Globalization And Financial Liberalization Development: How Influence Financial Liberalization? (Research Paper Sample)

Globalization
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Institution
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Introduction
There is a difference between these two words, liberal and liberalism. Although they are inclined to the same meaning, partially, we can say that being liberal is granting freedom and liberalism is granting more freedom. When we talk about financial liberalization the most common idea that comes to our mind is the freedom that the state gives to financial institutions by eliminating any restrictions. This may also apply to the financial markets as well. However, there is no standard definition that can be used to define financial liberalization. Although the idea is the same different scholars and economists try and bring in a new approach to it but the idea behind it remains unchanged.
Other people define financial liberalization as breaking away from financial repression. They say that it tries to break away from the influence of the government fixing the interest rates of financial institutions and affecting these institutions greatly. Breaking away from the states repression as far as borrowing, lending and investments are concerned can have a positive or a negative effect in the economy.
This article focuses on first defining financial liberalization and giving examples. Later on in the paper, we shall be able to look at example of cases of financial liberalization. Besides that, to give a clear understanding on the niche in study, we shall compare financial liberalization and financial repression that took place during this time, especially in the 1980’s. We shall look how it worked during this time and the processes that were involved to achieve it.
On the same line of thought, as we conclude the final parts of this note, we shall be discussing and giving a general opinion on the effects of financial liberalization. We shall mainly focus of its effects on the economies of the middle and the low income economies.
Financial liberalization: An overview and development
To be free there must have been some restrictions that have been elevated. Before we look at financial liberalization we should discuss financial repression. According to the world bank, (World Bank and International Monetary Fund 2005), financial repression in a nutshell can be defined as when the financial system is repressed or kept small by a series of Government interventions and indulgences that have the effect of keeping very low, in the worst case scenario often at negative levels interest rates that domestic banks can offer to savers; the most common forms that these interventions would take were interest rate regulations, directed credit schemes, and high reserve ratios (Ahmed and Islam 2010). This normally occurred before financial liberalization was dreamt of. Mainly the late 70s and early 80s in most developing countries this was the plan.
The main reasons why the governments of this era decide to suppress the financial institutions were because they wanted to develop but they lacked the resources to do so. There was no money (Tornell and Westermann 2006). To suit their fiscal demands and interest, they had to come in and force the banks to impose low interest rates on its debts. Chwieroth recommended the same strategy in her book (Chwieroth 2010)
In real sense these governments did not have the normal citizens’ interest at heart when they made this decision. Although the decision was beneficial to the common citizens it really did more harm than good to the financial institution and markets. The government used the money that they borrowed from the banks to finance their own projects keeping in mind that the interest rates were low, so, they money payable to the banks for the debts will be relatively lower. This move created excess credit demand, and directed credit to its own priority sectors. An additional means for financial repression involves limiting the menu of instruments that the public can hold for example foreign exchange deposits in order to ensure greater “seigniorage” revenue (Ahmed and Islam 2010).
People were against financial repression for many reasons. It brought more harm than good to the financial sector and generally to the economies during this time. Most countries decide to take a divergent route and scrapped off financial repression and adopted financial liberalization. A good example is Turkey. We shall look at how Turkey adopted this strategy in the early 80’s and how it worked for them.
The main reason to scrap out financial liberalization was largely influenced by the interest rates. The government at this time had to let go of the cap and raised the interest rates greatly (Dekle Dekle and Pradhan 1997) The main reasons why they did this was to mobilize more resources that was needed by the government so that the deposit rates would increase and inn turn the deficit in the budget will be met. This meant that more responsibility was handed to the private sector towards achieving development. This was something that was lacking in financial suppression.
Financial liberalization made government of most countries start admitting foreign countries deposits (Chwieroth 2010). This was largely influenced by the mantle that was handed to the private sector by the government. They imposed freer rates and were subject to lower directed credit requirements. This was a move that was aimed to attract offshore funds and foreign currency holdings into the financial system as well as to allow residents legal access to foreign currency assets.
Freeing of the interest rates was not welcomed by the borrowers during this time. It generated pressure to the financial institutions and markets as more people were demanding low cost loans. At the same time, if they took loans with this new terms and conditions, the payment period they chose was too long (Sikorski 1996). Besides that, very few of them were in the mood of taking loans any more.
This Financial liberalization did not only focus mostly on the interest rates, it had other matters to clear that financial repression had specified. One of them was central banks were made more independent. Previously these banks were tasked with the job of ensuring that inflation was something that would never happen in a country. The government was trying to protect its citizens at all cost. Financial liberalization made sure that the central banks abandoned this job of curbing inflation and being the clutching straw when it comes to achieving development. The central banks were freed the role of stabilizing the economy. The government was left to handle that.
During this time of financial liberalization, direct credits and high reserve requirements were eliminated (Agénor and Montiel 2008). Besides that, what came out financial liberalization was that the capital accounts were liberalized. This meant that the relationship between foreign investors and a country’s financial institutions was made more cordial. In the same line of thought, foreign investors were allowed to participate in the capital market. They were allowed to borrow money from the local banks and also bring in money directly from their countries and save it at the local banks. The locals were not left behind either, liberalization of capital accounts meant that the locals were also allowed to raise funds and do business in foreign lands and still wires the money and stores it directly at their local banks.
There are other important things that financial liberalization was all about. One, different markets were set up for the central bank debt and government debt. People were notified of the same and knew exactly what suits their demand. In addition this system ensured that, equity markets were set up in the transition countries and liberalized where they already existed. In some countries, pension systems added defined contribution or defined benefits elements, often operated by private intermediaries.
During the times of financial repression one thing was clear. State banks remained state banks; with the same interest rates for all (Odekon 2005). I do not conclude that financial repression was completely hideous; of course it had its advantages. During this time of financial liberalization, this policy demanded change in the ownership of banks. The state at some point, though gradually had to let go of the state owned banks. It was a good thing in the long run. It granted more freedom to the banks especially in decision making. The banks were free to make their own decisions as far as capitalism was concerned. The banks were now a money making institution that had targets and profits to make. With this freedom brought by financial liberalization, more private banks also started coming up. In addition, foreign banks started creeping in slowly into different countries to set up shops (World Bank and International Monetary Fund 2005). It was now a matter of competition to satisfy the customer and promote the saving culture among them. These banks were definitely competing to increase the deposit rates. The higher it went the more money the bank was going to make at the end of the day. This was greatly influenced by freeing up the interest rates from the helms of the state.
Effect of introducing financial liberalization
Deposit growth
The introduction of financial liberalization had effects on the financial institutions and markets around the world. Of the most important one was the growth it brought in terms of deposits. Although this growth was not seen immediately, it was a gradual process. One of the major contributors in the growth in deposits was the legalization of foreign countries that was brought about by financial liberalization (Agénor 2004). Allowing people and investors to make money and use it as it is regardless of the currency that you prefer to use. Besides that, allowing people to work in foreign countries and transfer the money to an...