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If its current-account deficit is financed by flighty short-term capital rather than long-term foreign direct investment, a country is vulnerable to sudden capital outflows.
The reports Tuesday noted that sudden capital inflows can cause inflation and asset bubbles, and found that capital controls can be useful — but mostly as a last resort.
The most damaging cases are the episodes of sudden capital flight, as occurred in Mexico in 1994 and several Asian countries in 1997.
NEW YORK TIMES Amid Rush for Corporate Bonds, a Word of Caution | Investors seem to love junk bonds, but "nobody really knows just how vulnerable the sector is to a sudden capital flight," Gillian Tett of The Financial Times writes.
Last month, the authorities in South Korea announced a step limiting the foreign exchange debts held by banks — a measure aimed at reducing the country's vulnerability to sudden capital reversals.
South Korea, in its role as G-20 chairman, is trying to take the notion of burden-sharing to mitigate financial mishaps a step further with a proposal for cross-border safety nets that would obviate the perceived need for huge exchange reserves to guard against sudden capital flight.
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Then there is the question of how emerging market policymakers respond to the turbulence: will they raise rates to stem inflationary depreciation and capital outflows, or will they cut rates to boost flagging GDP growth, thus increasing the risk of inflation and of a sudden capital-flow reversal?
A sudden new capital charge could wipe out some British fund managers.
Sudden massive capital flight out of Italy and Spain caused havoc in bond and equity markets, plunging the entire euro zone into recession just two months later.The ECB tried many things to contain the damage.
But Galante said Sriracha's sudden political capital has nothing to do with it.
Investors have lost confidence.We have also put together a "capital-freeze index" that assesses the vulnerability of large emerging markets to a sudden slowdown in capital flows:A large current-account gap implies lots of net borrowing from abroad, which could presage a credit crunch if funding dries up.
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