THE CAPITAL INFLOWS PROBLEM: CONCEPTS AND ISSUES

Since 1990, capital has flowed from industrial countries to developing regions like Latin America and parts of Asia. Most countries welcome reentry into international capital markets. However, capital inflows often are associated with inflationary pressures, a real exchange rate appreciation, a deterioration in the current account, and a boom in bank lending. This paper briefly examines how these inflows have altered the macroeconomic environment in a number of Asian and Latin American countries, and discusses the pros and cons of the policy options .     

Capital flows in a transitional economy and the sterilization dilemma: The hungarian experience, 1992–97

This paper evaluates Hungary's dilemma with sterilization in the context of the record of countries elsewhere that have experienced similar capital inflow episodes, e.g., Latin America and Asia. The study focuses on the short-run impact of sterilization on monetary policy. The empirical results indicate that sterilized interventions by the National Bank of Hungary (NBH) did not neutralize capital inflows until possibly the middle of 1995, following a change in government and, more significantly, a change in exchange rate regimes. Indeed, it appears that monetary policy was overly restrictive and that, for a time, the NBH overcompensated for the inflows of capital.     

Output Growth Decomposition in the Presence of Input Quality Effects: A Stochastic Frontier Approach

How do physical capital accumulation and total factor productivity (TFP) individually add to economic growth? We approach this question from the perspective of the quality of physical capital and labor, namely the age of physical capital and human capital. We build a unique dataset by explicitly calculating the age of physical capital for each country and each year of our time frame and estimate a stochastic frontier production function incorporating input quality in five regions of countries (Africa, East Asia, Latin America, South Asia and West). Physical capital accumulation generally proves much more important than either the improved quality of factors or TFP growth in explaining output growth. The age of capital decreases growth in all regions except in Africa, while human capital increases growth in all regions except in East Asia.     

A Model of Crises in Emerging Markets

This paper presents a perfect foresight model of speculative attacks on emerging markets. Credit constrained governments are assumed to have two objectives: to accumulate liquid assets in order to self-insure against shocks to national consumption and to insure poorly regulated domestic financial markets. This policy regime generates endogenous fiscal deficits defined to include the growth of contingent liabilities. The model sets out a sequence of yield differentials consistent with capital inflows followed by anticipated speculative attacks. The model suggests that a common shock generated capital inflows to emerging markets in Asia and Latin America after 1989.     

Determinants of capital flows to emerging and advanced economies between 1990 and 2011

The previous and latest crises confirmed that stability of external financing of the economy is determined not only by the volume of capital inflow but also by its structure. It is established that a bias in gross external liabilities towards debt, especially short-term, may rise vulnerability to financial crises. Greater share of equity capital, mainly direct investment is not found to bear such financial risk. The results of Bayesian Model Averaging (BMA) show that influence of variables inherent in macroeconomic and portfolio approaches varies depending on the type of capital inflow and the group of countries. We also find some arguments that equity investment is a more desirable form of foreign capital because debt inflows are more responsive to global factors and therefore more volatile. As a word of caution, we highlight the need for diversification and careful monitoring of external financing sources and forms.     

资本账户自由化、信贷扩张与系统性银行危机风险*

本文研究在资本账户自由化下，信贷扩张与资本流入对于系统性银行危机风险的影响。利用89个国家1973—2016年的长面板数据，并控制影响银行危机风险多项因素后，研究发现资本账户自由化有助于降低银行危机风险。进一步研究发现，FDI流入能显著降低银行危机风险；适量的股权投资流入有助于增强银行业稳定性；但当股权投资大量流入时，伴随着信贷过度扩张和资产泡沫，银行危机风险急剧增加；较低的债权投资流入对银行业稳定性无显著影响，但当超过一定规模时，银行危机风险显著增加。     

资本账户自由化、信贷扩张与系统性银行危机风险*

本文研究在资本账户自由化下，信贷扩张与资本流入对于系统性银行危机风险的影响。利用89个国家1973—2016年的长面板数据，并控制影响银行危机风险多项因素后，研究发现资本账户自由化有助于降低银行危机风险。进一步研究发现，FDI流入能显著降低银行危机风险；适量的股权投资流入有助于增强银行业稳定性；但当股权投资大量流入时，伴随着信贷过度扩张和资产泡沫，银行危机风险急剧增加；较低的债权投资流入对银行业稳定性无显著影响，但当超过一定规模时，银行危机风险显著增加。       

Sterilization, Monetary Policy, and Global Financial Integration

This paper investigates the changing pattern and efficacy of sterilization within emerging market countries as they liberalize markets and integrate with the world economy. We estimate the marginal propensity to sterilize foreign asset accumulation associated with net balance of payments inflows, across countries, and over time. We find that the extent of sterilization of foreign reserve inflows has risen in recent years to varying degrees in Asia as well as in Latin America, consistent with greater concerns about the potential inflationary impact of reserve inflows. We also find that sterilization depends on the composition of balance of payments inflows.     

Are there different linkages of foreign capital inflows and the current account between industrial countries and emerging markets?

This article investigates the causal relationship between the current account and foreign capital inflows on two groups of countries, industrial countries (ICs) and emerging markets (EMs), during the time period of 1987?C2006. Apart from including three sets of control variables (macroeconomic, financial, and institutional) in the regression to avoid omitted variable bias, we additionally examine whether there is a disparate interaction between gross capital inflows and the current account and between net foreign inflows and the current account. Our empirical results show that for EMs, it is mostly true that foreign capital inflow Granger causes the current account, while for ICs, it is the other way around for causality although when using gross foreign capital inflows, there is less evidence of causality detected. We also find that for EMs, after the 1997?C1998 currency crises, capital inflows change the nature of their effects on the current account, particularly for Asian EMs.     

Distribution dynamics and convergence in Latin America: A non-parametric analysis

This paper examines the dynamics of income distribution and convergence in Latin America during the period 1960 to 2000. Our results, based on the intradistribution dynamics approach, reveal a “twin peaks” dynamics, which echoes findings reported for the OECD, the Asia Pacific Basin and worldwide. Notable differences, however, are found between the income dynamics in Latin America and in these other regions. Further, our findings indicate that physical capital investment and health capital serve to explain Latin America’s “twin peaks” polarization. Other factors, such as geographical proximity, trade openness and human capital, are also found to help explaining it to some extent. We gratefully acknowledge the helpful comments and suggestions of the referee.     

Capital Flows to Latin America (2003–17): A Critical Survey from Prebisch’s Business Cycle Theory

ABSTRACT

The economic literature on capital flows to developing countries has shared two important commonalities since the 1990s. Published works (whether they focus on the external situation or stress the domestic determinants of capital flows) tend to assume a beneficial effect of capital inflows, which leads to an improvement of peripheral institutions, whose deficiencies are ostensibly the main cause of economic turmoil and/or failure in attracting capital flows, in continuity with New Institutional Economics. In doing so, mainstream economists deliberately overlook the asymmetric characteristics of the international monetary system and the persisting hegemony of dollar. Raul Prebisch’s pioneering work on business cycles in Latin America provide an alternative view, one capable of amending the existing mainstream literature. On the one hand, Prebisch stressed the destabilizing role of capital inflows on Latin American economies, particularly short-term speculative capital. On the other hand, Prebisch designed a set of counter cyclical monetary policies in order to contrast capital volatility, particularly during downturns. An analysis of stylized facts shows that, when correctly updated, Prebisch’s theory has remarkable explanatory potential when applied to Latin America’s current economic and financial situation.     

China's Capital and ‘Hot’ Money Flows: An Empirical Investigation

We examine time‐series characteristics of China's capital flows during 1998–2014. More specifically, we employ Kalman filtering state‐space models to gauge the relative importance of permanent and transitory components in China's overall foreign direct investment (FDI), equity, bond, other investment and bank credit flows. Our results show that only in the case of FDI are both gross inflow and net flow dominated by a permanent stochastic level, suggesting that this source of capital is largely permanent. Incorporating covariates into the state‐space models, we find that a larger difference between onshore and offshore renminbi interest rates encourages capital inflows that are dominated by a transitory component. Greater global risk perception, proxied by S&P 500's volatility index, in contrast, discourages them. These covariates imply that capital control may not be effective in stemming volatile and speculative flows. Our results on bilateral capital flows between China and the USA also suggest that these flows are less persistent and more volatile during 1998–2014 than previously found based on 1988–1997 data. Our results bear important policy implications as China engages in further reforms in its domestic financial system and greater integration with the world financial system.     

Taxing capital flows: an empirical comparative analysis

Recent studies have analysed the impact of capital account opening on income growth, implicitly assuming that the various forms of foreign savings have similar effects. In fact, theoretical considerations suggest that the individual components of private capital inflows have different effects on growth. This paper analyses the link between income growth and private capital inflows. It presents system GMM estimates with annual observations from 1985 to 1996 for 72 countries. When full-sample results are checked for country and period changes, most of capital inflow series lose their ability to explain income growth. Bank flows stand as the sole source of foreign financing that displays a positive and robust correlation with growth.     

Monetary union in Latin America: an assessment in the context of optimum currency area

The article applies the optimum currency area (OCA) theory to Latin America to assess the potential of a monetary union in Latin America and in its major existing regional trade agreements (RTAs). According to OCA criteria we find that Latin America is far from being an optimum currency area, as its countries’ exposure to asymmetric shocks is high and their capacities to adjust in response to macroeconomic disturbances are limited. Using a panel of 20 Latin American countries from 1990 to 2014, we apply the dynamic OLS estimation techniques to estimate the costs and benefits of a potential monetary union in Latin America and in its various RTAs. to estimate the costs and benefits of a potential monetary union in Latin America and in its various RTAs. We find that the costs are high, because Latin America’s economies are vulnerable to severe macroeconomic disturbances and its RTAs differ significantly in their response to negative demand shocks. Most of the monetary efficiency gains are shown to be the result of a common restrictive monetary policy which would result in higher FDI inflows and, to a more limited extent, increased GDP, both overall and per capita. Although Central American countries are shown to be most suitable for further monetary integration, we conclude that Latin American countries should head first towards greater economic and political integration.     

Capital Inflows and House Prices: Aggregate and Regional Evidence from China

Rising house prices in China have been of concern for investors and policymakers. Prices have risen substantially in the last decade, especially in large urban cities, and some economists have expressed concerns about the affordability of residential housing for young adults. This phenomenon becomes a major concern for policymakers, in terms of managing policies to balance the residential needs of individuals and the transition to a market economy. Theoretically, house prices ought to be linked to economic factors such as disposable income, availability of land to build and credit policy. However, it appears that traditional economic theories fail to appropriately explain house prices in China. We provide an explanation from the perspective of capital inflows into China. In terms of per capita remittances, China receives the highest inflow of foreign capital, and this may have a significant impact on risk adjusted returns in the Chinese market. To investigate this relationship, we use the vector error correction model to assess the impact of capital inflows on house prices. We find that capital inflows have a significant positive effect on house prices. The study makes important contributions to understanding the relationship between house prices and foreign remittances after controlling for other economic factors. China is a large economy. Because the impact of economic development in China has not been consistent across the country, we address the regional differences in the house price changes to capital inflows. Using regional data, we show that capital inflows have an asymmetric effect on the housing market across different provinces and cities of China. This has important implications for the development of economic policies in China that aim to provide fair access to residential housing for everyone. These findings are also relevant to investors in the housing market, whether investing for a personal residential home or as part of their diversified investment portfolio. It will also be informative to see how a reversal of capital inflows associated with tighter financing conditions in advanced countries will affect house prices in China.     

Capital Inflows to Hungary in 1995–96 and the Accompanying Policy Responses

In order to analyze the composition and effects of, and the policy responses to, capital inflows to Hungary during 1995–96, we present an analytical framework that emphasizes the distinction between net capital flows to the private and public sectors (the latter includes the government and the central bank). This distinction is essential in Hungary's case, because figures for overall net inflows conceal the fact that huge net capital inflows to the private sector were accompanied by large repayments of foreign public debt, covered by significant privatization revenues. We present indicators of the domestic monetary impact of net capital inflows in order to analyze the magnitude, costs, and effects of sterilization. We note that extensive sterilization and the use of privatization revenues for public debt repayment largely explain why capital inflows to Hungary did not have significant effects on the real economy or on domestic monetary aggregates in the period reviewed.     

Do regional trade agreements stimulate FDI? Evidence for the Agadir,MERCOSUR and AFTA regions

The integration of emerging markets into the global economy is heavily promoted by foreign direct investment (FDI ) inflows. Among the factors explaining the location of FDI , regional trade agreements (RTA s) can be relevant for emerging markets, as they can promote economic integration and increase the attractiveness of the region for foreign investors. This paper investigates the impact of South–South trade agreements on the FDI decision of multinationals, where the Agadir, mercado comun del sur (MERCOSUR), and ASEAN free trade area (AFTA) agreements are considered. Three panels of countries are defined, where the members joined a specific agreement or not. Non‐Gulf Arab states are compared to better performing regions in Latin America and Southern and Eastern Asia. The analysis provides evidence that openness to foreign trade and financial markets are among the main catalysts to attract FDI , provided that business‐friendly institutions exist in the host country. Other variables, like the size of the industrial sector, urbanization rates, and external debt appear to be important in some cases. The integration of China into the world economy is a specific trigger for FDI to Asian destinations. Since RTA s influence the market size by reducing barriers to trade, their impact operates via GDP growth and openness. Gains from the agreement are striking for Latin America and Asia, but not for Arab states. To attract more FDI , business‐friendly institutional reforms and mechanisms to support new firm foundation should be implemented in this region.     

Endogenous inflows of speculative capital and the optimal currency appreciation path

Abstract This paper examines the optimal appreciation path of an undervalued currency in the presence of speculative capital inflows that are endogenously affected by the appreciation path. A central bank decides its appreciation policy based on three costs: (i) misalignment costs associated with the gap between the actual and long‐run equilibrium exchange rates, (ii) short‐term adjustment costs due to resource reallocation, and (iii) capital losses due to speculative capital inflows. Our model finds (1) when speculators face no liquidity shocks, the central bank tends to appreciate the currency quickly to discourage speculative capital; (2) when speculators face liquidity shocks, the central bank optimally pre‐commits to a slower appreciation path, and the appreciation takes the longest time when the probability of liquidity shocks takes intermediate values; (3) the central bank tends to appreciate the currency more quickly when it conducts discretionary policy.     

Balance of payments accounting and exchange rate dynamics

The balance of payments is an accounting identity. Many wonder how the current and capital accounts, which add up to zero, can influence exchange rates. This paper shows how payment flows arising from balance of payments imbalances affect the demands for different currencies in the foreign exchange market over time. Based on a dynamical system approach, the paper demonstrates how international payments evolve depending on the joint dynamic behaviour of different balance of payments components. It finds that international payments and exchange rates interact in fundamentally different ways depending on whether a country restricts its capital inflows and outflows, whether capital flows are accommodating or autonomous and whether the exchange rate is fixed, flexible or, say, governed by a crawling peg. Empirical evidence from major industrial countries as well as from countries hit by currency crises support the paper's theoretical predictions.     

Tipping the (Im)balance: Capital inflows,financial market structure,and banking crises

An emerging consensus among scholars and policy‐makers identifies foreign capital inflows as one of the primary determinants of banking crises in developed countries. We challenge this view by arguing that external imbalances are destabilizing only when banks face substantial competition from securities markets in the process of financial intermediation. We assemble a dataset of banking crises covering the advanced industrialized countries from 1976 to 2011 and find evidence of a conditional relationship between capital inflows, a well‐developed securities market, and the incidence of banking crises. We further explore the impact of capital inflows on banks’ actual risk taking as indicated by their capital adequacy levels and measures of insolvency risk. Our results demonstrate that prudential capital cushions tend to decline with the combination of capital inflows and prominent securities markets. We highlight the political decisions—often made during the early days of a country's financial development—that determine the relative prominence of banks vs. non‐bank financial institutions and conclude with policy recommendations.