Lecture XII & XIII

1. Lecture XII & XIII • Questions from last lecture • Microfinance • Sovereign Wealth Funds

2. Lecture XII Micro Finance A lot of recent attention • Nobel Peace Prize awarded to founder of Grameen bank • G8 dedicated 2005 to be the year of Microfinance • UN made similar dedication • Big growth in the market, big promises and accolades. Being sold by some as the next Horatio Alger story. Credited with launching millions of new enterprises and entrepreneurs.

3. Lecture XII What is it? • Small, short-term, uncollateralized loans to people (or groups) for investment or urgent consumption purposes (e.g. health care, funeral). • Interest rates are usually high by comparison to prime interest rate. Higher rates reflect both greater credit risk and the relatively higher loan origination costs of making a short-term loan. There is a lot of labor involved in issuing a loan to uncollateralized borrower with little or no steady income and often little in the way of identification or formal address. • Credit risk is managed by microfinance institution (MFI) by lending to group, requiring co-signers or spending time to carefully evaluation the borrower and the purpose of the loan (e.g. business model) and then coach them through repayment process.

4. Lecture XII History • Microfinance is not new, widespread attention is new • US had its own version of microfinance. Both credit unions and industrial loan banks (Morris Plan banks) were variations on microfinance in the US. Similar experiences are found in Canada, France and Germany.

5. Lecture XII How does it work? • Variety of micro lenders and methods. Some are almost established as banks. Some are regulated and some take deposits like banks. Others are very small and only made loans. They are funded through retained earnings and donations and sometimes with loans from local banks or foreign investors.

6. Lecture XII How big is the market? • Very big and growing fast. However maybe not fast enough to meet the demand or need. • UN estimates that there should be 500 million customers – far short of actual number being served. • 10,000 MFIs and about $1.2 billion in capital. Amount of assets or loans not known. The market is concentrated: the top 3% of MFI serve 80% of customers.

7. Lecture XII How to promote microfinance, how to increase growth? • Air or grants to MFIs – however grants and donations do not always promote the best business practices – MFI lenders don’t treat their loans as seriously when they are funded by gifts • Low interest rate loans from donors and official sources. – these however are often hard currency loans • Loans from SRI – socially responsible investors – these too are often hard currency loans • Local currency loans – challenge to get private sector to make such loans

8. Lecture XII Criticism • Too much Horatio Alger promises • Interest rates too high Regulation • Anti-money laundering and counter-terrorist financing regulations pose a potential challenge for small, otherwise unregulated and informally managed MFIs • Prudential regulation – likely to prove useful to MFIs that become large and begin to accept foreign loans and domestic deposits. Would help prevent a big failure from tainting the industry.

9. Lecture XIII Sovereign Wealth Funds and Foreign Reserve Accumulation     Reading: +  Simon Johnson, The Rise of Sovereign Wealth Funds, F&D September 2007 + Edwin M. Truman, Meeting the Challenge of Sovereign Wealth Funds

10. Lecture XIII Sovereign Wealth Funds Many foreign governments have created funds to buy assets around the world. The mega-funds were created mainly from oil revenue and trade surpluses. Here are some of the biggest: SOURCE: Merrill Lynch, Norway's Finance Ministry | The Washington Post - October 30, 2007

11. Lecture XIII • A few facts: • Current SWF assets estimated to be $2-3 trillion • Projections are for $10 trillion by 2012 • More than 20 countries have SWF, Truman says 32 funds in 29 countries • Recent actions: 1) movement out of dollar assets; 2) major capital investment in Citigroup following write-down; 2) major investment in UBS following write-down. • General features or characteristics: • not very transparent in most cases, Norway is exemplary of transparency • Variations: • State owned enterprises. 8 of 20 largest corporations in the world are state owned, including the biggest PetroChina • Sovereign pension funds. Those in G10 countries total $4.4 trillion according to Morgan Stanley study.

12. Lecture XIII • Causes – how they came about • Usually through export surpluses or capital account surpluses • - export surpluses are largely energy or commodity related and have benefited from strong global growth that has pushed up commodity prices (the IMF has been encouraging commodity exporters to accumulate a rainy day fund) • - capital account surpluses are part-and-parcel to neutralizing effects of carry trade and local currency speculation (some of which has resulted from mercantilist exchange rate management and other times from inflation targeting monetary policy) • Purposes of SWF include • - economic stabilization (Joseph, or rainy day fund) • - intergenerational wealth transfer • - income maximization • - other ?

13. Lecture XIII If Clausewitz is right, and war is the continuation of politics by other means, then sovereign wealth fund investment is the continuation of politics by economic means. Diplomacy is the peaceful and low cost – usually – means of handling international problems, so again it is diplomacy of sorts that needs to be addressed to the economic dimension of international relations. Fear is that foreign governments will use their economic resources to exert influence on other countries. This could be from oil or other natural resources. Today the focus is on financial assets. These resources can be used to obtain controlling influence of banks, natural resources (energy or mining companies) or strategic manufacturing (hi tech, defense industry, agri-business).

14. Lecture XIII The presumption is that control by a foreign government would result in production or distribution decisions that are different from free market principles (i.e. what the market would have done otherwise) and that the results would be less efficient and/or in some ways especially advantageous to the foreign government. Keep in mind that private market incentives might also result in decisions that favor a foreign government rather than the domestic one. This is why the US has export controls and CFUS, and why we had to bribe the Swedes to sell us ball bearings in WWII.

15. Lecture XIII • Response – Criticism and Support • For • Protectionism focused on the capital account – not just trade anymore • National security may be used for economic nationalism • Capital account interventions are not governed by agreements and institutions such as WTO – thus movements against free flows must be stopped pronto • Against • Operations are obscure • Structures are not transparent • Management not accountable internationally • Assets will be used ‘as continuation of international politics by other means’ • Government should not nationalize private assets and should not be expected to manage its own assets efficiently or like private shareholders (AEI and Cox) • Unfair competition between individual investors and governments that have greater access to information

16. Lecture XIII • Policy Recommendations • IMF recommends that countries share information – before issue becomes politically charged or part of an election campaign. Chief Economist says that “there is no apparent reason to see the continued existence of these funds as destabilizing or worrying.” • Truman • State policy objectives of international investment activities of SWF • Establish roles of government and fund managers [investment policies?], and Guidelines for corporate governance when they are more than passive investments • Transparent operations, annual reports and published audited reports • Behavior guidelines includes pace of portfolio adjustments [presumably don’t dump and run] • SEC • Working to ensure the transparency of sovereign businesses and investments • Professional management would depoliticize their activities

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