Working Paper: CEPR ID: DP11451
Authors: Eduardo Cavallo; Barry Eichengreen; Ugo Panizza
Abstract: A surprisingly large number of countries have been able to finance a significant fraction of domestic investment using foreign finance for extended periods. While many of these episodes are in low-income countries where official finance is more important than private finance, this paper also identifies a number of episodes where a substantial fraction of domestic investment was financed via private capital inflows. That said, foreign savings are not a good substitute for domestic savings, since more often than not episodes of large and persistent current account deficits do not end happily. Rather, they end abruptly with compression of the current account, real exchange rate depreciation, and a sharp slowdown in investment. Summing over the deficit episode and its aftermath, growth is slower than when countries rely on domestic savings. The paper concludes that financing growth and investment out of foreign savings, while not impossible, is risky.
Keywords: current account; growth; volatility; savings
JEL Codes: F32; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large current account deficits (F32) | lower long-term growth (O49) |
| foreign savings (F32) | finance domestic investment (O16) |
| foreign savings (F32) | negative economic outcomes (F69) |
| large current account deficits (F32) | real exchange rate depreciation (F31) |
| large current account deficits (F32) | slowdown in investment (E22) |
| large current account deficits (F32) | volatility of output increases (E39) |
| reliance on foreign savings (F34) | slower growth (O49) |