Friday, April 22
Zsoka Koczan, Economist, International Monetary Fund
Helene Schuberth, Head of the Foreign Research Division, Oesterreichische Nationalbank
Rafael Portillo, Senior Economist, Joint Vienna Institute
Following a surge in capital inflows during the last decade, flows to emerging markets (EMs) have since slowed considerably. Why? And will the falloff result in new debt crises in these countries? Ms. Zsoka Koczan, an economist in the IMF’s research department and coauthor of a recent IMF World Economic Outlook chapter on the topic, recently presented its findings at the JVI. Helene Schuberth from the OeNB served as discussant.
Anatomy of the Slowdown
The magnitude of the slowdown in net capital flows to EMs between 2010 and 2015, Ms. Koczan said, has been on the order of 5 percent of GDP. The decline has been broad-based: Inflows—net acquisitions of domestic assets by nonresidents—have dropped, and outflows—net purchases of foreign assets by EM residents—have risen. Moreover, all asset types and all regions of the world have been affected to at least some extent, which might suggest the existence of a “global financial cycle” that involves all counties.
Of further interest is that the slowdown has coincided with a halt in reserve accumulation by EMs, and even in some cases an outright decline, while EM exchange rates have depreciated against the dollar. Thus policies have responded, but are they helping?
What Is Different this Time Around?
Ms. Koczan then compared recent events with previous slowdown episodes. Citing the 1995 – 2000 slowdown as an example, she noted that although the magnitudes are similar, the outcomes have so far been quite different—which she attributed in no small part to better EM policies.
For example, previous slowdowns typically resulted in a large current account adjustment because countries were forced to compress their demand for imports. This time, the adjustment has been borne by international reserves, with the current account remaining fairly insulated from external developments. This time, the depreciation of EM exchange rates has been more orderly, that is more a reflection of immediate adjustment under sufficiently flexible exchange rate regimes than the delayed (and painful) adjustment that followed the collapse of fixed exchange rate regimes. This is also likely reflected in the lower number of crises observed so far.
Finally, flows have been slowing against the backdrop of a lower stock of net foreign debt in EMs, which are therefore less exposed to currency mismatches in domestic balance sheets. To the extent that fewer net foreign liabilities are a result of better macro policies (monetary, fiscal, and macroprudential), this would confirm the view that EMs can weather volatile capital flows if their macro fundamentals are sound.
Why Are Capital Flows to EMs Slowing?
Ms. Koczan concluded by discussing what is driving global financial flows to EMs. She and her coauthors found that narrowing growth differentials between advanced economies and EMs have been the most important factor. This is not surprising: lower growth in EMs (taken as a whole) implies lower expected returns from investing there.
This does not mean, however, that EMs are merely bystanders in the global financial cycle. Capital flows in countries with flexible exchange rates, higher reserves, or lower external debt are less sensitive to the global cycle. In sum, not only do policy choices influence the effect of capital flows on the domestic economy, they also shape the size of these flows.
Flows to Central, Eastern and Southeastern Europe
In her discussion of Ms. Koczan’s presentation, Ms. Schuberth zeroed in on the CESEE region and the policy mix those countries should use in response to capital flows. As in other EMs, flows to the region have been volatile. Yet some of these countries do not have the option of exchange rate flexibility, given their membership in the euro area or tight exchange rate arrangements. Instead, Ms. Schuberth emphasized, they can use macro-prudential policies to help address capital flow spillovers. Such policies could help reduce excessive credit growth—with the proviso that they must be implemented during the surge period and not after the flows reverse.
Rafael Portillo, Senior Economist, JVI