Financial Crises and the Composition of International Capital Flows: Does FDI Guarantee Stability?

The conventional wisdom is that crises are largely due to swings in short-term capital (mainly bank loans in the case of East Asia). Hence economies that finance their current account deficits mainly via foreign direct investment (FDI) are seen as being less susceptible to a crisis. The spate of financial crises in emerging economies in the 1990s, coinciding as they have with increased cross-border flows of capital, motivates our interest in examining the nexus between crises and the composition of capital flows. Does reliance on FDI guarantee stability? The analysis in this paper challenges the casual presumption that the switch towards FDI alone will automatically imply that extreme capital instability will become a thing of the past.