Self-Financing Development

NEW YORK – A remarkable feature of the international financial system in the last decade has been the rapid and vast accumulation of foreign-exchange reserves by developing countries. World foreign reserves tripled from $2.1 trillion in December 2001 to an unprecedented $6.5 trillion in early 2008, according to IMF data.

Developing countries as a whole accounted for more than 80% of global reserve accumulation during this period, and their current level of reserves approaches $5 trillion. Half of this volume is concentrated in developing Asia, but Latin America and Africa have also been amassing international assets at a remarkable pace. This pool of reserves surpasses developing countries’ immediate liquidity needs, leading to their increased creation and expansion of sovereign wealth funds, which have an additional level of assets of more than $3 trillion.

The unprecedented increase in developing countries’ foreign exchange reserves is due both to their current-account surpluses and large net capital inflows. Practically all developing countries’ reserves are invested in developed countries’ assets, leading to an increasing net transfer of resources from the developing to the developed world, which, according to UNDESA estimates, reached $720 billion in 2007 alone.

Although economic growth and poverty reduction in many developing countries has been impressive in recent years, a significant increase in investment in areas such as infrastructure is required to sustain such growth in the future. We propose that a very small portion of developing countries’ total foreign-exchange reserves – say, 1% – be channeled to the expansion of existing regional development banks or the creation of new ones that would invest in infrastructure and other crucial sectors.