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Capital Inflows and the Real Exchange Rate: Can Financial Development Cure the Dutch Disease?

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Author Info
Christian Saborowski
Abstract

This paper argues that, in improving the efficient allocation of resources, financial sector development could dampen the appreciation effect of capital inflows. Using dynamic panel data techniques, the paper finds that the exchange rate appreciation effect of FDI inflows is indeed attenuated when financial and capital markets are larger and more active. The main implication of these results is that one of the main dangers associated with large capital inflows in emerging markets-the destabilization of macroeconomic management due to a sizeable appreciation of the real exchange rate-can be mitigated partly by developing a deep financial sector.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/20.

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Length: 42 pages
Date of creation: 29 Jan 2009
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Handle: RePEc:imf:imfwpa:09/20

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Keywords: Capital inflows ; Real effective exchange rates ; Capital markets ; Emerging markets ; Financial sector ; Economic models ; Cross country analysis ; Statistical annexes ;

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