Making a home for investment.


The mid-nineties has seen a boom in private capital flows to emerging countries. According to the Washington-based Institute of International Finance (IIF), total net private flows between 1996 and 1999 were over $l trillion. Twelve countries, mostly in Asia and led by China, attracted 75% of total inflows. But a recent International Monetary Fund (IMF) study shows that 140 of 166 developing countries accounted for just 5% of total inflows.

This is in marked contrast to the late seventies and eighties when commercial bank lending had fuelled a massive injection of foreign capital into the developing world.

What drives inward investment? A combination of factors account for the surge in foreign investment by multinational corporations (MNCs) and institutional investors during this decade. First, rising production costs, mostly of labour, and higher taxation in developed markets, coupled with fierce competition, led MNCs to shift their manufacturing plants to lower-cost countries.

Second, the credit-worthiness of several developing countries, including some in Africa is improving, thanks largely to the relaxation or abolition of capital controls. Economic reforms have also boosted productivity.

Third, any exchange rate depreciation in the host countries makes investment cheap in hard-currency terms. Finally, in more recent years, declining interest rates in industrial countries have encouraged institutional investors to invest in emerging markets, because of long-term higher returns on assets and new opportunities for risk-diversification. For example, yields on South African gilts exceed 14%, compared to just over 6% on US long-bonds.

Privatisation is an important channel for inward investment. In 1998 Brazil's telecoms company, Telebras, raised $19bn through this method. There is much scope for privatisation-related foreign direct investment (FDI) in South Africa and Nigeria. The estimated worth of South African public assets is officially put at $150bn, equivalent to 20% of GDP.

Equities could backfire

The World Bank estimates FDI flows to emerging nations last year at $155bn, down from a peak of $163 billion in 1997.

But too much reliance on portfolio equity flows could backfire for countries with low forex reserves. The ever-increasing integration of global capital markets can lead to huge sudden outflows. For example, if highly-leveraged investors, i.e. those...

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