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Drivers of Capital Flows and the Role of the Investor Base in Latin America

Port of Spain – June 14, 2017

Carlos Caceres(with Carlos Gonçalves, Gen Lindow, and Galen Sher)

International Monetary Fund

Capital Flows in Emerging Markets

2

• Questions addressed here: What are the main drivers of capital flows in emerging

markets? Are there any factors that can help mitigate or amplify the

sensitivity of capital flows to external shocks?

• IMF-WHD work on capital flows: Spring 2017 Regional Economic Outlook (Chapter 4) Caceres et al (2017 A; forthcoming): “Understanding the Cyclical

and Structural Drivers of Capital Flows in Emerging Markets” Caceres et al (2017 B; forthcoming): “The Role of the Investor

Base in the Sensitivity of Capital Flows to External Shocks”

OUTLINE

3

Part I: Stylized Facts of Capital Flows- Recent developments- Cyclical behavior of capital flows- Structural component of capital flows

Part II: Analyzing the Drivers of Capital Flows- Global ‘push’ factors- Country-specific ‘pull’ factors

Part III: Sensitivity of Capital Flows to External Shocks- The role of the “Investor Base”

Part IV: Conclusions

I. Stylized Facts

Gross Inflows to Latin America

5

Capital flows to LAC have halved since the end of the “commodity super-cycle”

LA7: Gross Inflows(Billions of U.S. dollars; 4-quarter moving averages)

Sources: IMF, Balance of Payments Statistics Yearbook database; Haver Analytics; and IMF staff calculations.Note: LA7 = Argentina, Brazil, Chile, Colombia, Mexico, Peru, Uruguay.

-50

0

50

100

150

200

250

300

350

400

450

2003:Q1 05:Q1 07:Q1 09:Q1 11:Q1 13:Q1 15:Q1

FDIPortfolioOther investmentFinancial derivativesTotal

360bn

175bn

Gross Inflows to TTO

6

…though TTO’s story is quite different; reflecting the country’s large CA surpluses over this period

TTO: Gross Inflows(Billions of U.S. dollars; 4-quarter moving averages)

Sources: IMF, Balance of Payments Statistics Yearbook database; Haver Analytics; and IMF staff calculations.

-8

-6

-4

-2

0

2

4

2002 2004 2006 2008 2010 2012 2014 2016

FDI Portfol ioOther investment Total


7

“Low frequency” of capital inflow cycles in LAC

-2

0

2

4

6

8

10

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

LA7: Gross Inflows(Percent of trend GDP; median)


Gross Inflows and Outflows in LAC

8

Gross outflows only partially offsetting gross inflows…

-2

0

2

4

6

8

10

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Gross inflows Gross outflows

LA7: Gross Inflows and Outflows(Percent of trend GDP; median)


Gross and Net Inflows in LAC

9

Overall, gross inflows tend to drive net inflows in LAC

-2

0

2

4

6

8

10

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Gross inflows Net inflows

LA7: Gross and Net Inflows(Percent of trend GDP; median)


Gross and Net Inflows in Other EMs

10

The predominant role of gross inflows over gross outflows is also observed in other emerging markets…

Other Emerging Markets: Capital Flows(Percent of trend GDP; median)


-2

0

2

4

6

8

10

12

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1

Gross inflowsNet inflowsGross outflows

Gross and Net Inflows in TTO

11

…and this is also the case in TTO

TTO: Capital Flows(Percent of trend GDP)


-7-6-5-4-3-2-10123

2002 2004 2006 2008 2010 2012 2014 2016

Thou

sand

s

Gross inflows Net inflows

Gross outflows

Cyclical Behavior of Capital Flows

12

Capital flows to LAC exhibit a common cyclical componentLA7: Gross Inflows(Percent of trend GDP)

Sources: Haver Analytics; IMF, Balance of Payment Statistics Yearbook database; IMF, World Economic Outlook database; and IMF staff calculations.

Argentina Brazil Chile

MexicoColombia Peru

-12

-8

-4

0

4

8

12

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1-2

0

2

4

6

8

10

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1-4

0

4

8

12

16

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1

-202468

1012

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q10

2

4

6

8

10

12

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q10

3

6

9

12

15

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1

Total gross inflows Average (2000–16) LA7 median


13

…which is mirrored by the high synchronicity observed in other macroeconomic and financial variables

First Principal Component(Percent share explained)

Sources: IMF, Balance of Payment Statistics Yearbook database; IMF, World Economic Outlook database; and IMF staff calculations.Note: For the exchange rate, all euro area countries are treated as a single entity.

0

20

40

60

80

100

LA5 LA7 Advanced OEM

Gross inflows Real GDP growth Exchange rate

Structural Behavior of Capital Flows

14

…but average levels of capital inflows differ substantially across countries

Gross Inflows Average 2000-16(Percent of trend GDP)

Haver Analytics; IMF, Balance of Payments Statistics Yearbook database; IMF, World Economic Outlook database; and IMF staff calculations.


Net Inflows Average 2000-16(Percent of trend GDP)

-8

-4

0

4

8

12

16

VN

MKA

ZA

LBBG

RG

HA

HU

NH

RV CH

LR

OU

UR

YPO

LD

OM

TUR

PER

CO

LM

EXM

YS

CH

NIN

DBR

ASA

UR

US

ZAF

MA

RPH

LTH

AID

NEG

YPR

YA

RG

TTO

Latin AmericaOther emerging markets

VNM = 29.1

-10

-6

-2

2

6

10

14

VN

MA

LBBG

RG

HA

HRV

RO

UD

OM

TUR

POL

PER

HU

NU

RY

IND

MEX ZA

FC

OL

KAZ

BRA

CH

NPR

YM

AR

EGY

CH

LPH

LID

NTH

AA

RG

SAU

RU

SM

YS

TTO

Latin AmericaOther emerging markets

VNM = 19.5

II. Drivers of Capital Flows

Gross inflows in LAC and other EMs

16

Quantitative analysis focused on the period 2000-2016

-2

0

2

4

6

8

10

2000 2002 2004 2006 2008 2010 2012 2014 2016



Sources: IMF, Balance of Payments Statistics Yearbook database; Haver Analytics; and IMF staff calculations.Note: OEM = Other emerging markets.

-2

0

2

4

6

8

10

12

2000 2002 2004 2006 2008 2010 2012 2014 2016

OEM: Gross Inflows(Percent of trend GDP; median)

Capital Inflows & Global Growth

17

High correlation of gross inflows and global GDP growth

-8

-6

-4

-2

0

2

4

6

-2

0

2

4

6

8

10

2000 2002 2004 2006 2008 2010 2012 2014 2016

Gross inflows G7 real GDP growth (right scale)

LA7: Gross Inflows and G7 Real GDP Growth(Percent of trend GDP; percent change; median)


OEM: Gross Inflows and G7 Real GDP Growth(Percent of trend GDP; percent change; median)


-8

-6

-4

-2

0

2

4

6

-2

0

2

4

6

8

10

12

2000 2002 2004 2006 2008 2010 2012 2014 2016

Gross inflows G7 real GDP growth (right scale)

Capital Inflows & Domestic Growth

18

High correlation of gross inflows and real GDP growth

-4

-2

0

2

4

6

8

10

-2

0

2

4

6

8

10

2000 2002 2004 2006 2008 2010 2012 2014 2016

Gross inflows Real GDP growth (right scale)

LA7: Gross Inflows and Real GDP Growth(Percent of trend GDP; percent change; median)


OEM: Gross Inflows and Real GDP Growth(Percent of trend GDP; percent change; median)


-2

-1

0

1

2

3

4

5

6

7

8

-2

0

2

4

6

8

10

12

2000 2002 2004 2006 2008 2010 2012 2014 2016

Gross inflows Real GDP growth (right scale)

Capital Inflows & Commodity Prices

19

Gross inflows track the “commodity super cycle” well

3.8

4.0

4.2

4.4

4.6

4.8

5.0

5.2

5.4

-2

0

2

4

6

8

10

2000 2002 2004 2006 2008 2010 2012 2014 2016

Gross inflows Commodity prices (right scale)

LA7: Gross Inflows and Commodity Prices(Percent of trend GDP; logs; median)


OEM: Gross Inflows and Commodity Prices(Percent of trend GDP; logs; median)


3.8

4.0

4.2

4.4

4.6

4.8

5.0

5.2

5.4

5.6

-2

0

2

4

6

8

10

12

2000 2002 2004 2006 2008 2010 2012 2014 2016

Gross inflows Commodity prices (right scale)

Capital Inflows & Structural Factors

20

Average level of capital inflows correlated with institutional and other structural factors

Gross Inflows Vs Regulatory Quality(Average 2000-16)

Sources: Haver Analytics; IMF, Balance of Payment Statistics Yearbook database; World Governance Indicators; and IMF staff calculations.Note: “Regulatory quality" and "rule of law" are composite indicators from the World Bank's Worldwide Governance Indicators (WGI); "political risk index" is computed within the International Country Risk Guide (ICRG) database."

ARG

BRACHL

COL

MEX

PER URY

0

4

8

12

16

-1 0 1 2

Gro

ss In

flow

s (p

erce

nt o

f tre

nd G

DP)

Regulatory Quality

Other emerging marketsLA7

ARG

BRA

CHL

COL

MEX

PERURY

0

4

8

12

16

-1 0 1 2

Gro

ss In

flow

s (p

erce

nt o

f tre

nd G

DP)

Rule of Law


Gross Inflows Vs Rule of Law(Average 2000-16)

ARG

BRA

CHL

COL

MEX

PERURY

0

4

8

12

16

50 60 70 80

Gro

ss In

flow

s (p

erce

nt o

f tre

nd G

DP)

Political Risk Index (higher = less risk)


Gross Inflows Vs Political Risk(Average 2000-16)

‘Pull’ and ‘Push’ Factors

21

• Panel of 29 emerging markets countries (incl. LA7)

• Period: 2000Q1-2016Q3

• Dependent variable(s): gross and net capital flows

• Cyclical behavior of capital flows:– Global ‘push’ factors– Country-specific ‘pull’ factors

• Structural behavior of capital flows:– Country-specific ‘pull’ factors (low time variability; high

cross-sectional variability)

Cyclical Drivers of Capital Inflows

22

Predominant role of commodity prices in driving the cyclical component of capital flow cycles…

Sources: IMF staff calculations; Caceres et al (2017; forthcoming A). Notes: green denotes a positive coefficient estimate; red denotes a negative coefficient estimate. *, **, *** denote statistical significance at the 10, 5, and 1 percent confidence level.

Individual effect

Joint effect

Individual effect

Joint effect

Individual effect

Joint effect

Global variables

VIX ** - - - - -

Global GDP growth ** ** - - - -

U.S. interest rates - - - - - *

Global commodity prices *** *** *** *** *** ***

Country-specific variables

GDP growth differential ** - *** *** *** ***

Interest rate differential *** - * - *** -

Latin America Other Emerging Markets All Emerging Markets

“We Just Ran A Million Regressions”

23

• Objective: minimize ‘model selection’ bias

• In the spirit of Sala-i-Martin (1997, AER)

• Idea: to avoid selecting a particular (non-random) model, can consider N potential explanatory variables, then regress dependent variable on all (2N-1) possible combinations… This yields a histogram of estimated coefficients

• The ‘most robust’ variables would tend to have their distribution mass to the right/left of the “zero” line

Robustness of Global Factors

24

Commodity prices robust to alternative model specifications

Sources: IMF staff calculations; Caceres et al (2017; forthcoming A). Note: LA5 = Brazil, Chile, Colombia, Mexico, Peru.

0

2,000

4,000

6,000

8,000

10,000

-7 -5 -2 0 2 4 7

LA5Other emerging markets

Commodity prices, log(Frequency)

0

2,000

4,000

6,000

8,000

10,000

-9 -6 -4 -1 1 3 6 8


VIX, log(Frequency)

G7 Real GDP growth(Frequency)

0

2,000

4,000

6,000

8,000

10,000

12,000

-1.1 -0.6 0.0 0.5 1.1


0

2,000

4,000

6,000

8,000

10,000

-2.1 -1.6 -1.1 -0.5 0.0 0.6 1.1 1.6


U.S. short-term interest rates(Frequency)

Structural Drivers of Capital Inflows

25

Country-specific structural factors strongly associated with higher average levels capital flows…

Sources: IMF staff calculations; Caceres et al (2017; forthcoming A). Notes: green denotes a positive coefficient estimate; red denotes a negative coefficient estimate. *, **, *** denote statistical significance at the 10, 5, and 1 percent confidence level.

Latin America Other Emerging Markets All Emerging Markets

Country-specific structural factors

Government effectiveness *** *** ***

Regulatory quality *** *** ***

Control of corruption *** *** ***

Rule of law *** *** ***

Law and order *** *** ***

Voice an accountability *** *** ***

Political stability *** *** ***

Political risk *** *** ***

Institutionalized democracy * *** ***

Corporate tax rate *** *** ***

Credit rating *** *** ***

III. Sensitivity of Capital Flows:The Role of the ‘Investor Base’

Response of Capital Flows to Shocks

27

High vulnerability of capital inflows to external shocksImpulse Response Functions of Gross Inflows:

Unrestricted Sample(Percent of trend GDP)

Source: IMF staff calculations; Caceres et al (2017; forthcoming B).Note: Bars represent the response of gross inflows four quarters after a positive one unit shock to each of the four exogenous global variables. A unit shock for the VIX and global commodity prices correspond to a unit change in the logarithm of these two variables; a unit shock for G7 growth and the “U.S. monetary shock” corresponds to a 1 percentage point change in these variables. Solid bars with black borders denote that the response is statistically significant at the 5 percent confidence level. G7 = Canada, France, Germany, Italy, Japan, United Kingdom, United States; VIX = Chicago Board Options Exchange Volatility Index.

-6

-3

0

3

6

9

12

Commodityprices

VIX G7 growth U.S. monetaryshock

Role of the Investor Base

28

Higher participation of non-resident investors increases the sensitivity of capital flows to external shocks…

Impulse Response Functions of Gross Inflows: Non-Residents’ Participation in Domestic Markets

(Percent of trend GDP)

Source: IMF staff calculations.Note: Bars represent the response of gross inflows four quarters after a positive one unit shock to each of the four exogenous global variables. A unit shock for the VIX and global commodity prices correspond to a unit change in the logarithm of these two variables; a unit shock for G7 growth and the “U.S. monetary shock” corresponds to a 1 percentage point change in these variables. Solid bars with black borders denote that the response is statistically significant at the 5 percent confidence level. G7 = Canada, France, Germany, Italy, Japan, United Kingdom, United States; VIX = Chicago Board Options Exchange Volatility Index.

-6

-3

0

3

6

9

12

15

18

Commodityprices


High Low


29

Deeper and more liquid domestic markets lower the sensitivity of capital flows to external shocks…

Impulse Response Functions of Gross Inflows: Domestic Market Capitalization



-6

-3

0

3

6

9

12

15

18

Commodityprices


High Low


30

A large stable domestic investor base can also help reduce the sensitivity of capital flows to external shocks…

Impulse Response Functions of Gross Inflows: Domestic Pension Funds Presence



-6

-3

0

3

6

9

12

15

Commodityprices


High Low

Role of Policy Choices

31

Exchange rate flexibility can also contribute to lower the sensitivity of capital flows to external shocks

Impulse Response Functions of Gross Inflows: Exchange Rate Flexibility



-8

-4

0

4

8

12

16

Commodityprices


Fixed Flexible

IV. Conclusions

Conclusions:

33

• Capital flows in emerging markets exhibit a largely common cyclical behavior, but a relatively differentiated structural component

• Predominant role of global factors - particularly commodity prices - in driving the cyclical behavior of capital flows in emerging markets

• Country-specific structural factors, such as good governance and strong institutional and regulatory frameworks, play a key role in attracting inflows over longer time horizons

Conclusions:

34

• Countries with high ‘foreign participation’ tend to exhibit higher sensitivity of capital flows to external shocks…

• …whereas countries with deeper and more liquid financial markets, with a large stable domestic investor base, appear to be less sensitive to shocks

• Exchange rate flexibility is another line of defense to lower the sensitivity of capital flows to external shocks

Thank You!

Auxiliary Slides:


37

Similar behavior of capital inflows across LA5 countries

-5

-4

-3

-2

-1

0

1

2

3

-2

0

2

4

6

8

10

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Median Mean Principal component (right scale)


Sources: IMF, Balance of Payments Statistics Yearbook database; Haver Analytics; and IMF staff calculations.Note: LA5 = Brazil, Chile, Colombia, Mexico, Peru.

Subcomponents of Capital Flows

38

Sub-components of capital flows are positively correlated with one another and with total flows…



-2

0

2

4

6

8

10

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1

Total Flows FDIPortfol io Other investment

Subcomponents of Capital Flows

39

…and FDI tends to be larger in magnitude, whereas portfolio (and other) flows tend to be more volatile

Other Emerging Markets: Gross Inflows(Percent of trend GDP; median)


-2

0

2

4

6

8

10

12

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1

Total Flows FDIPortfol io Other investment


40

Broadly similar behavior observed across regions

Gross Inflows (Percent of trend GDP; median)



0

2

4

6

8

10

12

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1

LA7 Other emerging markets

0

4

8

12

16

20

-4

-2

0

2

4

6

8

10

2000:Q1 04:Q1 08:Q1 12:Q1 16:Q1

LA7 Emerging Asia Emerging Europe (rhs)

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