## Capital Flows to Latin America in the Aftermath of the Commodities Super-Cycle

## Source details

**Canonical URL:** [Capital Flows to Latin America in the Aftermath of the Commodities Super-Cycle](https://www.imf.org/-/media/files/publications/reo/whd/2019/october/english/capitalflowspresentation.pdf)

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### Motivation
- Capital flows enable growth when domestic savings are insufficient to finance investment and when they bring technological and managerial improvements along with them.
- These two factors are particularly relevant for countries in LAC.
- Volatile capital flows can disrupt the domestic economy during difficult times, or fuel overheating and asset price bubbles in boom periods.
- The study documents how the size and composition of capital flows to LAC has changed after the end of the commodities super cycle, and explores policy options to mitigate the adverse effects of a possible boom-bust event.

### Aggregate Trends: Composition and Magnitude of Flows
- Net capital flows to LAC declined since 2014, mostly because of a fall in gross inflows.
- The decline was mainly driven by changes in portfolio inflows.
- FDI showed resilience in LAC relative to steep declines in advanced economies and other EMs.
- Note: LA7 = Argentina, Brazil, Chile, Colombia, Mexico, Peru, Uruguay.
- Note: FDI = foreign direct investments.
- Time series evidence (percent of GDP):
  - Net inflows and Gross inflows plotted for 2006–2018 (percent of GDP).
  - Types of inflows to LA7 (percent of GDP) displayed for 2013–2018: Portfolio investments, Foreign direct investments, Other investments.
  - FDI across regions and income groups shown for 2012–2018 (percent of GDP).

### Cross-Country Differences
- Aggregate trends mask important cross-country heterogeneity.
- Since 2014:
  - FDI increased in Brazil (percent of GDP series shown for 2004–2018).
  - FDI fell in metal exporters (Chile and Peru) (percent of GDP series shown for 2004–2018).
  - Gross portfolio inflows declined in most countries, except for Peru.
- In-country time series separate Portfolio investments, Foreign direct investments, and Other investments for Brazil, Chile, and Peru (2004–2018; percent of GDP).

### Sensitivity to Main Drivers Has Changed
- Portfolio flows to the region have become more sensitive to global factors.
  - Panel: Portfolio Flows: Sensitivity to Global Risk Aversion for periods 2000–18 and 2012–18; LA7 versus Emerging market and developing economies.
- Portfolio flows have also become more sensitive to growth differentials relative to AEs.
  - Panel: Portfolio Flows: Sensitivity to Growth Differentials (2000–18 and 2012–18; LA7 versus Emerging market and developing economies).
- Implication: increased vulnerabilities given the current global environment.

### Domestic Fundamentals versus External Vulnerabilities
- Currently the region has weaker domestic fundamentals than prior to the 2008–09 event:
  - Growth in the region is lower and fiscal deficits, and public debt are higher today than at the end of 2007 in most countries.
  - LAC: Real GDP Growth (year-over-year percent change; average; excludes Venezuela): Average 2007–08 versus Average 2018–19 (values shown by country).
  - Fiscal Balance (Percent of GDP) and Gross Debt (Percent of fiscal year GDP) compared: 2007 vs 2019 (country panels shown).
- Yet most countries have lower external vulnerabilities:
  - Most countries have adequate reserve buffers relative to projected external financing requirements.
  - External financing requirements (public and private sector) calculated as the difference between short-term debt on a remaining maturity basis and current account balance.
  - Reserves and External financing requirements displayed for 2019 (percent of GDP) by country.
- Liability dollarization has remained broadly stable over the past year:
  - Liability Dollarization (Percent of GDP) shown: One-year lag versus Latest for a set of countries.

### Foreign Participation in Domestic Debt Markets
- Foreign participation in domestic debt markets has increased in Colombia, but remained stable in Brazil and Mexico.
- Peru stands out as having relatively high levels of foreign participation in debt markets.
- Time series: Foreign Ownership in Local Currency Government Debt Markets (Percent of total) plotted for Colombia, Brazil, Mexico, Peru from Mar-12 to Mar-19.
- Cross-country snapshot: Foreign Ownership in Local Currency Government Debt Markets: Emerging Markets, 2019:Q1 (Percent of total) with country comparisons showing PER highest among listed countries.

### How Have Countries Responded to Sudden Stops?
- LAC countries are more prone to tighten fiscal policy and use capital controls after the onset of sudden stops.
  - Policy Tightening during Sudden Stops (Percent of cases): categories Fiscal, Monetary, Capital controls; LAC versus Other countries.
- Sudden stops tend to be less costly in countries with floating exchange rate regimes at the onset of the episode.
  - Average Costs of Sudden Stops (Percent of trend GDP): All versus Latin America and the Caribbean; Floating versus Fixed regimes.

### How to Deal with Sudden Stops? Duration Models and Key Findings
- Duration models of sudden stops and growth decelerations estimated using Weibull and Gompertz baseline hazards. Exponentiated coefficients reported; t-statistics in parentheses; standard errors clustered by country.
- Selected coefficient results (exponentiated coefficients; significance levels *** p<0.01, ** p<0.05, * p<0.1):
  - GDP per capita (initial): 0.76** (Weibull), 0.76** (Gompertz), 0.74** (Weibull), 0.75** (Gompertz).
  - Exchange rate regime (initial): 1.62***, 1.96***, 1.84***, 1.81***.
  - ∆ Terms of trade: 1.13***, 1.12***, 1.10***, 1.09***.
  - ∆ Monetary: 1.03, 1.06*, 1.05***, 1.05***.
  - ∆ Fiscal: 1.02, 1.02, 0.99, 0.99.
  - ∆ Reserves: 1.01**, 1.01***, 1.01, 1.01.
  - ∆ Capital controls: 0.96, 1.00, 0.97, 1.03.
  - Constant reported in each specification (0.16, 0.41, 0.34, 0.79).
  - θ and γ parameters and observations: θ 2.90*** and 1.57*** (models), γ 1.83*** and 1.06***; Observations 145, 145, 97, 97 across columns.
- Interpretative finding from the model:
  - "Coefficient means that featuring a flexible exchange rate regime increases the odds of exiting the sudden stop in 81%."

### Policy Implications and Conclusions
- Capital flows have become more sensitive to global risk aversion, U.S. interest rates, and growth differentials vis-à-vis advanced economies.
- Domestic fundamentals are weaker than in 2007–08 but external vulnerabilities are lower.
- Floating exchange rate regimes reduce the duration of sudden stops and the output losses associated with them:
  - A flexible regime increases the probability of exiting a sudden stop by at least 60 percent (model summary).
- Monetary policy tightening shortens the duration of sudden stops.
- Capital controls do not have statistically significant effects on shortening sudden stops.

*International Monetary Fund, "Capital Flows to Latin America in the Aftermath of the Commodities Super-Cycle", OCTOBER 2019.*

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_Source: https://www.imf.org/-/media/files/publications/reo/whd/2019/october/english/capitalflowspresentation.pdf_