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New International
Capital Flows
Lino Covarrubias
Heather Edelstein
Matthew Peabody
Kristina Spacone

5/23/2017
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Topics of Discussion
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Behavior of Capital Flows
Long Term Investment
Asian Economic Crisis
Mexican Peso Crisis
Chilean Regulation of Capital
Flows
Lessons for Capital Mobility
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Capital Flows to Latin
America
Supply of Capital

Technology

Pension and Insurance Funds

Baby Boomers
 Low Interest Rates in US
Structural
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Investment Codes
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Macroeconomic Policy (exchange rates)
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Privatization
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Political reform
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Types of Capital
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Foreign Direct Investment
Bond Purchases
Portfolio Equity Flows
Lending Directly to support trade
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Risk of new Capital Flows
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Lack of efficiency
Short-term money
External vulnerability
Exchange rates
Interest Rates
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Long Term Investment
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Focus on local manufacturing
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Preferable to short term investment
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Concentrated in Mexico & Brazil
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Pros and Cons of FDI
Pros
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Technology
Efficiency
Source of capital
Job creation
Management
skills
Cons
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Culture
Human rights
abuse
Environment
Job loss in parent
country
Linkage w/locals
Technology
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Maple Gas – Positive
Example
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Drill gas in Peruvian jungle
Provide electricity to Peru
New ideas
Environmental challenges
Community
Success – effect on Peru
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Asia Crisis – Effect on
Latin America
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Global loss in investor confidence
Increasing interest rates
Brazil’s downfall
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MEXICAN PESO CRISIS OF 9495---->
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History Prior to the Event:
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Healthy recovery from 1982 debt crisis1987 PACTO -bus, labor, and govt price
controlFiscal Stabilization (low and stable
inflation- 8% in 94 compared to 20% in
late 80’s)
Opening of internal markets
NAFTA talks beginning in 91 and signed
in 94
Hi returns in Mexico--outlook lured Int’l
Capital10
WHAT WENT WRONG?
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Demand by Investors to Invest in
Mexico created an ASSET
Overvaluation. To ensure not
missing out on the opportunity,
Investors willingly infused capital
without knowing the full extent of
the value (sound familiar?)

Capital Inflows artificially
overvalued the PESO (up to 30%).11
What went wrong?
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Mexican Gov’t did nothing- sugar
coated the problem
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This overvaluation increased the
prices of Mexican exports, making
them less competitive in World
Markets. This caused a decrease
in exports= increase in CA (current
Account)-GRI
Peso not overvalued- reflects
growth potential.
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CA and Peso strength
MEX CADEF AND E-RATE
CAD
RER
70000
100
80
50000
40000
60
30000
40
20000
Real buy pwr
CAD $ MILL
60000
20
10000
0
83-90 91
92
93
94
95
96
97
YEARS
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What went wrong?
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Presidential election-PRI under attackcould not afford domestic econ problem
(I.e. devaluation)
Economic problems:
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By 1994: CA is 8% of GDP- deficit must
be funded by capital inflows. Although
Investors were concerned, this did not
cause the capital flight Mexico feared.
If there was a problem Intl Capital flow
would not come in.
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Mexico CA Deficit 1988-1994
4
2
0
85
86
87
88
89
90
91
92
93
94
% GDP
-2
% GPD
-4
-6
-8
-10
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Years
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What went wrong?
1994 political uncertainty did- Jan:
Chiapas uprising; MAR- Pres
candidate Colosio assassinated;
 INT Capital flew!!! This caused
dwindling dollar reserves at Central
Bank to pay for public debt
 Situation screamed for
devaluation- Mexico said no and
spent $10Bill from MAR-MAY in
reserves to keep from devaluing
peso.
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
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What went wrong?
To prevent further Capital flight-Int
Investors were protected by
“TESOBONOS”- dollar dominated
treasury bonds.--> MEX
internalized currency devalue risk.
 After AUG 99 elections- still no
devaluation
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THE BIG BLOW
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DEC 94-Reserve decreased to
dangerous levels- $9bill
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MEX has no choice but to devalue
peso
 Bad
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timing- Did it Tuesday before
XMAS, with a Finance minister not
yet connected
 Investors felt deceived and didn’t
believe MEX would make good on
TESOBONOS
 Major Capital flight
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MEXICO’S RESCUE
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MEXICO did following:
 increase in privatization of railroads,
ports
 wages held down, cut govt spending,
 Interest rates increased to 55% to hold
investors
 domestically, caused a recessionary
environment- further decreasing
investor confidence.
JAN95: US, IMF, and Bank Intl
Settlements- $28 BILL loan - help Mexico
stabilize
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LESSONS LEARNED

CA deficit below what is
sustainable by the economy
(normally 3% GDP) is a recipe for
disaster, especially if it is being
funded by short-term int’l capital.
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Short-term int’l capital is very
susceptible to political volatility.
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Chilean case: Regulation
An anecdote…but a cure?
100
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80
60
GDP
40
Capital
Inflows
20
0
1979 1981
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Composition had shifted
from loans to FDI, “hot
money” as well as
portfolio investments and
Chilean investment
abroad.
Laws attracted FDI into
Chile. Most money
entered the export sector
particularly mining.
Similar recipe for disaster confronts Chile with large
inflows of international capital.
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Chile opens doors to investment
abroad
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1991-Chile liberalizes laws regulating the
outflow of capital.
$
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Pours money into other LA countries.
Primarily:
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Argentina-electricity business, ceramics,
industrial oils.
Bolivia-Railways
Peru-Pension industry, copper wire
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Impact of Capital Flows:
Vicious Circles
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Chilean model driven by exports.
Moving on up
Exports
Capital Inflows
•Copper
•Agricultural Products
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Appreciated
CHP
ex-rate chokes exports that had originally made the success
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Downside Risk-Is the Chilean
model bullet proof?
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Capital Controls are difficult to
enforce.
Because Chile is largely
dependent on commodities, a drop
in global commodity prices could
have devastating effects on the
balance of payments on current
account.
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Chilean Remedy
Balance external sector growth
and internal stability
How?
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Reserve requirements
 Quotas, Fees
 Foreign exchange market
intervention, and sterilization.
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Capital enters Chile on “Chilean”
terms.
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Conclusion
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Changes in the LA economic
environment are perceived to be more
permanent.
Improvements, regulatory action, and
changes are restoring investor
confidence.
Stability, confidence, and predictability
are being restored prompting financial
investments.
Investors see LA as a “good investment
risk”
Inflow of capital has it’s benefits and
drawbacks.
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