Capital flows and spillovers

Abstract

This paper shows that debt flows have contractionary effects while equity flows have expansion- ary effects on emerging markets output. Such correlations can be driven by countercyclical debt flows and procyclical equity flows or debt flows leading to an appreciation and hurting exports and equity flows improving productivity of real economy broadly defined. To separate out the stories, we focus on business cycle frequencies and the effect of global risk appetite (VIX) in driving capital flows into emerging markets. A positive initial impact of debt flows on output is followed by a negative impact afterwards. Equity flows has a positive impact on output initially and thereafter. FDI inflows have a positive affect on output only with a two year lag and if this period coincides with increased global uncertainty, the effect on output reverses but total effect stays positive. This result holds also for equity flows, suggesting that during increased periods of uncertainty private investors leave emerging markets. Quantitative impacts are not big except the case of FDI flows.