Large Capital Outflows Research Articles

Market Stabilisation Scheme and Management of Liquidity in the Period of Volatile Capital Inflows: The Indian Experience

India recorded large and exogenous capital inflow from the very beginning of this century. This made monetary and liquidity management increasingly complex and difficult in India. Independent monetary policy in the era of free and volatile capital flow became challenging. To deal with the problems of excess liquidity in the system, the Reserve Bank of India (RBI) in consultation with the Government of India (GOI) introduced Market Stabilisation Scheme (MSS) in April 2004 with the objective of impounding excess liquidity from the system. In this paper, we have attempted to examine whether MSS was effective as an instrument of sterilisation in absorbing excess liquidity from the system and enabled the RBI to manage the liquidity condition smoothly. This paper has found that MSS was an effective instrument of sterilisation that helped the RBI in managing liquidity conditions in the period of large and exogenous capital inflows. This paper has also found that MSS was even effective in injecting back liquidity into the system through unwinding of securities under MSS redemption and its buyback operations in the period of large capital outflows during the international financial crisis of 2008-09. This helped the large borrowing programmes of the government during 2009-10. The paper has estimated the cost of MSS operations and found it on the lower side considering the scale of operation of this scheme.

Monetary policy in an oil-dependent economy in the presence of multiple shocks

Russian monetary policy has been challenged by large and continuous private capital outflows and a sharp drop in oil prices during 2014. Both contributed to significant depreciation pressures on the ruble and led the central bank to give up its exchange rate management strategy. Against this background, this work estimates a small open economy model for Russia, featuring an oil price sector and extended by a specification of the foreign exchange market to correctly account for systematic central bank interventions. We find that shocks to the oil price and private capital flows substantially affect domestic variables such as inflation and output. Simulations for the estimated actual strategy and alternative regimes suggest that the vulnerability of the Russian economy to external shocks can substantially be lowered by adopting some form of inflation targeting. Strategies to target the nominal exchange rate or the ruble price of oil prove to be inferior.

Market expectation management and renminbi exchange rate policy under depreciation pressure

ABSTRACT Motivated by the capital outflow episode after the 8/11 renminbi exchange rate reform, we establish formal models to study renminbi exchange rate policy under depreciation pressure with a focus on its effect on market expectations. In an economy where capital controls are imposed, a central bank aims both to discourage speculative capital outflows and to reduce exchange rate misalignment. We find that (i) both capital controls and speculators’ uncertainty about the central bank’s exchange rate target can effectively discourage capital outflows; (ii) Any action taken by the central bank will send a signal to speculators about the central bank’s exchange rate target, causing a change in speculators’ expectations and subsequently in capital flows. This explains large capital outflows triggered by the 8/11 reform. A key takeaway is that exchange rate policy should take into account its effect on market expectations to avoid unnecessary exchange rate and capital flow volatility.

Analyzing Capital Flow Drivers Using the ‘At-Risk’ Framework: South Africa’s Case

Cross-border capital flows are important for South Africa. They fund the nation’s relatively large external financing needs and have important financial stability implications evidenced by the large capital outflows and asset price selloffs during the COVID-19 pandemic. This paper adds to the literature on the drivers of South Africa’s capital flows by applying the ‘at-risk’ framework––which differentiates between the likelihood of “extreme” inflows (surges) and outflows (reversals) and of “typical” flows––to both nonresident and resident capital flows. Estimated results show that among nonresident flows, the portfolio debt component is most sensitive to changes in external risk sentiment particularly during reversals. This applies to flows to the sovereign sector. Nonresident equity flows, both portfolio and FDI, are most sensitive to domestic economic activity especially during surges. This applies to flows to the corporate and banking sectors. Results also suggest that resident flows, in particular the FDI component, tend to offset nonresident flows, thus acting as buffers against funding withdrawal during periods of global risk aversion.

Capital flight: The travel channel

This paper provides evidence for a rarely studied channel for capital flight: traveling. During an unprecedented period of large net capital outflows in 2014–2016, China’s travel expenditure rose to a level that was abnormally high relative to China’s outbound departures data, counterparty statistics, or by the norm of other countries. I estimated a gravity equation model adapted to travel trade for a panel of countries and found that reported travel expenditure by China was significantly above that predicted by the model during this period. The unexplained travel imports, reaching about 1 percent of China’s GDP during this period, were inversely associated with domestic growth and positively associated with renminbi depreciation expectations against the dollar, suggesting that they were less likely to be consumption of goods and services abroad than domestic residents’ acquisition of foreign financial assets. These results suggest that Chinese households, through the travel channel, had exploited China’s more liberalized capital account in recent years to transfer wealth abroad during periods of elevated economic uncertainty.

The impact of capital flow reversal shocks in South Africa: a stock- and-flow-consistent analysis

ABSTRACT South Africa has a very well-developed financial sector and high reliance on capital flows. The country saw large capital outflows as the Covid-19 crisis developed, accompanied by a large depreciation of the rand and spikes in bold yields. We employ a stock- and flow-consistent model to study the impact of capital flow reversal shocks on the South African economy. The model includes a richer representation of institutional balance sheets than existing models. The financial sectors behaviour in the model draws on the theoretical frameworks, which highlight the relationship between bank capital, the risk-taking behaviour of the financial sector, lending spreads and economic activity. We specify a dynamic adjustment model of household expectations with properties that differ from the way in which expectations are formed in either stock- and flow-consistent or (DSGE) models. Household expectations resemble bounded rationality. The financial accelerator mechanism operates through the balance sheets of all institutions in the economy. We find that a reversal in capital flows can affect the domestic economy through its impact on domestic liquidity, on the risk-taking behaviour of the financial sector, and on the demand for assets.

Diffusion of COVID-19 impact across selected stock markets: a wavelet coherency analysis

COVID-19 has impacted the world economy in an unprecedented manner; the financial markets indicate the same. This spontaneous event landed most of the stock markets into extreme volatility. Large capital outflow and extreme rapid fall were seen among almost all the world financial markets. Though similar trend prevailed everywhere during this pandemic, the impact could not be accumulated in absolute terms. Using the data of five stock markets, the current study endeavored to draw an impact of COVID-19 on major stock exchanges. The study uses wavelet coherency analysis on one-year daily data from June 2019 to May 2020 of five stock markets: Bombay Stock Exchange (BSE), London Stock Exchange (LSE), NASDAQ, Tokyo Stock Exchange (Nikkei), and Shanghai Stock Exchange. It is observed that there are time-variation and scale-variation in co-movements between the studied markets. During the crisis, the co-movement concentrates on a short time scale, even for two days. These results have significant implications for international investors, which will help them in portfolio diversification with time elements. All the stock markets under study have indicated co-movement at different time scales and frequencies with varying cross-power levels. However, the concentration of co-movement is found the most between the UK and the US stock markets. It is the least between Japan and the UK. In BSE, co-movement at shorter time scales started late. NASDAQ is leading only in one case, i.e., Shanghai Stock Exchange. BSE is not leading any stock index. LSE is in the leading position in all four cases. It has also been observed that co-movement started to concentrate at a shorter time scale as soon as the impact of the crisis increased.

Credible Emerging Market Central Banks could Embrace Quantitative Easing to Fight COVID-19

Emerging economies are fighting COVID-19 and the economic sudden stop imposed by the containment and lockdown policies, in the same way as advanced economies. However, emerging markets also face large and rapid capital outflows as a result of the pandemic. This column argues that credible emerging market central banks could rely on purchases of local currency government bonds to support the needed health and welfare expenditures and fiscal stimulus. In countries with flexible exchange rate regimes and well-anchored inflation expectations, such quantitative easing would help ease financial conditions, while minimising the risks of large depreciations and spiralling inflation.

Impact of global uncertainty on the global economy and large developed and developing economies

ABSTRACTGlobal uncertainty shocks are associated with a sharp decline in global inflation, growth and interest rate. Global uncertainty shocks have more protracted, statistically significant and substantial effects on global growth, inflation and interest rate than U.S. uncertainty shocks. When controlling for domestic uncertainty, the decline in output following a rise in global uncertainty is statistically significant in each large country, except for the decline for China. For most economies, a positive shock to global uncertainty has a depressing effect on prices and official interest rates – exceptions are Brazil, Mexico and Russia, which are economies with large capital outflows during financial crises.

Deteriorating agriculture: it's reasons and impacts on socio-economic profile of J&K state

In terms of dependence on livelihoods and employment, the state of Jammu and Kashmir can be considered as agrarian, hence the overwhelming majority of the people live in rural areas. There are many reasons that have led to a dwindling share of GDP of the sector at a time when it should have retained its role given large proportion of people depending on it. These include: Reduction in public expenditure in the sector after reforms, decrease in agricultural land due to conversion, lack of appropriate irrigation facilities, and acute lack of infrastructure, lack of quality pesticides, occasional flooding, and lack of research. This imbalance between production and employment has resulted into compromised socio-economic profile of the state which includes: Low per capita income, compromised Food security, large Capital outflow, and Low employment. Therefore, in a bid to arrest any further deterioration in its socioeconomic profile, it is imperative for the state to initiate a stream of measures that will enhance the productivity in the sector and safeguard it from undue competition from abroad.

STIGMA? WHAT STIGMA? A Contribution to the Debate on the Effectiveness of IMF Lending

There is a perception that IMF programmes are not catalytic and instead associated with large capital outflows, higher refinancing costs for sovereigns and adverse movements in stock markets. This has led to concerns that an expectation of adverse effects of IMF programmes may deter countries from asking for an IMF programme when they need one, a form of ‘IMF stigma’. We address these questions using monthly data by estimating how and to which extent adverse market reactions to a programme materialise and how past experience with adverse market reactions affects subsequent IMF programme participation. Our results, derived with a propensity score matching approach, indicate no role for ‘IMF stigma’ stemming from the fear of adverse market movements.

Comment on “China's New Role in the International Financial Architecture”

Comment on “China's New Role in the International Financial Architecture”

The Impact of Global Uncertainty on the Global Economy, and Large Developed and Developing Economies

Global uncertainty shocks are associated with a sharp decline in global inflation, global growth and in the global interest rate. Over 1981 to 2014 global financial uncertainty forecasts 18.26% and 14.95% of the variation in global growth and global inflation respectively. Global uncertainty shocks have more protracted, statistically significant and substantial effects on global growth, inflation and interest rate than U.S. uncertainty shocks. U.S. uncertainty lags global uncertainty by one month. When controlling for domestic uncertainty, the decline in output following a rise in global uncertainty is statistically significant in each country, with the exception of the decline for China. The effects for the U.S. and for China are also relatively small. For most economies, a positive shock to global uncertainty has a depressing effect on prices and official interest rates. Exceptions are Brazil, Mexico and Russia, economies with large capital outflows during financial crises. Decomposition of global uncertainty shocks shows that global financial uncertainty shocks are more important than non-financial shocks.

The Impact of Global Uncertainty on the Global Economy, and Large Developed and Developing Economies

Global uncertainty shocks are associated with a sharp decline in global inflation, global growth and in the global interest rate. Over 1981 to 2014 global financial uncertainty forecasts 18.26% and 14.95% of the variation in global growth and global inflation respectively. Global uncertainty shocks have more protracted, statistically significant and substantial effects on global growth, inflation and interest rate than U.S. uncertainty shocks. U.S. uncertainty lags global uncertainty by one month. When controlling for domestic uncertainty, the decline in output following a rise in global uncertainty is statistically significant in each country, with the exception of the decline for China. The effects for the U.S. and for China are also relatively small. For most economies, a positive shock to global uncertainty has a depressing effect on prices and official interest rates. Exceptions are Brazil, Mexico and Russia, economies with large capital outflows during financial crises. Decomposition of global uncertainty shocks shows that global financial uncertainty shocks are more important than non-financial shocks.

Can Greater Openness and Deeper Financial Development Drag ASEAN-5 into Another Series of Economic Crises?

<p>In the event of economic crises, it is observed that economic volatility becomes more severe. Therefore, the aim of this study is to examine the impact of greater openness and deeper financial sector development in influencing the level of economic volatility which could trigger economic crises in both long-and short-run periods in the case of ASEAN-5 countries, namely Indonesia, Malaysia, Philippines, Singapore and Thailand. Given that more attention is needed to address the issue, the Pooled Mean Group (PMG) estimations developed by Pesaran et al. (1999) and data ranging from 1980 to 2014 were employed to address the issue. With the ability to estimate short-run coefficients at each country level and its speed of adjustment, this study further fills the knowledge gap. Based on the analysis, it is found that greater trade and financial openness may further relax economic volatility in the long-run, suggesting greater international risk sharing which soothes consumption shocks. In terms of the effect of financial development towards economic volatility, it is found that only deeper banking sector development may reduce economic volatility in the long-run, but the same may not apply in the case of greater stock market development. Particularly, it is suggested that it is in the nature of developments in the banking sector to likely provide longer financing options and greater banker capabilities in detecting riskier investments, thus giving a favourable impact on economic volatility. It is a contrast with the stock market sector where it is more likely to be more susceptible towards large and sudden capital outflows. Its tendency to provide capital towards riskier investments may worsen volatility in the longer term. Nevertheless, in the short-run, the effects of greater openness and financial development is not as obvious as in the long-run; financial openness and greater stock market sector development may significantly relax economic volatility. As suggested by the speed of adjustment, the equilibrium from short-run to long-run is corrected by 1.71% and 2.33% in a year. Cumulatively, it can be said that there is no evidence that greater openness and deeper financial development may drag ASEAN-5 into another series of crises except in the case of stock market sector development. Therefore, the source of instability in the region is likely to be driven from greater stock market sector development rather than greater openness and banking sector development.</p>

Asymmetric growth effect of capital flows: Evidence and quantitative theory

The empirical evidence of the causal relationship between capital flows and economic growth over the decades is largely indecisive. While the promised benefits to countries that open for capital inflows have not been realized, sudden and massive capital outflows often visibly wreak havoc on the economy. By using the recently developed asymmetric Granger causality test, we find overwhelming evidence across nine selected Asian countries in support of an asymmetric effect of capital flows on economic growth in the sense that cumulative capital inflows are irrelevant to growth, whereas cumulative capital outflows are destructive to growth. Based on a small open economy model expanded with heterogeneous investment goods and endogenous nonlinear credit constraints, we provide an economic intuition for the asymmetry that survives different levels of financial development. In particular, the arbitrage condition between heterogeneous investment goods sets a boundary over which massive and persistent capital inflows have no impact on long-run growth. On the other hand, endogenous nonlinear credit constraints trigger a debt deflation process, making large and persistent capital outflows destructive to growth.

Lessons from the 1997 and the 2008 Crises in the Republic of Korea

The economy of the Republic of Korea was hit harder than anticipated by the global financial crisis. In the first phase, large capital outflows led to a severe liquidity strain in the foreign exchange market resulting in a rapid depreciation of the exchange rate. Then, in the second phase, the contraction of global demand led to a collapse of exports and a sharp decline in economic activity, raising concerns about a full-fledged financial crisis in the country. This paper describes how the global financial crisis spilled over into the Korean economy and how the government responded to the financial turmoil. It also provides the background and rationale for the Korean government’s decisions to adopt specific policy measures. Based on Korean experiences during the 1997 and the 2008 crises, this paper documents the lessons learned and identifies several important policy issues that might have regional implications for Asia.

The effect of reducing quantitative easing on emerging markets

On 22 May and 19 June 2013, the US Federal Reserve (Fed) announced a reduction in the asset purchase programme of its quantitative easing policy. This article investigates the impact of this news on the currencies of emerging markets. Using event study methodology, our results report a global significant depreciation in the currencies of all emerging markets in our sample, but with different depreciation sizes from one market to another. To test whether the depreciation in currencies is driven by capital flow components, a regression analysis is performed. Inward FDI as well as outward FDI appear to have more explanatory power than inward and outward portfolio investment in explaining the impact. With the slowdown in asset purchases by the Fed, emerging countries have incurred large capital outflows from their markets to the US market, resulting in a drop in their currencies.

Simple Models to Understand and Teach Business Cycle Macroeconomics for Emerging Market and Developing Economies

The canonical neoclassical model is insufficient to understand business cycle fluctuations in emerging market and developing economies (EMDEs). I reformulate the models proposed by Aguiar and Gopinath (2007) and Neumeyer and Perri (2005) in simple settings that can be used to do back-of-the-envelope analysis and teach business cycle macroeconomics for EMDEs at the undergraduate level. The simplified models are employed for qualitatively explaining facts such as the countercyclicality of the trade balance and the real interest rate, and the higher volatility of output, consumption, and real wages compared with those observed in advanced countries. Simple extensions can be used to understand other empirical facts such as large capital outflows and output drops, small government spending he cyclical behavior of prices, and the negative association between currency depreciations and output.

Vietnam: The Global Economy and Macroeconomic Outlook

After almost a decade of high growth, Vietnam’s growth rate fell during 2011–13. Since 2001, the country has also experienced two bouts of high inflation, booms and busts in equity and real estate markets, and episodes of large capital inflows and outflows. Against the backdrop of the global economy, this paper provides an account of macroeconomic developments in Vietnam during 2011 to 2013, examines the imbalances that came to a head in 2011, the macroeconomic stabilization achieved during 2012 to 2014, and the outlook and challenges going forward. The paper concludes that successfully designing and implementing a broad set of policies — staying the course on macroeconomic stabilization, while accelerating the pace of structural reform significantly, and integrating into the global economy — will allow Vietnam to further advance the remarkable gains that it has already made in poverty alleviation and achieving its Millenium Development Goals.