The Boom in Capital Flows to Developing Contries : Will It Go Bust Again?

This paper argues that the policy of quantitative easing and maintaining close-to-zero interest rates in advanced economies, notably the US, has been generating a surge in speculative capital flows to developing countries in search of yield and creating bubbles in foreign exchange, asset, credit and commodity markets. This latest generalized surge constitutes the fourth postwar boom in capital flows to developing countries. All previous ones ended with busts, causing serious damage to recipient countries. The conditions driving the recent boom in capital flows and commodity prices are not sustainable, and they are likely to be followed by a sharp downturn. Various scenarios that can bring them to an abrupt end are discussed. Examining the policy responses and financial and macroeconomic developments in major emerging economies, the paper concludes that deficit commodity-rich economies that have been enjoying the dual benefits of global liquidity expansion –that is, the boom in capital flows and commodity markets – are most vulnerable to a possible reversal and urges them to manage capital flows more effectively.