ContentsContents

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/GDPCapital Inflows/GDP(1975-2009, Annual)(1975-2009, Annual)

Capital Inflows/GDPCapital Inflows/GDP(2000-2009, Quarterly)(2000-2009, Quarterly)

MotivationMotivation

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 The Time of Financial Globalization Globalization

(1990-2007)(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 Deepening (Financial Assets/GDP)(Financial Assets/GDP)

World MapWorld MapBefore the RetrenchmentBefore the Retrenchment

Portfolio Re-allocationPortfolio Re-allocation

Restrictions to Capital FlowsRestrictions to Capital FlowsSchindler (2009)Schindler (2009)

Capital Account LiberalizationCapital Account Liberalization(Chinn and Ito, 2008)(Chinn and Ito, 2008)

World Map World Map Before the RetrenchmentBefore the Retrenchment

The Time of Great The Time of Great RetrenchmentRetrenchment

(2007-2010)(2007-2010)

Stylized FactsStylized FactsThe Great RetrenchmentThe 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 A Picture of Rising Home BiasBias

Way Too Many Way Too Many Heterogeneities!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 EconomiesDeveloped Economies Gross Outflows and Inflows (USD, bn) Gross Outflows and Inflows (USD, bn)

Emerging EconomiesEmerging EconomiesGross Outflows and Inflows (USD, bn)Gross Outflows and Inflows (USD, bn)

More Pictures of More Pictures of HeterogeneityHeterogeneity

More Pictures of More Pictures of HeterogeneityHeterogeneity

More Pictures of More Pictures of HeterogeneityHeterogeneity

More Pictures of More Pictures of HeterogeneityHeterogeneity

More Pictures of More Pictures of HeterogeneityHeterogeneity

More Pictures of More Pictures of HeterogeneityHeterogeneity

Policy ResponsesPolicy 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 Causes and Consequences of CrisesCrises

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 FlowsDrivers of the Capital Flows A Risk PerspectiveA 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 Risk Shock Transmission ChannelsChannels

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 Testing different channelschannels

Dependent variableChange in capital flows relative to the pre-crisis situation

Compute for each countryCompute for collapse and recovery stagesCompute for inflows as well as outflowsScale by country GDP and/or external positions in 2005Exclude official capital flows

Testing different Testing different channelschannels

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 channelsTesting 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 FactsStylized 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 AnalysisEconometric 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 AnalysisEconometric 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 ResultsEvaluating 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

ConclusionsConclusions

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 Future of International Financial IntegrationFinancial 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