Ride the Wild Surf: An investigation of the drivers of surges in capital inflows

Abstract

Industrial countries and emerging markets economies (EMEs) have experienced a wild ride on gross capital inflows over the past 15 years. After reaching a record high in the run-up to the global financial crisis, they collapsed dramatically in 2008–9. As the world economy started to recover, global capital flows resumed at different speeds. Capital flows into EMEs recovered faster than those flows in industrial economies. This paper aims at understanding the drivers of these surges in gross inflows using quarterly data for 79 countries from 1975 to 2014. We find that domestic and external drivers have a significant explanatory power in driving surges of inflows. Domestic factors appear to play a significantly larger role in explaining surges into EMEs. Zooming in our findings shows that: (a) overvalued currencies rather than credit growth tend to attract massive capital inflows, (b) surges to either industrial countries or EMEs are driven by regional contagion, (c) strong growth and natural resource abundance are key to attract inflows of foreign capital into EMEs, (d) lower policy uncertainty about the global economy tend to trigger surge episodes, and (e) an increase in global risk aversion would precede the end of surges.