International Monetary Fund

Capital Flow Reversals

Josh FelmanIMF Research Department

Philippine Economic Association November 15, 2013

The views expressed in this presentation are those of the author and do not necessarily represent those of the IMF or IMF policy.

10 11 12 13010203040506070

Oct. 13

Latin AmericaEmerging Asia

Source: IMF, EPFR database.

Capital Flows to EMs (cumulative inflows since January 2010; billions of U.S. dollars)

10 11 12 130

20

40

60

80 Equity Bond

Oct. 13

10 11 12 13012345

Oct. 13 10 11 12 13010203040506070

Oct. 13

Middle East and North Africa Other Emerging Markets

GreekCrisis

IrishCrisis

1st ECBLTROs

Draghi’sSpeech

BernankeTaper Talk

GreekCrisis

IrishCrisis

1st ECBLTROs

Draghi’sSpeech

BernankeTaper Talk

GreekCrisis

IrishCrisis

1st ECBLTROs

Draghi’sSpeech

BernankeTaper Talk

GreekCrisis

IrishCrisis

1st ECBLTROs

Draghi’sSpeech

BernankeTaper Talk

2

Capital Flows and Output

00 01 02 03 04 05 06 07 08 09 10 11 12 13-4

-2

0

2

4

6

8

10 Real GDP growth (percent; yoy; sa) Net capital inflows (percent of GDP; 4-quarter moving average)

13Q2

G-20 Emerging: Net Capital Inflows and Growth

Sources: IMF, Balance of Payments Statistics; and IMF staff calculations.

3

Flows to Advanced Countries

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13-10

-5

0

5

10

15

20

13Q2

Australia: Domestic Portfolio Investments(percent of GDP)

Sources: IMF, Balance of Payments Statistics; and IMF staff calculations.

4

t t+1

t+2

t+3

t+4

t+5

t+6

t+7

t+8

t+9

t+10

t+11

t+12

-0.5

0.0

0.5

1.0

1.5

2.0

2.5Tequila crisis 1/ Taper talk 2/

Jan-93 Aug-93 Mar-94 Oct-94 May-95 Dec-950

1

2

3

4

5

6

7

8

G20 Emerging: Net Cumulative Inflows(percent of GDP)

Sources: IMF, World Economic Outlook; and Bloomberg, L.P.1/ Mexican crisis; t = December 1993.2/ Bernanke taper talk; t = April 2013.

US: Change in 10-Year Government Bond Yield(percentage point)

Gross Capital Flows(percent of GDP)

1994 Redux?

1990-1993 2009-20120

1

2

3

4

5

6

7

8

9

10

5

Mexican Crisis

Mexican Crisis

90 91 92 93 94-10

0

10

20

30

40

-2

-1

0

1

2

3

4

5

6

7

8Credit growth (percent; qoq; saar)Reserve assets (RHS)

t t+1

t+2

t+3

t+4

t+5

t+6

t+7

t+8

t+9

t+10

t+11

t+12

90

95

100

105

110

115

120Tequila crisis 1/ Taper talk 2/

90 91 92 93 94 95 960

1

2

3

4

5

6

7

8

9

10 Emerging Asia

Emerging Markets: MSCI(index; t=100)

Sources: IMF, World Economic Outlook; and Bloomberg, L.P.1/ Mexican crisis; t = December 1993.2/ Bernanke taper talk; t = April 2013.

G-20 Emerging: Inflows, Credit, and Change in Reserves(percent of GDP)

Emerging Economies: Real GDP Growth(percent)

Impact on EM’s

6

Mexican Crisis

Textbook Model

• Assumptions• Y = Y(E, i) • E= (1+i)/(1+i*)Ē• No domestic imbalances• No intervention• Then, i* increases

• Policy response• Can maintain Y = `Y with right combination of i and E• 0< Δ i < Δ i*

• Too easy

7

E

• Nature of relationship• Correlation?• Causal?

• If causal, mechanism?

8

Capital Flows and Output

Balance Sheet Effects?

• Depreciation with fx debt stresses balance sheets

• Policy implication: greater increase in i (compared to baseline).

• But Δi increases burden of domestic debt

• Key: how important is fx exposure?

9

Balance Sheet Effects?

92 040

5

10

15

20

25

30

35

40

45

50

40

45

50

55

60

65

70On-balance sheet currency mismatches Share of short term liabilities (RHS)

2013

Mexico: Financial Indicators of the Corporate Sector(percent)

10

Sources: Economatica; and IMF staff calculations.

Liquidity Effects?

00 01 02 03 04 05 06 07 08 09 10 11 12 130

2

4

6

8

10

12

14

16

18

20

-2

0

2

4

6

8

10Credit growth (percent; yoy; sa) Gross inflows (percent of GDP; 4-quarter moving average; RHS)

13Q1

G20 Emerging: Gross Inflows and Credit Growth

11

Sources: IMF, Balance of Payments Statistics; IMF, International Financial Statistics; and IMF staff calculations.

Liquidity Effects?

• Are liquidity effects inevitable?

• Not if exchange rate is freely floating

• Not if cb intervenes and sterilizes• Effectively, cb purchases bonds foreigners are selling• Provides liquidity to institutions deprived of funding

12

Poorly Anchored Expectations?

• Then, depreciation leads to inflation

• Implication: increase in i, compared to baseline

• Key: are expectations generally fragile?

13

Korea Argentina Russia Brazil Indonesia India China Mexico Turkey0

2

4

6

8

10

12

14

16 Apr. 1996 Apr. 2013

Inflation ExpectationsInflation Expectations, 5-year(percent)

14

Sources: Consensus Forecasts; and IMF, World Economic Outlook.1/ Data in Apr. 1996 for Russia and Turkey is from the May 1996 WEO.

0

50

100

150

200

2501997 Crisis EMs 1/ Key EMs under pressure 2/

Interest on external debt(% of total exports)

Short-term external debt(% of GDP)

0

2

4

6

8

10

12

Sources: IMF, World Economic Outlook, April 2013.1/ Indonesia, Korea, Thailand, Malaysia, and Philippines. Data shown for 1996.2/ Brazil, Indonesia, India, Turkey, and South Africa. Data shown for 2012.

Key EMs Under Pressure Today vs. 1997 Asian Financial Crisis EMs(percent)

15

Macro Vulnerabilities?(initial conditions)

15

A New World

• EM world has changed since the 1990s

• Central banks target inflation

• Exchange rates are largely floating

• Macro stability has improved

• Any reason left to fear outflows?

16

Back to Model

• Assume:• Current account given in short run• No FX intervention

• Then if foreigners sell, domestics must buy• Need different preferences

17

Distribution Effects

• Possibility: • Foreign sales cause asset prices to fall• Financial accelerator goes in reverse, bankruptcies

• But if asset prices determined by fundamentals (NPV of earnings), flows irrelevant

• Further assume:• Prices detached from fundamentals• Or foreigners have lower discount rate

• Then when foreigners sell to domestics, asset prices can fall

18

00 01 02 03 04 05 06 07 08 09 10 11 12 13-15

-10

-5

0

5

10

15

0

100

200

300

400

500

600Gross inflows (percent of GDP)MSCI EM stock market index (1990=100; RHS)

13Q200 01 02 03 04 05 06 07 08 09 10 11 12 13-15

-10

-5

0

5

10

15 0

2

4

6

8

10

12

14

16

18

20

Gross inflows (percent of GDP)ELMI+ (yield; inverted RHS)

13Q2

Gross Inflows and Interest Rates

Gross Inflows and Equity Prices

Sources: IMF, Balance of Payments Statistics; IMF staff calculations; and Bloomberg, L.P.

Capital Flows and Asset Prices

19

Financial Disruptions

• Foreign bank cuts funds to subsidiaries

• Subsidiaries have firm-specific knowledge

• Certain firms lose access to credit

20

Latvia Bulgaria Ukraine Hungary-30

-25

-20

-15

-10

-5

0

5

10

Sources: Bank for International Settlements, Locational Statistics; and IMF, World Economic Outlook.

Emerging Europe: External Positions of Western Banks vis-à-vis Emerging Europe(percent of GDP; adjusted for exchange rate changes; 2008Q3 change in flows)

21

Financial Disruptions

21

Back to Monetary Policy

• Conclusion • Capital outflows may have adverse effects

• Policy options • Increase i• Fx intervention

22

1990-1993 2009-20120

5

10

15

20

25

30

35 Cumulative inflows / GDP 1/ Cumulative reserves / inflows

1990-1993 2009-20120

10

20

30

40

50

60

70

Sources: IMF, Financial Flows Analytics; Haver Analytics; and IMF staff calculations.1/ Based off of end year GDP.

G-20 Emerging: Gross Inflows to GDP and Reserves(percent)

23 23

Inflows and InterventionG-20 Emerging: Net Inflows to GDP and Reserves(percent)

FX Intervention

• Should intervention policy be symmetric?• Reserves adequate• Can avoid attack by fixing quantities, not prices

• Possible rule: sell x dollars for every 100 in outflows

24

Conclusion

• Capital outflows a serious problem when• Fx debt exposures significant• Inflation expectations poorly anchored• Macro vulnerabilities

• Conditions now less prevalent• But outflows may still affect asset prices, disrupt credit

• Policy response can be very different.• Less need to increase i• More scope for depreciation• Can decumulate some reserves

25

26

Capital Inflows

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13-15

-10

-5

0

5

10

15

20

25

30

-50

-40

-30

-20

-10

0

10

20Thailand India Korea

13Q2

Gross Inflows(percent of GDP)

27

Sources: IMF, Financial Flows Analytics; and IMF staff calculations.

Increase i Greater depreciation

Revised model

Balance sheet effects + −Inflation expectations + −Vulnerabilities ? ?Note: + means an increase in i or greater depreciation compared to the revised model case.

28

Monetary Policy Response

28

Capital Flows and Federal Funds Rate

00 01 02 03 04 05 06 07 08 09 10 11 12 13-12

-10

-8

-6

-4

-2

0

2

4

6

8 0

1

2

3

4

5

6

7

Net capital flows (percent of GDP) Fed funds rate (inverted RHS)

13Q2

G-20 Emerging: Net Capital Inflows and Growth

Sources: IMF, Balance of Payments Statistics; Bloomberg L.P.; and IMF staff calculations.

29

Risk Premium Shock?

00 01 02 03 04 05 06 07 08 09 10 11 12 130

200

400

600

800

1000

1200

9/18/2013

JP Morgan Emerging Bond Index Global Sovereign Spread(basis points)

Source: Bloomberg L.P.

30

31Source: IMF, World Economic Outlook.

t-2 t-1 t t+1 t+2-6-4-20246

Gross Domestic Product Private Consumption Investment

t-2 t-1 t t+1 t+2-20-15-10

-505

1015

t-2 t-1 t t+1 t+2-3-2-1012

t-2 t-1 t t+1 t+2-5

0

5

10

15Net Exports (percent of GDP) Real Exchange RateAsset Price

Sudden Stops

t-2 t-1 t t+1 t+2-4-3-2-101234 World Emerging Market Economies Advanced Economies

t-2 t-1 t t+1 t+2708090

100110120130140

Gross Flows

32

Foreign Mutual Fund

Domestic Mutual Fund

Domestic Bond

Foreign BondDollars Dollars

Balance Sheet Effects?

96 080

2

4

6

8

10

12

14

16 Official debt Bank debt Other private debt

External Debt(percent of GDP, debtor based)

Source: IMF, World Economic Outlook.

2013

33