To a large degree, these capital flows have been driven by perceived return differentials that favor emerging markets, resulting from factors such as stronger expected growth – both in the short term and in the longer run – and higher interest rates, which reflect differences in policy settings as well as other forces.
As figures 6 and 7 show, even before the crisis, fastgrowing emerging market economies were attractive destinations for cross-border investment. However, beyond these fundamental factors, an important driver of the rapid capital inflows to some emerging markets is incomplete adjustment of exchange rates in those economies, which leads investors to anticipate additional returns arising from expected exchange rate appreciation.