VoxEU Column International Finance

What drives surges in capital flows?

In the immediate aftermath of the global financial crisis, there was a rapid surge in net capital flows to emerging market economies. The subsequent decline in recent months has been even more rapid. Looking at data on 56 emerging market economies between 1980 and 2009, this column examines the causes of the mercurial movement of capital flows across countries and outlines the implications for policy.

After collapsing during the 2008 global financial crisis, capital flows to emerging market economies surged in late 2009 and 2010, raising both macroeconomic challenges and financial-stability concerns. Several commentators have argued that country-specific determinants – or ‘pull’ factors – in emerging markets were the dominant factor in accounting for the post-crisis surge (eg Fratzscher 2011). By the second half of 2011, however, amid a worsening global economic outlook, capital flows receded rapidly, eliminating much of the cumulated currency gains, and leaving emerging markets grappling with sharply depreciating currencies in their wake. While such volatility is nothing new – historically, flows have been episodic (Figure 1) – it rekindles questions about the nature of capital flows to emerging markets.

Figure 1. Net Capital Flows to emerging markets, 1980–2009 (in USD billions)

Source: IMF’s IFS database

In a recent paper (Ghosh et al 2012), we examine what drives surges of capital to emerging markets, and what determines the allocation of capital across countries during these surge episodes. The literature on this subject has a long tradition of trying to identify global ‘push’ and domestic ‘pull’ factors in determining normal capital flows to recipient economies (for example, Chuhan et al 1993, Taylor and Sarno 1997). Some recent studies (Reinhart and Reinhart 2008, and Cardarelli et al 2009) specifically focus on exceptionally large cross-border flows, but mostly restrict the analysis to identifying some stylised facts surrounding these episodes. Forbes and Warnock (2011) use gross capital flows to differentiate between episodes of surges, stops, flight, and retrenchment. They find that global factors, in particular risk aversion and global growth, have a significant effect on the occurrence of surges, but that advanced economy interest rates are unimportant, perhaps because their sample comingles advanced and emerging economies (so any effect of higher advanced-economy interest rates in reducing flows to emerging markets may be offset by their positive impact on flows to advanced economies).

In our study, we identify surges for 56 emerging markets over 1980–2009 based on net capital inflows (expressed in percent of GDP), using two different algorithms: a ‘threshold’ approach – net inflows (in percent of GDP) that fall in the top 30th percentile of both the country’s own, and the entire sample’s, observations; and a ‘cluster’ approach, which avoids imposing ad hoc thresholds and uses statistical clustering techniques on (standardised) net flows to distinguish between surges, normal flows, and outflows. In addition, once surges have been identified on the basis of net capital flows, we differentiate between those caused mainly by changes in residents’ liabilities (liability-driven surges), which we associate with the investment decisions of foreigners, and those caused by changes in foreign assets (asset-driven surges), which we associate with the investment decisions of domestic residents. We then examine whether these two types of surges respond differently to changes in global and local factors.

Identifying surges: Stylised facts

With the two approaches, we identify some 300 surges (around one fourth of the panel), the majority of which are in Eastern Europe and Latin America. Surges appear to have become more common in recent years – with the share of surge observations rising from about 10% in the 1980s to more than 20% in the 1990s and almost 30% in the last decade (Figure 2).

Figure 2. Surges of Net Capital Flows to emerging markets, 1980–2009

Source: Authors' estimates based on IFS.

An initial snapshot of surges suggests three noteworthy points.

  • First, they seem to be synchronised internationally, generally corresponding to ‘well-established’ periods of high global capital mobility – the early 1980s (just before the Latin American debt crisis), the mid-1990s (before the East Asian financial crisis and Russian default), and the mid-2000s in the run-up to the recent financial crisis.
  • Second, even in times of such global surges, not all emerging markets are affected. In fact, the proportion of emerging markets experiencing a surge in any given year never exceeds one half of the sample, with some countries experiencing them repeatedly.
  • Third, there is considerable time-series and cross-sectional variation in the magnitude of flows conditional on surge occurrence. For example, Asian countries experienced the largest surges (in proportion of GDP) during the 1990s, whereas emerging Europe experienced the largest surges in the mid-2000s wave of capital flows.
Push or pull?

The very synchronicity of surge episodes across countries suggests that global factors might be at play. Indeed, we find this to be the case – global factors, including US interest rates, and global risk aversion (as captured by the volatility of the S&P500 index) – are key determinants of whether capital surges towards emerging markets. Commodity price booms, which likely signal higher global demand for emerging market exports, are also positively associated with surges. Specifically, against an unconditional surge probability of 22%, a 100 basis-point rise in US real interest rates – evaluated at mean values – lowers the likelihood of an inflow surge by three percentage points (Figure 3). Similarly, a one standard deviation shock to the volatility of the S&P500 index lowers the predicted surge probability by about three percentage points, while the corresponding shock to the commodity price index raises the surge probability by about seven percentage points.

Figure 3. Predicted probabilities of surge occurrence

Source: Authors’ estimates.

Notes: Predicted probabilities (valuated at mean values based on the estimation results of a probit model of surge occurrence on global factors (real US interest rates, S&P500 index volatility, and commodity price index), regional contagion, domestic factors (external financing need, real GDP growth rate, real domestic interest rate, real exchange rate overvaluation, capital-account openness, financial interconnectedness, institutional quality, sovereign default, exchange-rate regime, and (log) real GDP per capita), and region-specific dummies.

At the same time, whether a particular emerging market experiences a surge also depends on its own attractiveness as an investment destination, which explains why some countries do (and others do not) experience surges when aggregate flows toward emerging markets rise. Fundamentals, including external financing needs – as implied by the optimal consumption-smoothing current-account deficit (Ghosh 1995) – matters strongly, as does real GDP growth: a one percentage point increase in recipient country’s GDP growth rate, or a 1% of GDP increase in its external financing needs, raises the predicted likelihood of a surge by about one and three percentage points, respectively. Countries with fewer capital-account restrictions, greater financial interconnectedness (in the sense of more sources of cross-border loans), and stronger institutions are also more likely to experience inflow surges. Higher domestic real interest rates in emerging markets, however, do not appear to be important for inducing surges.

Regarding the magnitude of surges (the net inflow conditional on surge occurrence), global factors appear to play a more limited role – a 100 basis-point decline in the US real interest rate is associated with almost 1% of GDP larger capital flows, but commodity price booms and global market volatility have economically and statistically insignificant effects. These findings suggest that global factors act largely as ‘gatekeepers’ – capital surges toward emerging markets only when these global conditions permit, but once this hurdle is passed, the volume of capital that flows is largely independent of it.

Among the domestic factors, the nominal exchange-rate regime, real exchange-rate overvaluation, capital-account openness, and external financing needs of the country are all important determinants of surge magnitude. Real exchange-rate overvaluation of 10%, for example, is associated with about 2% of GDP lower net capital flows, while during a surge a country with a pegged exchange rate is estimated to experience larger capital flows by 3% of GDP than if it had a more flexible exchange-rate regime. Finally, countries with more open capital accounts appear to experience larger surges: moving from the 25th percentile of the sample’s capital-account openness index to the 75th percentile is associated with 1% of GDP higher capital inflows during a surge.

Our analysis also shows that inflow surges to emerging markets are mainly liability-driven – only one third of the net flow surges correspond to changes in residents’ foreign assets. The factors driving the two types of surges turn out to be quite similar: global factors matter for both, with lower US interest rates (or greater risk appetite) encouraging both foreigners to invest more in emerging markets, and domestic residents to invest less abroad. Yet some differences are discernible. Foreign investors are equally attuned to local conditions (the external financing need, real economic growth, capital-account openness, and institutional quality) as domestic investors, but tend to be more sensitive to changes in the real US interest rate and global market volatility, and are also more subject to regional contagion than domestic investors.

Policy implications

These findings hold important policy implications.

Inasmuch as surges reflect exogenous supply-side factors that could reverse abruptly, or are driven by contagion rather than by fundamentals:

  • There is a stronger case for imposing capital controls (provided macro policy prerequisites have been met, Ostry et al 2011) on inflow surges that may cause economic or financial disruption.
  • Greater policy coordination between capital source and recipient countries may also be called for.

If the aggregate volume of capital flows to emerging markets is largely determined by supply-side factors, but the allocation of flows across countries depends on local factors (including capital-account openness):

There may also be a need for coordination among recipient countries to ensure that they do not pursue beggar-thy-neighbour policies in an effort to deflect unwanted surges to each other.

Further, while the drivers of asset- and liability-driven surges may be largely similar, policy responses may need to be adjusted to the type of surge, for example:

  • Prudential measures might be more important for dealing with financial-stability risks caused by asset-driven surges,
  • Capital controls on inflows may be an additional option for liability-driven surges.

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


Cardarelli, R, S Elekdag, and A Kose (2009), “Capital Inflows: Macroeconomic Implications and Policy Responses”, IMF Working Paper 09/40.

Chuhan, P, S Claessens, and N Mamingi (1993), “Equity and Bond Flows to Latin America and Asia: The Role of Global and Cuntry Factors”, World Bank Policy Research Working Paper 1160.

Forbes, K and F Warnock (2011), “Capital Flow Waves: Surges, Stops, Flight and Retrenchment”, NBER Working Paper 17351.

Fratzscher, M (2011), “Capital Flows, Push Versus Pull Factors and the Global Financial Crisis”, NBER Working Paper 17357.

Ghosh, A (1995), “International Capital Mobility amongst the Major Industrialised Countries: Too Little or Too Much?”, Economic Journal, 105(428):107-128.

Ghosh, A, J Kim, MS Qureshi, and J Zalduendo (2012), “Surges”, IMF Working Paper 12/22.

Ghosh, K Habermeier, L Laeven, M Chamon, MS Qureshi, and A Kokenyne (2011), “Managing Capital Inflows: What Tools to Use?” Staff Discussion Notes 11/06, IMF.

Reinhart, C, and V Reinhart (2008), “Capital Flow Bonanzas: An Encompassing View of the Past and Present”, NBER Working Paper 14321.

Taylor, M and L Sarno (1997), “Capital Flows to Developing Countries: Long- and Short-Term Determinants”, World Bank Economic Review, 11(3):451-470.

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