Inter-American Development Bank
facebook
twitter
youtube
linkedin
instagram
Abierto al públicoBeyond BordersCaribbean Development TrendsCiudades SosteniblesEnergía para el FuturoEnfoque EducaciónFactor TrabajoGente SaludableGestión fiscalGobernarteIdeas MatterIdeas que CuentanIdeaçãoImpactoIndustrias CreativasLa Maleta AbiertaMoviliblogMás Allá de las FronterasNegocios SosteniblesPrimeros PasosPuntos sobre la iSeguridad CiudadanaSostenibilidadVolvamos a la fuente¿Y si hablamos de igualdad?Home
Citizen Security and Justice Creative Industries Development Effectiveness Early Childhood Development Education Energy Envirnment. Climate Change and Safeguards Fiscal policy and management Gender and Diversity Health Labor and pensions Open Knowledge Public management Science, Technology and Innovation  Trade and Regional Integration Urban Development and Housing Water and Sanitation
  • Skip to main content
  • Skip to secondary menu
  • Skip to primary sidebar
  • Skip to footer

Ideas Matter

  • HOME
  • CATEGORIES
    • Behavioral Economics
    • Environment and Climate Change
    • Macroeconomics and Finance
    • Microeconomics and Competitiveness
    • Politics and Institutions
    • Social Issues
  • Authors
  • Spanish

Financial Integration: Friend or Foe of Low-Saving Countries?

August 8, 2017 by Eduardo Cavallo Leave a Comment


They are like exhibits in a gallery of dread: the Tequila Crisis of 1994; the Asian and Russian crises of 1997 and 1998, and the global financial crisis of 2008. They represent moments when foreign investors pulled away from Latin America and the Caribbean; when foreign credit and investment were withdrawn and the region suffered.

They instill fear to this day. With a low average savings rate of around 17%, the region has long been excessively dependent on foreign credit to finance investments. Foreign financing, of course, makes possible the building of roads, ports and airports; power plants and energy grids; and facilities for sanitation and potable water. But the region’s seemingly excessive dependence on such financing also feeds the fear—and the conventional wisdom—that while financial integration with the rest of the world can be useful to increase available credit, it can also be highly perilous.

While there is certainly truth to that bit of conventional wisdom, what it fails to take into account is that financial integration can also provide a form of insurance. When countries increase integration with other regions of the world, they not only receive inflows of foreign capital that accumulate into risky foreign liabilities. They also accumulate foreign assets. That is to say they both borrow from abroad and invest abroad. And if domestic “fundamentals” are strong, those foreign assets can be repatriated creating a source of financing that compensates for the money the rest of the world withdraws when foreigners cut back.

The greater resilience that the region showed to external shocks during the global financial crisis of 2008 compared to previous episodes is a testament to this: domestic investors repatriated more foreign assets than ever before, partially offsetting the enormous retrenchment of foreigners (see IDB Macro Report 2014, chapter 6).

The trick is figuring out what blend of foreign assets and liabilities provides the greatest benefits and the least risk.

As Eduardo Fernández-Arias, Matías Marzani and I describe in a recent study, this begins with an understanding that not all foreign assets and liabilities are created equal. Foreign Direct Investment in which an investor purchases a company, for example, is more difficult to liquidate. By contrast, bank loans are more liquid and portfolio investments (stocks and bonds) more liquid still.

We show that those differences matter for countries’ vulnerabilities to external shocks. The key point is that different types of capital inflows perform differently with regard to how they impact country solvency and the liquidity needed for macroeconomic stability. When it comes to foreign assets, we find that the ease with which they can be repatriated is key for their insurance value.

When we add up all the effects, we find that financial integration reduces risks on net because the safety provided by foreign assets generally outweighs the increased risk created by foreign liabilities. Whether this materializes in individual cases depends on the specifics of the composition of the country’s external balance sheet, i.e., on the composition of foreign liabilities and foreign assets. The results reveal that financial integration does not unambiguously impose a trade-off between access to foreign credit and macroeconomic stability as per the conventional wisdom. In fact, we conclude that financial integration is an imperfect remedy for the disease of “low national savings.”

What do I mean by imperfect remedy? Low national saving rates limit the domestic financing available for investment. Financial integration can, in principle remedy that because it can enable countries to access foreign capital. But, as we show in the IDB flagship publication Saving for Development: How Latin America and the Caribbean Can Save More and Better, the region’s low national saving rates are a manifestation of multiple distortions, including lack of trust in its economies. Those distortions are likely to reduce the effectiveness of financial integration as a remedy to the low savings malaise. For example, foreign investors are probably less willing to finance long-term investments (i.e., FDI) in countries where local investors are not willing to save, and to invest those savings locally. If and when foreign investors lend to those countries, they will prefer to lend short term and at higher rates, which in turn translate into a risky portfolio of foreign liabilities. By the same token, local investors that accumulate foreign assets are going to be less prone to repatriate them when needed.

Higher national savings is the key to solving the problem. Higher national saving would not only finance investment cheaper (as foreign financing comes with a risk premium.) It would reduce the need to build up foreign liabilities that make the region more vulnerable to external factors. And with higher national savings, financial integration could even help to further reduce risks by facilitating the accumulation of foreign assets that can be repatriated.

The ideal, as discussed in a recent study and blog, is to generate a virtuous circle in which more savings generate more domestic financing, better allocation of resources and higher productivity growth, leading to higher returns on domestic investments. It is creating a recipe for greater growth with less risk.

 


Filed Under: Macroeconomics and Finance Tagged With: #Caribbean, #ExternalShocks, #FinancialCrisis, #LatAm, #saving

Eduardo Cavallo

Eduardo Cavallo is Principal Economist at the Research Department of the Inter-American Development Bank (IDB) in Washington DC. Prior to joining the IDB, Eduardo was a Vice-President and Senior Latin American Economist for Goldman Sachs in New York. Eduardo had already worked at the IDB as a Research Economist between 2006 and 2010. Before that he served as a research fellow at the Center for International Development (CID), a visiting scholar at the Federal Reserve Bank of Atlanta, and a member of the faculty at the Kennedy School of Government's Summer Program. In Argentina he co-founded Fundación Grupo Innova. Eduardo’s research interests are in the fields of international finance and macroeconomics with a focus on Latin America. He has published in several academic journals, and is the co-editor of the books “Building Opportunities for Growth in a Challenging World” (IDB, 2019); “A Mandate to Grow” (IDB, 2018); “Saving for Development: how Latin America and the Caribbean can save more and better” (Palgrave, 2016) and “Dealing with an International Credit Crunch: Policy Responses to Sudden Stops in Latin America” (IDB, 2009). He holds a Ph.D. in Public Policy and an MPP from Harvard University, and a B.A. in Economics from Universidad de San Andres (UdeSA) in Buenos Aires, Argentina.

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Primary Sidebar

Follow Us

Subscribe

Search

Related posts

  • When Too Much External Borrowing to Finance Investment Gets Dangerous
  • What Are the Antidotes to Sudden Stops?
  • Developing Domestic Bond Markets for Growth and Stability
  • Foreign Investment Drops and Concerns Rise in Latin America and the Caribbean
  • The Impact of War on External Financing in Latin America and the Caribbean

About this blog

The blog of the IDB's Research Department shares ideas that matter on public policy and development in Latin America and the Caribbean.

Footer

Banco Interamericano de Desarrollo
facebook
twitter
youtube
youtube
youtube

    Blog posts written by Bank employees:

    Copyright © Inter-American Development Bank ("IDB"). This work is licensed under a Creative Commons IGO 3.0 Attribution-NonCommercial-NoDerivatives. (CC-IGO 3.0 BY-NC-ND) license and may be reproduced with attribution to the IDB and for any non-commercial purpose. No derivative work is allowed. Any dispute related to the use of the works of the IDB that cannot be settled amicably shall be submitted to arbitration pursuant to the UNCITRAL rules. The use of the IDB's name for any purpose other than for attribution, and the use of IDB's logo shall be subject to a separate written license agreement between the IDB and the user and is not authorized as part of this CC- IGO license. Note that link provided above includes additional terms and conditions of the license.


    For blogs written by external parties:

    For questions concerning copyright for authors that are not IADB employees please complete the contact form for this blog.

    The opinions expressed in this blog are those of the authors and do not necessarily reflect the views of the IDB, its Board of Directors, or the countries they represent.

    Attribution: in addition to giving attribution to the respective author and copyright owner, as appropriate, we would appreciate if you could include a link that remits back the IDB Blogs website.



    Privacy Policy

    Copyright © 2025 · Magazine Pro on Genesis Framework · WordPress · Log in

    Banco Interamericano de Desarrollo

    Aviso Legal

    Las opiniones expresadas en estos blogs son las de los autores y no necesariamente reflejan las opiniones del Banco Interamericano de Desarrollo, sus directivas, la Asamblea de Gobernadores o sus países miembros.

    facebook
    twitter
    youtube
    This site uses cookies to optimize functionality and give you the best possible experience. If you continue to navigate this website beyond this page, cookies will be placed on your browser.
    To learn more about cookies, click here
    X
    Manage consent

    Privacy Overview

    This website uses cookies to improve your experience while you navigate through the website. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website. These cookies will be stored in your browser only with your consent. You also have the option to opt-out of these cookies. But opting out of some of these cookies may affect your browsing experience.
    Necessary
    Always Enabled
    Necessary cookies are absolutely essential for the website to function properly. This category only includes cookies that ensures basic functionalities and security features of the website. These cookies do not store any personal information.
    Non-necessary
    Any cookies that may not be particularly necessary for the website to function and is used specifically to collect user personal data via analytics, ads, other embedded contents are termed as non-necessary cookies. It is mandatory to procure user consent prior to running these cookies on your website.
    SAVE & ACCEPT