Proceedings of the German Development Economics Conference, Berlin 2011 12
As economic reforms are mutually interdependent, a liberal policy package needs internal coherence. How can a coherent reform strategy be achieved for a well-balanced and functional economic system? In this paper, we analyze the relationship between financial reforms coherence and international capital inflows (foreign direct investments (FDI) and portfolio investments). We consider a package of eight financial reforms, comprising interest rate deregulation, credit ceiling and directed-credit programs liberalization, elimination of banking sector entry barriers, privatization of state owed banks, development of security markets and banking sector supervision measures. Complementarity is measured through the reciprocal of the Herfindahl-Hirschman concentration index. The results suggest that the manner with which financial reforms are implemented matters. Particularly, complementarity increases FDI inflows by 0.10%. Moreover, this effect depends on the location of the countries on the distribution of financial reforms level. Indeed, the countries located above the median value of financial reform level experience larger FDI and portfolio investment inflows than others. Finally, when privatization of state owned banks and the adoption of a capital adequacy ratio based on the Basle I standard occur after other preliminary financial reforms, the returns to complementarity are higher. In others words, a developed and relatively safe domestic financial system attracts more FDI and portfolio investments than a developed but unsafe financial system.