Private Capital Flows and Growth Deepak Mishra, Ashoka Mody, and Antu Panini Murshid

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Private Capital Flows and GrowthDeepak Mishra,
Ashoka Mody, and Antu Panini Murshid

• Presented By
• Kumari Dheerasinghe

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Introduction

• Enhance international capital flows to developing
  countries in recent years
• Difficult to identify the impact not clear
• Capital flows causes the higher growth in most
  countries, but faced some crisis
• Do the benefits justify the costs?

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Topics of Discussion

• Overview
• Capital flows and domestic investment
• Productivity
• Volatility
• Conclusion

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Overview

• Some countries experienced financial crises in
  the second half of the 1990s
• At this point they have experienced higher
  international capital flows
• It creates doubts on the ability of such flows to
  stimulate LR growth in developing economies

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• Volatility of capital flows inhibit the growth
• But, this gives an evidence to countries how to
  manage the volatility in a correct way
• Global financial integration offers the
  possibility of growth dividend that must be
  earned

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• Countries open their capital accounts
• Increase in capital outflows and changes in the
  composition of flows imply how flows involve to
  enhance the growth

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• The impact of capital flows on growth influenced
  by
• Whether policies are improving over time
• How quickly countries are relaxing capital
  controls
• The degree of composition of flows changing.

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Share of Capital Flows

• Most developing countries participated in global
  increase of capital flows
• Capital inflows to developing countries increased
  sharply
• But a few share of private capital flows flow to
  low - income countries

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Capital flows and domestic investment

• According to the economic theory
• Capital moves from abundant to scare
• Reason is that abundant opportunities for new
  investment will bring higher returns

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• New allocation boosts the investment in recipient
  country and enhance benefits
• Is this always true?
• Why capital flows are low to low income
  countries?

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What This Means

• Productivity increases with
• more skilled workforce.
• well developed infrastructure
• Favorable business environment
• Both economic theory and empirical evidence are
  less definitive about the impact of such flows

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• However, private capital flows causes to increase
• Domestic consumption or
• Domestic investment or
• Foreign exchange reserves

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• If flows are driven merely away by incentive to
  evade taxes or jump legal barriers money flows
  out quickly
• In spite of these uncertainty, private capital
  flows have significant impact of domestic
  investment

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In the case of poor countries -

• Little savings
• However, additional capital from outside increase
  investment
• Example 1 outside capital flows increase more
  than 1 investment

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• However, a low productivity and slow economic
  growth have limited to flow of private capital to
  these countries
• The long-term impact of foreign capital on growth
  may be limited

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Chart 2

• Better improvements over the time with the rest
  of the world
• A dollar of foreign capital raises less than it
  did in the past

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• Reasons
• Change in composition of capital flows
• New arrangements for the larger foreign reserves
  to face the out flow related problems
• Apparent increase of capital outflows

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Productivity

• The relationship between private capital flows
  and domestic investment has weakened
• The role of private capital flows on productivity
  has increased compared to what they did in past
• In the 1990s, countries with above-average ratios
  of capital flows to GDP also had above-average to
  growth rates

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• Productivity benefits are higher in countries
  with a skilled workforce and well developed
  physical infrastructure
• Example
• FDI boosts productivity in Malaysia, Taiwan, and
  China
• Lower benefits in Morocco, Tunisia and Uruguay

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• Reason no spillover benefits to domestic firms
  and they lose their market share due to newly
  arrived firms
• However, it depends on the capability of
  absorbing benefits

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Evidence

• According to cross-country regression findings
  FDI is more productive with a well-educated labor
  force
• In this sense private capital flows are more
  efficient in higher income countries

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• Especially the role of portfolio flows is higher
  for booster growth
• However, vulnerability can happen due to weak
  financial markets resulting exchange rate crises

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Volatility

• Recent financial crises are like a sign of
  warning
• These crises led to short-term declines in output
• Volatility of capital flows could be observed and
  suggested the lower long term growth

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• Volatility of capital flows can happen either the
  side of domestic or foreign
• Some argued predomination of the domestic side
• Policy shifts also lead high or low volatility

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• In this sense volatility is only a symptom of
  policy deficiencies
• Other extreme is a view that recent movements of
  capital flows bear little relationship to changes
  in countries economic fundamentals

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• An intermediate position links domestic weakness
  specially in financial sector
• It is important to strengthen the domestic
  financial sector to link with the rest of the
  world financially
• Meanwhile the volatility of capital flows fell in
  some developing countries and they become easily
  recovered

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This is because -

• Countries have become more diversified in their
  production structures or
• Allowing exchange rates to float or
• Strengthen financial sectors, prudential policy
  actions to maintain greater international
  liquidity and tax capital inflows

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Conclusions

• Private capital flows can impose significant
  costs
• It is not the solution for all development
  problems
• However, it boosts investment and productivity
  growth

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• It is need to strengthen domestic financial
  sector and take correct policy actions
• Advice availability of special safeguards like
  higher foreign reserves or contingent credit lines