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Presentation for the AHE Annual Conference 2009 Capital Flight or Volatile Financial Flows: which one is the best indicator to measure Brazilian External Vulnerability Vanessa da Costa Val (Professor at IE-UFU/Brazil and PhD student at Cedeplar/UFMG) Gilberto Libânio (Professor at Cedeplar/UFMG) 23/05/2017 1 Introduction Importance of confidence in the global economy to the international capital flow movement. The liquidity and dynamics of international financial markets determines the caractheristics and volume of these flows towards peripheral countries. In Brazil, the financial liberalization associated with capital flight results in external vulnerability, high interest rate and public debt, and low economic growth. The vulnerability depends on the weight of volatile capital flows in the Balance of payments. 2 Objectives To Evaluate which indicator - capital flows volatility or capital flight measures - best reveals the resource reversal potential for Brazil and, then, the external vulnerability of this economy. - To measure the volatility of each sub-account of the Financial Account, detecting which flows have more influence on the vulnerability of this account. - To find out which capital flight measure is the best one for the Brazilian case. 3 Capital Flows Volatility: Motivation Analysis Monthly Financial Account – 1995 to 2008 (U$ Millions) 20000 15000 10000 5000 jan/09 jul/08 jan/08 jul/07 jan/07 jul/06 jan/06 jul/05 jan/05 jul/04 jan/04 jul/03 jan/03 jul/02 jan/02 jul/01 jan/01 jul/00 jan/00 jul/99 jan/99 jul/98 jan/98 jul/97 jan/97 jul/96 jan/96 jul/95 jan/95 0 -5000 -10000 -15000 -20000 Financial Sub-accounts of the Brazilian balance of payments - 1990 to 2008 (U$ Millions) 60000 40000 20000 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 -20000 -40000 -60000 Total Direct Investment Portfolio Investment Derivatives Other Foreign Investment Brazilian Direct Investment Brazilian Portfolio Investment Other Investment Foreign Direct Investment Foreign Portfolio Investment Other Brazilian Investment 4 Data treatment and Time cut Data resource: time series of the National Account System, displayed by the Central Bank of Brazil. Data treatment: four groups of capital flows - 1) Direct Investment; 2) Portfolio Investment; 3) Derivatives; e 4) Other Investments. Each of these flows is again divided in further sub-accounts to show specific details. GARCH Model(generalized autoregressive conditional heteroskedasticity model): instantaneous volatility in the series at specific moments of its trajectory. Periodicity: monthly Time cut: 1) between January 1995 and December 1998; 2) between January 1999 and August 2008. 5 Capital flows volatility: results for the first period Financial Account series volatility - 1995: 01 to 1998:12 (first level of openness of BoP) 2.00E+07 1.60E+07 1.20E+07 8.00E+06 4.00E+06 0.00E+00 1995 1996 1997 GARCHDERIVATIVOS GARCHIC 1998 GARCHID GARCHOI 6 Capital flows volatility: results for the first period Financial Account series volatility - 1995: 01 to 1998:12 (Second level of openness of BoP) 9.0E+07 8.0E+07 7.0E+07 6.0E+07 5.0E+07 4.0E+07 3.0E+07 2.0E+07 1.0E+07 0.0E+00 1995 1996 GARCHIBC GARCHIBD GARCHIEC 1997 1998 GARCHIED GARCHOIB GARCHOIE 7 Capital flows volatility: results for the second period Financial Account series volatility - 1999: 01 to 2008: 08 (first level of openness of BoP) 2.40E+07 2.00E+07 1.60E+07 1.20E+07 8.00E+06 4.00E+06 0.00E+00 99 00 01 02 03 04 GARCHDERIVATIVOS GARCHIC 05 06 07 GARCHID GARCHOI 08 8 Capital flows volatility: results for the second period Financial Account series volatility - 1999: 01 to 2008: 08 (second level of openness of BoP) 6.0E+07 5.0E+07 4.0E+07 3.0E+07 2.0E+07 1.0E+07 0.0E+00 99 00 01 02 03 GARCHOIE GARCHOIB GARCHIED 04 05 06 GARCHIEC GARCHIBD GARCHIBC 07 08 9 External Vulnerability showed by external debtors indicators Indicator/Year 2000 2001 2002 2003 2004 2005 2006 2007 Debt service/Exports (%) Debt service/GDP (%) Interest rates/Exports (%) - annual Total external debt/GDP (%) Total public sector external debt/total external debt (%) Net total external debt/GDP (%) Reserves (liquidity)/Total debt (%) Total external debt/Exports - Ratio Net total external debt/Exports - Ratio Reserves (liquidity)/Debt service - Ratio 88,6 7,6 29 33,6 48,5 26,5 15,2 3,9 3,1 0,7 Source: Central Bank of Brazil 84,9 8,9 28 37,9 51,5 29,4 17,1 3,6 2,8 0,7 82,7 9,9 23,6 41,8 59,4 32,7 18 3,5 2,7 0,8 72,5 9,6 19,4 38,8 63,1 27,3 22,9 2,9 2,1 0,9 53,7 7,8 14,8 30,3 65,7 20,4 26,3 2,1 1,4 1 55,8 7,5 12,2 19,2 59,2 11,5 31,7 1,4 0,9 0,8 41,4 5,3 10,8 16,2 51,7 7 49,8 1,3 0,5 1,510 32,3 4 9,5 14,9 44,4 -0,8 93,2 1,2 -0,1 3,5 Capital flows volatility: Results High volatility of Direct Investments during the second period: historical record in July 2007. High volatility in Other Brazilian Investments account in June 2007: large outflow/inflow of “currency and deposits”. The high volatility of short run capital flows causes macroeconomics effects, such as interest rate trap and exchange rate valorization even when the crisis is not so deep. The Subprime market crisis in USA in 2007 shows that capital flows volatility remains very high in the Brazilian economy. 11 Capital Flight Definition: capital flight refers to the capital outflow not registered. It is abnormal or illegal capital outflow. This capital outflow usually occurs due to speculation movements. Capital flight is related to uncertainty and to the risk of keeping certain domestic assets, that is, capital “flies” trying to avoid huge wealth losses. 12 Capital Flight: residual method It measures capital flight indirectly: the residuals between officially registered resources and the use it funds. KFWB = CDET + NFI – CAD – CRES CDET: net growth of external debt registered by Central Bank of Brazil (BCB). NFI: Foreign Direct Investment + Portfolio Investment + Other Investments (IMF). CAD: – (net current account) CRES: international reserves variation (“RESERVE ASSETS: NET” of IMF). 13 -10000 -40000 Q2 2007 Q4 2006 Q2 2006 Q4 2005 Q2 2005 Q4 2004 Q2 2004 Q4 2003 Q2 2003 Q4 2002 Q2 2002 Q4 2001 Q2 2001 Q4 2000 Q2 2000 Q4 1999 Q4 1997 Q2 1996 Q2 1995 Q2 1994 Q4 1992 Q4 1991 Q2 1991 Q4 1990 Q2 1990 Capital Flight: residual method Capital flight using residual method (US$ millions) 60000 50000 40000 30000 20000 10000 0 -20000 -30000 14 Capital Flight: residual method results Capital flight peaks coincide with moments of international financial crisis or with some exogenous event, out of domestic control: in 1994’s 2nd quarter (Tequil Effect), 1998’s 4th quarter (Russian Crisis), and 2007’s 2nd quarter (positive international reserve variation). During moments of crisis capital flight reaches a very significant percentage of GDP, as occurred in 1994 and 1998 in Mexico and Russia, respectively. It exceeded 50% of Brazil’s economic activity. In periods of favorable international liquidity a reverse capital flight is observed. 15 Capital Flight: Hot Money method Capital flight is represented by short term capital outflow. KFH = – SK (short term private capital flows) – EO (errors and omissions) SK = SK1 + PORT. Where SK1 = other assets from other investments; PORT = net Portfolio Investments; EO = net errors and omissions. 16 -50000 Q2 2007 Q3 2006 Q4 2005 Q1 2005 Q2 2004 Q3 2003 Q4 2002 Q1 2002 Q2 2001 Q3 2000 Q4 1999 Q1 1999 Q2 1998 Q3 1997 Q4 1996 Q1 1996 Q2 1995 Q3 1994 Q4 1993 Q1 1993 Q2 1992 Q3 1991 Q4 1990 Q1 1990 Capital Flight: Hot Money method Capital flight using Hot Money method (US$ millions) 20000 10000 0 -10000 -20000 -30000 -40000 17 Capital Flight: Misinvoicing trade method Capital flight is represented by export under-invoicing and import over-invoicing. Export misinvoicing = (Xw / CIFFOB factor) - Xc Import misinvoicing = (Mc / CIFFOB factor) – Mw Where: Xw = Brazil’s imports registered by the world on CIF basis; Xc = Exports registered by Brazil on FOB basis; Mc = Imports registered by Brazil on CIF basis; Mw = Exports to Brazil registered by the world on FOB basis; CIFFOB factor = CIF / FOB. 18 Q1 1990 Q3 1990 Q1 1991 Q3 1991 Q1 1992 Q3 1992 Q1 1993 Q3 1993 Q1 1994 Q3 1994 Q1 1995 Q3 1995 Q1 1996 Q3 1996 Q1 1997 Q3 1997 Q1 1998 Q3 1998 Q1 1999 Q3 1999 Q1 2000 Q3 2000 Q1 2001 Q3 2001 Q1 2002 Q3 2002 Q1 2003 Q3 2003 Q1 2004 Q3 2004 Q1 2005 Q3 2005 Q1 2006 Q3 2006 Q1 2007 Q3 2007 Capital Flight: Misinvoicing trade method Capital flight using Misinvoicing trade method (US$ millions) 20000000 15000000 10000000 5000000 0 -5000000 19 Preliminary conclusions External Events→ volatility of capital flows → Brazilian economic performance → reduce the scope of macroeconomic policy conduction. High volatility → impacts on domestic variables (interest rate, exchange rate, public debt). Increase of Minskyan behavior of International Financial System. Most volatile capital flows: the ones of most reversal potential. 20 Preliminary conclusions The changes in structures of international capital flow and of domestic economy are important to analyze capital flight in Brazil. Capital flights are resulting from macroeconomic instability, the consequence of the financial liberalization process. While financial flow volatility can indicate moments in which Brazil turns from receptor to emitter of international resources, capital flight can indicate the sensibility of capital flow towards Brazil when facing unstabilizing factors and external shocks. 21