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Capital Flows and Emerging Market Economies: a larger playing field?
Briefing Paper
Paola Subacchi, September 2007
- The build-up of foreign exchange reserves to match trade surpluses is giving China and the oil-exporting countries a relatively new role as well as presenting a strategic challenge. Indeed any swing in the policies and investment strategies of these countries could have uncertain consequences for global capital flows as well as trade.
- So far exchange rate management has been largely geared to maintaining dollar pegs, which has undoubtedly influenced both trade and capital flows. However, this policy may already be changing as the continuation of large trade surpluses is not necessarily in the interests of the 'surplus' countries any more than it is in the interests of the United States to accumulate large trade deficits.
- The contradiction between the large external surpluses and the needs of domestic development is now evident, and a shift in the use of surpluses and in the 'tools' used to control domestic liquidity and stabilize the balance of payments is under way.
- Anecdotal evidence and recent trends in capital flows leave little doubt about the intention of countries with large external surpluses to switch to more 'aggressive' investment strategies - i.e. looking for a return, rather than being directed purely on the basis of liquidity considerations.
- Sovereign Wealth Funds are likely to capture the key changes underlying current trends in global capital flows. Their already considerable size is likely to grow in the years ahead.
- The relatively more important role of direct investments in foreign countries is likely to create market volatility and political instability, and therefore requires careful management and coordinated action.
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