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Abstract

Contrary to widespread presumption, a surprisingly large number of countries have been able to finance a significant fraction of their investment for extended periods using foreign finance. While many of these episodes are in countries where official finance is important, we also identify episodes where a substantial fraction of domestic investment is financed by private capital inflows. Although there is evidence of a positive growth effect of such inflows in the short run, that positive impact dissipates after 5 years and turns negative over longer horizons. Many such episodes end abruptly, with compression of the current account and sharp slowdowns in investment and growth. Summing over the inflow (current account deficit) episode and its aftermath, we find that growth is slower than when countries rely on domestic savings. The implication is that financing growth and investment out of foreign savings, while not impossible, is risky and too often counterproductive.

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