Causes of Capital Inflows and Policy Responses to Them

In recent years, a number of developing and transition countries have enjoyed large inflows of foreign capital that have eased their financing contraints. Despite their obvious benefits, the inflows have aroused concern because of their potential effects on macroeconomic stability, the competitiveness of the export sector, and external viability. The most serious risks are that they will fuel inflation and drive the real effective exchange rate to unsustainably high levels. To design policies that will enable these developing countries to guard against the dangers, they need to identify what is driving the inflows. Some of the causes and policy responses of capital inflows to developing nations are discussed