Capital Markets, COVID-19 and Policy Measures

Abstract

The COVID-19 episode triggered a historically large wave of capital reallocation and provided an opportunity to revisit the relevance of domestic policies for capital flows. Using high-frequency country-level data, this paper examines how COVID-19 cases, the stringency of the lockdown, and the fiscal and monetary policy response determined the dynamics of portfolio flows. Despite the sizeable impact of global factors, we find that these domestic factors played a key role, particularly for emerging markets and bond flows. Our results indicate that rising domestic COVID-19 cases had a strong positive effect on portfolio flows. Lockdown and fiscal policy measures also supported portfolio flows. In contrast, we find that interest rate cuts led to a decline in portfolio flows as investors searched for yield. Finally, we show that these policies and pre-COVID-19 macroeconomic conditions contributed to countries’ exposure to the global shock.

Keywords: Capital flows, COVID-19, Lockdown stringency, Fiscal policy, Monetary policy, Pull factors, emerging markets