The Boom in Capital Flows to Developing Countries: Will It Go Bust Again?

Year 2012, Volume: 1 Issue: 1, 63 - 96, 01.02.2012

Yılmaz Akyüz

Abstract

This paper argues that the policy of quantitative easing and maintaining close-to-zero interest rates in advanced economies, notably the US, has been generating a surge in speculative capital flows to developing countries in search of yield and creating bubbles in foreign exchange, asset, credit and commodity markets. This latest generalized surge constitutes the fourth postwar boom in capital flows to developing countries. All previous ones ended with busts, causing serious damage to recipient countries. The conditions driving the recent boom in capital flows and commodity prices are not sustainable, and they are likely to be followed by a sharp downturn. Various scenarios that can bring them to an abrupt end are discussed. Examining the policy responses and financial and macroeconomic developments in major emerging economies, the paper concludes that deficit commodity-rich economies that have been enjoying the dual benefits of global liquidity expansion – that is, the boom in capital flows and commodity markets – are most vulnerable to a possible reversal and urges them to manage capital flows more effectively.

Keywords

Boom-bust cycles, global liquidity, capital flows, foreign exchange markets, commodity markets, developing countries

Thanks

An earlier version was presented at a South Center workshop, “Global Economy, Climate Change, and Sustainable Development: Issues for Developing Countries,” held on 26 January 2011 in Palais des Nations, Geneva. I am grateful to Venugopal Reddy, Martin Khor, Richard Kozul-Wright, Michael Mah-Hui Lim, and the participants in a seminar held in UNDESA in New York on 1 March 2011, particularly to Rob Vos, Butch Montes, and Alex Izurieta, for their comments and suggestions, and to Xuan Zhang of the South Center for assistance with the data used in this paper. The usual caveat applies

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