Towards Suistaining Mdg Progress

3

privatE capital Flows: ForEign DirEct invEstmEnt anD portFolio invEstmEnt

Private capital flows have become an increasingly significant source of investment in developing countries, indicating the high degree to which developing countries have become integrated into the global economy and thus how exposed they are to any financial shock.

Photo: Eskinder Debebe/UN Haiti

Private Capital Flows: Foreign Direct Investment and Portfolio Investment
Introduction
Since the late 1990s, private capital flows (PCF) 1 have become a significant source of investment for many developing countries. 2 Although these flows are still largely concentrated in a few high-income and emerging economies, more PCF are moving into LICs than ever before. In countries such as Zambia, foreign private capital stocks as a percentage of GDP reached 75 percent by 2007 and, for many countries in Africa (Uganda, Cameroon, the United Republic of Tanzania and the Gambia), stocks reached 30 percent of GDP (Bhinda and Martin 2009). However, as is well-known, PCF tend to be highly volatile — even aid is less volatile and more predictable in most countries. A financial shock can result in the sudden reversal of capital flows and also in sharp declines in inflows. Generally, it is assumed that FDI as compared to Portfolio Investment (PI) is more stable, less prone to volatility and brings significant development benefits to the country, reasons why many developing countries have designed incentive packages to attract foreign capital. “FDI triggers technology spillovers, assists human capital formation, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise development. All of these contribute to higher economic growth, which is the most potent tool for poverty alleviation” (OECD 2002). However, recent evidence highlights the volatility of FDI, laying to rest the idea of FDI’s supposed stability. The consequences of such volatility

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