Capital Inflows — The Good, the Bad and the Bubbly

Abstract

Capital inflows come in all shapes and sizes. This paper highlights that equity flows, especially foreign direct investment, are the most stable forms of capital inflows. In contrast, debt inflows from banks particularly in foreign currency are most prone to booms and busts. These flows also seem most sensitive to external factors, especially changes in global risk, and also to changes in domestic credit growth. Although portfolio debt flows are somewhat more stable particularly to advanced countries, granular data highlight that (open-ended) emerging market mutual funds in foreign currency and aimed at retail investors are also prone to inflow ‘surges’ and ‘stops’. The share of external debt denominated in foreign currency is significantly higher in emerging market economies (EMEs) than in advanced countries. EMEs also usually have shallower and narrower financial markets. This suggests these countries are more prone to risks from capital inflow booms and busts.

Keywords: capital flows, international monetary and financial system, macro-prudential policy, banking flows, portfolio flows, bank and non-bank creditors

JEL Classification: F21, F32, F34, G21, G28