POLIcY RESEARtH WORKING PAPER 1360

# Summary findings

Increasing portfolio investment flows to emerging markets in the past few years have led to fears of a sudden revcrsal of these flows and possible portfolio switching (from one emerging market to another) among foreign investors.

To assess the sustainability of such portfolio flows, Gooptu examines econometrically whether portfolio investment _flows_ to one region in the developing world are significantly related to those going to another region. This question has important policy implications for policymakers in developing countries who, in considering domestic policy reforms to attract foreign portfolio investment, want to ascertain whether financial flows from abroad are coming from an increasing pool of investible resources in the industrial world or whether they rcpresent the same funds (for examplc, 'hot money') chasing different high-yield securities as emerging markets change.

In other words, does a sort of 'adding-up" constraint - apply to these flows do they function as substitutesor not? Or could these flows be complementary?

markets (India, Indonesia, the Republic of Korea, and Thailand in Asia, and Argentina, Brazil, Chile, and Mexico in Latin America) for the period from the first quarter of 1989 to the second quarter of 1993.

Results indicate an inverse relationship between total portfolio flows to emerging Asian stock markets and those to Latin America. This negative relationship holds for both _debt portfolio_ flows (through bonds, certificates of deposit, and commercial paper) and _e4uity portfolio flows_ (through closed-end couantry funds, depository receipts, and direct equity purchases by foreigners in the emerging markets).

There has been a surge of portfolio flows to developing countries in the 1990s, but developing countries must compete for those flows.

In the long term, portfolio flows to well-performing countries will be sustained because of improved creditworthiness and proportionately greater investor interest (however marginal, on the whole). Increasing the pace of reform in an emerging stock market is essential for sustaining portfolio flows.

Gooptu analyzes new quarterly World Bank data on gross portfolio investment flows for eight emerging

- - This paper a product of the International Finance Division, International Economics Department is part of a larger effort in the department to analyze the behavior of private capital flows to developing countries. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Rose Vo, room S8-114, extension 31047 (32 pages). September 1994.

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