Investors brave the turbulence of foreign exchange markets.
One of the more encouraging developments in the global economy of recent years has been the renewed flow of private capital to the developing world. From $42 billion in 1989, flows of private capital accelerated to $173 billion last year (see chart), climbing - since official lending remained stable - from one half to over three-quarters of the total. This year there have been fears of a slowdown following the crisis in Mexico, which both exposed some of the problems still faced by developing economies and led to a sharp withdrawal of capital. Investors have also had to contend with the uncertainties created by turbulence in the foreign exchange markets.
Nevertheless, while these events have led to some reappraisal of the merits of investing in developing economies, capital flows are expected to remain robust. Nearly half the flow is in the form of foreign direct investment, which is driven by structural rather than speculative considerations. This is likely to have remained steady, and will probably gather pace as Japanese industry steps up overseas investment in an attempt to beat the effects of the rising yen.
Portfolio equity investment is also likely to return. Investors are already showing interest in the stock markets of developing countries again, following their fall in value. Institutional investors hold only a small proportion of their assets in this area, allowing scope for significant flows in coming years as they bring their holdings into line with the greater growth potential of the emerging economies. Keith Wade, chief economist at Schroder Economics, expects portfolio investment to be weaker this year then last, but the weakness should be offset by stronger growth in foreign direct investment. Overall, private flows to developing countries will continue to grow.