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Liberalized Portfolio Capital Inflows in Emerging Markets: Sterilization, Expectations, and the Incompleteness of Interest Rate Convergence

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Author Info
Jeffrey A. Frankel and Chudozie Okongwu.

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Abstract

The paper examines interest rates in nine Latin American and East Asian countries during the period 1987-1994. The goal is to discover why interest rates have remained high, failing to converge to U.S. levels, despite capital market liberalization and a resurgence of portfolio capital inflows during the second half of this sample period. Related questions are whether portfolio capital flows are strong enough to equalize expected returns between these "emerging markets" and the U.S., and whether there is any scope left for the authorities to sterilize inflows. The conclusion of the study is that the\e largest single component of the gap in interest rates is expectations of depreciation of the local currencies against the dollar. Key to the analysis is the use of survey data on exchange rate forecasts by market participants. Indicative of integrated financial markets, we also find a big effect of U.S. interest rates on local interest rates, and a highly significant degree of capital flow offset to monetary policy.

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Publisher Info
Paper provided by University of California at Berkeley in its series Center for International and Development Economics Research (CIDER) Working Papers with number C95-054.

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Date of creation: 01 Jun 1995
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Handle: RePEc:ucb:calbcd:c95-054

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  1. Jeffrey Frankel & Sergio Schmukler & Luis Serven, 2000. "Verifiability and the Vanishing Intermediate Exchange Rate Regime," NBER Working Papers 7901, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Philippe Bacchetta & Eric van Wincoop, 1998. "Capital Flows to Emerging Markets: Liberalization, Overshooting, and Volatility," NBER Working Papers 6530, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Felipe Alarcón G. & Daniel Calvo C. & Pamela Jervis O., 2008. "Mercado de Cobertura Cambiaria y Tasa de Interés Local en Dólares," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 11(2), pages 79-88, August. [Downloadable!]
  4. Tony Cavoli & Ramkishen S. Rajan, 2005. "The Capital Inflows Problem in Selected Asian Economies in the 1990s Revisited: The Role of Monetary Sterilization," SCAPE Policy Research Working Paper Series 0518, National University of Singapore, Department of Economics, SCAPE. [Downloadable!]
  5. Melisso Boschi, 2007. "Foreign capital in Latin America: A long-run structural Global VAR perspective," Economics Discussion Papers 647, University of Essex, Department of Economics. [Downloadable!]
  6. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. L. Sarno & M. P. Taylor, 2003. "An empirical investigation of asset price bubbles in Latin American emerging financial markets," Applied Financial Economics, Taylor and Francis Journals, vol. 13(9), pages 635-643, September. [Downloadable!] (restricted)
  8. Caprio, Gerard Jr. & Dooley, Michael & Leipziger, Danny & Walsh, Carl, 1996. "The lender of last resort function under a currency board : the case of Argentina," Policy Research Working Paper Series 1648, The World Bank. [Downloadable!]
    Other versions:
  9. Reinhart, Carmen & Reinhart, Vincent, 1999. "On the use of reserve requirements in dealing with capital flow problems," MPRA Paper 13703, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  10. Thomas D. Willett & Young Seok Ahn & Manfred W. Keil, . "Capital Mobility for Developing Countries May Not Be So High," Claremont Colleges Working Papers 2000-26, Claremont Colleges. [Downloadable!]
  11. Carmen M. Reinhart & Vincent R. Reinhart, 2008. "Capital Inflows and Reserve Accumulation: The Recent Evidence," NBER Working Papers 13842, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Michael D. Bordo & Hugh Rockoff, 1996. "The Gold Standard as a `Good Housekeeping Seal of Approval'," NBER Working Papers 5340, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Kenneth Kletzer & Mark Spiegel, 1999. "Sterilization costs and exchange rate targeting," Pacific Basin Working Paper Series 99-03, Federal Reserve Bank of San Francisco. [Downloadable!]
    Other versions:
  14. Alex Luiz Ferreira & Miguel León-Ledesma, 2003. "Does the Real Interest Parity Hypothesis Hold? Evidence for Developed and Emerging Markets," Studies in Economics 0301, Department of Economics, University of Kent. [Downloadable!]
    Other versions:
  15. Jeffrey A. Frankel & Nouriel Roubini & Mervyn King & Robert Rubin & George Soros, 2003. "Industrial Country Policies," NBER Chapters, in: Economic and Financial Crises in Emerging Market Economies, pages 155-296 National Bureau of Economic Research, Inc. [Downloadable!]
  16. Remberto Rhenals Monterroso & Alejandro Torres García, 2007. "Volatilidad de los flujos de capital hacia los países en desarrollo: evidencia para América Latina, 1970-2002," Lecturas de Economía, Universidad de Antioquia, Departamento de Economía, issue 67, pages 9-42, Julio-Dic. [Downloadable!]
  17. Frankel, Jeffrey & Roubini, Nouriel, 2002. "The Role of Industrial Country Policies in Emerging Market Crises," Working Paper Series rwp02-002, Harvard University, John F. Kennedy School of Government. [Downloadable!]
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  18. Ajay Shah & Ila Patnaik, 2005. "India's Experience with Capital Flows: The Elusive Quest for a Sustainable Current Account Defecit," NBER Working Papers 11387, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  19. Pierre-Richard Agénor & Alexander W. Hoffmaister & Carlos Medeiros, 2002. "Cyclical Fluctuations in Brazil's Real Exchange Rate: the Role of Domestic and External Factors (1988-95)," Revista Brasileira de Economia, Graduate School of Economics, Getulio Vargas Foundation (Brazil), vol. 56(1), April. [Downloadable!]
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