Real Effects Of Capital Inflows In Emerging Markets

We examine the association between capital inflows and industry growth in a sample of 22 emerging market economies from 1998 to 2010. We expect more external finance dependent industries in countries that host more capital inflows to grow disproportionately faster. This is indeed the case in the pre-crisis period of 1998–2007, and is driven by debt, rather than equity, inflows. We also observe a reduction in output volatility but this association is more pronounced for equity, rather than debt, inflows. These relationships, however, break down during the crisis, hinting at the importance of an undisrupted global financial system for emerging markets to harness the growth benefits of capital inflows. In line with this observation, we also document that the inflows-growth nexus is stronger in countries with well-functioning banks.

This paper documents the evolution of gross and net capital flows to emerging market economies and surveys the large literature on the potential drivers. While the capital flow landscape has been shaped by the evolution of both global and country-specific factors, the relative importance of these factors has varied over time and differs depending on the type of capital flows. The findings from the survey of the literature thus underscores the importance of policies in both source and recipient countries in shaping capital flows.

We reassess the connection between capital account openness and capital flows in an empirical framework that is grounded in theory and makes use of previously unexplored variation in the data. We demonstrate how our theory-consistent regressions may overcome some ubiquitous measurement problems in the literature by relying on interaction terms between financial openness and traditional push-pull factors. Within our proposed framework, we ask: what can be said robustly about the effect of capital account restrictions on capital flows? Our results warrant against over-interpreting the existing cross-country evidence as we find very few robust relationships between capital account restrictiveness and various types of capital inflows. Countries with a higher degree of financial openness are more susceptible to some, but by no means all, push and pull factors. Overall, the results are still consistent with a complex set of tradeoffs faced by policymakers, where the ability to shield the domestic economy from volatile capital flow cycles must be weighed against the sources of exogenous risks and potential long run growth effects.

This paper examines whether—and how—emerging market economies (EMEs) respond to capital flows to mitigate their untoward consequences. Based on a sample of about 50 EMEs over 2005Q1–2013Q4, we find that EME policy makers respond proactively to capital inflows by using a combination of policy tools: central banks raise the policy interest rate to address economic overheating concerns; intervene in the foreign exchange market to resist currency appreciation pressures; tighten macroprudential measures to dampen credit growth; and deploy capital inflow controls in the face of competitiveness and financial-stability concerns. Contrary to conventional policy advice to EMEs, we find no evidence of counter-cyclical fiscal policy in the face of capital inflows. Overall, policies are more likely to respond, and used in combination, during inflow surges than in more normal times.

Staff Discussion Notes showcase the latest policy-related analysis and research being developed by individual IMF staff and are published to elicit comment and to further debate. These papers are generally brief and written in nontechnical language, and so are aimed at a broad audience interested in economic policy issues. This Web-only series replaced Staff Position Notes in January 2011.

This paper analyzes the behavior of gross capital inflows across 34 emerging markets (EMs). We first confirm that aggregate inflows to EMs co-move considerably. We then report three findings: (i) the aggregate co-movement conceals significant heterogeneity across asset types as only bank-related and portfolio bond and equity inflows do co-move; (ii) while global push factors in advanced economies mostly explain the common dynamics, their relative importance varies by type of flow; and (iii) the sensitivity to common dynamics varies significantly across borrower countries, with market structure characteristics (especially the composition of the foreign investor base and the level of liquidity) rather than borrower country’s institutional fundamentals strongly affecting sensitivities. Countries relying more on international funds and global banks are found to be more sensitive to push factors. Our findings suggest that EMs need to closely monitor their lenders and investors to assess their inflow exposures to global push factors.

Capital flow volatility is a concern for macroeconomic and financial stability. Nonetheless, literature is scarce in this topic. Our paper sheds light on this issue in two dimensions. First, using quarterly data for 65 countries over the period 1970Q1-2016Q1, we construct three measures of volatility, for total capital flows and key instruments. Second, we perform panel regressions to understand the determinants of volatility. The measures show that the volatility of all instruments is prone to bouts, rising sharply during global shocks like the taper tantrum episode. Capital flow volatility thus remains a challenge for policy makers. The regression results suggest that push factors can be more important than pull factors in explaining volatility, illustrating that the characteristics of volatility can be different from those of the flows levels.

This paper reviews the causes, consequences, and policy responses to large capital flows in several emerging markets. It opens by studying recent patterns of capital flows, and then discusses the causes of capital flows. Emphasis is given to the reasons behind the capital inflow episode in the 1990s, the major reversals, and the volatility observed in these flows. The paper goes on to examine the consequences of capital inflows and the pros and cons of alternative policy responses. It concludes with policy lessons derived from country experiences.