Role of International Credit in Contemporary Economies
Money works as the medium of exchange through trade.People use money for food and housing in different forms like bank deposits, cheques, credit cards and cash etc. Credit markets grow through the interaction of lenders and borrowers for balancing income and spending. Banks create the market with the joint cooperation of lenders and borrowers. A country can have more or less income than its capacity of investing. So one country can be a complete lender and another country can be a complete borrower through international loans. International banks play important role in international credit flow. Every country has its own loan market but all the countries are benefitted by ‘international credit market.’As the interest rate is the return on a loan and cost of borrowing, the international interest rates originate from international lending and borrowing. The main issue of international credit market is to compare real interest rates in all the countries. The foreign countries have special borrowers and lenders with their own plans and perceptions for future (Henry Thompson, 2006).
During 1890s the international credit markets were incorporated very well but the two World Wars and Great Depression upset them. In 1950s and 1960s the output of international investment became very low and now since the late 1970s, the growth of international investment can be observed but it’s not actually very high, instead, it’s below the level of hundred years ago. The free markets of foreign exchange and investment can support the growth of international capital flow but many governments donot believe in the strategies of free markets (Henry Thompson, 2006).
The prerequisites to the rise of international credit
A country functions in a world credit market like an individual who works for the credit market of the closed market economy. Suppose the home country initially does not have a single balance in its current account and due to some temporary supply shock everyone in the country needs to borrow money, they borrow it at the initial real interest rate. If the home country does not have big economy, then the international credit market can have the increase in borrowing with no change in the world’s real interest rate (Robert J. Barro, 1997).
During 1990s, particulary in developing countries, international financial flows burst out. The economic growth which has happened through the capital flow into countries like Mexico has brought changes into the lives of many people. In the early 1990s the financial liberalization brought a little capital flow into Thailand and Philippines for the time being. During this period it could be observed that the financial flow in developing countries was greater from public institutions like the World Bank to the private sources like the Citicorp. In the course of 1990 and 1996 the debtor countries like US and institutions like World Bank and IMF thought to open their stock market for the foreign investors for developing their financial market (Sarah Anderson, 1998).
In the middle of 1997, due to Asian financial crisis, the currencies and stock market dropped by one-third in seven nations. Three of them were the “newly industrializing economies” (NICs): Hong Kong, Singapore and South Korea and the other four were Malaysia, Indonesia, Thailand, and the Philippines (Sarah Anderson, 1998).
Then the time came when the international financial system started improving after Asian crisis and Mexican peso crash and the supporters was economic globalization were encouraged to participate in the debate about the requirement of the “new architecture of the international financial system”- the name given by the Treasury Secretary Robert Rubin (Sarah Anderson, 1998).
The nature and necessity of international credit
It is necessary to know the importance of international credit market which is advantageous for borrowers and lenders both. The market encourages borrowing countries to spend more than their income. The probability of lending abroad gives chance to the countries to achieve higher rates on their savings than that would be available in their home countries. Though there have been major defaults on foreign loans, still the existence of the international credit market can be considered as a good thought on the whole (Robert J. Barro, 1997).
A ‘perfect’ international credit market is the one which has the real interest rate same for each country (Robert J. Barro, 1997). International Financial Intermediation happen when banks put lenders and borrowers together in different countries. Borrowers are in a better position at home because there they can take loans at a lower rate and lenders are in a better position in the foreign country because here they can achieve higher interest. Alternatively, lenders in their home country get lower interest as they have competition with foreign lenders and the borrowers in the foreign countries pay more as they have competition with their home country borrowers (Henry Thompson, 2006).
Lenders gain and borrowers lose in the foreign country. International gains are calculated by doing the total of all the gains of each country (Henry Thompson, 2006). The International Credit Market and the Foreign Exchange are very much related to each other. Exchange rates put impact on the direction of international finance. In the case of home currency’s depreciation, foreign investors can buy more stocks or bond in their home country as they will become cheaper (Henry Thompson, 2006).
Forms of international credit
The forms of credit have been recognised as consumption, investment and speculation. Inernational credit is being used by speculators, investors and consumers through international trade. Globalization is bringing up these forms of credit to exercise deals among various countries around the world. Stock markets, credit rating agencies all are playing a major role in world credit market.
The relative significance and functions of each form of international credit
The economic reports say that government borrowing has intention to increase business invetments but it’s also seen that consumer borrowing have negative impact on business investments. The American policy makers and the economists for consumers spending think that the economic growth is under the influence of Keynes. Actually, it originated during 1920s which was long before Keynes. During the same period the capitalistic economy struggled a lot due to lack of consumer income and demand ((Dr. Kurt Richebächer, 2006).
According to William Trufant Foster and Waddill Catchings “Money spent in the consumption of commodities is the force that moves all the wheels of industry” and “The one thing that is needed above all others to sustain a forward movement of business is enough money in the hand of consumers” ((Dr. Kurt Richebächer, 2006).
It was believed that it would be easier to increase in consumer credits so the deficiency in buying power of the consumer and the reason of the Depression could be eliminated. In the end of the twentieth century investment spending and employement in the capital goods industries also played an important role. Some econimists found out the significance of deviations in business investments to decide economic growth ((Dr. Kurt Richebächer, 2006).
Tugan-Baranowski brought new thinking in business cycle in Europe and it was accepted that economic growth depends upon the independent capital investments. In the past few years the American policies have encouraged private consumption. Economic growth is being considered to be dependent upon consumer spending which is subjected to the rising prices of houses that guarantee the most consumer borrowing as the income growth has crashed and the borrowing has become very important. American policy makers and economists feel that the four credit bubbles: bonds, house prices, residential building and mortgage refinancing are damaging economy so we need to focus on the income growth (Dr. Kurt Richebächer, 2006).
The current debt or consumer credit in the US is blowing up and encouraging foreign financing but same weigtage is also being given to domestic financing because it redirects domestic spending to foreign producers that creates corresponding loss to domestic producers. This situtaion is balanced by credit creation (Dr. Kurt Richebächer, 2006).
After discussing credit for consumption we will move on the next form which is credit for investment. Some people think that there is a difference between borrowing for capital investment and borrowing for consumption. On the other hand the researches say that credit for capital investment produce collective employment and income growth and here debt growth is not much but credit for consumption produce mixed debt growth with less income growth and employment (Dr. Kurt Richebächer, 2006).
When businesses take credit for fixed investments it puts effect on the production of the buildings, plant and the equipments that creates corresponding employment, solid wealth and income. After the installation of capital goods it gives extra employment, supply, productivity and income. Investment spending affects consumer credit. Once it is spent, their economic effects decrease. If there is any new increment in spending it needs new credit. Consumer borrowing is important for them who want high future income (Dr. Kurt Richebächer, 2006).
Now we move to credit for speculation which is supposed to be ‘bad credit’. It is considered to be a bad idea to influence investment excessively. In 1993 Israel’s stock market crashed because the banks were giving excess credits to the customers to invest in mutual funds. Too much lending of the banks damaged the market. There are many examples of this kind of speculation. American property speculators spent their credit money to buy second and third apartmentsjust to sell them on more profit than they paid for them. Israeli property speculators also did the same (Doron Tsur, 2009).
After the stock market bubble of the 1920s, the renowned British economist John Maynard Keynes wrote, “Speculators will not be harmful since bubbles are on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation,” which proves to be true even today itself (Doron Tsur, 2009).
Excessive cheap and easy credits like stock markets, the real estate markets and commodities create speculative bubbles (Doron Tsur, 2009).
Economic agents and institutions that participate in international credit market
Economic agents like Moody, Standard & Poor and AM Best are playing major role in international credit market through credit ratings.Credit ratings are used to check credit risks. S&P’s ratings focus on the ability and willingness of an issuer that may be any corporation, state or city government. It checks if such types of organizations meet with the financial obligations fully and promptly. The international credit rating agency like S&P is also specialiazed in a geographical region or industry (Guide To Credit Rating Essentials, 2009).
While doing its rating analysis, S&P evaluates current and historical information and also analyzes the possible impact of future events. For example while rating a corporation, the agency checks its business status and evaluates the credit worthiness of that corporation. The credit ratings given by S&P donot indicate any kind of investment merit. They just see one aspect of an investment decision which is credit quality. They also attend to some cases if the investor can recover from the event of default (Guide To Credit Rating Essentials, 2009).
The financial crsis in the United States and high prices of commodities are discouraging government and private companies of the region to produce income so the prominent investors are becoming hesiatant in investments. According to Clara Lau, Moody’s chief credit officer for Asia Pacific,’it will be challenging now to access to funding specially for low and speculative grade firms because tight market liquidit is being worsening due to US financial crisis’ He further mentioned that ‘rising costs and drop in consumer demand regionally and globally demoralizing the credit metrics of these isuers’ (Michelle Remo, 2008).
The impact of international credit on domestic economies
The effect of growth in liquidity preference and the rise in speculative activities have increased interest rates in international financial markets with incidental effects on domestic market (Johan Deprez & John T. Harvey, 1999).
A foreign lender expects an equal treatment with domestic lenders. Generally, the rights of lenders and of a firm’s equity holders differ internationally (Pranab K. Bardhan, 2003).
When the credit and money become the center of attention, then the differences in doemestic banking system turn out to be important contradicting the assumed homogeneity of global monetarism. The nature of domestic banking system needs to be understood when we take into consideration the impact on domestic economies of higher interest rates and the decisions of international banks in regard with credit availability. According to Monetarist theory the inflow of foreign exchange is homogeneous that adds to the reserves of the doemstic banking system and is multiplied in an expansion of domestic credit. Gross substitutability between assets, domestic and foreign makes sure that doemstic interest rates will respond to international interest rates but national banking systems may differ in many ways. Firstly, a domestic firm which borrows from an international bank can preserve its balances outside the domestic system. In that case capital inflow is solely national. Secondly, the domestic monetary authority should purify the effect of a capital inflow on domestic bank reserves. From the time of banking development some remarkable differences in formal regulation and informal convention could be noticed which put impact on the relationship between international financial developments and the domestic banking system. Thirdly, there will not be any direct effect on domestic credit provision if domestic bank reserves get an addition. The banks may prefer to lend outside the domestic economy if confidence in domestic assests is low. The effect of international liquidity preference on interest rates can be overstated in domestic banks which are fighting for deposits with international banks (Johan Deprez & John T. Harvey, 1999).
International credit crunch and business fluctuations
Multinational corporations and export traders are facing lots of challenges (Mary S. Schaeffer, 2001). Since 2007 the crisis in international financial market has diminished consumer spending and has affected an investor’s confidence. Consumer goods companies are having pressure on their profit margins as consumers worldwide are spending less and banks are not willing to provide with the funds to the corporate sector in these market uncertainities (An Hodgson, 2007).
The international financial market is experiencing fluctuations and uncertenities coming from a crisis in the US sub-prime mortgage market. Lenders from US and EU countries will not be that flexible in their credit facilities to other countries to respond to market uncertainities. Households in developed countries will not have easy access to credits which will reduce consumer spending. Companies will have pressure on their profit margins due to less consumer spending and lack of funds to expand production. Developing economies will experience slow export growth and economic expansion. Central banks in many countries cut their key interest rates in late 2007 and early 2008 to bring back consumer and investor confidence and to re-establish economic growth (An Hodgson, 2007). This strategy is being practised these days too.
International credit regulation
The basic objective of all financial policy is to make sure that there should be best possible results in real economy and for this an international financial system is must to maintain world trade and investment. Money markets are supposed to be essential elements for economy. There has been the progression of serious financial crisis. The financial crisis in the past twenty years like the European exchange rate crises of 1992, and the Mexican bond crisis of 1994 depict that there is an urgent demand of a clear and convincing hypothetical and pragmatic relationship between financial liberalization and economic performance. ‘The structure of the real economy’ is being understood as a trend performance. From this point of view the financial factors may be deviated from trend but they will not change the fundamentals and basic performance of the economy (John Eatwell & Lance Taylor, 1999). Also, after the Asian crisis there is a need of reshaping international financial architecture (Rainer Grote & Thilo Marauhn, 2006). Following are some necessary steps for this purpose:
- As the financial liberalization can increase the risks for both the national and international economy, the effective policy for capital markets must be international in character.
- Efficient regulation is a must condition to be an effective lender.
Finally, the biggest task of international financial regulation should be to minimize risks coming form the future markets and to make that regulatory structure which will play a vital role in international credit market. The objectives of international financial regulation should be the maintenance of the highest possible standards of integrity, consumer protection, market conduct and professional skills in the financial services industry, and the minimization of systemic risk (John Eatwell & Lance Taylor, 1999). To achieve these objectives the government of each and every country should come forward and establish such kinds of regulation which could facilitate their people with these services.
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