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Tuesday, January 16, 2007

Recycling Imbalances and FDI

This news is interesting:

The South Korean government on Monday unveiled its much-heralded measures to encourage companies to invest more abroad, exempting domestic investors from capital gains tax on overseas equity earnings and easing restrictions on foreign real estate purchases.

It also fits in with a point Stephen Jen made on the MS GEF last Friday:

‘Sovereign wealth funds’ increasingly important

China has recently announced that its Hueijing Holding Company, which is managed by SAFE, will start to invest some of the reserves in a broader portfolio of foreign assets than sovereign bonds and publicly guaranteed mortgage instruments. Further, it is likely that Japan will also start to deploy the investment earnings on its stock of reserves (leaving the principal untouched) to more aggressive investments. We have argued for a while that central banks, as they accumulate reserves that they don’t need for liquidity purposes, will start to invest the ‘excess reserves’ in more creative ways. This process is likely to take a major step forward this year, we believe, with some official reserve money being allocated to equities and non-G3 markets.

This is rather different from the kind of plan which is being currently considered by the Indian government since the excess reserves will be recycled externally, while the Indian proposal would seem to be for an internal recycling, which would hardly, I think, address the main problem:

India is exploring whether it can use a part of its near-record foreign-exchange reserves of $175.5 billion to fund the nation's bid to modernize roads, ports and airports, the finance minister said.

Prime Minister Manmohan Singh said in October that the nation will need as much as $320 billion over the next five years to improve roads, ports and other infrastructure, underscoring the key nature of public works in attracting companies, generating jobs and speeding up economic expansion to cut poverty. India's economy has grown by an average of about 8 percent in the past three years.

Now while these external recycling proposals would undoubtedly help ease the internal problems generated by the imbalances for the countries concerned, they would, in effect, simply displace the problem as they would add to the already high levels of global liquidity. As the above-linked FT article notes, in the Korean case:

The cap on investment in overseas real estate was raised from $1m to $3m (€2.3m, £1.5m), and the finance ministry signalled the limit would be scrapped within three years.

So this could well be a policy to help ease the rising won issue, but could have the knock-on effect of sending even more cash into already over-heated property markets in Shanghai, New Delhi, Berlin or downtown Tokyo. In other words all of this will do little or nothing to get to grips with the outstanding imbalances problem. If there is a dearth of real investment opportunities (the reverse face of the savings glut) then sending more cash in to fund them does not necessarily help much.

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