(c) As the balance of payments deteriorated, especially after interruptions of capital inflows and sometimes massive flights of capital, the national currency was sharply devalued.

Thus, the pattern in emerging market economies that liberalized capital inflows has been lower investment in the modern sectors of the economy, and eventually slower economic growth (once the consumption boom associated with the capital inflows plays out). By contrast, countries like China and India, which avoided a surge of capital inflows, managed to maintain highly competitive domestic currencies, and thereby kept profitability and investment high.

The fourth option is to impose capital controls on inflows (or liberalize controls on outflows). Leaving aside the issue of whether or not such controls are leaky, evidence suggests that controls on inflows of short term hot money do not affect the overall amount of capital inflows. Thus, such controls are ineffective in reducing short term cyclical pressure on the currency to appreciate.

Monetary policy was undermined by the banking crisis, and any reduction of interest rates to boost economic activities would encourage further flight of capital and stop capital inflows.

High world oil prices and capital inflows are strengthening the balance of payments and contributing to exchange rate appreciation.

The participation of foreign investors in these markets means that the risks of sudden reversals of foreign capital inflows is not eliminated.

(a) Promote an economic and regulatory climate that is conducive to inward remittances and to capital inflows, in general.

Cheap external finance, plentiful capital inflows, and commodity booms helped hide many such shortcomings and fueled 15 years of emerging market growth.

Remittances from workers are a major, stable source of capital inflows for many developing countries, but they are nevertheless subject to shocks.

The 1990s witnessed a rapid expansion of private capital inflows into developing countries, registering a sevenfold increase over the average for the 1980s.

The ability to refinance government debt and keep costs down is essential to strengthening public finances and boosting GDP growth. Furthermore, attracting more direct investment is crucial, given that capital inflows, while recovering, remain 30 below their pre crisis level with outflows exceeding inflows, Italy has become a net capital exporter.

In particular, capital expenditure revived in many countries and foreign direct investment inflows into the region also increased sharply in 2004.

The precise circumstances in which the vulnerability to the reversal of capital inflows arose and the subsequent impact on growth varied from region to region.

Industrialized economies are seeking to recover from the crisis, and want credit and capital to stay home to boost growth, while developing countries have little interest in gaining short term capital inflows. This could form the basis for industrialized countries to adjust their tax codes and deploy other types of regulation to keep capital at home, while emerging markets implement measures aimed at changing the composition and reducing the level of potentially destabilizing inflows.

Should a country with weaknesses in its financial system simply avoid letting capital in? While this has become more difficult, countries can still choose at least to some degree how open they are to capital inflows.

Some countries responded by doing nothing, but many, including industrialized countries like Japan and Switzerland, intervened heavily in currency markets. Some resorted to capital account regulations on inflows, such as taxes on the foreign purchases of bonds, equities, and derivatives, reserve requirements on short term inflows, and so forth.

By mid 2003, some 776 of the country s financial institutions were closed. And the authorities strong commitment to reform restored investor confidence, reviving inflows of private capital and reactivating foreign trade.

Other emerging markets growth prospects are even worse not least because of low commodity prices. As a result, these countries can expect lower capital inflows, again making for weak local currencies.

If appreciation does not reduce the current account surplus and capital inflows, then the renminbi s exchange rate is bound to face further upward pressure. That is why some people are advocating that China undertake a one shot, big bang appreciation large enough to defuse expectations of further strengthening and deter inflows of speculative hot money.

With the global economy recovering, China s trade surplus began to grow. Moreover, capital inflows increased significantly, owing to real investment opportunities in the high growth economy and the expectation of renminbi revaluation.

And what was true of China was also true of other emerging market countries receiving capital inflows. These countries foreign reserves, mainly held in US securities, topped 8 trillion at their peak last year.

BEIJING In theory, the difference between capital inflows and outflows in developing countries should be positive they should be net capital importers, with the magnitude of the balance equivalent to the current account deficit. Since the 1997 1998 Asian financial crisis, however, many East Asian countries have been running current account surpluses and hence have become net capital exporters.

Another global financial crisis could disrupt short term capital inflows. A dangerous neighborhood means inescapable risks, though Turkey has demonstrated a remarkable capacity during the last decade to surmount them.

Some argue that China needs to adjust its exchange rate to prevent inflation or bubbles. Inflation remains contained, but, more to the point, China s government has an arsenal of other weapons (from taxes on capital inflows and capital gains taxes to a variety of monetary instruments) at its disposal.

In many cases, a combination of capital outflows, profit remittances and the accumulation of exchange reserves greatly reduced net inflows, and of these a growing proportion was absorbed by activities which added little to productive capacity.

To respond to inflation by increasing interest rates would simply compound the difficulties of high prices with high unemployment and an even less competitive exchange rate. Direct interventions, restrictions on short term capital inflows, capital gains taxes, and stabilizing prudential banking regulations will all have to be considered.

These, together with the external shocks triggered by the volatility of speculative capital flows, drastic terms of trade adjustments and even inflows of remittances, make the potential benefits of structural adjustment and stabilization policies difficult to attain.

For starters, countries should embrace policies that favor foreign direct investment (FDI) over inflows that can be withdrawn more quickly, such as foreign bank loans, debt, or equity investments. My research with Hui Tong of the International Monetary Fund shows that countries whose capital inflows that are mainly in the form of FDI tend to be more resilient to foreign financial shocks.

As long as China was running a trade surplus and receiving net inflows of foreign direct investment, the RMB remained under upward pressure. Short term capital flows had little impact on the direction of the RMB s exchange rate.

But most have suffered from the opposite syndrome excessive reliance on capital inflows, which, by spurring domestic credit and consumption, generate temporary growth. But recipient economies are vulnerable to financial market sentiment and sudden capital flight as happened recently when investors anticipated monetary policy tightening in the United States.

One approach might be simply to let the renminbi float without official intervention or controls on capital inflows. Again, this would inevitably trigger hot money inflows, with speculators taking advantage of the spread between Chinese interest rates and the near zero, short term rates in developed economies, thereby driving up the renminbi further (and creating yet more opportunities for speculation).

Second, many argue that raising interest rates would trigger a flood of speculative capital from low yielding advanced economies. With the PBOC unable to sterilize the inflows, upward pressure on the renminbi s exchange rate would threaten competitiveness.

Although these booms were initially financed by domestic capital, they soon became dependent on foreign capital, which flowed into their economies as advanced country central banks pumped huge amounts of liquidity into financial markets. Now, just as the US Federal Reserve contemplates an exit from its unconventional monetary policies, emerging economies current account positions are weakening, making their reliance on capital inflows increasingly apparent and increasingly dangerous.

Currently, Russia s greatest economic concern is growing inflationary pressure, driven especially by food prices. Rising food prices are an international phenomenon, and Russia s inflation is driven by the large current account surpluses and capital inflows.

Witness the surge in capital flows to emerging markets as investors chase higher financial returns. Complicating matters even more, these inflows have become less and less connected to the recipient countries economic and financial fundamentals.

Yet imposing capital controls on inflows is difficult and sometimes leaky. Macroprudential controls on credit growth are useful, but sometimes ineffective in stopping asset bubbles when low interest rates continue to underpin generous liquidity conditions.

Although a marked liberalization, and deregulation and privatization policies, had been implemented, FDI inflows to Africa as a proportion of total developing country inflows had declined.

In a world of ultra low returns, Greece would be seen as a splendid opportunity, sustaining a steady stream of inward foreign direct investment. But why would this be different from the pre 2008 capital inflows that fueled debt financed growth?

Policymakers in many emerging market countries worry that surging capital inflows will drive up the value of the local currency, destabilize financial markets, and fuel economic overheating. Their reactions range from buying up the foreign money to prevent currency appreciation to adopting capital controls, and, in extreme cases, to keeping the money out altogether.

While the debt crisis in the developing world was triggered by a reorientation of policies in the industrial countries (UNCTAD, 1986), it did reveal the extent to which rapid growth had come to depend on steadily rising capital inflows.

It was also increasingly concentrated in a small group of 20 or so emerging markets which received over 90 per cent of total inflows of capital in the 1990s, compared to some 50 per cent before the outbreak of the debt crisis.

But China s 3.2 trillion problem will become a 20 trillion renminbi problem if China cannot reduce its current account surplus and fence off capital inflows. There is no escape from the need for domestic structural adjustment.

BERKELEY Complaints about the inflationary effects of American monetary policy are rampant, despite there being barely a hint of inflation in the United States. Rapidly growing catch up economies are paddling furiously to avoid being dragged down by a torrent of capital inflows.

Thus, China must maintain controls on inflows of financial capital for the time being, with the PBOC intervening to stabilize the renminbi dollar exchange rate. Until conditions in the world economy improve substantially, China s policymakers will have no easy way out.

When justified by economic fundamentals, the exchange rate should be allowed to rise gradually. But when a currency s appreciation is triggered by capital inflows that represent the asset diversification preferences of advanced economy investors, it can and should be resisted.