## Going with the Flow: Benefits of Capital Inflows for Emerging Markets

_IMF Blog, December 6, 2016_

## Source details

**Canonical URL:** [Going with the Flow: Benefits of Capital Inflows for Emerging Markets](https://www.imf.org/en/blogs/articles/2016/12/06/going-with-the-flow-benefits-of-capital-inflows-for-emerging-markets)

## Other formats

- [Markdown version](/en/blogs/articles/2016/12/06/going-with-the-flow-benefits-of-capital-inflows-for-emerging-markets/index.md)
- [Structured JSON version](/en/blogs/articles/2016/12/06/going-with-the-flow-benefits-of-capital-inflows-for-emerging-markets/index.json)
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## Bibliographic details
- Authors: Deniz Igan
- Published: December 6, 2016

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### Overview
- Author: Deniz Igan
- Date: December 6, 2016
- Motivating metaphor: Michael Mussa likened capital account liberalization to fire (remarks at the IMF Economic Forum on October 2, 1998), useful but potentially destructive.
- Research question: Do capital inflows enhance growth in emerging market economies, or are they chiefly a source of vulnerability?

### Data and empirical approach
- Sample: 22 emerging market economies from 1998 to 2010.
- Unit of observation: industry-level (micro) data.
- Identification strategy: exploit differences across industries in their need for external financing to infer causal impacts of capital inflows on output and value added.
- Distinctions made:  
  - Types of capital flows (debt vs. equity and other sub-components).  
  - Outcomes considered: industry growth and growth volatility.  
  - Role of domestic financial market performance and large shocks to global financial markets.

### Key findings
- Heterogeneous effects by industry financing needs:
  - Industries more dependent on external finance grow disproportionately faster in countries hosting more capital inflows.
- Time variation:
  - Positive association is observed in the pre-crisis period of 1998–2007.
  - The inflows–growth relationships break down during the crisis period (within the 1998–2010 sample).
- Composition of inflows matters:
  - The positive association with industry growth is driven by debt, rather than equity, inflows.
  - Reduction in output volatility is more pronounced for equity, rather than debt, inflows.
- Financial system interactions:
  - The inflows–growth nexus is stronger in countries with well-functioning banks.
- Role of global shocks:
  - Large shocks to the global financial system are disruptive and hinder emerging market firms’ ability to turn capital inflows into investment and output.

### Policy implications and recommendations
- Consider composition of capital inflows when assessing costs and benefits:
  - Debt inflows are more closely associated with higher industry growth; equity inflows are more associated with volatility reduction.
- Strengthen domestic banking and financial systems:
  - Well-functioning banks improve the ability to harness growth benefits from capital inflows.
- Improve global financial system resilience:
  - A well-functioning global financial system reduces the risk that large shocks will prevent inflows from translating into growth.
- Implement “fire safety measures”:
  - Appropriate safeguards and policies (the domestic analog of fire safety) can improve the trade-off associated with capital inflow surges.

*Source: Going with the Flow: Benefits of Capital Inflows for Emerging Markets — Deniz Igan, December 6, 2016.*

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## Content in this bundle

- **Staff Paper**
  - [Staff Paper (Markdown version)](/external/pubs/ft/spn/2010/spn1004.pdf.md){rel="alternate" type="text/markdown"}
  - [Staff Paper (PDF)](/external/pubs/ft/spn/2010/spn1004.pdf){rel="external" type="application/pdf"}

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## References

- [recent work](https://www.imf.org/external/pubs/cat/longres.aspx?sk=44438.0)

_Source: https://www.imf.org/en/blogs/articles/2016/12/06/going-with-the-flow-benefits-of-capital-inflows-for-emerging-markets_