Polish inflation and Zloty devaluation

-5%

0%

5%

10%

15%

20%

25%

30%

35%

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92 93 94 95 96 97 98 99 0 1

Devaluation

Inflation

Direct costs of September 11 Attacks

• OCTOBER 29, 2001 – BusinessWeek

Now, Argentina's Default Looks Inevitable With the U.S. preoccupied, a bailout is unlikely

Things in Buenos Aires seem to be going from bad to worse. Any hopes that Argentina would eventually emerge from a four-year recession were snuffed out by the September 11 terrorist attacks, which dealt a body blow to the global economy. Argentine bonds are now trading at less than 60 cents to the dollar. Meanwhile, local interest rates have soared to a punishing 35%, even for blue-chip borrowers. These are signs that the markets believe that Argentina cannot go on servicing its $132 billion national debt. U.S. rating agencies are assuming as much. On Oct. 9, Standard & Poor's Corp. downgraded Argentina's sovereign debt rating to CCC+, putting the country on a par with deadbeats such as Ecuador. Rival Moody's Investors Service quickly followed suit.

• Wall Street has already resigned itself to the idea of an Argentine default. A recent survey of emerging-market portfolio managers by Morgan Stanley Dean Witter & Co. revealed that 85% now believe default is inevitable.

Emerging Economies: Net capital flows

A Busang Lesson• The root problem that Bre-X faced was the absence of the rule of law in

Indonesia. This political risk takes on the form of “creeping expropriation,” something not easily insured.

• Rule of law, taken for granted in developed economies, is often missing in emerging economies. Why?

– The ruling class benefits more from discretion than from the rule of law.• Discretion or non-transparency gives the ruling class the means to extract rents from

the society.• The cost of the economic inefficiency is borne by the population.• Rule of law would limits the power of the ruling class.

– The absence of the rule of law in most developing countries is not simply a result of history. It is what keeps emerging economies always emerging.

• Portfolio investors would often stay away from some emerging markets where creeping expropriation/corruption is suspected to be serious.

• Direct investors can, in theory, manage this risk. But managing this kind of political risk is not easy. Barrick tried to take advantage of the environment, but failed miserably.

Foreign direct investment vs. portfolio investment

• FDI, according to the IMF, is “an investment that is made to acquire a lasting interest in an enterprise operating in an economy, other than that of the investor, the investor’s purpose being to have an effective voice in the management of the enterprise.”

• Portfolio investment is “passive.”• FDI allows the use of almost all risk

management techniques.• Portfolio investors can only “vote by money” and

employ financial market based risk hedging.