Capital Flows to Brazil in the Nineties : Macroeconomic Aspects and the Effectiveness of Capital Controls

The resumption of capital flows to developing countries in the nineties is intertwined in the Brazilian case with the attempts to achieve inflation stabilization. A very restrictive monetary policy has, since the last Quarter of 1991, offered probably the world's highest yield to fixed income investments. The huge interest rate differential constituted the main determinant of capital inflows to Brazil. The magnitude of those flows exacerbated two main macroeconomic problems: an increase in the quasi-fiscal deficit due to the interest payments on the debt used to sterilize the inflows, and, after the Real Plan. also the overvaluation of the currency. The restrictions to capital inflows are described and analyzed, as well as the main "financial engineering" strategies used to circumvent the restrictions. Given the advanced stage of domestic financial markets-including a powerful derivatives market-the restrictions imposed have not been effective in preventing the inflows of foreign capital to invest in the high-yield-public debt. Given the small progress achieved so far in the fiscal side of the reforms, it is also doubtful that the capital inflows' restrictions have been effective in a broader sense, that of allowing the government to buy time to implement the essential structural reforms. By reducing the urgency of the politically costly structural reforms aimed at increasing domestic savings, capital inflows are believed to have detrimental incentive effects on the government's resolve to push forward the stabilization plan