Sustainability of Private Capital Flows to Developing Countries - is a Generalized Reversal Likely?

44 Pages Posted: 28 Dec 2004

See all articles by Leonardo Hernández

Leonardo Hernández

Banco Central de Chile

Heinz Rudolph

Ministry of Finance of Chile

Date Written: October 1995

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.

JEL Classification: O16, G15

Suggested Citation

Hernández, Leonardo and Rudolph, Heinz, Sustainability of Private Capital Flows to Developing Countries - is a Generalized Reversal Likely? (October 1995). Available at SSRN: https://ssrn.com/abstract=9520

Leonardo Hernández (Contact Author)

Banco Central de Chile ( email )

Agustinas 1180
Santiago
Chile
56-2-670-2618 (Phone)
56-2-670-2106 (Fax)

Heinz Rudolph

Ministry of Finance of Chile ( email )

Teatinos 120
Santiago, 8340487
Chile

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