Managing Foreign Capital Flows

Between 1990 and 1994, developing countries in Asia posted $261 billion in net capital inflows, an amount
equivalent to about half the total inflows to all developing countries. Although foreign direct investment
accounts for the largest portion of net inflows to Asia, the share of portfolio investment has been steadily
rising, from an average of 8 percent of net inflows between 1983 and 1989 to 24 percent between 1990 and
1994. Suggested reasons for the increase in portfolio investment have been a high demand for capital coupled
with favorable growth prospects, deregulation and liberalization of capital accounts, domestic financial reform
(which has facilitated foreign investment in domestic securities), lower interest rates, and international portfolio
diversification. Capital inflows have been important in supporting high rates of investment, particularly in
Indonesia, Malaysia, and Thailand, but short-term capital inflows also have threatened macroeconomic
instability by inducing volatility of key financial variables such as the exchange rate. Threats to stability have, in
turn, led countries to install direct control measures to dampen large swings in short-term capital inflows. In
this working paper, Yung Chul Park, of Korea University and the Korea Institute of Finance, and Chi-Young
Song, of the Korea Institute of Finance, analyze the experiences of Korea, Thailand, Malaysia, and Indonesia in
managing these capital inflows.