`Mexican crisis will not frighten off investors'

World's poorest countries still rely on official loans
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The Independent Online
The tidal wave of private funds that washed into emerging markets in the early 1990s will not be reversed despite the Mexican crisis, according to the World Bank. Its annual World Debt Tables , published yesterday, show that the flow of private c apital to developing countries nevertheless slowed down sharply last year, even before capital started flooding out of Mexico.

Total private capital flows into developing countries came to $172.9bn, up from $159.2bn in 1993. Direct investment and debt flows both increased, more than offsetting a fall in portfolio equity investment. Investment in emerging stock markets dropped from $46.9bn in 1993 to $39.5bn after steep falls in some markets early last year.

The rise in the total was significantly less than in the heady days of 1992-93, which saw increases of $39.8bn and $56.5bn, respectively, thanks to stock market investment by first world funds. Private capital now accounts for three-quarters of all long-term finance flowing to developing countries. The recipients have mainly been middle-income countries in East Asia and Latin America, along with China and India.

The World Bank insists the trend will continue, for a variety of reasons set out in the new report. These include the importance of foreign direct investment - buying or building production facilities.

International companies increasingly source and produce worldwide, and also seek access to growing markets for their goods, the bank says. More than 40 per cent of total investment flows in 1994 were explained by direct investment.

The bank also reckons institutional investors from the industrial countries are still underweight in the faster-growing developing economies. In the long run the funds should increase their exposure to the higher returns available in Asia and Latin America.

Some observers think this is an optimistic analysis. Malcolm Roberts, head of global bond research at securities firm UBS, argues that the expansion of liquidity around the world in 1991-93 has gone into reverse now that US interest rates have risen fromabnormally low levels."There is a systematic withdrawal of liquidity from global markets. It is not just a question of sentiment and expectations of risk," he says.

Mexico's problems have certainly dented sentiment, anyway. The country was one of the World Bank's star graduates. Along with the International Monetary Fund it has supervised the Mexican economy for more than a decade, since the 1982 debt crisis.

The bank has two excuses for its failure to head off the latest crisis, despite its decade, in effect, at the helm. Masood Ahmed, director of the bank's international economics department, says it was aware of Mexico's ballooning current account deficit and backed the government's strategy of slow depreciation of the exchange rate to correct it. "The market reacted more suddenly than anyone anticipated," he says.

The bank's chief economist, Michael Bruno, also blames Mexico's over-reliance on short-term capital - stock market investment and short-term bonds. According to Mr Bruno: "The Mexican case shows how excessive reliance on short-term capital flows can bring greater volatility in its wake."

How should a country control the proportion of its capital that takes this feckless short-term form?

Mr Ahmed says it is a question of adjusting macro-economic policies to attract direct investment, instead.

Investment in shares has concentrated on the Latin American and East Asian markets, which attracted more than 90 per cent of gross portfolio equity flows to developing countries between 1989 and 1993. A handful of stock markets could prove particularly vulnerable. Of net investment of $35bn in 1993, a third went into Mexico.

Most of the rest was shared among Korea ($5.7bn in 1993), Brazil ($5.5bn), Malaysia ($3.7bn), Thailand ($2.5bn) and India ($1.5bn).

The world's poorest countries, still struggling under their decade-old debt overhang, have won almost none of the recent private investment flows. They still depend on official loans as their source of capital.