International Capital Flows: Is This Tapering Different?

This webinar took stock of the nature of international capital flows during the pandemic and focused on the challenges ahead given the expectations of less expansionary monetary policy in advanced economies. Şebnem Kalemli-Özcan and Elina Ribakova started with giving an overview of the dynamics of capital flows over the last 18 months. Markus Eller complemented the global picture with the focus on the JVI region. The COVID-19 pandemic resulted in a dramatic sudden stop of capital flows to emerging market economies. A sharp and very abrupt reversal of capital flows put the currencies of these countries under pressure and distressed local financial markets in the first half of 2020. Once the acute phase of the sell-off was over, highly accommodative monetary policy in advanced economies created conditions for a gradual return of capital flows to emerging markets. Thanks to this relatively quick recovery in capital flows, for 2020 as a whole, total non-resident capital flows remained relatively stable. Portfolio flows, however, exhibited much higher volatility.

Numerous studies show that monetary policy in advanced economies is the key driver for capital flows to emerging markets. Consequently, the expectations of a less expansionary monetary policy in advanced economies in response to a strong recovery and rising inflationary pressures will play an important role for international capital flows in the coming quarters. The panelists broadly agreed that the looming asset purchases tapering in the US will have different spillover effects compared to the taper tantrum episode of 2013. Policymakers have learnt their lessons and are communicating their next steps more cautiously this time. As a result, markets seem to have priced in the upcoming monetary policy steps in advanced economies. Elina Ribakova cited numerous examples of strong investor appetite for emerging market assets despite the approaching tapering.

The panelists also discussed possible policy responses to risks stemming from less accommodative monetary policy in advanced economies. They emphasized the importance of monetary and fiscal policy coordination as well as the risk of a premature withdrawal of support. Vaccine policy was described as the key element of the policy mix in the short run. As for the long run, the panelists recommended the implementation of structural measures to move up in the global value-added chains and to focus on digital and green transition. The ESG aspect was emphasized as an increasingly important factor for investors interested in emerging market assets. Diverging progress with transition to a greener economy is becoming another dimension for investors when differentiating across EM countries. Governments that are forced to withdraw policy support prematurely risk to miss opportunities to green and digitalize their economies.

Tatiana Evdokimova, Economist, JVI