Instability and Volatility of Capital Flows to Developing Countries

Despite the recent recovery in capital flows towards developing countries, some of their characteristics have generated serious problems. As these flows are increasingly concentrated in a small group of emerging markets, most developing countries have been facing a severe scarcity of external resources, while for the minority endowed with some measure of access to international financial markets, volatility and sustainability remain the key issues. Financial liberalisation has helped to create new channels for resource transfers from the developed world, but it has also generated conditions wherein such transfers can easily be reversed with serious consequences in terms of instability. The present study depicts, discusses and analyses some of the issues related to capital movements between developed and developing countries. Section 2 is an overview of the recent controversies on external financial liberalisation. Section 2 is an surveys the post-1970 developments in capital inflows to developing countries, their main components and their contribution to development finance. Section 4 examines the instability and volatility of total inflows and their components using two different statistical measures. Section 5 concentrates on a particular type of capital movement, i.e. short-term, arbitrage-seeking capital flows to emerging market economies. This analysis requires specific conceptualisation, definition and data generation from balance of payments statistics. In Section 6 a similar analysis of volatility and instability of short-term inflows and outflows to emerging market economies is undertaken. The penultimate Section 7 discusses the policy implications of the foregoing analysis and is followed by a summary and conclusions.