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Abstract
The shift in the composition of capital inflows into developing countries toward relatively more bank credit and less foreign private investment is likely to have increased their vulnerability to various economic disturbances. Total income payments on foreign investment tend to move more closely with a country’s ability to service them than do interest payments on external debt, which continue even if the original borrowing financed unprofitable investments or consumption. In this sense, the greater the share of foreign investments in a country’s portfolio of external liabilities, the greater is the share of risk associated with economic disturbances that is borne by foreign investors. In addition, since foreign investment can be sensitive to changes in a host country’s relative competitiveness, as well as to its interest rate and credit policies, a higher proportion of such investment in total capital flows can increase their responsiveness to a country’s adjustment policies.
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