International Capital Flows and Extreme Exchange Market Pressure: Evidence from Emerging Market Economies
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International Capital Flows and Extreme Exchange Market Pressure: Evidence from Emerging Market Economies Sook-Rei Tan1
· Wei-Siang Wang1 · Wai-Mun Chia1
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract In response to the currency crises in the emerging market economies (EMEs) during the 1990s, earlier studies tended to put emphasis on identifying and explaining currency crash, which is an extreme event mostly associated with massive capital reversals. After the 2008 global financial crisis, the focus shifted towards enormous capital inflows which have put a sharp appreciation pressure on domestic currency and inflated a large housing and construction bubble. In this paper, we examine the foreign exchange instabilities of a group of EMEs between 1995Q1 and 2019Q4 using the exchange market pressure (EMP) index by taking into considerations both extreme positive and negative episodes. The identification of tail observations is carried out under the framework of Extreme Value Theory (EVT) to handle asymmetric and heavy-tailed data. A panel multinomial logit model is used to explore whether the predictors differ between extreme positive and negative EMP events. Our findings show that (1) there is asymmetry in the EMP distributions, where the occurrence of currency crises is more frequent than excessive appreciations in most EMEs, (2) portfolio and credit flows are significant predictors to both extreme events, and (3) by distinguishing the residency of capital flows, foreign credit flow is the key factor that contributes to the devaluation pressure in the EMEs. Keywords Exchange market pressure · Extreme value theory · Capital flows · Emerging market economies · Multinomial logit model Sook-Rei Tan
[email protected] Wai-Mun Chia
[email protected] Wei-Siang Wang [email protected] 1
Department of Economics, Nanyang Technological University, School of Social Sciences, 14 Nanyang Drive Singapore 637332, Singapore
S.-R. Tan et al.
JEL Classification F15 · F21 · F31 · F32
1 Introduction The past few decades have witnessed an unprecedented scale of financial integration from the emerging market economies (EMEs) into the world. This burgeoning financial liberalization that swept across the EMEs has attracted tremendous capital inflows which have brought mixed impacts on the EMEs. On one hand, capital inflows from developed countries provide ample liquidity which helps facilitate business expansion and stimulates economic growth of the EMEs. On the other hand, excessive capital flows are often associated with currency appreciation and hence asset price bubble which results in the erosion of external competitiveness. Reliance on foreign financial flows will also expose the EMEs to the risk of ‘Sudden Stop’ and consequently increase the likelihood of financial crises to the recipient country (Calvo 1998). While financial globalization seems to be an inevitable trend to most EMEs, its pros and cons invite controversial debates. Passari and Rey (2015) even conclude from the findings of
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