Working Paper
Country Responses to Massive Capital Flows

The emergence of a select group of developing countries as destinations for private portfolio investment in the 1990s (and the subsequent peso crisis in Mexico in 1994) has rekindled the old issues about the responsibilities and capacities public authorities have with regard to managing the absorption of these resources. This paper discusses the purposes public authorities might have in resisting these flows and presents a model of how authorities might intervene through their domestic financial system. It reviews the experiences of Chile, Malaysia, and Korea as countries whose policy responses have straddled the range of options. It suggests three key issues in the attempts of authorities to intervene in these private decisions. First, it is important for authorities to have clear objectives if they are going to attempt to resist market signals, such as exchange appreciation. Second, authorities should have a constant stance with regard to desirable flows and use flexible instruments. Third, authorities should exert efforts to improve their capacity to intervene through efforts such as building up reserves and creating domestic markets for sterilization instruments.