New Delhi (ABC Live): Portfolio Inflows Eclipsing Banking Inflows : The collapse in international capital inflows during the global financial crisis has proven to be very persistent. Capital inflows fell sharply during the crisis, and have only partially recovered in recent years to about one third of their pre-crisis (2003-07) global GDP average.
This phenomenon and the heterogeneity behind the aggregate numbers are receiving increasing attention in the literature (e.g., Bluedorn et al 2013, Bussière et al 2016, and Advjiev et al 2017).
Most of the decline in capital inflows has been experienced in Advanced Economies (AEs) rather than in Emerging Markets (EMs). And, in terms of the type of capital flows, most of the decline has taken place in portfolio inflows (equity and debt securities) and ‘other investments’ (which are often related to the lending of activity of international banks), while FDI inflows have proved to be more resilient .
Despite such overall decrease in both portfolio inflows and ‘other investments’, their respective falls have not been similar, and there has been a substantial change in the composition of nonFDI related inflows.
At the aggregate worldwide level, this is especially the case with portfolio inflows, which went from representing about half of total non-FDI inflows during the pre-crisis period (2003-07) to representing above 80 percent during 2008-16.
Such increase in portfolio inflows was met by a decline of other components, particularly, the ‘other investment’ category whose share dropped to below 20 percent after the crisis. Furthermore, the breakdown by borrower sectors also displays a high degree of heterogeneity in the patterns of capital flows.
While the share of non-FDI inflows to corporates slightly declined to below half during the crisis period (2008-12) and then jumped to about three quarters during the post crisis (2013- 16), non-FDI gross inflows to banks represent about 15 percent during the post-crisis period (about half of their pre-crisis share).
At the same time, the share to sovereign borrowers increased from negative inflows during the pre-crisis, to about half of inflows during the crisis, and 10 percent during the post crisis period.
In this context, three questions arise to understand the nature of the increased share of portfolio flows in non-FDI capital inflows:
Were any borrowers substituting international bank-related inflows with either portfolio debt or equity inflows during the period 2003-16? If so, are these relationships driven by negative or positive gross inflows? Was this a common phenomenon across countries and type of borrowers (banks, corporates, and sovereigns)?
Two recent studies highlight the importance of using disaggregate gross capital inflows data and show that the analysis of aggregate inflows is not necessarily indicative of the underlying relationships of disaggregate capital flows. Galstyan et al (2016), using IMF Coordinated Portfolio Investment Survey (CPIS) data, examine separately portfolio debt and equity, distinguishing by the sectoral identity of the holder of the security, and find that a full understanding of cross-border portfolio positions requires granular-level analysis.
More related to our study, Advjiev et al (2017), using mostly Balance of Payments (BOP) data, analyze the borrower type decomposition of the evolution of two type of instruments: portfolio inflows and other investment inflows.
They analyze 85 countries (25 advanced, 34 emerging, and 26 developing economies) during 1996-2014, and highlight that empirical regularities that characterize aggregate inflows do not hold for all borrowing sectors, either with respect to their evolution or their sensitivity to proxies to the global financial cycle, such as VIX variables.
In this context, our paper adds value on two aspects. First, we continue the direction of Advjiev et al (2017) and break down gross capital inflows further by type of instruments, distinguishing between debt securities and equity in the case of portfolio inflows, as well as loans (made by international banks) and the remainder (mostly in the form of currency and deposits, trade credit and advances, and other accounts receivable/payable, etc.; which we label other investment miscellaneous) in the case of ‘other investments’.
Furthermore, for each of these categories, we identify how much of the flows by each instrument was allocated to borrowers’ corporate, bank, and sovereign sectors. As a result, we compile a novel dataset with those wider instrument breakdowns by each of the 3 types of borrowers for 43 countries . We are the first, to our knowledge, to take advantage of these detailed BOP data breakdown.
Our additional breakdowns by type of instrument offer merits in the following sense. By distinguishing portfolio debt and equity, our work makes a closer connection to the finance theory of capital structure.
There are clear differences between borrowing through portfolio debt and equity as shown in the rich literature on optimal capital structures, where companies trade off benefits (e.g. tax benefits) and costs (e.g., financial distress costs; agency costs) of debt financing (see Modigliani and Miller, 1963; Jensen and Meckling, 1976, Tirole, 2006).
Similarly, separating loans from other investment clarifies the object of interest. Loans in the BOP data usually represent the largest sub-category of the general ‘other investment’ category and they are directly linked by definition to international banks’ activity.
As stated in the BOP data compilation methodology, “loans” correspond to cross-border loans from deposit-taking institutions to non-affiliates. The evolution of other investment miscellaneous is much more volatile and international banks are not necessarily the non-resident lenders behind these inflows.
Second, and more importantly, we focus on the patterns between the type of flows in order to highlight any complementarity and substitution patterns across the three types of borrowers (banks, corporates, and sovereigns), while also considering the global financial cycle.
We label as ‘substitution’ cases where two types of capital inflows are moving in opposite directions within a given quarter (e.g. an increase in portfolio debt inflows happens together with a decline in other investment loans), and as ‘complementary’ when two types of inflows are moving in same direction within a given quarter.
Although our results should be interpreted with caution, given the difficulties of effectively controlling for demand and supply factors, the sign of the correlations are informative with regard to the relative evolution among the different types of capital inflows. For example, a complementarity relationship might reflect that borrowers are able to borrow more across different type of inflows because non-residents increase their supply of funds due to changes in the global financial cycle.
We capture the potential supply influence of the global financial cycle using common factors that allow us to tease out in an innovative way, whether or not substitution or complementary patterns are associated with global co-movements or more idiosyncratic factors.
More specifically, using the dynamic common factor technique introduced by Kose et al (2003), we compute the comovement across countries for each type of instrument (portfolio debt, portfolio equity, other investment loans, and other investment miscellaneous) as well as sub-factors for each of the borrower types.
We then decompose each capital inflow series into two components: (i) predicted values driven by the global factor and borrower-type sub-factors, and (ii) a residual component reflecting country-specific factors. 7 Our key findings can be summarized in three main points: First, while some document that at the aggregate level, there was no substitution between types of gross capital flows (e.g., as explicitly highlighted in Bussière et al. 2016), we find evidence of some degree of substitution in the case of AE corporates during 2008-16; as well as in the case of both AE and EM sovereign throughout the sample period when performing a more detailed analysis.
These substitution relationships were especially strong and significant between the two larger instruments, portfolio debt and loans.
The opposite seems to be true in the case of EMs’ corporates, which show a complementary relationship between portfolio debt inflows and international bank loans.
Second, in most cases, statistically significant complementarity or substitution relationships were present when there was an increase in non-residents’ debt securities inflows. The complementary relationships experienced by EM corporates since the crisis, and AE corporates before the crisis were driven by an increase in their borrowing through both debt securities and loans. The substitution relationship in the case of AE and EM sovereigns as well as AE corporates (since the crisis) reflects an increase in borrowing through debt securities, which replaced international bank loans.
Only in the case of EM banks did a complementarity relationship during the peak of the crisis seem to have been driven by an outflow of both debt securities and loans.
Third, the substitution/complementarity relationships seem to be explained more by idiosyncratic-country factors than a general factor common across countries.
However, this also depends on the type of borrower sector and instrument type. While idiosyncratic components seem to play a larger role in explaining the substitution between loans and debt inflows to AE and EM sovereigns, both common and idiosyncratic factors drive the substitution (complementarity) between loans and debt inflows to AE corporates (EM corporates) since the crisis.
In this context, our results complement and shed light onto two areas of the policy debate on capital flows. First, the different type of relationship between debt security and loans for EM and AE corporate borrowers during the post-crisis period signal different realities. Our results for EMs put the literature on the new wave of debt financing (Shin, 2013, Lo Duca et al 2014, Avdjiev et al., 2016) in a broader context, highlighting that the documented large increase in bond borrowing (domestically or from abroad) from non-residents did not seem to trigger a general substitution in EM’s private sectors.
At the same time, our results for AEs are consistent with the strong evidence of domestic substitution between bank loans and bond financing highlighted by Becker and Ivashina (2014) using US firm level data during periods of tight lending standards, depressed aggregate lending, and poor bank performance. We find that this US behavior was also present in other AEs, where corporates substituted cross-border loans for debt-securities since the crisis.
This pattern was not present before the crisis. AEs’ corporates increased both their loans and debt-security borrowing during the pre-crisis period when non-residents largely increased their exposure to AEs, funding a large increase in external private sector debt which was one of the main causes of the crisis (see Reinhart and Rogoff, 2009). Finally, our finding that the global financial cycle does not alone explain the complementarity/substitution relationships also contributes to the debate on the importance of the global financial cycle on capital flows.
Our findings coincide with Advjiev et al. (2017)’s take away that empirical regularities that characterize aggregate inflows do not hold for all borrowing sectors, either with respect to their evolution or their sensitivity to the global financial cycle. We confirm the need to distinguish as much as possible between sovereign and non-sovereign capital inflows when analyzing their patterns and drivers.
Furthermore, our results do not favor a view where gross cross-border flows are clearly moving in tandem across countries regardless of borrower characteristics (e.g., exchange rate regimes as in Passari and Rey 2015). Our results are more in line with Cerutti, Claessens, and Rose (2017), which finds little systematic evidence that the global financial cycle explains as much of the variation in capital flows. In addition, our findings that part of the substitution between loans and debt inflows into AE corporates was driven by common factors could help in explaining Barrot and Serven (2017) finding of larger synchronization in aggregate gross capital inflows to AEs than in those to EMs.
Their aggregation across types of capital flows (and borrowers) could increase the cross-country synchronicity in case of substitution relationships between type of capital flows, especially if those are driven by a common factor.
The rest of the paper is structured as follows. Section II describes the data set used and presents stylized facts about some key patterns of international capital flows dynamics using the new data set. Section III presents empirical results in cross-country panel framework to assess the relationship between different types of capital flows.
Section IV analyzes which direction of the non-resident flows (inflows or outflows) play a larger role. Section V studies the significance of common dynamics across countries as a determinant of capital flows patterns. Finally, in Section VI, we summarize and conclude.
Source : IMF Paper on Portfolio Inflows Eclipsing Banking Inflows
