Discussion of Bacchetta & Benhima paper The Demand for Liquid Assets and International Capital Flows Marcel Fratzscher European Central Bank Conference Financial Globalization: Shifting Balances Banco de España, Madrid, 1-21 2 July 2010 Disclaimer: The views expressed here are solely the views of the presenter and do not necessarily reflect those of the ECB or the Eurosystem.
Main theme Contribution to literature on global imbalances focus on EME role Complementary (vs alternative) explanation of global excess savings demand for liquid assets (absence of risk) Role of financial constraints on EME firms amid lack of liquid domestic assets triggers capital outflows Implication for asymmetric effects of EME shocks vs. advanced economy shocks Claim: model can account for capital flow dynamics (and exchange rates) in normal times and during 2007-09 crisis 2
Key aspects of model Three key aspects Production takes time period t: invest K t+1 but production available only in t+2 Cost before production available period t+1: workers need to be paid (w t+1 l t+1 ) Firms are credit-constrained period t: investment in (shortterm, liquid) bond B t+1 to cover costs lack of pledgeability of future output (Holmstrom and Tirole 2001) Demand for liquid assets arises even in the absence of risk is highly inelastic to (world) interest rate, and reduces them is a complement to investment K t+1 3
Contribution Important aspect: EME demand for liquid assets Claim: alternative explanation to other hypotheses Financial development hypothesis: Limited supply of liquid & safe assets (Caballero et al. 2008, Dooley et al 2005, Ju & Wei 2006) Complement: BB demand hypothesis requires lack of supply of domestic liquid assets; otherwise no EME capital outflows Precautionary savings hypothesis: Insurance against idiosyncratic risk of EMEs (Mendoza et al. 2009) Complements: investment/capital=risk and bonds=safe asset May be better in accounting for crisis capital flows (more later) 4
How well does the model fit the facts? Stylised facts about EME capital flows Net outflows vs. gross flows Composition is key: Outflows in portfolio investment (bonds in particular) vs sizeable share of inflows in FDI (vs. liquid assets) Big role of EME official outflows accounting for most of EME net outflows - or sometimes even more net private inflows into many EMEs Importance of household savings vs. corporate savings 5
Net private capital inflows into EMEs Cumulated portfolio flows by region (Feb 2007=100; index) Net private capital flows to emerging economies (1995 2011; USD billions) 115 110 Advanced Economies Emerging Economies 1,400 1,200 1,000 private creditors equity investment private flows 105 800 100 600 400 95 200 90 85 Jan-07 Jan-08 Jan-09 Jan-10 0-200 (e) (p) (p) 1995 1997 1999 2001 2003 2005 2007 2009 2011 Source: Emerging Portfolio Fund Research (EPFR). Source: The International Institute of Finance (IIF). Note: (e) stands for estimated and (p) for projected. 6
Composition: Capital Bypass Circulation Source: Ju and Wei (2007) 7
How well does the model fit the facts? Composition of gross flows suggests that lack of financial intermediation is important, rather than demand for liquid assets alone Ju & Wei (2006): bypass circulation effect large EME gross flows as a form of financial intermediation across EME sectors BB model: why are capital flows not more volatile? Gross capital flows should be volatile as some EME firms draw on liquid foreign assets, while other firms build up such assets Little evidence of large movements in EME foreign assets both in aggregate and at the firm level 8
How well does the model fit the facts? EME household sector important source of savings Missing from model Decisions likely in part due to precautionary motives and also credit constraints, yet of a different form precautionary motive more consistent with stability of gross EME asset outflows during normal times EMEs very heterogenous in terms of savings behaviour, often not that different from some ACs 9
Are savings in EMEs really that different? Gross national savings, as % of GDP, average 2005-07 Source: Ma & Yi (BIS WP No. 312, June 2010) 10
China s excess savings rate Key motivations for saving in China, % of respondents 40 35 30 25 20 15 10 5 60 50 40 30 20 10 The savings by sectors % of GDP Households Companies Public sector 0 Kid's education Retirement Medical care Home purchase Kid's wedding expenditure 0 2000 2001 2002 2003 2004 2005 2006 2007 Source: HSBC Source: CEIC 11
How well does the model fit the facts in crisis? Claim: the hypothesis is consistent with the limited reaction of net capital flows and exchange rates in the wake of the financial crisis But capital flows and exchange rates reacted massively during the crisis Biggest effects on EMEs (rather than advanced countries) Flight to safety or liquidity Shift into government bonds risk one key motive behind global capital flow dynamics during crisis Massive depreciation of EME exchange rates & some loss in reserves Some evidence 12
EMEs strongly affected by the crisis Real GDP growth developments and outlook (quarter-on-quarter % change) Exchange rate developments in selected EMEs (vis-à-vis USD, in pp contribution) 3 CIS CEE EU countries Advanced Emerging Asia Latin America United States Euro Area mid Sept 08 to end March 09 Apr 09 to current 2 Japan 1 0 China Hong Kong India -1 Indonesia -2-3 Korea Malaysia Singapore -4 Turkey -5-6 S. Africa Russia Argentina -7 2008 2009 2010 2011 2012 Source: ECB Staff Calculations. Note: Last observation refers to 2014. Brazil Mexico -30-20 -10 0 10 20 30 Source: Haver Analytics and ECB Staff Calculations Note: Last observation refers to 10 May 2010. 13
Equity markets: EMEs hit hardest particularly via capital flows retrenchment and flight to safety Total EME equity flows and prices (since Jan 2004, cumulative monthly flows in bn USD and total MSCI return index) Stock market developments in selected EMEs (total return since 15/9/2008, in pp contribution) 1400 1300 MSCI (lhs) FLOWS (rhs) 180 160 Mid Sept 08 to end March 09 United States Euro Area Apr 09 to current 1200 140 Japan China 1100 120 Hong Kong India 1000 900 800 700 100 80 60 Indonesia Korea Malaysia Singapore Turkey S. Africa 600 40 Russia Ukraine 500 20 Argentina Brazil 400 2004 2005 2006 2007 2008 2009 Source: EPFR and Bloomberg. Note: Last observation refers to end April 2009. 0 Mexico -60-40 -20 0 20 40 60 80 100 120 140 160 Source: Haver Analytics and ECB Staff Calculations Note: Last observation refers to 10 May 2010. 14
Market perception of fiscal risk: Sovereign spreads Selected bond spreads (vis-à-vis German bonds for euro area countries, vis-à-vis US bonds for EMEs) 1200 EMBIG bond spreads (actual versus fitted bps) 700 1000 600 actual fitted 800 500 600 400 400 300 200 200 0 100 UK Spain Portugal Ireland Greece China Malaysia South Africa Mexico Brazil Russia Philipines Indonesia Turkey Ukraine Argentina Ecuador Venezuela 0 2000 2002 2004 2006 2008 2010 Source: Haver Analytics. Note: Observation refers to 12 May 2010. Source: ECB Staff Calculations. Note: Last observation refers to March 2010. 15
Reserve depletion during the crisis Percentage decrease of reserves between March 2008 and August 2009 (*) 40% 37% 35% 30% 25% 31% Average reserve depletion from pre-crisis peak: -14% 20% 15% 10% 5% 0% 0.2% Russia Malaysia Korea India Peru Mexico Indonesia Turkey Argentina Brazil Singapore Thailand S. Africa Hong Kong Colombia Chile Philippines China Source: Haver Analytics and ECB staff calculations. (*) The pre-crisis maximum reserve level that had been reached by August 2008 was reached in: 08-2008 in the Philippines, China, Mexico, Colombia, Chile and Brazil; in 07-2008 in Russia, South-Africa and Indonesia; in 06-2008 in Malaysia; in 05-2008 in India, in 04-2008 in Peru and in 03-2008 in Argentina, Hong Kong SAR, Korea, Singapore, Thailand and Turkey. The crisis minimum was reached in 10-2008 in China, Hong Kong SAR, the Philippines, Singapore, Thailand and South Africa; in 11-2008 in Chile, Indonesia and Korea; in 02-2009 in Brazil, Colombia, Peru and India; in 03-2009 in Russia; in 04-2009 in Turkey and Malaysia; and in 08-2009 in Argentina and Mexico. 16
Asymmetric effects of shocks AC shocks have little effect on EMEs in model and AC behave like closed economies EME shocks (productivity) have effect on advanced economies via capital flows/liquidity and interest rates Pos. productivity shock induces outflows of capital and a decrease in world interest rates due to financial constraints on EME firms This implication of model seems rather counter-intuitive and not entirely consistent with observed transmission Missing from model is real side of the economy EME investment in part causes by AC demand 17
Effect of reserve accumulation on US interest rates substantial Source Banque de France (2005) Estimated reduction 125 Bernanke et al. (2004) 50-100 BIS (2006) ~ 0 Goldman Sachs (2004) 40 IXIS (2005) 75 JP Morgan (2005) 30-50 Krishnamurthy and Vissing-Jorgensen (2007) 20-55 Merrill Lynch (2005) 30 Morgan Stanley (2005) 100-150 PIMCO (2005) 100 Roubini and Setser (2005) 200 Truman (2005) 75 Vanguard Group (2005) ~0 Warnock and Warnock (2006) 90 Source: Bracke et al. (2008) 18
Summary Nice and compelling contribution to the literature, esp. for understanding EME demand for liquid AC assets Complementary, rather than alternative explanation to that of the literature (financial development, precautionary motives) Yet some open issues as to how well model can account for observed pattern of capital flows, asset prices & exchange rates Also not clear to what extent model s implications about the international transmission of shocks captures main features of shock transmission 19
Annex 20
Emerging and re-emerging global imbalances 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0-1.5-2.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014. Latin America Emerging Europe Other industrialised Other Asia China Japan Euro area Oil exporters United States Source: IMF WEO (April 2010) 21
Current account benchmarks United States China 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% 1980 1984 1988 1992 1996 2000 2004 2008 2012(e) 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% 1980 1984 1988 1992 1996 2000 2004 2008 2012(e) Actual Equilibrium Cyclical* Actual Equilibrium Cyclical* 3% 2% 1% 0% -1% -2% -3% -4% -5% -0.5% -0.2% 0.1% -0.1% -0.5% 1.0% 0.1% -0.2% -0.3% -0.4% -1.1% -3.6% 10% 8% 6% 4% 2% 0% -2% -4% 0.9% -0.2% -0.5% 0.7% 0.3% -1.6% 0.7% 1.0% -0.1% 2.0% 3.2% 7.7% Source: ECB staff calculations based on Bussiere, CA Zorzi, Chudik and Dieppe (2009) 22 NFA Oil balance Investment/GDP Growth Fiscal balance Relative income Demography Institutional quality Trade/finance int. Dummies Sum 2014 CA projection NFA Oil balance Investment/GDP Growth Fiscal balance Relative income Demography Institutional quality Trade/finance int. Dummies Sum 2014 CA projection
Importance of EME official capital flows Reserve accumulation beyond self-insurance EMEs foreign exchange reserves and reserve adequacy benchmarks (USD bn) 7,000 Total EMEs holdings of foreign exchgange reserves 6,000 5,000 4,000 3,000 2,000 6 months of imports (pre crisis country average) 330% of short term debt (pre-crisis country average) 3 months of imports 1,000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 100% of short term debt 23