er. To the extent that the flows depend on continued high gains, mostly appreciation, one could wonder whether the high of return of 1992-93 will resume after the 1994 correction. Even in the best of circumstances, one would expect some flow reversals, in addition to normal volatility. Unfortunately, the best of circumstances rarely occurs, and the Mexican episode of December 1994 has precipitated outflows in many emerging markets as fund managers have bailed out everywhere. It is hard not to view this as herd behavior with a tinge of panic, but it caused a 3 percent devaluation in Thailand and more than doubled short-term interest rates there. Other East Asian markets have also suffered outflows as international investors have generally reduced their exposure in emerging markets. However, giver the long-term growth potential of the East Asian economies and the indications of a longer-term stock adjustment process, there is reason to except that such reactions will be temporary set backs in a persistent trend toward a lager share of sound emerging market stocks in global portfolios. The spectacular yields witnessed recently may not be sustainable, but the East Asian countries should offer high rates of return over the long term and should continue to attract investment.
A number of countries in East Asia and elsewhere have begun attracting foreign portfolio investors into their own fixed-income markets, purchasing, instruments in local currency. In this case the foreign bondholder takes the exchange risk, for which he expects added compensation. It is encouraging that these economies are becoming attractive enough, and their exchange management is considered stable enough, to attract investment in local currency securities. For obvious reasons, interest tends to be in bank deposits, in shorter maturities, and in guaranteed instruments of government or their agencies.
To the extent that short-term capital flows exceed working balances, trade financing, or bridge activities to long-term investment, they are most likely the result of relatively high interest rates not offset by an expected devolution. For the most part, these flows are seeking high short-term rates of return and reflect cash management or speculative decisions rather than long-term investment decisions rather than long-term investment decisions. But like long-term flows, they tend to lower domestic interest rates and appreciate the exchange rate. They are likely to expand bank reserves and lead to more credit expansion, although on a potentially more volatile base. To the extend that a government is trying to restrain domestic demand with high interest rates, the inflow would undermine its policy. These flows may not directly influence long-term savings and investment, but they may do so.
The World Bank and investment bankers regularly provide advice to developing countries on asset and liability management. But that advice often is non optim...
