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Sustainability of private capital flows to developing countries : Is a generalized reversal likely?

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  • Hernandez, Leonardo
  • Rudolph, Heinz
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    Abstract

    Since 1989, private capital flows to a select group of developing countries have increased sharply, but developments in 1994 have caused concern about the sustainability of those flows. Several highly indebted developing countries that are implementing reform are concerned that a generalized reversal - similar to episodes of capital flight in the early 1980s - might disrupt their economies and threaten economic reform. Because the surge in private capital flows coincided with a period of low international interest rates and intensive policy reform in developing countries, debate has been active about whether the surge is driven mainly by domestic (pull) or external (push) factors. Under the pull hypothesis, successful domestic policies are the key to ensuring sustainable capital inflows; under the push hypothesis, an increase in international interest rates would cause a reversal of those flows (back to the industrial world). Using a partial adjustment model in which both domestic and external variables are defined, the authors explain why private capital flows to some developing countries but not to others (using panel data for 1986-93 for 22 countries). They argue that a generalized reversal is unlikely in countries that maintain a fundamentally sound macroeconomic environment. In fact, their empirical results show that domestic factors such as domestic savings and investment ratios significantly affected the recent surge in capital inflows. Further, they suggest that countries that have not received significant foreign capital - including countries in sub-Saharan Africa - could begin to if they implemented structural reforms that allow them to export, save, and invest at higher rates. Reducing their foreign debt (which might call for a continuation of recent debt reduction operations) could also help attract foreign private investors.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1518.

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    Date of creation: 31 Oct 1995
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    Handle: RePEc:wbk:wbrwps:1518

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    Keywords: International Terrorism&Counterterrorism; Economic Theory&Research; Capital Markets and Capital Flows; Banks&Banking Reform; Payment Systems&Infrastructure; Economic Theory&Research; Macroeconomic Management; Banks&Banking Reform; Environmental Economics&Policies; International Terrorism&Counterterrorism;

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    1. Fernandez-Arias, Eduardo & DEC, 1994. "The new wave of private capital inflows : push or pull?," Policy Research Working Paper Series 1312, The World Bank.
    2. Chuhan, Punam & Claessens,Constantijn A. & Mamingi, Nlandu, 1993. "Equity and bond flows to Asia and Latin America : the role of global and country factors," Policy Research Working Paper Series 1160, The World Bank.
    3. Dadush, Uri & Dhareshwar, Ashok & Johannes, Ron, 1994. "Are private capital flows to developing countries sustainable?," Policy Research Working Paper Series 1397, The World Bank.
    4. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 90(358), pages 314-29, June.
    5. Fernandez-Arias, Eduardo, 1993. "Costs and benefits of debt and debt service reduction," Policy Research Working Paper Series 1169, The World Bank.
    6. Martin Feldstein, 1991. "Domestic Saving and International Capital Movements in the Long Run and the Short Run," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 331-353 National Bureau of Economic Research, Inc.
    7. Alan C. Stockman, 1988. "On the roles of international financial markets and their relevance for economic policy," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 531-558.
    8. Michael Dooley & Jeffrey Frankel & Donald J. Mathieson, 1987. "International Capital Mobility: What Do Saving-Investment Correlations Tell Us?," IMF Staff Papers, Palgrave Macmillan, vol. 34(3), pages 503-530, September.
    9. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America," MPRA Paper 13843, University Library of Munich, Germany.
    10. Fernandez-Arias, Eduardo & Montiel, Peter J., 1995. "The surge in capital inflows to developing countries : prospects and policy response," Policy Research Working Paper Series 1473, The World Bank.
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    Cited by:
    1. de Haas, Ralph & van Lelyveld, Iman, 2006. "Foreign banks and credit stability in Central and Eastern Europe. A panel data analysis," Journal of Banking & Finance, Elsevier, Elsevier, vol. 30(7), pages 1927-1952, July.
    2. Chuhan, Punam & Claessens, Stijn & Mamingi, Nlandu, 1998. "Equity and bond flows to Latin America and Asia: the role of global and country factors," Journal of Development Economics, Elsevier, Elsevier, vol. 55(2), pages 439-463, April.
    3. Sarno, Lucio & Taylor, Mark P., 1999. "Hot money, accounting labels and the permanence of capital flows to developing countries: an empirical investigation," Journal of Development Economics, Elsevier, Elsevier, vol. 59(2), pages 337-364, August.
    4. Goopu, Sudarshan, 1996. "The analysis of emerging policy issues in development finance," Policy Research Working Paper Series 1589, The World Bank.
    5. Leonardo Hernández & Heinz Rudolph, 1997. "Sustainability of Private Capital Flows to Developing Countries: Is a Generalized Reversal Likely?," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 34(102), pages 237-266.
    6. Renu Kohli, 2001. "Capital Flows and their Macroeconomic Effects in India," IMF Working Papers 01/192, International Monetary Fund.
    7. Jeffrey Sachs & Aaron Tornell & Andres Velasco, 1996. "Financial Crises in Emerging Markets: The Lessons from 1995," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1759, Harvard - Institute of Economic Research.
    8. Montiel, Peter & Reinhart, Carmen M., 1999. "Do capital controls and macroeconomic policies influence the volume and composition of capital flows? Evidence from the 1990s," Journal of International Money and Finance, Elsevier, Elsevier, vol. 18(4), pages 619-635, August.
    9. Claudia M. Buch & Lusine Lusinyan, 2000. "Determinants of Short-Term Debt," Kiel Working Papers 994, Kiel Institute for the World Economy.
    10. Dr. Claudia M. Buch, 2000. "What Determines Maturity? An Analysis for Foreign Assets of German Commercial Banks," Kiel Working Papers 974, Kiel Institute for the World Economy.
    11. Cardenas, Mauricio & Barrera, Felipe, 1997. "On the effectiveness of capital controls: The experience of Colombia during the 1990s," Journal of Development Economics, Elsevier, Elsevier, vol. 54(1), pages 27-57, October.
    12. Chuhan, Punam & Perez-Quiros, Gabriel & Popper, Helen, 1996. "International capital flows : do short-term investment and direct investment differ?," Policy Research Working Paper Series 1669, The World Bank.
    13. Buch, Claudia M. & Lusinyan, Lusine, 2003. "Determinants of short-term debt: a note," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 13(2), pages 157-170, April.

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