Portfolio capital flows and the US dollar exchange rate: Viewed from the lens of time and frequency dynamics of connectedness

This study uses proprietary data on daily net non-resident portfolio flows to emerging markets to analyse the interconnectedness of non-resident debt and equity portfolio flows under different market conditions. We find that there is less interconnectedness during normal times but increased interconnectedness during periods of uncertainty and stress, suggesting an asymmetry in the spillovers of these portfolio flows. Importantly, we find that shocks in the broad EM US dollar exchange rate are a net transmitter of shocks to debt and equity portfolio flows of EM economies. Our analysis, based on the net directional spillover index, shows that this effect is most pronounced during the COVID-19 pandemic. Furthermore, using a frequency domain approach to connectedness, we find that the broad EM US dollar exchange rate is a net transmitter of shocks to the EM economies’ debt and equity flows, with the impact hitting portfolio capital flows within at least a week to 100 days. Our results suggest that pre-emptive macroprudential policy measures and better risk monitoring can improve the resilience of borrowers and investors in EM economies during times of global shocks, particularly during US dollar appreciations when portfolio flows tend to reverse.