Capital inflows and the real exchange rate

Abstract

Prema-chandra Athukorala and Sarath Rajapatirana, note that the major capital importing countries in Asia (China, India, Indonesia, South Korea, Malaysia, The Philippines, Singapore and Thailand), had experienced much lower appreciation of their real exchange rates from capital inflows compared to their counterparts in Latin America (Argentina, Brazil, Chile, Colombia, Mexico and Peru). They raise the question whether the greater susceptibility of real exchange rates in Latin America to capital flows compared to Asia in the 1990s can be explained in terms of the differences in policy responses to these flows? Asian countries have a history of good macroeconomic management compared to Latin America. Asian countries were able to use fiscal contraction more effectively than the Latin American countries to cushion the real exchange rate from the pressure of capital inflows. They undertook periodic nominal rate adjustments to counter the appreciation of their real exchange rates compared to Latin America. The authors find that sterilised interventions undertaken to dampen the real exchange rate appreciation had no lasting impact and that the composition of the capital inflow mattered in determining the magnitude of the impact of the real exchange rate. In framing this inquiry, the authors have leaned heavily on the Corden's work from his earliest to his latest contributions. Show more