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This page was processed by aws-apollo1 in 0. Skip to main content. Copy URL. See all articles by Linda S. Goldberg Linda S. Number of pages: 59 Posted: 14 Mar Number of pages: 56 Posted: 08 Feb You are currently viewing this paper. Number of pages: 60 Posted: 05 Feb Abstract This paper presents a new measure of capital flow pressures in the form of a recast exchange market pressure index. Goldberg, Linda S. Linda S.
Some empirical evidence suggests that aid can crowd- out public expenditure in certain sectors and thereby adversely affect growth. Sustained aid dependence could, in fact, weaken the internal forces of growth Potiowski and Qayum, Lack of sound policy environment in the aid receiving countries has operated as a major factor in eroding aid effectiveness World Bank, Despite the general dissatisfaction with aid effectiveness, factors such as lower cost and higher maturity of aid in relation to commercial loans has encouraged many developing countries to maintain their access to aid flows Chart VI.
A number of countries have successfully accessed international markets and raised adequate levels of private capital to meet the financing gap. It is also being increasingly highlighted that "more aid" policy should give way to "more trade", requiring a change in the policy stance of the donors to liberalise their extant restrictions on exports from aid-receivers so as to allow them to reap the benefits of their true competitive advantage and in that process to reduce their dependence on aid.
External commercial loans could include bank loans, buyer's credit, supplier's credit, securitised instruments such as Floating Rate Notes and Fixed Rate Bonds, and commercial borrowings from the private sector window of multilateral financial institutions.
The oil crisis of dramatically altered both the demand and supply conditions for commercial capital. The Organisation of Petroleum Exporting Countries OPEC experienced a 10 fold increase in their current account surplus in and their surplus positions remained large for the subsequent years.
Oil-importing developing countries, in turn, experienced widening financing gaps. The surplus petro-dollars were recycled by the banks of the developed countries to the developing countries. Financing gaps of the oil-importing countries created and sustained the demand for the surplus international banking funds.
The external debt crisis of brought about an interruption in banking capital flows to the developing world.
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The inadequate recognition of the vulnerabilities arising from interest rate and exchange rate risk exposures associated with foreign debt capital emerged as the key areas of concern. In the first half of the s when the US dollar appreciated and international interest rates hardened significantly, debt servicing problems turned unsustainable. Many emerging economies, however, had to increase their dependence on commercial capital in the s in the quest for higher growth, particularly in terms of access to critical imported capital goods and other inputs. Cross-border bank lending - a major element of commercial borrowing - registered modest increase during the s, gathering momentum in the s Chart VI.
Structural changes were visible in the pattern of these flows reflecting the need for raising the productivity of banking capital flows by directing them to emerging markets. The most important change was in the form of large scale contraction in bank lending to public sector enterprises and a perceptible shift in favour of non-bank private corporates NBPCs Charts VI.
Government guarantees had reduced the role for monitoring and there was a perception that "governments cannot go bankrupt" Aerni and Junge, In the aftermath of the debt crisis of when about 70 per cent of the private capital flows to developing countries was in the form of banking capital, it became important to address the problem of information asymmetry and the fear of non-performance of the debt contract within the legal jurisdiction of another country.
Information asymmetry could be partly addressed by lending to the corporate sector through domestic banks and financial institutions. Local banks and institutions could monitor the individual borrowers better and also service small and medium clients for whom direct access to international lending could be limited and costly. Furthermore, non-performance of contracts by individual borrowers could shift the costs of opportunistic behaviour to the government and this would be reflected in reduced access to international capital for the country as a whole.
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These concerns underscored the relevance of monitoring of private debt by the national authorities. The fear of improper monitoring and the difficulties in collateralising cross-border loans have, however, resulted in a strong shift in the preference of lending banks for short-term loans Chart VI. Weak domestic banking systems and the nexus between banks and various influential interest groups can not only overheat the economy but also expose the economy to a large-scale loss of output and employment during a crisis. It became evident that even if banking capital does not directly flow to the public sector, credit allocation decisions of banks and financial institutions could be influenced to direct the flow of credit to favoured firms and industries at subsidised rates.
Despite the diversification in the s in favour of commercial borrowings from the market, loans from banks continue to dominate the commercial debt segment for the developing countries. The advantage of raising longer-term debt capital to finance projects with large gestation period, particularly in the infrastructure sector has mainly driven the shift to market. At the end of March , the share of government and state enterprises in the total volume of capital raised through issuance of securities in both money and capital market was about 54 per cent as against the corporate sector's share of 32 per cent and financial institution's share of 14 per cent.
This indicates that the shift in the composition of bank loans away from state enterprises has been partly offset by the market in the bond segment. The extent to which the growth augmenting potential of foreign capital could be actually realised depends on the domestic business and policy environment of the receiving country.
Lessons from the cross-country experiences have particularly been viewed as important due to the lack of any clear consensus on what could be the right approach to capital flows and also the absence of sufficient empirical research to establish the net positive impact of a liberalised capital account on growth.
Growth regressions with various measures of international financial openness as determinants suggest either no statistically significant relationship between the two Kraay, ; Rodrik, or that such results are obtained only for countries with higher income Edwards, , better-educated labour force Borensztein, et al. The correlation coefficients rose from 0. Correlation between capital flows and growth, however, reflects the effects of both capital deepening and capital productivity.
The investment augmenting capacity of capital flows seems to have weakened with increasing cross-border integration of trade and finance. The earlier one-to-one association between private capital flows and domestic real investment has changed over time which is reflected in a lower order of increase in domestic real investment for every unit increase in capital flows.
In view of the perceived weakening in the investment deepening effect of capital flows in the face of increasing correlation, it is possible to infer that productivity gains associated with foreign capital must have gone up in the s. Empirical findings indicate that capital flows in the form of FDI and bank lending had significant and strong effects on domestic investment during Bosworth and Collins, The impact of portfolio flows, however, turned out to be statistically insignificant, though positive.
For the period , the incremental impact in terms of raising both domestic investment and current account deficit was almost one-to-one in case of total capital flows. While long-term capital inflows exhibited a similar pattern, the impact of short-term flows was extremely weak. FDI flows exhibited close to one-to-one relationship, banking flows tended to raise domestic investment more than proportionately and current account deficits tended to deteriorate by more than the extent of inflows. The impact of portfolio flows on domestic investment was found to be modest and the current account position, in fact, improved.
Sub-Saharan African region showed the strongest association between capital flows and investment, even more than the East Asian and the Pacific region. The association appeared to be marginal in case of Latin American and the Carribean countries Table 6. Greater exposure to portfolio capital flows is, however, associated with heightened volatility which may negate the growth enhancing effects of foreign capital. Controlling for the volatility effects, it is estimated that an increase in capital flows by 1 percentage point of GDP could give rise to an increase in per capita growth of 0.
Countries with higher absorptive capacity benefit from foreign capital by raising investment and productivity. Human capital and infrastructure raise the absorptive capacity of a country which, in turn, helps in raising the productivity of foreign capital World Bank , Soto FDI with a lag of one year significantly boosts per- for 44 developing countries capita income growth in the receiving country.
Causality tests have been employed to identify the 'growth induced' versus 'growth enhancing" aspects of FDI.
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On the other hand, studies on determinants of FDI help in ascertaining the importance of various determinants in attracting FDI. Other studies examine complementarities between FDI and domestic investment. Over the period , evidence of significant crowding-in effects of FDI on domestic investment have been found for Asia and modest crowding-out effects for Latin America Agosin and Mayer, For Africa, the link between FDI and domestic investment turns out to be one-to-one.
For every incremental unit of FDI in Asia, domestic investment rose by 2. Contribution of different forms of foreign capital have been evaluated using cross-section panel regressions so as to segregate best forms of foreign capital from the second best Soto, ; Bailliu, In countries with better capitalised domestic banks, foreign banking capital may turn out to be growth enhancing. International interest rate movements may not play a major role in pushing capital to emerging markets. The pool of foreign capital available to the emerging markets as a whole appears to be one of the important determinants, implying that the prospect of getting foreign capital for an individual country could brighten when the size of the pool itself increases.
Among the set of domestic determinants, investment rate and debt-service ratio turn out to be significant. There is also a shift in the significance of some of the determinants over time; as opposed to the real appreciation in the s and early s, growth in domestic bank credit appears to have emerged as the more dominant internal risk factor in the s.