Many global investors have poured their resources in emerging market economies because of the returns accrued, which is higher compared to investments in advanced market economies. The returns are not necessarily high for the emerging market economies. External financing is always accompanied by high social costs to the countries with emerging market economies.
Moreover, volatile external financing may reduce economic growth of such countries because of some uncertainties involved. It is for this reason that government should intervene and place controls on this economic aspect. Too much intervention by the government is not productive because side effects will also arise, e.g., if a government imposes a limit to the amount of cash that can be ploughed into a country for investment, the investor may be limited to a strict budget.
This may deprive the country from gaining other benefits, e.g. infrastructure. Investors sometimes build roads and bridges for easy access and transportation of goods to the locations of investment. These remain the assets of the host country. It is very critical that the government limit their restrictions by formulating favorable policies.
Governments should issue contracts to all investors. These contracts should explain in detail the length of time that the investors will stay. In addition to this, the contracts should restrict pulling out of the investors until a certain stage in the process of market liberalization is reached.
This is better than having no contracts, and allowing investors to emerge markets at will. In so doing, the government plays an important role; they ensure that there is a constant and continuous accumulation of capital within the country. Without contracts specifying the stay of investors in a country, they may decide to pull out their resources and capital as they wish.
This is very dangerous to the economy of any country because the assets in that country may become less valued. The main reason why investors may decide to pull out of a country in the course of their stay is loss of faith in that country’s economy. Since the economic stability of most developing countries is uncertain, it is wise for them to give contracts (specifying the duration of stay, and the time to pull out) to investors.
Capital flight occurs when the capital injected by investors rapidly flows out of the country. This takes place when investors lose faith in the project or when their confidence on the economy of that country is gone. This is mostly associated with the fall in the exchange rate in the deserted country’s currency. One major way of dealing with capital flight is changing of the exchange rates of a country to values more favorable to the direct foreign investors.
The investors should not lose a lot of money while converting their currencies and vice versa. There are other ways of dealing with capital flight other than adjusting the exchange rate. These methods are equally important in dealing with capital flight. One of them involves reducing the taxation rates on capital. When the government reduces the amount of tax imposed on capital, investors are more likely to stay.
This is because they end up retaining money that would have otherwise have been used as tax. Other than the two examples given, any initiative by the government in strengthening the economy of a country will ensure that investors always remain in that country. In general, it is correct to conclude that maintaining the stability of a country’s economy will win the confidence of investors thereby making them stay.