Structure of capital flows and exchange rate: the case of Croatia

Abstract

The paper analyses the impact of different types of capital flows on the exchange rate in a small open economy using Croatian data. We estimate structural vector autoregressive models based on Cholesky decomposition with block exogeneity restrictions using different types of capital flows and find that the structure of capital flows matters for their impact on the exchange rate. On the one hand, debt capital inflows lead to kuna appreciation, irrespective of their maturity, while in terms of sectoral structure this is mostly due to corporate and government borrowing. On the other hand, there is some evidence that equity capital inflows lead to kuna depreciation, which could stem from their stronger orientation towards the tradable sector. The results also indicate that capital flows to the banking sector have no effect on the exchange rate, providing support for the use of countercyclical measures by the central bank.