Pakistan: Prospects for Private Capital Flows and Financial Sector Development

In less than a decade after the debt crisis of 1982, developing countries have experienced a surge of capital inflows in recent years. This trend became more pronounced in the 1990s resulting in overall balance of payments surpluses and accumulation of reserves. Total private capital inflows to developing countries exceeded $173 billion in 1994, compared to annual average inflows of $34 billion during 1983–90 [World Bank (1995)]. Although the characteristics of capital inflows in this episode are different than in the period prior to the last debt crisis, nevertheless concerns about macroeconomic stability, loss in competitiveness, financial sector vulnerability and excessive borrowing remain the same. While the rise in inflows during 1991–93 was supported in part by low interest rates and weak economic activity in industrial countries, improved economic policies and prospects in most recipient countries also played an important role. The larger share in inflows of those countries that achieved greater progress in economic reforms, is evidence of the importance of recipient country policies. During this period, the composition of private flows to developing countries also became more diversified. Foreign direct investment (FDI) accounted for 45 percent of total equity inflows in 1994, with debt accounting for 32 percent and portfolio flows accounting for the remaining 23 percent. According to a recent assessment [World Bank (1995)], overall private capital flows to developing countries are likely to continue to increase in the medium term, though at a much slower pace than in the early 1990s, growing on average at about 7–10 percent annually. Many countries are at the limit of prudential borrowing, so at most their net liabilities can rise in line with exports. However, within this overall trend, some economies in Asia and several transitional economies are likely to see a larger increase.