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Contents International Capital Flows Before the Crisis Describe the Patterns of Financial Integration Before the Crisis Identify the Drivers Financial Integration Before the Crisis International Capital Flows During the Crisis Identify the Heterogeneities of Capital Flows Analyze the Determinants of Capital Flows International Capital Flows After the Crisis Evaluate the Prospects of International Financial Integration Capital Inflows/GDP (1975-2009, Annual) Capital Inflows/GDP (2000-2009, Quarterly) Motivation What lies behind the retrenchment? Did flows fall evenly across countries and categories of flows? Can we link the intensity of the retrenchment to financial and macroeconomic characteristics? Is the trend for rising financial globalization over? The Time of Financial Globalization (1990-2007) Portfolio Growth Financial Deepening Portfolio Re-allocation Active portfolio management favoring foreign assets Reductions in Formal Restrictions against Capital Decreasing trend in Chin-Ito index and Schindler’s index International Banking Operations Cross-border Lending Lending through Affiliates Financial Deepening (Financial Assets/GDP) World Map Before the Retrenchment Portfolio Re-allocation Restrictions to Capital Flows Schindler (2009) Capital Account Liberalization (Chinn and Ito, 2008) World Map Before the Retrenchment The Time of Great Retrenchment (2007-2010) Stylized Facts The Great Retrenchment Financial Regression Regression in financial deepening Rising Home Bias Active portfolio re-allocation away from foreign assets Heterogeneous Patterns Across Time/Countries/Types of Flows Decreasing cross-border lending Effective Policy Response to the Retrenchment A Picture of Rising Home Bias Way Too Many Heterogeneities! Across Time Pre-Crisis Period (2006q1-2007q2) Initial Stage of the Crisis (August 2007 – 2008q3) Collapse Stage of the Crisis (2008q4-2009q1) Recovery Stage of the Crisis (2009q2-2009q4) Across Countries Advanced economies vs. Emerging Economies Across Types of Flows Debt Flows: Bonds and Bank Flows Equity Flows: FDI and Portfolio Investment Reserves and Net Derivative Flows Developed Economies Gross Outflows and Inflows (USD, bn) Emerging Economies Gross Outflows and Inflows (USD, bn) More Pictures of Heterogeneity More Pictures of Heterogeneity More Pictures of Heterogeneity More Pictures of Heterogeneity More Pictures of Heterogeneity More Pictures of Heterogeneity Policy Responses Emerging Economies Foreign exchange reserves Advanced Economies Currency Swaps by Central Banks US 50 billion in 2008q3 US 500 billion in 2008q4 Multilateral Institutions IMF and EU Causes and Consequences of Crises Incidence of Crisis Financial Excess & Macroeconomic Imbalances International Financial Linkages Incidence of Sudden Stops Specifics and Degree of Financial Integration Currency and Maturity Mismatch Domestic macroeconomic conditions The ultimate recipe for sudden stop…. Drivers of the Capital Flows A Risk Perspective The effect of “risk shock” on cross-border capital flows An increase in financial risk A decrease in the risk tolerance of investors Regress Global Capital Flows on VIX Data: 1996q1-2009q4 Control for world growth and trade openness A statistically significant association between the two Let’s dig deeper into this risk perspective… Risk Shock Transmission Channels Channel 1: International Trade Sharp decline in exports/imports Sharp decline in commodity prices/export revenues Channel 2: International Financial Exposure Sell-off liquid assets a la bank runs Channel 3: Macroeconomic conditions Weak fundamentals for pre-/during/post-crisis periods Channel 4: Future Economic Prospects Revisions in economic prospects Testing different channels Dependent variable Change in capital flows relative to the pre-crisis situation Compute for each country Compute for collapse and recovery stages Compute for inflows as well as outflows Scale by country GDP and/or external positions in 2005 Exclude official capital flows Testing different channels Channel 1:International Trade Regressors Trade flows (X+M) Openness to trade (X+M)/GDP Share of manufacturing in GDP Reliance on primary commodities Growth in Trading Partner Channel 2: International Financial Exposure Regressors Size of external balance sheet (Debt vs. Equity) Net Reliance on Foreign Funds (solvency risk) Foreign Reserves Testing for different channels Channel 3: Macroeconomic Regressors GDP per capita GDP growth (2005-2007) Private credit/GDP Channel 4: Future Economic Prospects Regressors Revisions in Growth Revisions in Fiscal Balance/GDP Revisions in Public Debt/GDP Stylized Facts Sudden Stop Countries Reduction in Capital inflows over 30% of GDP larger Larger declines in capital inflows in countries with larger gross external positions in debt instruments banks that have more negative external position higher GDP per capita weaker growth and public finance prospects more openness to trade trading partners who suffered a decline in capital inflows Econometric Analysis Collapse Stage of the Crisis Larger reductions in capital inflows for countries with larger gross bank assets and liabilities in debt instruments faster pre-crisis growth and higher GDP per capita. slower growth in trading partners during the crisis Larger reductions in capital outflows for countries with Larger pre-crisis cross-border debt positions Net liabilities in debt instruments Larger reductions in banking inflows and net banking flows Econometric Analysis Recovery Stage of the Crisis Larger decline in capital inflows in countries with Larger gross debt positions Trading patners who experience slower growth Larger pre-crisis credit growth (CEE) Larger declines in capital outflows in countries with Larger gross debt positions Oil exports dominating their trade Evaluating the Results International financial exposure matters Holdings of large debt and bank positions Dependence on external finance International trade matters Macroeconomic conditions of trading partners Declining export revenues in commodity exporters Macroeconomic conditions and prospects matters GDP per capita Faster pre-crisis growth Higher pre-crisis credit-growth Conclusions What lies behind the retrenchment? Contraction in banking flows due to global deleveraging and declining international banking activity Did flows fall evenly across countries/categories of flows? Advanced economies and bank flows are affected much more What drives the intensity of the retrenchment? Financial and macroeconomic characteristics Future of International Financial Integration Financial deepening unlikely to recover soon… Weak fiscal prospects for advanced economies Concerns over financial excess by emerging markets No more declining home bias in advanced economies Cross-border banking activities unlikely to recover soon Financial integration in EU has run its course