International capital markets

Objectives

What you will learn in this chapter:

lthe reasons for international capital ows

lwhat eurocurrencies are

lwhy eurocurrency markets grew so rapidly

lthe characteristics of the eurocurrency and eurobond markets

lthe possible connection between eurocurrency markets and ination

lwhat interest rate swaps are and how they are used

As we pointed out at the beginning of Chapter 8, the considerable growth in activity

on world foreign exchange markets over recent decades has been caused largely by

the vast increase in international capital mobility. This has had profound impacts

on national economies, on the international monetary system, and on the ability of

rms and countries to raise funds abroad. Much of this increase in capital mobility

has taken place through international capital markets in which individuals, rms

and governments are able to borrow and lend across national boundaries. These

markets have both grown massively and changed in form.

Our interests in this chapter lie in the changes which have taken place in the

markets and in the way in which nancial intermediation has altered as a result of

their growth. We begin by looking at the principal types of international capital

movements, before moving on to concentrate on eurocurrencies. We explain what

eurocurrencies are and how they are created. We look at the major reasons for the

rapid growth in eurocurrency markets from the early 1960s on and then consider

the impact of this growth on the world economy. We look in particular in this

section at the difculties that the great increase in international capital mobility

has caused for governments attempting to control their interest rates and rates of

ination and at the possible impact on the stability of the world economy. We then

explain some of the techniques in international capital markets, concentrating on

interest rate swaps. The chapter concludes with an examination of the arguments for

and against attempting to control international capital ows.

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10.1 The world capital market

10.1The world capital market

It is possible to identify a world capital market although it is clearly imperfectly integ-

rated due to the existence of exchange controls, exchange rate risk and sovereign risk

(the problem of the creditworthiness of countries). Because of these barriers, the poorer

developing countries are, at best, marginal participants in the market, borrowing very

largely from other governments or the international agencies such as the International

Monetary Fund and the World Bank. Even so, many of them have become heavily

indebted, and a high proportion of their annual incomes goes in debt repayments.

We return to this issue in Chapter 12. The developed industrial countries participate

fully as both providers and users of funds while the better-off developing countries,

including most of Latin America, participate as users of funds only. The international

capital market may be classied by motives for capital ow, or by types of lender.

International capital ows may be divided into public sector and private sector

capital movements. Public sector movements include loans and/or aid by governments

and the major international agencies. Private international capital movements can

be put into ve principal categories:

l	those resulting from normal trading relationships;

l	foreign direct investment (FDI) of transnational corporations and capital owsresulting from their other activities, including the repatriation of prots and themovement of funds to minimise tax payments;

l	ight capital (funk money) which moves to avoid risks of seizure, the blocking of accounts, restrictions on convertibility, taxation, legal requirements for foreigncurrencies to be converted into domestic currency at unfavourable exchange rates,and so on;

l	commercial hot money that moves in order to prot from changes in interest ratesin different countries;

l	speculation based on expected future changes in exchange rates.

Speculation covers both pure speculation and the leading (payment earlier than

needed) and lagging (delaying payment) of bills in foreign currencies in the expecta-

tion that the value of the domestic currency will fall or rise in the near future.

A classication of ows by lender would include:

l	loans by governments and international agencies such as the World Bank;
l	national bank lending in domestic currency to foreign borrowers;
l	the euromarkets (offshore markets);

l	international bond nance – the otation of bonds in foreign markets or the purchase of bonds in foreign markets;

l	international ows of equity capital (investors entering foreign equity markets);

l	export credits (bank loans to exporters who grant extended credit to foreign customers);

l	shifting bank deposits by companies with bank accounts in more than one currency.

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Chapter 10 • International capital markets

By far the most attention has been paid to the development and growth of the

euromarkets. The euromarkets consist of the eurocurrency, eurobond and euronote

markets. The eurocurrency market involves lending by offshore banks through the

transfer of bank deposits and is essentially short term. Medium-term bank loans,

covering periods of anything from two to seventeen years, are sometimes regarded

as part of the eurocredit market. Eurobonds are bonds that are issued on behalf

of borrowers in a currency other than that of the country in which it is issued.

Banks act not as lenders but as guarantors of loans or as brokers. Lending in the

euronote (or europaper) market takes the form of short-term bearer notes that can

be re-sold.