ACCUMULATION OF FOREX AND

LONG TERM ECONOMIC GROWTH

Victor Polterovich, Vladimir Popov

In many countries accumulation of FOREX
goes hand in hand with economic growth
Mauritius - Annual grow th rates and reserves/GDP ratios (5-year moving averages)

10 28

GDP per capita grow th rates (left scale)

8
23
6

18
4

2
13

0
Res/GDP (right scale)
8
-2

-4 3
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 In many countries accumulation of FOREX
goes hand in hand with economic growth
Malaysia - Annual growth rates and reserves/GDP ratios (5-year moving averages)

7 33

GDP per capita grow th rates (left scale) 31

6
29

27
5
25

4 23

21
3
19
Res/GDP (right scale)
17
2
15

1 13
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 In many countries accumulation of FOREX
goes hand in hand with economic growth
Chile - Annual growth rates and reserves/GDP ratios (5-year moving averages)

8 25

6
20

4
GDP per capita growth rates (left scale) 15

10
0

5
-2

-4 Res/GDP (right scale) 0

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 In many countries accumulation of FOREX
goes hand in hand with economic growth
China - Annual growth rates, terms of trade and reserves/GDP ratios (5-year moving averages)

100

15
100

10 100
GDP per capita growth rates (left scale)
100
5

Res/GDP (left scale) 100

0
100

-5
100
Terms of trade (right scale)
-10 100
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 In many countries accumulation of FOREX
goes hand in hand with economic growth
India - Annual grow th rates, terms of trade and reserves/GDP ratios (5-year moving averages)

8
Terms of trade (right scale)
110
7
100
6
90
5
Res/GDP 80
4

70
3

2 60

1 GDP per capita growth rates 50

0 40
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 In many countries accumulation of FOREX
goes hand in hand with economic growth
Indonesia - Annual growth rates and reserves/GDP ratios (5-year moving averages)

7 15
GDP per capita grow th rates (left scale)
6 13

5 11

4 9

3 7

2 Res/GDP (right scale) 5

1 3

0 1

-1 -1
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 In many countries accumulation of FOREX
goes hand in hand with economic growth
Sri Lanka - Annual growth ratesand reserves/GDP ratios (5-year moving averages)

140 12
Res/GDP (right scale)
130
10
120
8
110
Terms of trade index (left scale)
100 6

90
4
80
2
70 GDP per capita grow th rates (right scale)

60 0
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 But in other countries the relationship between
FOREX accumulation and growth is not that obvious...
Thailand - Annual growth rates, terms of trade and reserves/GDP ratios (5-year moving averages)

25 160
Terms of trade (right scale)
140
20

120
15 Res/GDP (left scale)
100

10
80

5 GDP per capita growth rates (left scale)

60

0 40
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 But in other countries the relationship between
FOREX accumulation and growth is not that obvious...
Korea - Annual growth rates and reserves/GDP ratios (5-year moving averages)

9 11

GDP per capita grow th rates (left scale) 10

8
9
7
8

6 7

6
5

Res/GDP (right scale) 5

4
4

3 3
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 But in other countries the relationship between
FOREX accumulation and growth is not that obvious...
Singapore - Annual growth rates and reserves/GDP ratios (5-year moving averages)

12 90

11
80
10
Res/GDP (right scale)
9
70
8

7 60

6
50
5

4
40
GDP per capita growth rates (left scale)
3

2 30
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 But in other countries the relationship between
FOREX accumulation and growth is not that obvious...
Egypt - Annual grow th rates and reserves/GDP ratios (5-year moving averages)

8 30

7
25

6
20
GDP per capita grow th rates (left scale)
5
15
4

10
3

5
2

1 Res/GDP (right scale) 0

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 But in other countries the relationship between FOREX
accumulation and growth is not that obvious...
Botswana - Annual growth rates and reserves/GDP ratios (5-year moving averages)

110
17 GDP per capita growth rates (left scale)
100
15 90

13 80

11 70

60
9
50
7
40
5
30
3 Res/GDP (right scale) 20

1 10
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
Russia - accumulation of FOREX and growth

Fig. GDP grow th rates (%, right scale) and year end gross foreign exchange
reserves, including gold, bln. $, left log scale

1000 15

10

GDP grow th rates

100 5

10 -5
FOREX
-10

1 -15
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
 Fig. 3.3. Average ratio of gross international reserves to GDP and average annual
growth rates of GDP per capita in 1960-99, %,

Botswana
Korea
Singapore
HK
6 China
Thailand
Japan Portugal
Malaysia
4
R2 = 0,2396
Averageannual growthrates
of GDPpercapita

2
Switzerland
0
Chad Venezuela
Sierra-Leone
-2
0 20 40 60
Average ratio of gross international reserves to GDP
 Fig. 3.7. Increase in the ratio of gross international reserves to GDP, p.p., and average
ratio of gross capital investment to GDP in 1960-99, %, for ... countries
40

35 Gabon Singapore
Algeria
Congo,Rep. Japan China (est.)
30
Average ratio of gross capital

Guyana R2 = 0,1353
investment to GDP

25

20
Korea
Chile
15
Philippines
10 Sierra-Leone

5
-20 -10 0 10 20 30 40 50 60 70 80
Increase in the ratio of gross international reserves to GDP, p.p.
 Fig. 3.3A. Average ratio of FOREX to GDP and GDP per capita growth rates in 1960-99

4,5
Japan
4
Ireland Portugal
3,5
GDPper capitaaverageannual

3
growthratesin1960-99

R2 = 0,0001
2,5

1,5
New Zealand Switzerland
1
0 5 10 15 20 25 30 35
Average ratio of reserves to GDP in 1960-99, %
Table 2. Some macroeconomic indicators for rapidly growing countries in 1960-99
Countries Annual average Increase in Average Highest FER/ Average FER in
GDP per capita FER/ GDP ratio, FER/GDP
p.p., GDP ratio in months of import,
Growth rate, % 1960-99 ratio, % 1960-99, % 1975-99
Botswana 6,13 86,93 68,89 121,82 13,64
(1976-99) (1976-99) (1998)
China 4,94 13,72 8,68 16,31 7,36
(1977-99) (1977-99) (1999)
Hong Kong, 5,12 27,59 42,74 60,56 3,61
China (1990-99) (1990-99) (1999)
Japan 4,18 2,37 3,42 6,76 3,54
(1999)
Korea, Rep. 5,82 14,17 5,89 18,21 2,11
(1999)
Singapore 5,87 72,76 60,55 90,52 4,76
(1998)
Thailand 4,51 14,44 14,75 27,97 4,47
(1997)
 Literature overview
 Rodrik (1986) developed a model demonstrating how
disequilibrium exchange rate in the presence of foreign trade
externalities could lead to the acceleration of growth.
 In this early paper Rodrik assumes the import externality, which is
used via the overvaluation of the exchange rate that stimulates
imports of machinery and equipment.

 It was shown for developing countries that overvaluation of the

exchange rate is detrimental for economic growth by including the
variable that characterizes the undervaluation of the exchange rate
into standard growth regressions (Dollar, 1992; Easterly, 1999).

 Aghion, Bacchetta, Ranciere, Rogoff (2006) examine mainly the

impact of volatility of the real exchange rate on productivity
growth, but also look at the impact on growth of
under/overvaluation of the exchange rate (the measure of
overvaluation is basically the residual from the regression of RER
on the GDP per capita – to control for the Balassa-Samuelson effect
– and a couple of regional dummies. They find that overvaluation of
RER negatively affects economic growth, especially in poorer
countries.

 Literature overview: Balassa-
Samuelson effect
 Grafe and Wyplosz (1997) argue that even if the
appreciation of the exchange rate in transition economies
undermines business profits (in the export sector and in
industries that compete with imports), this should not
necessarily lead to a deterioration of the current account,
since the need for capital accumulation in transition
economies declines - that is, they can operate with lower
savings ratios than they could before the transition.

 Halpern and Wyplosz (1997) argue that real appreciation in

transition economies will continue until the transition is
over, which may be “decades away.”
 Another study (ESE, 2001) found evidence of Balassa-
Samuelson effect in transition economies of Eastern Europe
and former Soviet Union in the 1990s. The period is too
short, however, and the increases in RER that actually took
place in most transition economies may be the reaction to
the overshooting initial devaluations that occurred in the
beginning of the 1990s, when convertibility was introduced.
Balassa-Samuelson effect: real exchange rate (national
prices for non-tradables as compared to foreign prices)
increase with the growth of GDP per capita

Fig. 3.6. PPP GDP per capita in 1999 and the ratio of domestic to US prices of tradables
and non-tradables in 1993, %

200
180
Cloth-dom /US
Ratio of domestic to US prices of

R2 = 0,6582
tradables and non-tradables, %

160
Health-dom/US
140
120
R2 = 0,723
100
80
60
40
20
0
0 5000 10000 15000 20000 25000 30000 35000 40000 45000
PPP GDP per capita in 1999, dollars
 Real exchange rate of national currencies versus the
US dollar for major groups of countries

Fig. 3.5. Ratio of official to PPP exchange rate (LCU per $1) in 1975-99 for groups of
countries (unw eighted average)
120
Average
110 developed
Ratio of official to PPP exchange rate, %

100
FAST RICH 6
90

80

70 All
countries
60

50 Average
developing
40

30 FAST POOR
10
20
1975

1977

1979

1981

1983

1987

1989

1991

1993

1995

1997
1985

1999
Table 1. Ratio of actual exchange rate of national currencies in $US to PPP for
countries in 1993, % (figures in brackets - for 1996)
Countries/regions Ratio, % Countries/regions Ratio, %
OECD* 116 Transition economies* 81
- Germany 126 (133) -Central Europe* 54
- Japan 165 (158) - Bulgaria 30 (25)
- U.S. 100 (100) - Croatia 65 (94)
- Portugal 73 (77) - Czech Republic 36 (48)
Developing countries* 44 - Hungary 62 (63)
-Asia* 36 - Poland 48 (59)
- India 24 (23) - Romania 31 (34)
- Indonesia 30 (33) - Slovak Republic 37 (47)
- Korea 72 (81) - Slovenia 69 (78)
- Malaysia (44) -USSR* 91
- Philippines 35 (34) -Armenia (20)
- Thailand 43 (45) - Azerbaijan (32)
- Turkey 54 (48) - Belarus 8 (30)
-Latin America* 46 - Estonia 29 (64)
- Argentina (90) - Georgia (29)**
- Brazil (70) - Kazakhstan (39)
- Chile (43) - Kyrghyzstan (19)
- Mexico 58 (45) - Latvia 27 (50)
- Peru (56) - Lithuania 19 (47)
- Venezuela (36) - Moldova 14 (28)
-Middle East* 83 - RUSSIA 26 (70)
- Kuwait (67) - Tajikistan (3)
-Saudi Arabia (68) - Turkmenistan (45)
- United Arab Emirates (100) - Ukraine 19 (39)
-Africa* 37 - Uzbekistan (22)
- Ethiopia (20) China 22 (20)
- Mozambique (17) Mongolia (21)
- Nigeria 36 (90) Vietnam (20)
* 1990. ** 1995.
How the accumulation of FOREX is financed?
 Formally, the following identities hold:

 ΔM=ΔFOREX+ΔBCB
 BD = ΔBCB + ΔBP
 ΔFOREX = ΔM + BS + ΔBP ,

 where ΔFOREX – increase in foreign exchange reserves,

 ΔM – increase in money supply,
 BS – budget surplus (BD – budget deficit),
 ΔB – increase in bonds held by the public,
P

 ΔBCB - increase in bonds held by the central bank.

 The last identity implies that the increase in foreign

exchange reserves can be financed by the increase in
money supply, i.e. inflation tax on everyone (ΔM),
budget surplus (BS), accumulation of debt held by the
public (ΔBP).22
 How the accumulation of FOREX is financed?
Table 3. Factors explaining the level of FER in 1960-99 and the sources of FER
accumulation - cross country OLS regression results

Dependent variable Average Average Increase in Increase in Increase in

ratio of ratio of the ratio of the ratio of the ratio of
FER to FER to FER to GDP FER to FER to GDP
GDP in GDP in from 1960 GDP from 1960
1960-99, 1960-99, to 1999, p.p. from 1960 to 1999, p.p.
% % to 1999, p.p.
Number of observations 172 122 62 58
Average budget surplus 0.55* 1.0*** 1.07***
in 1960-99, % of GDP
Average government 0.08* 0.09**
debt in 1960-99, % of
GDP
Average annual inflation 0.05 0.07
(GDP deflator), 1960-
99, %
Average import of goods 0.29*** 0.32***
and services, % of GDP
2000 investment 0.18**
climate index, ICRG, %
Constant 0.09 -13.1** 7.1*** 5.6** 4.5*
Adjusted R2 26 32 2 8 7
*, **, *** - Significant at 10%, 5% and 1% level respectively.
 Fig. 3.1. Fore ign e xchange rese rves as a % of GDP, ave rage ratios for 1960-99

Congo, Rep.
US
Japan
Mexico
Rus sia(93-99)
India
Brazil
UK
Pakistan
Argentina
Turke y(68-99)
Germ (91-99)
Korea, Rep.
France
Indon(67-99)
Philippine s
Italy
Nigeria
China(77-99)
Egypt
Chile
UAE
Iran(74-99)
Israe l
Mauritius
Ireland
Thailand
Kuw ait
Malays ia
Saudi Arabia
Libya
HK(90-99)
Singapore
Botsw ana (1976-99)

0 10 20 30 40 50 60 70
%
 Fig. 3.2. Share of gold in reserves in the w orld and in the US (%, left scale) and the ratio of
foreign exchange reserves to GDP in the world (%, right scale)

100 10
Share of gold in reserves
90 in the US (left sৣale) 9

80 8

70 Share of gold in reserves 7

in the world (left scale)
Share of gold in reserves, %

60 6

50 Ratio of reserves to GDP 5

40 (right scale) 4

30 3
Ratio of net reserves (excluding gold) to GDP (right scale)
20 2

10 1

0 0
1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998
 Fig. 3.2A. Average ratio of imports to GDP and average ratio of reserves to GDP in 1960-
99, %

Lebanon
100
90 Malta

80
70 Botswana Singapore
FER as a %of GDP

60
50
R2 = 0,2611
40
30
20
10
0
0 20 40 60 80 100 120 140 160 180
Import as a % of GDP
 Why a country keeps FOREX?
 The standard formula for explaining FER is:

   
FER 
, where
Y  O  O  i
 Y is income,
 O is the measure of openness of the economy
(external trade to GDP ratio),
O is the volatility of openness,

 i is the opportunity costs of holding foreign
exchange reserves (difference between the interest
rate earned on FER invested into short-term low
risk securities and interest rate on alternative
investment).
 The collapse of the Bretton-Woods fixed exchange
rates system in 1971 did not have a large impact on
the demand for FER (Grennes, 1984, Ch. 22).
 What are the determinants of the
accumulation of FOREX?
 delta R = 38 – 11.4logYcap75 + 0.1(T/Y) +
0.24(delta T/Y)

(R2=34%, N=82, all coefficients significant at 0.1%

level).

 Then we considered the residual as the policy-

induced change in reserves.
 Afterwards we used the policy induced change in
foreign exchange reserves as one of the explanatory
variables in growth regressions together with import
taxes and change in government revenues/GDP ratio
 Does policy induced FOREX
accumulation influence growth?

 GROWTH= CONST.+CONTR.VAR.+ T(0.06–

0.0027Ycap75us)+ Rpol (0.07-0.006T)
 The control variables are the rule of law index
for 2001, the size of the economy in 1975, and
the population growth rates in 1975-99.
 N=74, R2=44%, all coefficients are significant at
less than 10% level, except for coefficients of
Rpol (11%) and the PPP GDP in 1975 (16%).
 What determines the accumulation of FOREX?
Another definition of policy-induced changes in FOREX
 We also experimented with another definition of
policy induced change in foreign exchange reserves, as a
residual from regression linking the increase in reserves to
GDP ratio to the following ratios: trade/GDP, increase in
trade/GDP, external debt/GDP(ED/Y) and debt
service/GDP(DS/Y):

R  3.3  0.6( DS / Y )  0.06( ED / Y )  0.2(T / Y )  0.28(T / Y )

 N=59, R2=36%, all coefficients significant at less than
7%.
 Does policy induced FOREX
accumulation influence growth?

 GROWTH=CONST.+CONTR.VAR.+T(0.001RISK–
0.0038Ycap75us)+Rpol(0.23-0.014T),
 N=48, R2 = 46, all coefficients significant at 7%
or less,
 control variables – PPP GDP per capita in 1975
and population growth rate.
What are the determinants of the accumulation of FOREX?

Another definition of policy-induced changes in FOREX

 For the 1975-99 period, for which more data are available,
the best equation explaining changes in FER is shown below:

R  39  0.4( R / Y 60  99)  6.2 lg Y  0.3ICI 84  90  0.2(T / Y )  0.3( [T / (1)


Y]

R2=50%, N=72, all coefficients significant at 3% level or less,

where:
 Y - initial (1975) GDP per capita,
 T/Y - average ratio of foreign trade to GDP over the period,
 -
[T / Y ] the increase in the same ratio over the period,
 R/Y60-99- average ratio of FER to GDP in 1960-99,

 ICI84-90 - average investment climate index in 1984-90

(ranges from 0 to 100, the higher, the better).
 Does policy induced FOREX
accumulation influence growth?
 GROWTH = CONST. + CONTR. VAR. +
Rpol (0.10 – 0.0015Ycap75us)

 R2 = 56, N=70, all variables are significant at

10% level or less,
 where Ycap75us – PPP GDP per capita in 1975
as a % of the US level.
 It turns out that there is a threshold level of GDP
per capita in 1975 – about 67% of the US level:
countries below this level could stimulate growth
via accumulation of FER in excess of objective
needs, whereas for richer countries the impact
of FER accumulation was negative
Does policy induced FOREX accumulation influence growth?
Table 4a. Factors explaining the average growth rate of GDP per capita in 1975-99 - cross
country OLS regression results, robust estimates
Dependent variable Average growth rate of GDP per capita in 1975-99
Number of observations 92 77 90 90 90 70 70
Average population growth rate in -0.88 -0.68 -0.77 -.086 -0.76 -1.22 -0.93
1975-99, % *** ** *** *** *** *** ***
Log PPP GDP per capita in 1975, $US -1.16* -1.44** -1.15***
1984-90 investment climate index, 0.06
ICRG, % ***
Average investment/GDP ratio in 0.12 0.11
1975-99 *** ***
Annual average inflation in 1975-99, % -0.01* -0.01 -0.01 -0.01** -0.01**
** **
Total population in 1999, million 3*10-09 3*10-09 2*10-09 3*10-09
*** *** ** **
Population density in 1999, people per .0005 .0003* .0007 .0004
1 sq. km *** *** ***
Increase in the ratio of FER to GDP 0.037 0.05 0.040 0.040 0.032
from 1975 to 1999, p.p. * ** *** ** *
Increase in the ratio of FER to GDP, 0.068**
determined by objective factors –
according to equation (1)
Policy-determined increase in the ratio 0.10** 0.059*
of FER to GDP in 1975-99 - R pol
Interaction term = (Policy-determined increase in -0.0015
the ratio of FER to GDP in 1975-99)* **
(Per capita PPP GDP in 1975, % of US
level)
Constant 2.8*** 2.9 0.11 2.65*** 0.2 7.3*** 3.0***
2
 Countries with faster accumulation of FOREX
had lower real exchange rates
Fig. 3.4. Increase in the ratio of gross foreign exchange reserves to GDP and the ratio
of PPP to official exchange rate in 1975-99, %

180
160 Congo, Rep.
140
Kuwait
Ratio of PPPto official

120 Denmark
Sw itzerland Sw eden Norway
exchange rate

100
80 Singapore
Saudi Arabia Chile Malaysia
60
R2 = 0,0811
40 Indonesia
Guyana
20
Nicaragua
0
-40 -30 -20 -10 0 10 20 30 40
Increase in the ratio of gross foreign exchange reserves to GDP
 Real effective exchange rate in som e fast grow ing countries,
1990=100%

China
400
Chile
Real exchange rate, 1990=100%

350 Malaysia
Philippines
300
Cyprus
250 Singapore

200

150

100

50
1977

1979

1981

1983

1985

1987

1991

1993

1995
1975

1989
 Ratio of official to PPP exchange rate in fast growing developing countries,
1975-99 (over 3% a year increase in GDP per capita)

90
Ratio of official to PPP exchange rate, %

80

Chile
70
Botswana
Malaysia
60
Egypt, Arab Rep.
Mauritius
50
Thailand
FAST POOR 10
40
Sri Lanka
Indonesia
30
China
India
20
1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999
 Ratio of official to PPP exchange rate in fast growing developed countries, 1975-99 (over 3% a year
increase in GDP per capita)
Hong Kong, China

140 Luxembourg
Ratio of official to PPPexchange rate, %

120 Singapore

100 Ireland

FAST RICH 6
80

Cyprus
60
Korea, Rep.
40
1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999
Table 5. Factors explaining the average ratio of domestic to US prices in 1975-99 –
country OLS regression results
Dependent variable = average ratio of domestic to US prices in 1975-99
Number of observations 89 78 78 72 (dev. only)
PPP GDP per capita in 1975 .006***
2000 investment climate index, 1.00*** 1.37***
ICRG, %
Increase in the ratio of FER to -0.53** -.88*** -0.54* -.57***
GDP from 1975 to 1999, p.p.
Average ratio of trade to PPP .35*** .39*** .41***
GDP in 1980-99
Average external balance in 1975- 1.37***
99, % of GDP
Net fuel imports, % of total imports -.27***
Constant 33.8*** -17.3 162.7*** 39.7
2
Adjusted R 64 53 45 62
*, **, *** - Significant at 10%, 5% and 1% level respectively.
Table 6. Correlation coefficients between prices of tradadbles and non- tradables (55
observations)
All domestic Domestic prices Domestic prices 1975 PPP
to US prices, of clothing to US of healthcare to capita
1980-99 prices US prices
All domestic to US prices, 1980-99 1
Domestic prices of clothing to US 0.6681 1
prices
Domestic prices of healthcare to US 0.7061 0.8392 1
prices
1975 PPP GDP per capita 0.7009 0.8365 0.8946 1

Table 7. Factors explaining 1993 price levels of health care and education, clothing and
footwear
Dependent variable Ratio of prices Ratio of of prices
Ratio of of domestic
Ratio of domestic
health care to prices
education
of to prices
healthof
care prices
clothing
to US and footwear
clothing clothing prices prices to the US prices
Number of observations 77 77 58 58
PPP GDP per capita in 1999 .000647* .0008086* 0.0033*** 0.0032***
Average ratio of domestic to 0.26** 0.28**
US prices in 1975-99
Increase FER/GDP ratio in -0.33** -0.32 (T stat=-1.47)
1980-99
Constant 38.93*** 34.57*** 17.95*** 41.52***
2
Adjusted R 23 23 78 64
*, **, *** - Significant at 10%, 5% and 1% level respectively.
Table 8a. Factors explaining the average share of investment in GDP in 1975-99 – cross
country OLS regression results
Dependent variable = average share of investment in GDP in 1975-99
Number of observations 79 79 79 72 59 (dev. 85 46 46 48 42
only)
Log PPP GDP per capita -.0008
In 1975 **
2000 investment 0.17 0.17 0.21 0.27 0.15 0.23 0.26 0.24
climate index, ICRG, % *** *** *** *** *** *** *** ***
1984-90 investment 0.14 0.14
climate index, ICRG, % *** ***
Increase in the ratio of 0.15 0.24 0.22 0.23 0.19 0.26
FER to GDP from 1975 *** *** *** *** *** ***
To 1999, p.p.
Policy-determined in- 0.28 0.22
Crease in the ratio of *** ***
FER to GDP from 1975
To 1999, p.p.
Ratio of prices for health- -0.06 -0.07 -0.08 -0.08
Care to prices for clothing *** *** *** ***
In 1993
Average external balance -0.21 -0.20
In 1960-99, % of GDP *** **
Net fuel imports in 1960- -0.09 -0.12 -0.09 -0.12 -0.06 -0.15 -0.13 -0.11
99, % of total imports *** *** *** *** *** *** *** ***
Interaction term = 0.03* 0.03
(increase in reserves) x *
(foreign/domestic prices)x
(external balance)
Constant 10.3 9.5 6.3 33.8 4.63 11.3 10.7 9.6 11.5 20.2
*** *** ** *** *** *** *** *** ***
2
Adjusted R 17 34 39 37 42 16 37 63 44 55
*, **, *** - Significant at 10%, 5% and 1% level respectively.
 Investment/GDP ratio and
export/GDP ratio
Fig. 3.8. Investm ent/GDP ratio and average ratio of foreign trade to PPP GDP in 1980-99

180 400
160 Exp/GDP-av60-99 350
140 Trade/PPPGDP-av80-99
300
Export/GDP in 1960-99

Trade/GDP in 1980-9i9
120
250
100
200
80
150
60
R = 0,1359
2

40 100
R2 = 0,0611
20 50

0 0
5 15 25 35 45 55 65
Investment/GDP ratio in 1960-99 and in 1980-99
Table 3.9. Factors explaining the share of export and foreign trade in GDP in 1960-99
– cross country OLS regression results
Dependent variable Increase in the ratio Average ratio Increase in the ratio of tra
of export to GDP in of trade to to PPP GDP
1960-99 PPP GDP in 1980-99, p.p.
in 1980-99
Number of observations 59 47 30 94 62 86 93 81

Log PPP GDP per capita 15.59 26.7

in 1975 *** ***
PPP GDP per capita in 0.0085 0.007
1975 *** ***
PPP GDP per capita in .003
1999 ***
2000 investment 0.76
climate index, ICRG *
Average ratio of export 0.77 0.71
to GDP in 1960-99 *** ***
Average ratio of trade to -0.19
PPP GDP in 1960-99,% ***
Terms of trade improve- -0.23
ment index, 1960-99 ***
Net fuel imports in 1960- 0.39 -.31** 0.53 0.40
99, % of total imports *** *** ***
Increase in the ratio of 1.06 0.37 0.56
FER to GDP from 1960 to *** (Tst= *
1999, p.p. 1.6)
Average ratio of domestic -0.49 -0.18
to US prices in 1980-99, % *** **
Increase in the ratio of 1.79
FER to GDP from 1960 to ***
1980 , p.p.
Increase in the ratio of 0.7 1.44 0.58 0.74
FER to GDP from 1980 to 8*** *** *** ***
1999, p.p.
PPP GDP in 1999, bill.$ -.004** -0.009 -.009
*** **
Average annual FDI net 4.9
inflow in 1980-99, % of **
GDP
Constant -25.57 12.3 -67.9 -15.40 .87 8.9 3.82 -80
** *** *** ***
2
Adjusted R 41 38 61 21 49 29 19 57
*, **, *** - Significant at 10%, 5% and 1% level respectively.
 Accumulation of FOREX and FDI
Fig. 3.9. Increase in the ratio of FOREX to GDP in 1960-99 and average net inflow s of FDI
as a % of GDP in 1980-99

8
Average annual net inflow of FDI as a %

R2 = 0,5093
6

4 R2 = 0,2686
of GDP

0
FDI in 1980-99
FDI in 1990-99
-2

-4
-15 -5 5 15 25 35 45 55 65 75
Increase in the ratio of FOREX to GDP in 1960-99, p.p.
Table 10. Factors explaining the net inflow of foreign direct investment (FDI) in
1980-99 – cross country OLS regression results
Dependent variable Average annual net inflow of FDI in 1980-99, % of GDP
Number of observations 59 40 47 40 39 37 36

PPP GDP per capita in -.0001 -.0004

1975 * ***
2000 investment -0.1 -0.02 0.05*
climate index, ICRG
Average ratio of FER 0.05
to GDP in1960-99, % ***
Increase in the ratio of 0.08 0.08
FER to GDP from 1960 *** ***
to 1999, p.p.
Increase in the ratio of 0.1 0.09 0.09
FER to GDP from 1960 *** *** ***
to 1980, p.p.
Increase in the ratio of 0.07 0.06
FER to GDP from 1980 *** ***
to 1999, p.p.
Increase in the ratio of 0.1,
FER to import from 1980 Tst.=
to 1999, p.p. 1.6
Constant 0.4 0.4* 1.7 0.26 0.8** 1.7
2
Adjusted R 18 50 -2 50 53 51 52
*, **, *** - Significant at 10%, 5% and 1% level respectively.
 Real exchange rate in fast growing developing countries
In this section we demonstrate, however, that
Fig.6. Average real exchange rate versus the US $ (Year 12 = 100%) in fast
growing developing econom ies, year "0" denotes the point of take-off

250
Botswana Chile
230 China Egypt, Arab Rep.
India Indonesia
210 Korea, Rep. Malaysia
Mauritius Singapore
190 Sri Lanka Thailand
FAST POOR
170

150

130

110

90

70

50
-5 -3 -1 1 3 5 7 9 11 13 15 17 19 21 23 25
 Reserves/GDP ratios and GDP per capita grow th rates for 12 fastest developing economies in
1975-99, unw eighted average, % ("0" is the year of take-off)

Pre-take-off stage Take-off stage Complacency stage New push and stabilization
10 35

9 Reserves/GDP ratios,
GDP grow th rates right scale
(actual and 5-year 30
8
moving average),
7 left scale
25
6

5 20

4
15
3

2
FDI inflow , % of GDP, left scale 10
1

0 5
-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
 Reserves/GDP ratios and GDP per capita grow th rates for 12 fastest developing economies in
1975-99, unw eighted average, % ("0" is the year of take-off)

Pre-take-off stage Take-off stage Complacency stage New push and stabilization
10 35
Reserves/GDP ratios,
8 GDP grow th rates right scale
(actual and 5-year 30
6 moving average),
left scale
4 25

2
FDI inflow , % of GDP,
20
left scale
0
-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
-2 15
Trade balance, % of GDP
-4
10
-6
External balance,
% of GDP, left scale
-8 5
 Fig. 3. 12. Average real exchange rate versus the US $ (Year 12 = 100%), trade balance and net
inflow of FDI as a % of GDP in 12 fast grow ing developing economies, year "0" denotes the
point of take-off

170 RER, left scale 6

160 FDI, right scale 4
150
140 2
130 0
120
110 -2

100 Trade balance, 3-year moving -4

90 average, right scale
-6
80
70 -8
-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
 CONSUMER
The model

Y3
Price p
Y2

3
PRODUCER 2 EXPORT
(consumption goods) TRADE Y3
k2 k3 q

dk2/dt
dk3/dt
Y1 + I
dk1/dt Y1 Price = 1 Import I

PRODUCER 1
(investment goods)
k1