Macroeconomic implications of capital inflows : Peru 1991-2007

During the early 1990s, many emerging market economies in Asia and Latin America experienced massive capital inflows, favoured by structural reforms and improvements in macroeconomic management. Although the higher degree of financial integration brought many benefits, the capital inflows resulted in overheating and increased vulnerability to financial crises, which led in some cases to sudden reversals of capital flows. In recent years, the high level of global liquidity and favourable economic conditions achieved via improved macroeconomic management have generated massive capital inflows to emerging market economies. Peru has also experienced significant capital inflows, especially in foreign direct investment (FDI), contributing to economic growth and development possibilities, but also creating downward pressures on the exchange rate. The strength of the fiscal position, with sustained primary surpluses and the de-dollarisation of the financial system, has helped neutralise the side effects of capital inflows and allowed the monetary authorities to respond through sterilised interventions without endangering the inflation targeting regime. This paper analyses the macroeconomic effects of the 2000s episode of capital inflows and compares it with the episode of the 1990s. It also evaluates policy measures implemented in order to reduce the impact of abrupt reversals of capital flows.