Chapter

Appendix II. Behavior of Different Types of Financial Flow

Author(s):
Paolo Mauro, Torbjorn Becker, Jonathan Ostry, Romain Ranciere, and Olivier Jeanne
Published Date:
April 2007
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Data Description

This appendix analyzes data on the financial account and six of its components—foreign direct investment (FDI); portfolio debt investment (PDI); portfolio equity investment (PEI); official flows (which include flows by government and monetary authorities); bank flows; and other investment—for 1970–2003. All flows are net, taken from IMF’s Balance of Payments Statistics (BOPS) database, and reported in current U.S. dollars. Throughout the analysis that follows, the flows are normalized by GDP in current U.S. dollars (taken primarily from the World Bank’s World Development Indicators database and supplemented with data from the IMF’s World Economic Outlook database). All data were checked for quality, with outliers and unusable observations dropped. The full sample includes 153 countries (Table A2.1), though only a subset of countries have reliable data for a sufficiently long time series.

Table A2.1.Economies, by Group
AdvancedEmergingDeveloping
AustraliaArgentinaAlbaniaKuwait
AustriaBrazilAlgeriaKyrgyz Republic
Belgium-LuxembourgBulgariaAngolaLao People’s Dem. Rep.
CanadaChileAntigua and BarbudaLatvia
CyprusChinaArmeniaLesotho
DenmarkColombiaArubaLithuania
FinlandCôte d’IvoireAzerbaijanMacedonia, former Yugoslav Republic of
FranceCzech RepublicBahamas, TheMadagascar
GermanyDominican RepublicBahrainMalawi
GreeceEcuadorBangladeshMaldives
Hong Kong SAREgyptBarbadosMali
IcelandEl SalvadorBelarusMalta
IrelandHungaryBelizeMauritania
IsraelIndiaBeninMauritius
ItalyIndonesiaBoliviaMoldova
JapanJordanBotswanaMongolia
NetherlandsKorea, Republic ofBurundiMozambique
New ZealandMalaysiaCambodiaNamibia
NorwayMexicoCameroonNepal
PortugalMoroccoCape VerdeNetherlands Antilles
SingaporeNigeriaCentral African RepublicNicaragua
SpainOmanChadNiger
SwedenPakistanComorosPapua New Guinea
SwitzerlandPanamaCongo, Republic ofParaguay
United KingdomPeruCosta RicaRomania
United StatesPhilippinesCroatiaRwanda
PolandDominicaSão Tomé and Príncipe
RussiaEstoniaSenegal
Saudi ArabiaFijiSeychelles
Slovak RepublicGabonSierra Leone
South AfricaGambia, TheSlovenia
Sri LankaGeorgiaSolomon Islands
ThailandGhanaSudan
TunisiaGrenadaSwaziland
TurkeyGuatemalaSyrian Arab Republic
UkraineGuineaTanzania
UruguayGuyanaTogo
Venezuela, RepúblicaHaitiTonga
Bolivariana deHondurasTrinidad and Tobago
ZimbabweJamaicaUganda
KazakhstanVanuatu
KenyaVietnam
Notes: Advanced countries are defined as in the IMF’s World Economic Outlook database, except for the Republic of Korea, which for the purpose of the empirical analysis is classified as emerging rather than advanced to capture the experience of its 1997–98 crisis; the remaining countries are considered emerging if they are included in either the (stock market-based) International Finance Corporation’s Major Index (2005) or JPMorgan’s EMBI Global Index (2005) (which includes countries that issue bonds on international markets); the remaining countries are classified as developing.
Notes: Advanced countries are defined as in the IMF’s World Economic Outlook database, except for the Republic of Korea, which for the purpose of the empirical analysis is classified as emerging rather than advanced to capture the experience of its 1997–98 crisis; the remaining countries are considered emerging if they are included in either the (stock market-based) International Finance Corporation’s Major Index (2005) or JPMorgan’s EMBI Global Index (2005) (which includes countries that issue bonds on international markets); the remaining countries are classified as developing.

Summary Statistics

Average Net Flows

Considering the average financial account balance for each country during 1970–2003, and taking the cross-country median within each country group over the period, it is perhaps not surprising that developing countries had the largest net inflows, followed by emerging markets and then advanced countries (Table A2.2). This pattern is even more pronounced for FDI, which has not been a net source of finance for advanced countries. By contrast, emerging markets received net FDI inflows averaging about 1.3 percentage points of GDP yearly, and developing countries received inflows averaging about 2.3 percentage points. The results (not reported here for the sake of brevity) are similar when considering 1990–2003 only, suggesting that the relative importance of FDI as a source of net inflows for emerging and developing countries has not diminished over the last decade. All the main results highlighted in this appendix hold for the subperiod 1990–2003.

Table A2.2.Financial Account and Its Subcomponents, 1970–2003
Financial AccountFDIPDIPEIOfficial FlowsBank FlowsOther Investment
Average of capital flows
Advanced1.30.10.3–0.20.00.40.1
Emerging2.11.30.20.20.10.00.0
Developing3.22.2–0.10.00.9–0.10.6
Volatility (standard deviation)
Advanced2.91.42.11.60.82.31.9
Emerging4.41.51.20.61.91.32.0
Developing4.62.10.90.32.21.11.9
Volatility (coefficient of variation)
Advanced1.32.22.33.32.75.05.6
Emerging1.81.03.22.03.27.23.6
Developing1.30.93.12.12.43.62.2
Persistence (AR1 pooled)
Advanced0.70.30.40.40.40.40.4
Emerging0.50.50.00.40.40.10.5
Developing0.50.40.50.40.50.20.4
Correlation with domestic growth
Advanced0.1–0.0–0.10.0–0.00.2–0.0
Emerging0.20.1–0.00.1–0.00.20.2
Developing0.20.2–0.10.0–0.00.00.1
Correlation with G-7 growth
Advanced0.00.0–0.00.0–0.00.0–0.0
Emerging–0.1–0.1–0.10.1–0.0–0.1–0.1
Developing0.00.00.00.20.0–0.0–0.0
Correlation with U.S. one-year treasury bill
Advanced0.20.10.10.10.00.00.2
Emerging0.1–0.3–0.10.10.30.00.1
Developing0.1–0.20.00.20.20.00.0
First principal component
Advanced0.30.40.20.40.20.30.2
Emerging0.20.40.30.30.30.20.2
Developing0.30.30.40.40.30.20.2
Sources: IMF, Balance of Payments Statistics database (all financial flows) and World Economic Outlook database, and World Bank, World Development Indicators database (GDP). See the text for details.Notes: FDI denotes foreign direct investment; PDI denoes portfolio direct investment; PEI denotes portfolio equity investment; and G-7 denotes the Group of Seven industrial countires. The data reported are medians across countries within each group. All flows are net and normalized by total GDP for each year. The coefficient of variation of a series is the standard deviation divided by the mean: it is computed for each country separately, and this table reports the median across countries. The measure of persistence is the slope coefficient in a regression of a variable on its lagged value. The first principal component is a measure of comovement across countries within each group: it is the share of total variance in a set of series that can be explained by a common component.
Sources: IMF, Balance of Payments Statistics database (all financial flows) and World Economic Outlook database, and World Bank, World Development Indicators database (GDP). See the text for details.Notes: FDI denotes foreign direct investment; PDI denoes portfolio direct investment; PEI denotes portfolio equity investment; and G-7 denotes the Group of Seven industrial countires. The data reported are medians across countries within each group. All flows are net and normalized by total GDP for each year. The coefficient of variation of a series is the standard deviation divided by the mean: it is computed for each country separately, and this table reports the median across countries. The measure of persistence is the slope coefficient in a regression of a variable on its lagged value. The first principal component is a measure of comovement across countries within each group: it is the share of total variance in a set of series that can be explained by a common component.

Volatility

Using the standard deviation of net flows as a measure of volatility, financial flows are found to be substantially more volatile in emerging and developing countries. The cross-country median of the standard deviation of the financial account is about 2.9 percentage points of GDP for advanced countries, and about 4.5 percentage points for emerging markets and developing countries, during 1970–2003. This corroborates findings by previous studies (Broner and Rigobon, 2006; Prasad and others, 2003). The ranking by standard deviation is the same for FDI and official flows. However, PDI and PEI are, respectively, two and five times more volatile in advanced countries than in developing countries with emerging market countries somewhere in between. Comparing across flows, in advanced countries, FDI is the least volatile type of flow, with the exception of official flows. For emerging markets, in contrast, FDI is more volatile than PDI or PEI. For developing countries, official flows are the most volatile, followed closely by FDI. Comparing across flows, it is important to take into account the size of the various types of flow by using the coefficient of variation. On that basis, FDI is the most stable of all flows to emerging and developing countries, with a coefficient of variation near 1, compared with 2–3 for PDI and PEI, or 5–7 for official flows, bank flows, and other investment (see also Wei, 2001).30

Persistence

Regarding the persistence properties of financial flows, autoregressive coefficients were calculated on pooled data for each relevant country group, using a fixed-effects regression with the first lag on the right-hand side.31 The financial account exhibits similar autoregressive properties for emerging markets and developing countries, with the AR (1) coefficient estimated at around 0.5. The financial account is more persistent in advanced countries, with an autoregressive coefficient of 0.7. Interestingly, for advanced countries, the AR (1) coefficient is also quite similar across flows, ranging between 0.3 and 0.4. For emerging market countries, the most persistent type of flow is FDI, with an AR (1) coefficient of 0.5, and the least persistent is PDI, with a coefficient of virtually zero. For developing countries, FDI has an AR (1) coefficient of 0.35, with the coefficients for PDI, PEI, and other flows lying between 0.2 and 0.5. These estimates are close to those in Obstfeld and Taylor (2004) and Broner and Rigobon (2006), though the latter argue that total financial flows are more persistent in emerging and developing countries.

Correlations

Table A2.2 also reports correlations of financial flows with domestic GDP growth, Group of Seven (G-7) growth, and the U.S. interest rate (the one-year treasury-bill rate). Correlations between financial flows and these variables turn out to be quite low, except as noted herein. Financial flows are mildly procyclical in emerging market and developing countries. In developing countries, FDI is the financial flow most correlated with growth, though the correlation is still low at 0.2. For emerging markets, official flows and other investment are the most procyclical. A positive correlation between financial flows and growth has also been reported by Albuquerque, Loayza, and Servén (2005). The only type of flow that exhibits significant correlation with G-7 growth is PEI for emerging markets (0.1) and developing countries (0.2). The U.S. interest rate is correlated with the inflows into advanced countries, with a coefficient of 0.2, and is virtually uncorrelated with the financial accounts of emerging and developing countries. FDI is negatively correlated with the U.S. interest rate in both emerging markets (correlation of –0.3) and developing countries (correlation of–0.16). Other studies, such as Fernandez-Arias (1996), find, using higher-frequency data for shorter time periods, that foreign interest rates do matter for financial flows. The present exercise shows that at a yearly frequency, foreign interest rates matter less, a result also found in Broner and Rigobon (2006). Different kinds of financial flow are also either uncorrelated or weakly negatively correlated with each other, a pattern that holds for all country groups—this finding is consistent with Claessens, Dooley, and Warner (1995). This may suggest that different types of flows may be substitutes rather than complements or that reclassifications are frequent.

Principal Components Analysis

The interrelationships of financial flows across regions and income groups were analyzed using principal components analysis, focusing on the share of variation explained by the first principal component for each country group or region. For total financial flows, the patterns across developed and developing countries are quite similar, with the first principal component accounting for 25–30 percent of the variation in financial flows. Comparing across flows, FDI and PEI display the largest common component for advanced countries; for emerging markets, FDI has the largest common component; for developing countries, FDI, PDI, and PEI are roughly similar in this respect. Overall, however, there are no pronounced differences across types of flows in the relative importance of the common component. Although Calvo, Leiderman, and Reinhart (1993) find that the first principal component can account for 60–80 percent of variation in financial flows, their use of monthly data for a shorter time span (four years) on a Latin American sample may explain the difference in results.

Note: This appendix was prepared by Andrei Levchenko and Paolo Mauro.
30One possible problem with calculating the coefficient of variation is that average net inflows are often quite close to zero. To check robustness, two alternative measures of relative volatility were calculated. First, the coefficient of variation was calculated for gross financial inflows. Second, the standard deviation of net flows was normalized by average gross flows. The conclusions reached were virtually the same.
31Alternatively, AR (1) regressions were estimated for each country separately. The disadvantage of the pooled approach is that it constrains the AR (1) coefficient to be the same for each country group. The advantage is that it allows for inclusion of countries for which only a short time series is available. Results were similar to those reported here.

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