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

  • Hernandez, Leonardo
  • Rudolph, Heinz
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    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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    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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    1. Stockman, Alan C, 1988. "On the Roles of International Financial Markets and Their Relevance for Economic Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(3), pages 531-49, August.
    2. Dadush, Uri & Dhareshwar, Ashok & Johannes, Ron, 1994. "Are private capital flows to developing countries sustainable?," Policy Research Working Paper Series 1397, The World Bank.
    3. Martin Feldstein, 1982. "Domestic Saving and International Capital Movements in the Long Run and the Short Run," NBER Working Papers 0947, National Bureau of Economic Research, Inc.
    4. Fernandez-Arias, Eduardo, 1993. "Costs and benefits of debt and debt service reduction," Policy Research Working Paper Series 1169, The World Bank.
    5. Fernandez-Arias, Eduardo, 1996. "The new wave of private capital inflows: Push or pull?," Journal of Development Economics, Elsevier, vol. 48(2), pages 389-418, March.
    6. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
    7. 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.
    8. 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.
    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. 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.
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