Are capital flows fickle? And does the solution still depend on type?

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According to conventional wisdom, capital runs are fickle. They are fickle pretty much independent of time and place. But various flows exhibit different degrees of volatility: FDI is least volatile, whilst bank-intermediated flows are most risky. Other portfolio capital flows rank in between, and within this intermediate class debt flows are more volatile than equity-based flows.

This conventional wisdom is a distillation of the experience of earlier decades. Yet the structure and regulation of international economic markets continue to change. Chinese outward FDI has risen dramatically relative to other sources of FDI; South-South FDI flows have risen more usually; bank-intermediated flows have fallen because large global banks have deleveraged and curtailed their cross-border functions in response to tighter regulatory oversight; Asian bond markets have grown relative to relationship markets in other regions; corporate bond markets have grown relative to sovereign relationship markets; and international investors are becoming active in equity markets worldwide.

In a new document and a Vox column, we ask whether the conventional wisdom holds within our contemporary world. We analyze styles in capital flows in emerging economies since 1990s, including in the post-global-financial-crisis era. While a majority of previous studies have utilized annual data mainly for reasons of availability and convenience, we work with quarterly data. This allows us to analyze capital flows at business cycle frequencies and around country-specific sudden stops and global stops, events that are hard to pinpoint using annual data.
Our main observations are below:

(i) On average, FDI and non-FDI inflows are of roughly equal magnitude. Median (unweighted) average annual flows to an growing market economy are 2 . six percent and 2 . 4 % of GDP. Within non-FDI flows, bank-related flows are the largest, accompanied by portfolio debt, while portfolio collateral flows are relatively small. The particular relative magnitude of bank-related flows has declined and that of portfolio debt has increased since the Global Financial Crisis. Outflows are smaller than inflows on average (these being emerging markets).


(ii) Measuring volatility by the standard deviation and coefficient of difference we find that non-FDI flows are relatively volatile, and less prolonged. Portfolio debt flows and banking flows are among the most volatile. Capital inflows into emerging markets are volatile but not increasingly so.

(iii) FDI outflows from growing markets rose strongly in 2006-10. Capital outflows from emerging marketplaces, FDI and bank-related outflows especially, have grown not just larger but also a lot more volatile. That outflows are a expanding source of capital account volatility in emerging markets is not adequately appreciated in the literature, in our view.

(iv) Following Eichengreen and Gupta (2016), we classify shows of sudden stops when overall capital inflows decline sharply below the average in previous years. Portfolio equity, portfolio debt and other inflows all turn negative during unexpected stops. The decline in inflows is sharpest for other moves and smallest for FDI. Profile equity and debt inflows switch negative in sudden stop intervals; although the initial drop is sharpened, inflows recover and are back to pre-crisis levels within four quarters. Financial institution flows turn negative, and recuperate very slowly—these flows remain adverse four quarters after the beginning of the unexpected stop episode.

(v) Resident flows are stabilizing throughout sudden stops in that portfolio equity and debt outflows and especially additional outflows drop significantly below their average. However , looking at the scale of outflows it is evident that this decline in outflows during unexpected stops is smaller than the decline in inflows. So even if the decline in outflows by residents partially offsets the decline in inflows by non-residents, this stabilizing influence is only partial, and net inflows still decline.

(vi) We analyze the drivers of capital flows. Results suggest that FDI inflows are driven mainly simply by pull factors, while portfolio runs are driven mainly by drive factors, and bank flows are driven both by push plus pull factors– FDI seems to be affected more by domestic than exterior factors; a better investment climate is associated with larger FDI inflows; many types of capital flows are not highly correlated with the federal funds rate; higher global risk aversion since measured by VIX reduces non-FDI capital inflows but not FDI inflows. We ask whether the effects of these variables have changed in recent years, but do not find evidence of a change in the coefficients.

We evaluate the correlates of outflows analogously. Some of the patterns for outflows are usually broadly similar to those for inflows. Using our regression results we ask which of the significant determinants of these outflows have themselves produced more volatile over time. The determinants of outflows that have become more variable over time are the VIX and the volatility of GDP growth, which convert in to more volatile capital outflows in the 2006-2010 period relative to additional years.

Our findings emphasize that emerging markets should treat capital flows with caution; and that the outflows from emerging marketplaces, both FDI and bank-related flows, have come to play a growing role plus deserve greater attention from experts and policy makers.

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