External Shocks, Cross Border Flows and Macroeconomic Risks in Emerging Market Economies

Abstract

We study the relationship between cross border flows and risks to macroeconomic stability for a sample of ten major emerging market economies (EMEs) from 2000-2017 in the presence of external shocks. We examine this relationship with a focus on two key channels of cross border flows, namely external debt securities (EDS) and cross-border loans (CBL). A Markov regime switching analysis shows that EDS flows became the dominant channel of cross border flows post global financial crisis 2008 (GFC), confirming the idea of second phase of global liquidity \citep{shin2013sec}. We further estimate panel vector autoregression models to show that volatility in global risk perception plays a larger role in channelizing cross border flows to EMEs compared to the US monetary policy stance. Post GFC, EDS flows are particularly sensitive to shocks in global risk perception. CBL flows are associated with smaller risks pre GFC compared to the post GFC period which is in contrast to the result for EDS flows. Our results also show that EMEs with high levels of CBL flows face larger macroeconomic risks relative to EMEs with low levels of CBL flows whereas riskiness is high for EMEs with high and low levels of EDS flows. Finally, a panel threshold model confirms a non-linear association between EDS/CBL flows and macroeconomic risks. This results suggest that intensity of the association depends upon global risk uncertainty and that EDS flows present a larger macroeconomic risks to EMEs than CBL flows post-GFC.