MACROECONOMIC ADJUSTMENT TO CAPITAL INFLOWS: LATIN AMERICAN STYLE VERSUS EAST ASIAN STYLE

# 1. Introduction

The debt crisis of 1982 was precipitated by a sudden reduction in capital inflows at a time when highly indebted developing countries were facing a slow down of the world economy, a large increase in intemational interest rates, and a sharp loss in terms of trade. Weak economic policies and institutions exacerbated the effects of these shocks. Under these circumstances, the sharp cut-off of capital inflows forced a quick and sharp increase in the size of the required net external transfer. In the short run, the increase ir! the extemal transfer took the form of a sharp reduction of imports with negative effects on econonuc activity, investment rates and future growth.

After the initial shock, most highly indebted countries were. occupied during the rest of the decade adjusting policies and institutions to the new scenario of extremely restricted availability of extenal financing. This adjustment process was intended to restore a sustainable balance of payments situation, while creating the basis for sustainable growth. Some countries had even the expectation of an eventual return to international capital markets, but this time, to reduce their exposure to exteral shocks, they wanted to rely less on debt and more on direct foreign investment and portfolio investment.

In the initial years following the debt crisis, most of the lending to developing countries took the form of official lending from Iteratonal Financial Institutions. This lending supported reforms of policies and institutions to create the appropriate conditions to reestablish.the macroeconomic balances and to lay the foundations for sustainable growth.

In recent years, private capital inflows towards countries that have advanced in their adjustment efforts have incrased sharply. In fact the Capiial Account Surplus (including net errors and omissions) for all developing countries incrcased from 74.9 billion doLars in 1987, to 83.3 billion dollars in 1990 and further to 146 billion dollars in 1991 and 1992.1 The repatriation of the capital that had flown out of these countries in the early 1980s has financed part of these capital inflows. These inflows have taken the form of a combination of commercial lending from banks and suppliers, direct foreign investment, and portfolio capital. For the case of portfolio investment the interest has arisen from the possibility of providing risk capital financing for the expansion of the private sector. This type of inflow increased from 6.2 billion dollars in 1987 to 37.2 billion dollars in 1992, and reached 26.9 billion doUlars in the first half of 1993 alone.<sup>2</sup> However, there has also been much interest in attracting direct foreign investment as this type of inflow comes with access to new technologies and markets. These flows have been encouraged by the host countnes through a combination of removal of restrictions, and better prospects as a result of the macroeconomic reforms.

The increase in capital. inflows is beneficial for the host countries because it relaxes the severe financial constraint that they faced during much of the 1980s. Also, this new wave of capital inflows is different from the capital inflows that occurred in the late 1970's and early 1980's, because now the resources are going to the private sector and predominantly in the form of equity rather than debt financing.

- _I World Economic Outlook, IMF,_ May 1993. 2 Sudarshan Gooptu (1993) and John Williamson (1993).

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