The capital inflow problem

This report provides a broad overview of the recent capital inflows to developing countries caused by large amounts of foreign capital arriving in the form of syndicated bank loans directed almost exclusively to public sector borrowers. Relying upon prior work done by the author, the report reviews various characteristics of the recent capital inflow episode, surveys empirical literature on the factors driving capital inflows, and examines the policy responses as well as the macroeconomic outcomes in the recipient countries. Each of the various policy instruments available to cope with the macroeconomic implications of these large capital inflows is then analyzed. The report format used is the following: The first section overviews the magnitude and composition of the new capital inflows, emphasizing the contrast with the capital movements that preceded the debt crisis. Section 2 looks at the explanations offered for the resurgence of capital flows into developing countries, reviewing the empirical literature on this issue. In section 3 the report explores the policy challenge posed by the inflows and both the policy options available to the recipient countries as well as the actual response. The final section examines macroeconomic performance by these countries over the course of the inflow episode.