Capital Flows and the Developing Countries

1. Describe how the level of foreign reserves and the debt/ export ratio affect the ability of a country to pay foreign debt.

2. Graph an exchange rate shock caused by a decrease in the supply of foreign exchange. next show how this shock affects a country’s price level and real GDP.

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Capital Flows and the Developing Countries CHAPTER ORGANIZATION Introduction Capital Flows to Developing Countries Exchange Rate Shocks The IMF and Developing Countries Summary INTRODUCTION Financial/capital account transactions affect economic development There are reasons for the movement of capital from developed to developing countries There are different forms such flows can take The most common problem associated with capital flows is the sudden depreciation of the currency of a developing country and there are macroeconomic consequences of these types of depreciations The IMF plays a controversial role in this CAPITAL FLOWS TO DEVELOPING COUNTRIES Capital tends to flow from the developed to the developing countries because of differences in factor abundance Developing countries tend to run current account deficits that are offset by capital/financial account surpluses This means that the developing countries are borrowing from the developed countries In many cases the developing country is a net debtor CAPITAL FLOWS TO DEVELOPING COUNTRIES Conceptually, there is not a problem with this borrowing as long as the capital is used productively Sadly, borrowing by governments in developing countries has a checkered history The form that this borrowing takes is important CAPITAL FLOWS TO DEVELOPING COUNTRIES Debt Versus Equity Borrowing by developing countries takes the form of either debt or equity Payments on debt have to be made at certain points in time no matter what the economic condition of the borrower is Debt refers to borrowing by countries in the form of 1)bonds or 2)bank loans or 3)borrowing from developed country governments Loans from commercial banks are referred to as sovereign loans CAPITAL FLOWS TO DEVELOPING COUNTRIES Equity is the situation where the lender is also an owner in the company or project being financed This is commonly FDI or the movement of portfolio capital between countries Debt payments have to be…

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