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Week 12 - Lecture B - ECON 4411A Fall 2011 Development...

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ECON 4411A, Fall 2011 Development Economics Summary Notes: Week 12, Lesson B The Debt Crises, Solutions and the Role of the IMF Quote of the day: The future belongs to those who believe in the beauty of their dreams. Eleanor Roosevelt The debt crises of the 80s in LDCs The debt problem of the 80s and what led up to this crises in LDCs, has been widely discussed in economic circles. One of the major problems that led to the crises in the 80s was that the outflow to repay accumulated debts exceeding the inflow of both public aid and new refinancing bank loans (see Figure 1 below). As a result, a $35.9 billion net transfer from developed to developing countries in 1981 became a $22.5 billion transfer from poor to rich nations by 1990. This negative capital account balance for many developing countries, added to the negative balance on their current account because of several factor including falling value of exports, led to major balance of payment deficit in the 80s and 90s. Unfortunately, though the inflow of both public aid and new refinancing bank loans exceeded the outflow for LDCs in the mid 1990s, substantial new problems emerged between 1997 and 2002. Figure 1: LDC current and capital account balances 1978-1990 1
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Financing & Reducing Payment Deficits As mentioned above, many LDCs have deficits on their balance of payment. It is important as development economists from a policy view point to discuss various alternatives of dealing with this issue. First, it is important to note that when a country has a deficit on its balance of payment account lets say $X million, this country will have to draw down $X million of its central bank holdings of o ffi cial monetary reserves to cover this deficit. Such reserves consist of foreign currencies, gold and special drawing rights at the IMF. Country’s international reserves serve for countries the same purpose that bank accounts serve for individuals. They can be drawn on to pay bills and debts and with deposits they are increased. Some sources of deposits are net export sales and capital inflows. This reserve can also be used as collateral to borrow additional reserves. Whatever the balance on current account plus the balance on capital account, it must be o ff set by the balance on this account. Hence, if the country is very poor, it is likely to have a very limited stock of these reserves to meet this deficit. The overall balance of payments deficit can therefore place severe strain on the economy and greatly inhibit the country’s ability to continue importing needed capital and consumer goods. This is why we need to know the policy options available to attenuate balance of payment deficits. 1. Seek to improve the balance on the current account. This can be done in three ways. First, promoting export expansion, second limit imports and third doing a mixture of both. Concentrating on primary or secondary product export expansion is one practical way of export expansion and import substitution policies to protect and stimulate domestic industries
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