ABSTRACT
In the late 1980s, a large volume of capital began to flow into developing countries. This phenomenon can be attributed to both foreign (or push) and domestic (or pull) factors (Calvo et al. 1993, 1994; Montiel and Reinhart 1999). International capital flows, of course, have both advantages and disadvantages (Calvo et al. 1993; Isard 1995; Montiel 1998; Reinhart and Reinhart 1998; Sinclair and Shu 2001). As disadvantageous aspects particularly evident to the central bank, large foreign capital inflows may bring about a rapid monetary expansion leading to an excessive rise in aggregate demand and inflationary pressures. Allowing exchange rate to appreciate in response to the higher demand for the currency of the recipient countries created by the capital inflows can adversely affect their international competitiveness widening current account deficits. Capital inflows may also increase the vulnerability of the recipient economy to a large and sudden reversal in capital flows. The Mexican peso crisis of 1994–95 and the Asian financial crisis of 1997 highlighted the point that large capital inflows to developing countries can create problems as well as benefits.
