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The growing importance of financial spillovers from emerging market economies

International financial spillovers from emerging markets have increased significantly over the last 20 years. This column argues that growing financial integration of emerging economies is more important than their rising share in global trade in driving this trend, that firms with lower liquidity and higher borrowing are more subject to spillovers, and that mutual funds are amplifying spillover effects. Policymakers in developed economies should pay increased attention to future spillovers from emerging markets, particularly from China.

Financial spillovers occur when fluctuations in the price of an asset trigger changes in the prices of other assets. They can reflect both desirable effects (incorporation of news into prices) and less desirable ones (transmission of excess volatility due to financial frictions). Recently, financial market volatility in emerging markets seems to have been widely transmitted to asset prices in other countries, even when there is not a crisis or near-crisis. For example, the suspension of trading after the drop of the Chinese stock market on 6 January 2016 affected major asset markets all over the world. The IMF’s Global Financial Stability Report systematically examines the evolution and extent of financial market spillovers from emerging markets, and the underlying drivers of their growth (IMF 2016).

To measure spillovers we estimated a vector autoregression model (VAR) of daily asset returns incorporating global control variables following the approach of Diebold and Yilmaz (2014).

The results indicate that over the last 20 years, spillovers of emerging market asset price shocks to equity prices and exchange rates in advanced and emerging market economies have risen substantially, and now explain over a third of the return variation in these countries (Figure 1). Since the start of the Global Crisis, average equity market spillovers from emerging market economies have increased by 28%. The growth in spillovers to other emerging economies is larger than to advanced economies. Financial spillovers from major emerging markets such as Brazil, China, India, and South Africa have grown at a much faster pace.

Figure 1 Spillover indices for various asset classes and components
(percentage points)

What matters more: trade or financial integration?

Since the mid-1990s, the share of emerging markets in global economic activity has risen dramatically, as has their integration into global trade and finance. We find that financial integration is a more important driver than trade behind the trend increase in emerging economies’ financial spillovers (Figure 2). While trade linkages explain no more than 10-20% of spillovers in equities and foreign exchange markets, financial linkages and other measures of financial integration explain close to 30%.

Figure 2 Contribution to variation in emerging market spillovers, 1996-2014
(percentage points)

Moreover, financial spillovers to global equity market have consistently been larger in financially integrated emerging markets like Brazil, Mexico and South Africa than in economically larger, but financially more segmented, emerging economies like China and India (Figure 3).

Figure 3 Average equity spillovers from selected emerging markets
(percentage points)

China's financial segmentation means that asset price shocks in China do not yet systematically have a large impact abroad, but news about China’s economy already has a growing effect on foreign equity markets. The impact of Chinese economic surprises on global equity returns, as measured by realised growth in industrial production compared to expectations, is significant and has more than quadrupled over the last 10 years (Figure 4).

Figure 4 Spillover of growth surprises in China
(percentage points)

These findings suggest that, as China becomes more financially integrated with the rest of the world, its impact on global financial markets will become more important.

Corporate financials and mutual fund flows amplify financial spillovers

We found that sectors that are more dependent on external finance are more susceptible to spillovers from emerging markets, as are firms with lower liquidity and higher leverage ratios. Corporate borrowing appears to be playing a growing role in spillover transmission.

Also the significant growth in intermediation of international capital flows through mutual funds since the global financial crisis (Figure 5) is affecting the nature and size of financial spillovers from emerging market economies. Global investors, such as mutual funds, can transmit financial shocks across countries if, to rebalance their portfolios, they sell or buy assets in country B in response to price movements in country A. This channel has become more important in recent years, in line with the increase in asset allocation to these countries.

Figure 5 Advanced economies’ financial exposures to emerging markets

Implications for policymakers

Our findings clearly emphasise the importance of taking into account economic and policy developments in emerging market economies when policymakers assess their macrofinancial conditions. This also includes the need to pay increased attention to possible financial spillbacks from emerging markets stemming from advanced economies’ policy actions. The results also underscore the importance of enhanced international macroeconomic and macroprudential policy cooperation.

Therefore  policymakers need more comprehensive and granular data on capital flows and their intermediation by banks, large institutional investors, and mutual funds, so they can understand and monitor shock triggers and transmission channels better.

As China’s role in the global financial system grows, clear and timely communication of its policy decisions, transparency about its policy goals and the strategies consistent with achieving them will become more important to ensure against volatile market reactions.

Finally, given evidence of the importance of mutual funds and corporate leverage in amplifying spillovers and financial market volatility, policymakers should identify and implement macroprudential measures targeted at attenuating systemic risk from these sources.

Authors’ note: The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.


Diebold, F.X. and Yılmaz, K. (2014) ‘On the network topology of variance decompositions: Measuring the connectedness of financial firms’, Journal of Econometrics, 182(1), pp. 119–134.

World Bank (2016), Potent Policies for a Successful Normalization, Global Financial Stability Report, April 2016

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