## External Financing Risks: How Important is the Composition of the International Investment Position?

_IMF Working Papers, January 29, 2021_

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## Bibliographic details
- Authors: Luis M. Cubeddu, Swarnali A Hannan, Pau Rabanal
- Published: January 29, 2021
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513568102.001

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### Overview
- Authors: Luis M. Cubeddu, Swarnali A Hannan, Pau Rabanal
- Date: January 29, 2021
- Research focus: Role of the structure of the international investment position (IIP)—especially currency composition—in affecting countries’ external vulnerabilities.
- Sample: 73 advanced and emerging economies.
- New input: A new database on the IIP’s currency composition.

### Key findings
- The size and structure of external liabilities and assets, especially currency denomination, matter for balance-of-payments pressures.
- Higher levels of gross external debt increase the likelihood of an external crisis.
- Higher levels of foreign-currency-denominated external debt increase the likelihood of sudden stops.
- Foreign reserve assets mitigate external risks, although with diminishing returns.
- The combination of flow and stock imbalances amplifies external risks, particularly during periods of heightened global risk aversion.
- Results are especially strong for emerging economies: the impacts of flow and stock imbalances and foreign currency mismatches are larger and more robust across specifications.

### Policy implications and recommendations
- Monitor not only net external positions but also gross stocks and the currency composition of external assets and liabilities.
- Strengthen foreign reserve buffers, recognizing diminishing marginal benefits.
- Address foreign-currency-denominated debt exposures to reduce susceptibility to sudden stops.
- Coordinate policies to reduce flow and stock imbalances, especially when global risk aversion rises.
- Tailor policy priorities for emerging economies, where vulnerabilities from currency mismatches and imbalances are more pronounced.

### Data and empirical approach
- Empirical strategy uses a sample of 73 advanced and emerging economies and a new database on the IIP’s currency composition.
- Outcomes analyzed include external crises and sudden stops, with controls for standard macroeconomic factors used in prior literature.

### Robustness and heterogeneity
- Findings hold beyond standard macroeconomic controls emphasized in other studies.
- Effects are more pronounced and robust in emerging economies compared with advanced economies.
- Interaction of flow and stock imbalances with episodes of heightened global risk aversion strengthens external risk outcomes.

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_Source: https://www.imf.org/en/publications/wp/issues/2021/01/29/external-financing-risks-how-important-is-the-composition-of-the-international-investment-50029_