Tue 5 Feb 2013
Filed under: Business / Trade,News,Opinion
We were told last week that Myanmar had paid off its US$6 billion debt arrears to the World Bank, the Asian Development Bank and the Paris Club of official creditors, with the help of $3 billion in debt forgiveness from Japan.
This has already released $1 billion in new money from the Asian Development Bank and the World Bank – to a government already rated the sixth-most corrupt in the world by Transparency International. It must raise the question of just how much benefit Myanmar’s people are likely to get from the flood of resources now available to the country.
Institutionally, the international development banks have a bias towards doing business with local governments, and to lending for
large infrastructure projects, while doing little for the local private sector. There are a number of reasons for this.
First, the international consensus has arisen that the World Bank, the International Monetary Fund (IMF) and other international institutions should be the last to suffer in a national default. Hence when dealing with governments, or government guaranteed entities their debt is effectively senior to that of private banks.
This has perverse effects, notably that in marginal cases, a large loan from international institutions can effectively close the market to private lending, since the credit default swap market comes to reflect the junior status of private obligations, which in cases such as that of Greece get shoved a very long way down the country’s monstrous list of creditors.
This superiority does not apply when lending to the private sector, when normal rules of bankruptcy are applied. Hence the officials of the international agencies are much more likely to suffer damaging career effects if they lend to a private company, rather than to a government. The World Bank has an affiliate, the International Finance Corporation, which specializes in private-sector finance, but its resources are derived from the parent bank and are only a modest fraction of those available to the parent.
A further problem in countries like Myanmar where the private sector is poorly developed is that its entities are both primitive in their record-keeping (thus making them unable to cope with the international agencies’ armies of bean-counters) and small in size, with correspondingly small financing requirements. World Bank officials are not going to make their career move ahead by negotiating a $5 million loan, and indeed the complexity and rigor of the World Bank’s lending procedures make such a loan uneconomic for both borrower and lender.
In the past, the international agencies have sought to get round the program by instituting two-tier lending programs, in which they lend money to a local bank, and then set criteria for the bank to on-lend it local borrowers. These generally result in expensive credit for the local borrowers. In countries like Myanmar (and most of the East European countries in the 1990s), where the great majority of the banking system is controlled by the state, this also generally results in loans being made to the pet projects of well-connected local officials, with the true private sector getting very little benefit from the program.
Thus the international institutions will make most of their loans to states for infrastructure, of one kind or another. Sometimes the infrastructure will take the form of a single large project, which can be monitored fairly easily, and which is genuinely necessary (since Myanmar has effectively been cut off from international sources of finance since 1990, there are worthy such projects to finance.)
In other cases, the institution will devote funds to such more nebulous sectors as education or healthcare, but in these cases it will be state-directed education or healthcare, with all the opportunities for inefficiency, politicization and graft that implies.
The problem is partly one of mindset: since the international institutions deal primarily with governments, they subscribe generally to the “Keynesian bureaucrat fallacy” in which benign and infinitely wise government bureaucrats are thought able to solve all economic problems. This causes them not only to trust governments, but to distinguish between governments on the basis of which fits best with their preconceptions.
For example, only an international bureaucrat could declare that the South Korean budget is in deficit while Brazil’s is in surplus. For Korea’s figure they take the persnickety approach of knocking out the substantial surplus on Korean social security, which like the US system in the 1990s benefits from favorable demographics, thus turning a true surplus into a deficit. For Brazil, they ignore debt interest payments altogether and talk only about the “primary surplus” which of course after interest is in reality a massive deficit.
Thus the two governments are held to very different performance standards, which doesn’t matter much in those cases, both of which are pretty fixed on their path but can be a real disincentive to good governance in borderline cases, such as many Eastern European countries in the 1990s.
For Myanmar, the international private sector financial markets are little more helpful. In the current global state of grossly excessive liquidity and ultra-high leverage, the size of a loan is much more important than its yield. On a large loan, the fees can be very substantial, producing chunky bonuses for those involved.
My former colleagues at Citibank in the early 1980s were entranced with a loan of $2 billion – real money in those days – to a speculative and overleveraged Canadian oil company called Dome Petroleum, run by a charming chancer known as Smiling Jack Gallagher. Irreverent then as I am now, I made up a country music song about the deal:
“My father said ‘Beware loose women,
Keep your gun behind your back
And never, never lend two billion dollars
To a man called Smiling Jack’.”
Alas, my reputation as credit prognosticator of doom was wrecked six months later by a Canadian government bailout!
There will alas be few Dome Petroleums in Myanmar’s private sector for the next decade or so, so the international banks, with money burning holes in their pockets, will do deals primarily for the government. By and large, the big banks’ overheads are so high and their officers so overpaid that they cannot afford to do banking business on the modest scale that the Myanmar private sector requires.
If money was fairly tight, margins on small loans would be sufficient to make them attractive to at least some of the behemoths, but with Bernankeism rife, margins have been squeezed to such an extent that private sector lending in Myanmar is unlikely to attract any significant capital flows.
Myanmar needs a substantial private sector. To get one, it needs a domestic savings base equivalent to that in China and other Asian emerging markets. For this it needs a banking system and other savings alternatives that offer returns that are positive after both tax and inflation. Without such savings, sound small businesses will not be able to appear, let alone to grow.
It also needs property rights and a judicial system that is both incorrupt and independent of government. Only after these essentials are in place will such reforms as privatization be possible, because only then will there be a base of money and people in Myanmar with the expertise to run a privatized company.
At that point also Myanmar will become an attractive market for banks from the region, whose scale is more appropriate for Myanmar’s needs but which cannot compete with the behemoths during the massive tidal wave of easy money.
None of these essentials are easily addressed by international institutions. Indeed, by their focus on the government and provision of massive loans, they are likely to make Myanmar’s position worse. Spectacularly corrupt as it is, Myanmar’s government has so far been restrained by its inability to raise more than 5% of GDP through the tax system. Pouring loan resources into it merely widens the field for corruption, and pushes up the exchange rate, thereby suppressing private business.
The final danger brought by the international institutions and the private sector behemoths is that of surfeit. We have seen it in Vietnam, where a tidal wave of capital inflows was succeeded by a balance of payments crisis. A boom-and-bust cycle like Vietnam’s that lasts only a couple of years would be hugely damaging to Myanmar’s future. One can beg Myanmar’s government not to borrow too much, and the international agencies and global banks not to lend too much, but such requests would be futile.
In the 19th century, Myanmar would have been advised by one of the London merchant banks, which would generally (not always, Barings got in trouble in Argentina in 1890) have carefully rationed the flow of credit and ensured that the local government followed sound policies, on penalty of having the money spigot cut off. It was a MUCH better system.
Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) – details can be found on the website www.greatconservatives.com – and co-author with Professor Kevin Dowd of Alchemists of Loss (Wiley, 2010). Both are now available on Amazon.com, Great Conservatives only in a Kindle edition, Alchemists of Loss in both Kindle and print editions.
(Republished with permission from PrudentBear.com. Copyright 2005-13 David W Tice & Associates.)