises to enable sustainable development finance. For the best part of two decades, the driving motor of the global economy has been debt, issued on a whim and traded for speculative purposes, rather than backing productive and long-term investment, including into the structural transformation of developing economies. With the worlds total gross debt-to-GDP ratio nearing 250 per cent (BIS 2017: 283) and global debt stocks surpassing their record level at the onset of the global financial crisis (US $ 142 trillions) by over US$ 80 trillion in 2017, it is little wonder that international financial markets continue to show periodic nerves, and policy-makers in lead economies struggle to stabilize an increasingly volatile, fragmented and unbalanced global economy. Advanced economies still hold the largest share of these debt stocks. This is as it should be in a context of sluggish recovery from a global economic crisis and impending stagnation. Yet, such continued dependence of world economic growth on debt, for the most part fuelling short-term speculative rather than long-term productive investments, is a constant source of instability as well as escalating income inequities. Governments in the core economies have been unwilling to tackle the systematic removal of toxic debt burdens, accumulated in the run-up to the global financial crisis of 2007/08, from non-bank private sector balance sheets in a comprehensive and orderly manner. In addition, with an irrational addiction to fiscal austerity, in particular in Europe, this has resulted in a surge of highly volatile international flows of cheap credit emanating from an excessive reliance on expansive monetary policies in these economies. Not only have these policies failed to ensure a fast and lasting economic recovery based on closing the global demand gap, but the negative spill over effects of persistent deflationary tendencies in advanced economies and global financial fragility have by now had a profoundly disruptive impact on developing economies prospects of sustained structural transformation. In this context, the growing stock of debt incurred by developing countries and transition economies estimated to have reached $7.64 trillion in 2017, an increase of over 80 per cent since 2009 is bound to become a serious liability for their immediate future. While external debt-to-GDP ratios remain relatively low by recent historical standards, on average rising from 21 per cent in 2009 to 26