Q80+-+Development

//**‘Indebtedness, non-convertible currencies and capital flight are all significant barriers to economic development’. Explain two of these three factors. **//

In developing countries that have fixed exchange rates and the domestic currency is pegged to another currency at an official rate that is higher than the market rate, then the currency is overvalued. In this case a parallel rate (black market) for foreign currency will arise. International foreign currency traders reject such activity and so tradability gets limited. Countries stop exchanging for such currency and the currency eventually become forbidden and considered non-convertible. Ethiopian birr, Lao kip, and the Azerbaijani gopik are examples of such currency.

Implications for currencies of the like do exist. Since currencies allow for trade, investment, and other economic exchanges; non-convertibility obstructs trade and foreign investment, thus impeding growth. Domestic producers also have to face export taxes as exporters have to change their foreign export earnings at the official exchange rate. Lastly, black markets that form distort prices and waste resources. Corruption also becomes much more prevalent.

Capital flight has to do with firms, governments, and individuals withdrawing and moving money to foreign deposits and assets. This may be done to avoid currency issues or low rates of savings and investment returns. The main reason why capital flight occurs is insecurity of money. So the causes of capital flight include corruption and lack of controls such as in countries where civil checks and balances are weak. Lawlessness and general instability accompany corruption. Improper policies such as exchange rate misalignment and indebtedness are also reasons for capital flight to occur. Financial deregulation has made capital markets efficient globally and facilitates capital flight.

The effects of capital flight can be quite severe. Capital flight can lead to the discontinuation of development projects and furthering of corruption. It can also weaken the domestic economy by diverting funds for investment from the domestic capital markets. __The Economist reckons that around 80 cents of every dollar lent to Africa between 1970 and 1996 was placed abroad the same year it was lent.__ “Capital flight is in reality a most tragic form of participation in globalization in non-globalized and marginalized LDCs.” It also undermines the eagerness of international donors and aid agencies to supply funds as loans and donations. Foreign investors also become discouraged to invest since much investment will simply end up in foreign accounts.

 Source: Page 661, //Econom// //ics //by Matt McGee

The d iagram above shows the different effects of these conditions. Indebtedness leads to debt serv icing, which leads to dependency on exports and lack of availability of funds for domestic investment. This lack leads to a low level of investment and thus capital flight. Non-convertible currencies and indebtedness bring about capital flight directly, as well. Capital flight again reduces the availability of funds for domestic investment. Non-convertible currencies cause a lack of foreign investment, a dependency, and capital flight. Hence, it can be seen how all three are related.