Joining the Club? Procyclicality of Private Capital Inflows in Low Income Developing Countries

Abstract

Using a newly developed dataset this paper examines the cyclicality of private capital inflows to low-income developing countries (LIDCs) over the period 1990-2012. The empirical analysis shows that capital inflows to LIDCs are procyclical, yet considerably less procyclical than flows to more advanced economies. The analysis also suggests that flows to LIDCs are more persistent than flows to emerging markets (EMs). There is also evidence that changes in risk aversion are a significant correlate of private capital inflows with the expected sign, but LIDCs seem to be less sensitive to changes in global risk aversion than EMs. A host of robustness checks to alternative estimation methods, samples, and control variables confirm the baseline results. In terms of policy implications, these findings suggest that private capital inflows are likely to become more procyclical as LIDCs move along the development path, which could in turn raise several associated policy challenges, not the least concerning the reform of traditional monetary policy frameworks.

Non-FDI Capital Inflows in Low-Income Developing Countries: Catching the Wave?

“…This is in line with the findings of Lane (2015) for net financial flows and debt inflows during the crisis.29 Araujo et al (2015) analyzes the relationship between capital inflows and the economic cycle of the receiver country. One of the main findings is that capital flows to LIDCs are more persistent than to EMs and less related to the cycle, which is in line with the pattern observed here.…”

International Financial Flows in Low‐Income Countries

“…22 In terms of international financial flow variables, we initially examine aidadjusted net financial inflows. However, we also examine the individual behaviour of the subcomponents of gross financial flows that are most relevant for the low-income group: adjusted debt inflows, FDI inflows and official reserve 20 The within-country time-series dimension is studied by Araujo et al (2014b). See also the earlier contribution by Kaminsky et al (2005).…”

“…The within‐country time‐series dimension is studied by Araujo et al . (). See also the earlier contribution by Kaminsky et al .…”

“…Araujo et al . (,b) provide complementary studies that focus on the time‐series variation in international capital flows for low‐income countries.…”

Financial Globalization and Inequality

“…36 But the pro-cyclicality of capital flows differs across countries and borrowers. Capital inflows into developing countries are less pro-cyclical than those into more developed countries (Araujo et al 2015b). This could be the result of the less pronounced financial accelerator in developing countries, given smaller banking systems and a less pronounced leverage cycle (Geanakoplos 2009).…”