## _wp12120

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---

### I. Introduction
- Episode studied: 2001–07, culminating with the collapse of Lehman Brothers in fall 2008; characterized by:
  - an unprecedented loosening of global monetary conditions,
  - a decline in global interest rates,
  - a general reduction in the price of risk.
- Consequences for developing countries:
  - financial conditions relaxed,
  - interest rates and spreads declined,
  - rapid increase in financial inflows, domestic credit, and capital-market valuations across most developing regions.
- Research questions:
  - What factors explain whether, in response to the global loosening of monetary conditions, domestic and international finance in developing countries expanded?
  - What factors explain whether the surge in global liquidity and financial intermediation translated into productive investment?
- Contribution:
  - Focus on 2001–07, a period with large exogenous financial shocks, and use of a new measure of the global price of risk.

### II. Model specifications and estimation approach
- Cross-sectional estimations:
  - Basic equation: Yi = α0 + α1′ Xi + α2′ NRi + εi
  - Yi = ratios to GDP of: (1) international net capital inflows; (2) domestic credit (total credit to private sector).
  - Xi includes: domestic cost of capital; institutional quality; exports of goods and non-factor services; government budget balance; CPI inflation; net capital inflows (for the domestic credit equation).
  - NRi controls for natural-resource intensity.
  - Dependent and independent variables primarily averaged over 2001–07; alternative specifications use 1998–2000 lagged averages or initial values.
- Panel estimations:
  - Basic panel: Yit = μi + β1′ Xit + β2 Zt + ζit
  - Zt = country-invariant global risk premium; μi = country fixed effects.
  - Annual data with one-year-lagged independent variables.
  - Yit: ratios to GDP for net capital inflows (total private flows, decomposed into bond flows, bank loans, equity flows) and domestic credit.
- Investment equations:
  - Cross-section: Ii = α0 + α1′ XXi + α2′ NRi + εi (XX includes cost of capital, institutional quality, capital inflows, domestic credit, interactions, terms-of-trade growth, export market growth).
  - Panel: Iit = μi + β1′ XXit + β2 Zt + ζit.
  - Dynamic panel estimators: Blundell and Bond (1998) system GMM and Arellano-Bond first-difference GMM used to address endogeneity (T = 7, N = 110).

### III. Data sources and variable construction
- Global risk premium:
  - Proxied by Kennedy and Palerm (2009) synthetic risk premium: first principal component of spreads on corporate bonds for US and euro area, implied equity risk premiums, and a representative global EMBI+ spread.
- Cost of capital:
  - Measured as required return on investment + assumed depreciation rate of 7 percent.
  - Required return = global risk-free rate (U.S. T-bill rate) + country-specific credit spread.
  - Credit spreads: J.P. Morgan EMBI Global stripped spread where available; regional averages otherwise.
- Capital flows:
  - Source: World Bank Global Development Finance (GDF).
  - Private net capital flows = net equity inflows (FDI + portfolio equity) + net debt inflows (bond issuance, bank lending, short-term debt, net lending from other private creditors).
  - Total capital inflows = private net capital flows + net official inflows (public and publicly guaranteed debt from official creditors + IMF purchases − IMF repurchases).
  - Net debt flows = disbursements − principal repayments.
- Institutional quality:
  - KKM index: average of six Kaufmann-Kraay-Mastruzzi (2009) governance indicators; percentile ranks 1–100.
  - ICRG law and order ranking used for robustness.
- Real-side openness and related measures:
  - Exports of goods and non-factor services as share of GDP.
  - Export market growth = weighted growth of partners' imports; weights = partners' average export share in 2000–03.
  - Sources: IFS, WEO, World Bank Global Economic Prospects.
- Other data:
  - WDI and IFS for fiscal balance, CPI, domestic credit.
  - Natural-resource intensity: countries in upper quartile of (fuel exports / GDP) and/or (metals exports / GDP) defined as resource-rich.
- Sample:
  - Contains 103 countries (listed in Appendix Table 1). Appendix Tables 2–3 summarize sources and statistics.

### IV. Main empirical findings — determinants of private finance and domestic credit
- Cross-country determinants (preferred specifications highlighted):
  - Net capital inflows significantly associated with:
    - institutional quality (KKM): coefficients in Net Private Capital Inflows regressions include 0.10**, 0.09**, 0.10**, 0.11***.
    - exports of goods and services (percent of GDP): coefficients 0.10***, 0.10***, 0.09***, 0.11***.
    - average rate of export growth over previous decade (negative conditional effect when controlling for export share).
  - Domestic credit significantly associated with:
    - institutional quality (KKM): coefficients 0.75***, 0.57***, 0.55***, 0.74***.
    - cost of capital (percent): coefficients −0.94**, −1.72**, −1.88**, −0.83**.
    - exports of goods and services: coefficients 0.36**, 0.25, 0.32**, 0.35**.
- Panel results on global price of risk (Table 2; annual data, lagged regressors, country fixed effects):
  - Global price of risk coefficients (various specifications): −1.79***, −1.08***, −0.72**, −0.25, −0.16, −1.73*, −1.91**, −1.85**, −1.60*, −2.03**.
  - Quantitative panel magnitude: a 1 point decline in the global price of risk (decline observed 2003–07) results in:
    - a 1.8 percentage point of GDP increase in foreign capital inflows,
    - a 1.7 percentage point of GDP increase in domestic credit.
  - Controlling for global price of risk, the cost of capital does not have an independent influence on capital inflows or domestic credit in panel specifications.
- Disaggregation of flows:
  - Equity flows are relatively more sensitive to changes in the global price of risk than debt flows.
  - Institutional quality has a significant positive effect on equity inflows.
- Cross-country differences and time-series drivers:
  - Levels of financial intermediation across countries best explained by fundamentals: institutional quality, export market access, cost of capital, and inflation.
  - Time-series expansion of intermediation in developing countries mainly driven by lower global risk and expansion of global liquidity.

### V. Quantitative decompositions and magnitudes
- Table 3 — Difference between top and bottom quartile (time average):
  - Net Private Capital Inflows: Difference = 7.4 (percent of GDP).
  - Domestic Credit: Difference = 27.8 (percent of GDP).
  - Contribution of institutional quality to Domestic Credit difference = 20.0.
  - Contribution of exports of goods and services to Net Private Capital Inflows difference = 2.9 and to Domestic Credit difference = 9.3.
  - Contribution of cost of capital to Net Private Capital Inflows difference = −1.4.
  - Contribution of inflation to Domestic Credit difference = −10.7.
- Table 4 — Change over 2001–07 in dependent variables (country average):
  - Change in Net Private Capital Inflows = 5.6 (percent of GDP).
  - Change in Domestic Credit = 8.07 (percent of GDP).
  - Contribution of global price of risk to changes: 2.6 to Net Private Capital Inflows and 2.5 to Domestic Credit.
  - Net private capital inflows contributed 1.5 to Domestic Credit (per decomposition where coefficients are significant).

### VI. Investment: determinants and transmission
- Cross-country investment regressions (Table 5, averages 2001–07):
  - Investment persistence (pre-period average 1998–2000): coefficients 0.68***, 0.62***, 0.65***, 0.69***.
  - Net private capital inflows (percent of GDP) positive and significant: examples 0.76***, 0.88***, 0.34*, 0.41**, 1.11***, 1.12***, 0.72***, 0.85*** across specifications.
  - Domestic credit (private sector credit / GDP) coefficients on Investment: 0.10**, 0.08***, 0.02, 0.01, 0.00, 0.02, 0.06, 0.03.
  - Cost of capital (percent) negative and often significant: examples −0.40***, −0.30**, −0.66***, −0.51***, −0.02, 0.02, −0.43***, −0.34***.
  - Interaction terms:
    - Capital inflows * institutional quality: coefficients include 0.01*, 0.01, 0.01***, 0.01***, −0.00, −0.00, 0.01, 0.00.
    - Capital inflows * domestic credit: negative coefficients consistently e.g. −0.02***, −0.02***, −0.01**, −0.01**, −0.01*, −0.02***, −0.01***, −0.01***.
  - Preferred IV specification: neither institutional quality nor domestic credit amplify the translation of capital inflows into domestic investment (null interaction).
- Panel investment regressions (Table 6):
  - Fixed effects and GMM results:
    - Lagged investment coefficients: 0.10, 0.19***, 0.88***, 0.81*** across specifications.
    - Institutional quality (KKM): examples 0.20**, 0.14, 0.15, 0.11*, 0.05.
    - Domestic credit: 0.09**, 0.15**, 0.13***, −0.02, −0.02.
    - Net private capital inflows: 0.31, 0.61, 0.46, 0.98***, 0.65**.
    - Government budget surplus (percent of GDP): 0.12, 0.96, 0.43, 1.01**, 1.08***.
    - Capital inflows * institutional quality: negative and significant in some GMM specifications: −0.02***, −0.01** (implying higher institutional quality does not amplify the investment effect of capital inflows in those specifications).
  - Dynamic GMM interpretation:
    - First-difference GMM: domestic credit positively affects investment.
    - System GMM: net capital inflows affect investment; fiscal balance statistically significant.
    - After controlling for net capital inflows and domestic credit, neither the global price of risk nor domestic borrowing costs have additional direct effects on investment — their impact operates mainly through net capital inflows and domestic credit.

### VII. Descriptive statistics (period averages, 2001–07)
- Net private capital inflows (percent of GDP): Obs. 110, Mean 6.4, Std Dev 6.4, Min −1.1, Max 28.9.
- Domestic credit (private sector credit, percent of GDP): Obs. 109, Mean 30.8, Std Dev 27.4, Min 1.8, Max 139.1.
- Investment (percent of GDP): Obs. 110, Mean 22.4, Std Dev 7.5, Min 6.4, Max 44.8.
- Cost of capital (percent): Obs. 110, Mean 16.1, Std Dev 3.6, Min 12.3, Max 41.7.
- Institutional quality: KKM index: Obs. 110, Mean 36.7, Std Dev 18.6, Min 3.0, Max 84.6.
- Exports of goods and services (percent of GDP): Obs. 110, Mean 38.9, Std Dev 19.8, Min 9.0, Max 116.7.
- Government budget surplus (percent of GDP): Obs. 110, Mean −3.1, Std Dev 4.8, Min −25.7, Max 16.3.
- CPI Inflation (log): Obs. 105, Mean 1.6, Std Dev 0.9, Min −0.5, Max 6.3.
- Terms of trade growth (* trade ratio, percent): Obs. 107, Mean 5.1, Std Dev 7.2, Min −9.7, Max 32.9.
- Export market growth (* export ratio, percent): Obs. 91, Mean 7.1, Std Dev 2.8, Min 0.0, Max 16.5.

### VIII. Key conclusions and policy implications
- Central determinants of cross-country differences in private finance and financial intermediation:
  - institutional quality,
  - export openness/access to international export markets,
  - borrowing costs,
  - appropriate macroeconomic policy (inflation, fiscal balance).
- Time-series increase in net capital inflows and domestic credit during 2001–07 mainly driven by:
  - decline in the global price of risk,
  - expansion of global liquidity.
- Transmission to investment:
  - Investment responds positively to private net capital inflows and negatively to borrowing costs.
  - Much of the effect of global and domestic financial conditions on investment operates via their impact on net capital inflows and domestic credit rather than as separate direct effects.
  - Neither greater institutional quality nor greater domestic credit clearly increase the extent to which capital inflows translate into domestic investment (robust null/weak interaction results).
- Policy implications and research agenda:
  - Policies that sustain low global risk premia and lower domestic borrowing costs can have sizable effects on net capital inflows and domestic credit, with downstream positive effects on investment.
  - Strengthening institutional quality and expanding access to export markets are key fundamentals explaining cross-country differences in private finance and domestic credit.
  - Further research recommended on channels through which surges in global liquidity feed into productive investment in developing countries.

*Source: _wp12120 - Appendix Tables*

### Appendix Tables

### Appendix Tables

### I. Introduction
- Between 2001 and the collapse of Lehman Brothers in the fall of 2008, international markets experienced a global credit boom characterized by:
  - an unprecedented loosening of global monetary conditions,
  - a decline in global interest rates,
  - a general reduction in the price of risk.
- Consequences for developing countries:
  - financial conditions relaxed,
  - interest rates and spreads declined,
  - rapid increase in financial inflows, domestic credit, and capital-market valuations across most developing regions.
- Key research questions:
  - What factors explain whether, in response to the global loosening of monetary conditions, domestic and international finance in developing countries expanded?
  - What factors explain whether the surge in global liquidity and financial intermediation translated into productive investment in any given developing country?
- Contribution:
  - Focus on a specific period with large, exogenous financial shocks to help identify causal relationships.
  - Use of a new measure of the global price of risk.

### II. Model Specifications
- Approach:
  - Both cross-sectional and panel estimation methods are used.
  - Cross-section: analyze country-specific determinants of capital inflows, domestic credit, and investment.
  - Panel: explore effects of country-invariant factors, such as changes in global risk conditions.
- Cross-sectional determinants of capital inflows and domestic credit:
  - Basic estimation equation (cross-section):
    - Yi = α0 + α1′ Xi + α2′ NRi + εi
    - Yi is, in turn, the ratio to GDP of: (1) international net capital inflows; and (2) domestic credit (total credit to the private sector).
  - Explanatory variables in Xi include:
    - The domestic cost of capital.
    - Institutional quality.
    - Exports of goods and non-factor services (real-side openness).
    - Government budget balance and CPI inflation (macroeconomic policy appropriateness).
    - Net capital inflows (in the domestic credit equation).
  - Natural-resource intensity controlled via NRi.
  - Dependent variables constructed using average values during 2001–07; independent variables primarily averaged over 2001–07. Alternative specifications use initial values or lagged averages (1998–2000).
- Panel specifications:
  - Basic panel equation:
    - Yit = μi + β1′ Xit + β2 Zt + ζit
    - Zt is the country-invariant global risk premium; μi are country fixed effects.
  - Annual data; one-year-lagged values for independent variables.
  - Yit represents ratios to GDP for: (1) international net capital inflows (total private flows, debt flows—aggregated and disaggregated into bond flows and bank loans—and equity flows); and (2) domestic credit.
- Determinants of investment:
  - Cross-sectional investment equation:
    - Ii = α0 + α1′ XXi + α2′ NRi + εi
    - XX includes cost of capital, institutional quality, measures of capital inflows and domestic credit, interactions between capital inflows and institutional quality and between capital inflows and domestic credit, terms-of-trade growth (weighted by trade ratio), and export market growth (weighted by export ratio).
  - Alternative specifications include lagged investment.
  - Panel investment equation:
    - Iit = μi + β1′ XXit + β2 Zt + ζit
  - Dynamic panel estimators:
    - Blundell and Bond (1998) GMM dynamic panel estimator to correct endogeneity bias (panel has short time dimension T= 7 and large country dimension N= 110).
    - Arellano-Bond estimator also appropriate.

### III. Data Sources
- Global risk premium:
  - Proxied by Kennedy and Palerm (2009) measure of the synthetic risk premium in high-income countries, computed as the first principal component of:
    - spreads on corporate bonds for the United States and the euro area,
    - implied equity risk premiums for each economy,
    - a representative global EMBI+ spread.
- Cost of capital:
  - Measured as the sum of the required return on investment and an assumed rate of capital depreciation of 7 percent.
  - Required return on investment = global risk-free rate (the U.S. T-bill rate) + country-specific credit spread.
  - Credit spreads: market spread on sovereign bonds (J.P. Morgan EMBI Global stripped spread) where available; regional averages used otherwise.
- Capital flow variables:
  - Derived from World Bank Global Development Finance (GDF) database.
  - Private net capital flows = net equity inflows (FDI flows and portfolio equity) + net debt inflows (bond issuance, bank lending, short-term debt, net lending from other private creditors).
  - Total capital inflows = private net capital flows + net official inflows (public and publicly guaranteed debt from official creditors + IMF purchases − IMF repurchases).
  - Net debt flows measured as disbursements minus principal repayments.
- Institutional quality:
  - Proxied by the average of six Kaufmann-Kraay-Mastruzzi (2009; KKM) governance indicators: voice and accountability; political stability and absence of violence/terrorism; government effectiveness; regulatory quality; rule of law; control of corruption.
  - On each indicator, countries ranked 1 to 100; percentile rank indicates percentage of countries worldwide that rate below the selected country.
  - ICRG law and order ranking used for robustness checks; KKM preferred due to wider country coverage.
- Real-side openness and related measures:
  - Exports of goods and non-factor services as a share of GDP.
  - Export market growth = weighted growth rate of total imports in a country’s trade partners; weights = each partner's average share in the country's total exports over 2000–03.
  - Sources: IMF International Financial Statistics (IFS), IMF World Economic Outlook, World Bank Global Economic Prospects.
- Other data:
  - World Bank World Development Indicators (WDI) and IFS for macroeconomic stability indicators (fiscal balance as share of GDP, CPI) and domestic credit (domestic credit to private sector as share of GDP).
  - Natural-resource intensity: countries in upper quartile of (fuel exports / GDP) and/or (metals exports / GDP) distribution defined as resource-rich.
- Sample:
  - Contains 103 countries (listed in Appendix Table 1).
  - Appendix Table 2 summarizes data sources; Appendix Table 3 presents summary statistics.
- Bivariate correlations (Figure 1 summary):
  - Private finance (foreign capital inflows and domestic credit) correlated negatively with borrowing costs, and positively with institutional quality and export intensity.

### IV. Empirical Results
- Estimation strategies:
  - For both net capital inflows and domestic credit, explanatory variables were calculated as:
    1. Contemporaneous averages over 2001–07.
    2. Initial values (first available year between 2001 and 2007).
    3. Lagged averages over 1998–2000 (also used as instruments).
- Determinants of capital inflows (cross-country results):
  - Net capital inflows significantly affected by:
    - institutional quality,
    - share of exports in GDP,
    - average rate of export growth over previous decade.
  - Quantitative example:
    - A 10–percentage–point increase in exports / GDP leads on average to a 1.1 percentage point of GDP increase in net capital inflows.
  - Controlling for export share, countries with higher export growth rates between 1990 and 1997 attracted less capital inflows between 2001 and 2007.
- Determinants of domestic credit (cross-country results):
  - Domestic credit significantly affected by:
    - cost of capital,
    - institutional quality,
    - exports.
  - Quantitative example:
    - For the average developing country, a 100 basis point decline in borrowing costs (relative to the pre–2001 average) results in an increase in domestic credit of 0.8 percentage points of GDP (preferred specification, column 8).
  - Some evidence domestic credit is negatively affected by inflation and by budget deficits (consistent with crowding out).
- Panel results on global risk premium:
  - Panel regressions confirm statistically significant associations between net capital inflows and the global price of risk (Table 2).
  - Domestic credit significantly associated with net private capital inflows, the global price of risk, and institutional quality.
  - Quantitative panel estimates:
    - A 1 point decline in the measure of the global price of risk, equivalent to the decline observed between 2003 and 2007, results in:
      - a 1.8 percentage point of GDP increase in foreign capital inflows,
      - a 1.7 percentage point of GDP increase in domestic credit.
  - Controlling for the global price of risk, the cost of capital does not have an independent influence on capital inflows or domestic credit.
- Disaggregation of capital inflows:
  - Equity flows are relatively more sensitive to changes in the global price of risk than debt flows.
  - Institutional quality has a significant effect on equity inflows.
- Cross-country differences and time-series drivers:
  - Differences in level of financial intermediation across countries are best explained by fundamentals: institutional quality, access to international export markets, cost of capital, and inflation (Table 3).
  - The increase over time in the extent of intermediation in developing countries is driven mainly by lower global risk and the overall expansion of global liquidity (Table 4).
- Determinants of investment:
  - Cross-country regressions:
    - Borrowing costs have a negative and significant impact on investment (Table 5, specifications 1, 2, and 4).
    - Private net capital inflows have a positive and significant impact on investment.
    - Results remain similar when controlling for lagged investment.
    - Strong persistence in investment observed.
    - In preferred IV specification, neither institutional quality nor domestic credit affect the extent to which capital inflows translate into domestic investment.
  - Panel fixed-effects regressions (Table 6, column 1):
    - Institutional quality, domestic credit, and export markets exert a positive effect on investment.
    - Growth in the trade-weighted terms of trade associated with higher investment.
    - Neither institutional quality nor domestic credit affect the extent to which capital inflows translate into domestic investment.
  - Dynamic panel (GMM) specifications:
    - First-difference GMM: domestic credit has a positive effect on investment.
    - System GMM: net capital inflows affect investment; fiscal balance also statistically significant.
    - After controlling for these variables, neither the global price of risk nor domestic borrowing costs exert any additional direct effect on investment.
    - Interpretation: global price of risk and domestic borrowing costs affect investment mainly through their impact on net capital inflows and domestic credit.

### V. Conclusions
- The paper empirically examines determinants and interactions between capital inflows, domestic credit, and domestic investment in developing countries during 2001–07.
- Key findings summarized:
  - Institutional quality, export openness, and borrowing costs are central determinants of cross-country differences in private finance and financial intermediation.
  - The decline in the global price of risk and the expansion of global liquidity played large roles in the time-series increase in foreign capital inflows and domestic credit.
  - Equity inflows are more sensitive to global risk conditions than debt inflows; institutional quality matters for equity inflows.
  - Investment responds positively to private net capital inflows and negatively to borrowing costs; much of the effect of global and domestic financial conditions on investment operates via capital inflows and domestic credit rather than exerting a separate direct effect.

*Source: _wp12120 - Appendix Tables*

### 2007.  This period saw an unprecedented loosening of global monetary conditions, resulting

### _wp12120 - 2007.  This period saw an unprecedented loosening of global monetary conditions, resulting

### Overview of the episode (2001–07)
- Period characterized by an unprecedented loosening of global monetary conditions, with a rapid decline in interest rates and spreads in most developing regions and a rapid increase in financial inflows, domestic credit, and capital-market valuations throughout the developing world.
- Large, exogenous financial shocks during this period enable estimation of underlying causal relationships.

### Main empirical findings
- Reductions in the global price of risk and in domestic borrowing costs were the main contributors to the increase over time in net capital inflows and domestic credit.
- Cross-country differences in international and domestic finance are large and best explained by fundamentals such as institutional quality, access to international export markets, and appropriate macroeconomic policy.
- Both net capital inflows and domestic credit exert a positive effect on investment.
- Effects of the global price of risk and domestic borrowing costs on investment operate mainly through their impact on net capital inflows and domestic credit.
- Greater institutional quality and greater domestic credit do not increase the extent to which capital inflows translate into domestic investment (surprising null interaction result).
- Recommendation for future research: investigate further the relationship between surges in global liquidity and productive investment in developing countries.

### Key regression results — private finance (cross-sectional and panel)
- Table 2 (Panel regressions, annual data over 2001–07, lagged independent variables, country fixed effects):
  - Global price of risk coefficients (various specifications): -1.79***, -1.08***, -0.72**, -0.25, -0.16, -1.73*, -1.91**, -1.85**, -1.60*, -2.03** (robust standard errors reported in parentheses in source).
  - Cost of capital: coefficients shown include -0.06, -0.00, -0.06, -0.06, -0.01, -0.27, -0.28, -0.27, -0.30, -0.28.
  - Institutional quality: KKM index coefficients include 0.08, 0.13*, -0.05, -0.05, 0.05, 0.23**, 0.25**, 0.25**, 0.24**, 0.27**.
  - Net equity inflows, net debt inflows, net bank inflows show positive within-panel persistence: Net Equity Inflows 0.22* (0.13), Net Debt Inflows 0.32** (0.15), Net Bank Inflows 1.00** (0.43), Net Bond Inflows 0.21 (0.34) (standard errors in parentheses per table).

- Table 1 (Cross-country regressions, preferred specifications columns 4 and 8 used for decomposition):
  - Institutional quality: KKM index coefficients for Net Private Capital Inflows regressions: 0.10**, 0.09**, 0.10**, 0.11*** and for Domestic Credit regressions: 0.75***, 0.57***, 0.55***, 0.74***.
  - Cost of Capital (percent) coefficients for Domestic Credit regressions: -0.94**, -1.72**, -1.88**, -0.83** (standard errors in parentheses as shown in table).
  - Exports of goods and services (percent of GDP) positive and significant for Net Private Capital Inflows and Domestic Credit: Net inflows coefficients 0.10***, 0.10***, 0.09***, 0.11***; Domestic Credit coefficients 0.36**, 0.25, 0.32**, 0.35**.

### Decompositions and magnitudes
- Table 3 — Difference between top and bottom quartile (time average):
  - Net Private Capital Inflows: Difference = 7.4 (percent of GDP).
  - Domestic Credit: Difference = 27.8 (percent of GDP).
  - Contribution of institutional quality to Domestic Credit difference = 20.0.
  - Contribution of exports of goods and services to Net Private Capital Inflows difference = 2.9 and to Domestic Credit difference = 9.3.
  - Contribution of cost of capital to Net Private Capital Inflows difference = -1.4.
  - Contribution of inflation to Domestic Credit difference = -10.7.
- Table 4 — Change over 2001–07 in dependent variables (country average):
  - Change in Net Private Capital Inflows = 5.6 (percent of GDP).
  - Change in Domestic Credit = 8.07 (percent of GDP).
  - Contribution of changes: Global price of risk contributed 2.6 to Net Private Capital Inflows and 2.5 to Domestic Credit.
  - Net private capital inflows contributed 1.5 to Domestic Credit (per decomposition note where coefficients are statistically significant).

### Investment results
- Table 5 (Cross-country regressions, Investment regressions average 2001–07):
  - Investment (pre-period average 1998–2000) coefficient across specifications: 0.68***, 0.62***, 0.65***, 0.69*** (standard errors reported in table).
  - Net private capital inflows (percent of GDP) coefficients on Investment: 0.76***, 0.88***, 0.34*, 0.41**, 1.11***, 1.12***, 0.72***, 0.85*** (across different specifications).
  - Domestic credit (private sector credit / GDP) coefficients on Investment: 0.10**, 0.08***, 0.02, 0.01, 0.00, 0.02, 0.06, 0.03.
  - Cost of capital (percent) negative and often significant: examples include -0.40***, -0.30**, -0.66***, -0.51***, -0.02, 0.02, -0.43***, -0.34***.
  - Interaction terms:
    - Capital inflows * institutional quality: coefficients reported include 0.01*, 0.01, 0.01***, 0.01***, -0.00, -0.00, 0.01, 0.00.
    - Capital inflows * domestic credit: negative coefficients consistently e.g. -0.02***, -0.02***, -0.01**, -0.01**, -0.01*, -0.02***, -0.01***, -0.01***.

- Table 6 (Investment: Panel regressions — Fixed Effects, Difference GMM, System GMM):
  - Lagged investment coefficients: 0.10, 0.19***, 0.88***, 0.81*** across specifications.
  - Institutional quality: KKM index coefficients include 0.20**, 0.14, 0.15, 0.11*, 0.05.
  - Domestic credit coefficient examples: 0.09**, 0.15**, 0.13***, -0.02, -0.02.
  - Net private capital inflows coefficients include 0.31, 0.61, 0.46, 0.98***, 0.65**.
  - Government budget surplus (percent of GDP) coefficients include 0.12, 0.96, 0.43, 1.01**, 1.08***.
  - Capital inflows * institutional quality: negative and significant in some GMM specifications: -0.02***, -0.01** (indicating that higher institutional quality does not amplify the investment effect of capital inflows in those specifications).

### Descriptive statistics (Period averages, 2001–07)
- Net private capital inflows (percent of GDP): Obs. 110, Mean 6.4, Std Dev 6.4, Min -1.1, Max 28.9.
- Domestic credit (private sector credit, percent of GDP): Obs. 109, Mean 30.8, Std Dev 27.4, Min 1.8, Max 139.1.
- Investment (percent of GDP): Obs. 110, Mean 22.4, Std Dev 7.5, Min 6.4, Max 44.8.
- Cost of capital (percent): Obs. 110, Mean 16.1, Std Dev 3.6, Min 12.3, Max 41.7.
- Institutional quality: KKM index: Obs. 110, Mean 36.7, Std Dev 18.6, Min 3.0, Max 84.6.
- Exports of goods and services (percent of GDP): Obs. 110, Mean 38.9, Std Dev 19.8, Min 9.0, Max 116.7.
- Government budget surplus (percent of GDP): Obs. 110, Mean -3.1, Std Dev 4.8, Min -25.7, Max 16.3.
- CPI Inflation (log): Obs. 105, Mean 1.6, Std Dev 0.9, Min -0.5, Max 6.3.
- Terms of trade growth (* trade ratio, percent): Obs. 107, Mean 5.1, Std Dev 7.2, Min -9.7, Max 32.9.
- Export market growth (* export ratio, percent): Obs. 91, Mean 7.1, Std Dev 2.8, Min 0.0, Max 16.5.

### Sample coverage
- Country list spans East Asia and Pacific; Europe and Central Asia; Latin America and the Caribbean; Middle East and North Africa; South Asia; Sub-Saharan Africa (full country list provided in Appendix Table 1 of source).

### Policy implications and research agenda
- Policies that sustain low global risk premia and lower domestic borrowing costs can have sizable effects on net capital inflows and domestic credit, with downstream positive effects on investment.
- Strengthening institutional quality and expanding access to export markets are key fundamentals explaining cross-country differences in private finance and domestic credit.
- Given the finding that institutional quality does not clearly amplify the translation of capital inflows into investment, further research is needed on the channels through which surges in global liquidity feed into productive investment in developing countries.

*Source: _wp12120 - 2007.  This period saw an unprecedented loosening of global monetary conditions, resulting (IMF PDF content provided).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp12120.pdf_