Do Some Forms of Financial Flows Help Protect Against "Sudden Stops"?

Do Some Forms of Financial Flows Help Protect Against "Sudden Stops"? Using a large panel data set that includes advanced, emerging, and developing economies during 1970 2003, this article analyzes the behavior of several types of flows: foreign direct investment (FDI), portfolio equity investment, portfolio debt investment, other flows to the official sector, other flows to banks, and other flows to the nonbank private sector. Financial Account and Subcomponents: Median Values across Economies within Each Group 1970 2003 Other flows to official sector 0.02 0.10* Other flows to nonbank private sector 0.04 0.04* Summary statistic and economy Financial account Foreign direct investment Portfolio debt investment 0.25 0.17* Portfolio equity investment Other flows to banks 0.42 0.01* Average of capital flows Advanced 1.38 20.02 economies Emerging 1.89 1.30 market economies Developing 2.98 1.88 economies Standard deviation Advanced 2.72 1.31 economies Emerging 4.39 1.50 market economies Developing 4.86 2.08 economies Coefficient of variation Advanced 1.37 2.20 economies Emerging 1.88 1.00 market economies Developing 1.41 0.96 Economies Correlation with domestic growth Advanced 0.10 0.00 economies Emerging 0.24 0.10 market economies Developing 0.16 0.17 economies Correlation with G-7 growth Advanced 20.01 0.03 economies Emerging 20.08 20.07 market economies Developing 0.01 0.04 economies Correlation with U.S. interest rate ( Continued Other flows to official sector 0.27* Other flows to nonbank private sector 0.13* Summary statistic and economy Financial account Foreign direct investment 20.29 Portfolio debt investment 20.07 Portfolio equity investment 20.08* Other flows to banks 0.03* Emerging 0.07 market economies Developing 0.10 economies Persistence (AR1 pooled) Advanced 0.68 economies Emerging 0.52 market economies Developing 0.51 economies First principal component Advanced 0.30 economies Emerging 0.24 market economies Principal Components Analysis This section analyzes the relationships of financial flows across income groups using principal components analysis, focusing on the share of variation explained by the first principal component--a standard measure of comovement--for each country group. Levchenko and Mauro 399 The empirical findings indicate that for total financial flows the patterns across advanced and developing economies are quite similar, with the first principal component accounting for 25 30 percent of the variation in financial flows. Replicating the analysis in figure 1 for gross inflows and gross outflows (analogous charts are available from the authors on request) shows that the results for gross inflows are strikingly similar to those reported in figure 1, whereas the results for gross outflows show far more limited action. A similar message emerges when considering the response of different components of financial flows at the quarterly frequency around the Russia/ Long-Term Capital Management crisis of August 1998, for all emerging market economies (figure 2, which--for the sake of brevity--reports data only for countries whose financial account balance was most affected by the crisis. Third, the analysis could explore the consequences of financial flows, looking at whether sudden stops in financial flows (and, more specifically, in non-FDI flows) have a large adverse impact on the deviation of output from forecast output--suggestive evidence that the causal relationship goes from capital flows to output, rather than the other way around.