The Drivers of Financial Globalization The Drivers of Financial Globalization Philip R. Lane Philip R. Lane IIIS, Trinity College Dublin IIIS, Trinity College Dublin WBI Paris Seminar WBI Paris Seminar Capital Flows, Capital Flows, Monetary Policy and Current Monetary Policy and Current Issues in International Finance Issues in International Finance April 2007 April 2007
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The Drivers of Financial GlobalizationThe Drivers of Financial Globalization
Philip R. Lane Philip R. Lane IIIS, Trinity College DublinIIIS, Trinity College Dublin
WBI Paris SeminarWBI Paris SeminarCapital Flows,Capital Flows, Monetary Policy and Current Monetary Policy and Current
Issues in International FinanceIssues in International FinanceApril 2007April 2007
IntroductionIntroduction
Measuring Financial Measuring Financial GlobalisationGlobalisationDrivers of International Financial IntegrationDrivers of International Financial IntegrationExternal Capital StructureExternal Capital StructureBilateral investment patternsBilateral investment patternsDeterminants of Net PositionsDeterminants of Net PositionsReturns, Exchange Rates and Capital FlowsReturns, Exchange Rates and Capital Flows
Scale of Global Financial DevelopmentScale of Global Financial Development
Global financial assets in 1990: $40 trillionGlobal financial assets in 1990: $40 trillionGlobal financial assets in 2005: $120 trillionGlobal financial assets in 2005: $120 trillion(sum of equity market capitalization, bond market (sum of equity market capitalization, bond market capitalization and bank deposits)capitalization and bank deposits)
Global Investor BaseGlobal Investor Base
Institutional investors (pension funds, mutual funds, Institutional investors (pension funds, mutual funds, insurance companies): $21 trillion in 1995, $53 trillion in insurance companies): $21 trillion in 1995, $53 trillion in 20052005Hedge funds: $50 billion in 1990, $1.4 trillion in 2005Hedge funds: $50 billion in 1990, $1.4 trillion in 2005Emerging markets: central banks and sovereign wealth Emerging markets: central banks and sovereign wealth fundsfunds
CrossCross--Border ActivityBorder Activity
Global crossGlobal cross--border flows tripled over 1995border flows tripled over 1995--2005, 2005, reaching $14.5 trillion in 2005 (14.5 percent of world reaching $14.5 trillion in 2005 (14.5 percent of world GDP)GDP)20012001--2005: doubling of cross2005: doubling of cross--border portfolio assets to border portfolio assets to $19 trillion$19 trillionUS: $2.3 trillion to $4.6 trillionUS: $2.3 trillion to $4.6 trillionJapan: $0.6 trillion to $2.1 trillionJapan: $0.6 trillion to $2.1 trillionEurope: increase of $6.1 trillion during 2001Europe: increase of $6.1 trillion during 2001--2005.2005.EM bond funds: $27 billion in 2000 to $230 billion in EM bond funds: $27 billion in 2000 to $230 billion in 2006.2006.
Restrictions on capital movementsRestrictions on capital movementsArbitrage gaps between onshore and offshore ratesArbitrage gaps between onshore and offshore ratesVolumeVolume--based measures: scale of international balance based measures: scale of international balance sheet; scale of gross capital flowssheet; scale of gross capital flowsVolumes important in capturing exposures and linkage Volumes important in capturing exposures and linkage mechanismsmechanisms
EWN Mark II: Dataset on external position (assets EWN Mark II: Dataset on external position (assets and liabilities) for 145 countriesand liabilities) for 145 countries
Extends and improves the dataset in Lane and MilesiExtends and improves the dataset in Lane and Milesi--Ferretti (JIE 2001)Ferretti (JIE 2001)From 67 countries to 145 countries (nearly universal From 67 countries to 145 countries (nearly universal coverage)coverage)Coverage extended to 1970Coverage extended to 1970--20042004Much larger availability of stock estimates from national Much larger availability of stock estimates from national authoritiesauthorities
Dataset Dataset ““outputsoutputs””
External assetsExternal assetsPortfolio equityPortfolio equityForeign direct investmentForeign direct investmentDebt assetsDebt assets
•• Portfolio debt (for some countries/periods)Portfolio debt (for some countries/periods)•• Other investment assets (for some countries/periods)Other investment assets (for some countries/periods)
Reserve assets (net of gold)Reserve assets (net of gold)Financial derivatives Financial derivatives (limited coverage)(limited coverage)
Dataset Dataset ““outputsoutputs”” (II)(II)
External liabilitiesExternal liabilitiesPortfolio equityPortfolio equityForeign direct investmentForeign direct investmentDebt liabilitiesDebt liabilities
•• Portfolio debt (for some countries/periods)Portfolio debt (for some countries/periods)•• Other investment liabilities (for some countries/periods)Other investment liabilities (for some countries/periods)
Data inputsData inputsInternational Investment Positions (when reported)International Investment Positions (when reported)Balance of payments flowsBalance of payments flowsWorld BankWorld Bank’’s Global Development Finance (external debt)s Global Development Finance (external debt)FDI stocks and flows from UNCTADFDI stocks and flows from UNCTADStock of portfolio equity holdings in the US and by US residentsStock of portfolio equity holdings in the US and by US residents(Warnock)(Warnock)CPIS Portfolio SurveyCPIS Portfolio SurveyBIS BIS locationallocational banking statisticsbanking statisticsNational sourcesNational sourcesHistorical data from Sinn (1990)Historical data from Sinn (1990)IMF desksIMF desksetc....etc....
Estimation methodsEstimation methods
Eclectic...Eclectic...Stock data, complemented by cumulative Stock data, complemented by cumulative capital flows with valuation adjustmentscapital flows with valuation adjustments
For portfolio equity, valuation reflects stock For portfolio equity, valuation reflects stock market pricesmarket pricesFor debt, its currency compositionFor debt, its currency compositionFor FDI, international relative pricesFor FDI, international relative prices
CaveatsCaveats
Substantial degree of uncertainty for estimatesSubstantial degree of uncertainty for estimatesSome offshore centers missingSome offshore centers missingLarge world NFA discrepancyLarge world NFA discrepancy
Some data featuresSome data features
Acceleration in scale of crossAcceleration in scale of cross--border asset trade (more border asset trade (more so for advanced nations)so for advanced nations)Increase in relative importance of equity finance for Increase in relative importance of equity finance for developing countriesdeveloping countriesMost advanced countries have positive net equity, Most advanced countries have positive net equity, negative net debt positions; most developing countries negative net debt positions; most developing countries have negative net equity positionshave negative net equity positionsWeakening correlation between CA and D(NFA)Weakening correlation between CA and D(NFA)Cumulative impact of valuation channel importantCumulative impact of valuation channel important
Figure 3. International Financial Integration: Industrial Group and Emerging Markets/Developing Countries Group, 1970-2004
Figure 10g. Change in NFA/GDP, 1996-2004: Western Hemisphere
Latin America
Trinidad and TobagoJamaica
Venezuela, Rep. Bol.
Uruguay
Peru
Paraguay
Panama
Mexico
Honduras
Haiti
Guatemala
El Salvador
Ecuador
Dominican Republic
Costa Rica
ColombiaChile
Brazil
Bolivia
Argentina
-120
-100
-80
-60
-40
-20
0
20
-120 -100 -80 -60 -40 -20 0 20
NFA (pct of GDP), 1996
NFA
(pct
of G
DP)
, 200
4
Figure 11a. Net Equity Position versus Net Debt Position: Industrial Group, 2004
NZE
AUS ESP
PRT
ICE
GRE
FIN
JPN
CAN
SWI
SWE NOR
NET
ITA GERFRA
DENBEL
AUT
UK
USA
-50
-40
-30
-20
-10
0
10
20
30
40
50
60
-150 -100 -50 0 50 100 150
Net debt (pct of GDP)
Net
equ
ity (p
ct o
f GD
P)
Figure 11b. Net Equity and Net Debt Position: Emerging Markets and Developing Countries, 2004
ROM
POL
BHZ
MAC
SLO
CROLIT
HUN
LAT
EST
SLK
CZE
UZBUKR TKM
CHNTAJ
RUS
MOLBUL
KYR
KAZGEO
ALB
BEL
AZE
ARM
PNGZMB
BUR
UGA
TUN
TOG
TAN SWASUD NAM
SEN
RWA
NGAMOZMOR
MWI
MAL
MDG
LIB
KEN
CIV
GUI
GHA
GBN
ETH
CHA
CMR
BOT
ANG
ALG
VTM
THA
SGP
PHL
PAK
NEP
MYS
LAOKOR
IDO IND
HKG
TAI
SLK
CAM
MYA
BGDYEM
EGY
UAE
SYR
SAUQTROMN
LBN
KWT
JORISR
IRN
CYP
BAH
TTO
JAM
VENURU
PER
PAR
PAN
NIC
MEXHND
GUA
SLVECU
DOM
CRI
COLCHLBRA
BOL
ARG SAFTUR
MLT
-120
-70
-20
30
80
130
-110 -60 -10 40 90 140 190 240 290
Net debt (pct of GDP)
Net
equ
ity (p
ct o
f GD
P)
Table 5a. Matrix of Net Debt and Net Equity Positions: Industrial Countries, 2004
Industrial countries
NET EQUITY <0 >0
<0 6 11
NET DEBT >0 3 3
Table 5b. Matrix of Net Debt and Net Equity Positions: Emerging Markets and Developing Countries, 2004
Developing countries
NET EQUITY
<0 >0
<0 73 0 NET DEBT
>0 31 8
Dynamics of External PositionsDynamics of External Positions
In addition to role of capital flows, increasing importance In addition to role of capital flows, increasing importance of valuation effects (capital gains and losses on external of valuation effects (capital gains and losses on external assets and liabilities)assets and liabilities)Valuation channel an important transmission mechanism Valuation channel an important transmission mechanism for exchange rate movementsfor exchange rate movementsAdvanced countries versus emerging market economiesAdvanced countries versus emerging market economies
An accounting frameworkAn accounting frameworkNFA accumulation equation:NFA accumulation equation:
Taking ratios of GDP:Taking ratios of GDP:
1t t t t tB B CA KG−− = + +Ε
1 1
1 1(1 )(1 )
A Lt t t t t t t
t t t t tt t t
i A i L KG gb b bgst bY g
π επ
− −− −
− + +− ≡ + − +
+ +
Accounting framework (II)Accounting framework (II)We can reWe can re--arrange terms of the previous arrange terms of the previous equation in a more familiar form:equation in a more familiar form:
Where Where aa is the stock of gross external assets.is the stock of gross external assets.When rates of return on assets and When rates of return on assets and liabsliabs are are equal, this is the familiar debt accumulation equal, this is the familiar debt accumulation eqneqn. . When they are not, When they are not, gross positions matter!gross positions matter!
1 1 11 1
L A Lt t t t
t t t t t tt t
r g r rb b bgst b ag g
ε− − −
− −− ≡ + + +
+ +
Large industrial countries: NFA 2001Large industrial countries: NFA 2001--20042004
Cumulative trade balance
Cumulative inv. income KA, EO Growth K-gains
United States -16.7 -8.3 -19.8 1.0 -0.9 4.0 7.4
United Kingdom -3.7 -9.1 -15.3 7.4 0.6 0.9 -2.9
Euro Area -9.8 -5.6 4.1 -2.5 0.4 1.4 -9.0
Canada -4.8 -5.7 18.5 -9.7 -1.0 1.8 -15.2
Japan 24.3 14.5 5.0 6.8 -1.2 0.3 3.7
Table 2. Decomposition of change in net foreign assets, 2001-2004
Initial NFA (2000)
Change in net foreign assets
Other factorsCumulative current account
Table 8a. Cumulative Current Account and Change in Net Foreign Asset Position: Industrial Group, 1972-2004
(1) (2) (3) Change
in NFACumulative
current account
Difference
Switzerland 142.6 121.4 21.2 United States -23.1 -38.4 15.2 Canada -9.2 -16.5 7.4 United Kingdom -13.3 -19.3 6.0 Austria -17.1 -18.7 1.6 Australia -62.3 -60.4 -1.8 Germany 7.6 10.9 -3.3 Belgium 30.1 33.6 -3.6 France 4.7 9.2 -4.5 Norway 65.5 71.1 -5.6 Japan 37.6 44.2 -6.6 Portugal -68.4 -58.7 -9.7 Ireland -19.3 -5.0 -14.3 Denmark -10.5 5.3 -15.9 Italy -18.4 -1.6 -16.8 Greece -73.4 -55.7 -17.7 Spain -48.7 -24.7 -24.0 New Zealand -93.2 -66.4 -26.7 Sweden -9.5 18.0 -27.6 Finland -10.7 18.8 -29.5 Iceland -91.8 -49.6 -42.2 Netherlands -8.0 48.5 -56.5
Table 8b. Cumulative Current Account and Change in Net Foreign Asset Position: Selected Developing Countries, 1982-2004
Table 6. Correlation Between Current Account and Change in Net Foreign Assets: Industrial Countries and Emerging Markets, Annual Data, 1971-2004
Industrial countries Emerging markets
1971-2004 0.42 0.58
1971-1981 0.71 0.72
1982-1992 0.63 0.68
1993-2004 0.34 0.47
Determinants of International Financial IntegrationDeterminants of International Financial Integration
Benchmark: expect very high levels of IFI under frictionless traBenchmark: expect very high levels of IFI under frictionless tradedeView recent evolution as convergence to benchmark, in line with View recent evolution as convergence to benchmark, in line with reductions in costs of trade and increases in gains to diversifireductions in costs of trade and increases in gains to diversificationcation
We explore the role of a wide set of determinants:We explore the role of a wide set of determinants:Capital account liberalizationCapital account liberalizationTrade in goods and servicesTrade in goods and servicesPer capita GDPPer capita GDPDomestic financial depthDomestic financial depthDomestic Domestic stockmarketstockmarket capitalizationcapitalizationPrivatizationPrivatizationTax structureTax structureQuality of financial regulationQuality of financial regulation
Level of International Financial IntegrationLevel of International Financial Integration
Increasing in income per capitaIncreasing in income per capitaIncreasing in trade openness Increasing in trade openness -- complementaritycomplementarityIncreasing in domestic financial developmentIncreasing in domestic financial developmentIncreasing in external account liberalizationIncreasing in external account liberalization
Panel Analysis of financial integration, Panel Analysis of financial integration, 19821982--20012001
(Dep. Var.: change in financial integration)(Dep. Var.: change in financial integration) (1) (2) (3) (4) (5)
Adjusted R2 0.12 0.31 0.41 0.89 0.9 Number of obs. 72 72 72 66 59
Institutions and Capital FlowsInstitutions and Capital Flows
Good institutions lead to:Good institutions lead to:Greater financial integrationGreater financial integrationGreater ability to attract capital inflowsGreater ability to attract capital inflowsImproved Improved ‘‘qualityquality’’ of inflows of inflows –– more portfolio equity, more more portfolio equity, more FDI, more bondsFDI, more bondsImproved Improved ‘‘qualityquality’’ of outflows of outflows –– less capital flight; lower less capital flight; lower need to hold reservesneed to hold reservesLower spreadsLower spreads
Institutional mix: general versus financialInstitutional mix: general versus financial
Dynamics of External Capital StructureDynamics of External Capital StructureFariaFaria et al, JEEA, April/May 2007et al, JEEA, April/May 2007
Focus on emerging markets and developing economiesFocus on emerging markets and developing economiesExternal capital structure: (total liabilities/GDP); (equity External capital structure: (total liabilities/GDP); (equity liabilities/total liabilities); (FDI liabilities / equity liabilliabilities/total liabilities); (FDI liabilities / equity liabilities)ities)Institutional Quality Index from Kaufman et al (World Institutional Quality Index from Kaufman et al (World Bank), available 1996Bank), available 1996--20042004Financial Reform Index: Financial Reform Index: DetragiacheDetragiache et al (IMF)et al (IMF)Country SizeCountry SizeGDP per capitaGDP per capitaTrade opennessTrade opennessNatural resourcesNatural resources
Existing LiteratureExisting Literature
Lane and Lane and MilesiMilesi--FerrettiFerretti (2001); Wei (2001); (2001); Wei (2001); Albuquerque (2003); Albuquerque (2003); FariaFaria and Mauro (2004); and Mauro (2004); KraayKraay et al et al (2005); (2005); RazinRazin and and SadkaSadka (2006)(2006)Empirical analysis: predominant focus is on crossEmpirical analysis: predominant focus is on cross--sectional variationsectional variationOur contribution: take advantage of greater data Our contribution: take advantage of greater data availability along the time series dimension (for both availability along the time series dimension (for both external capital structure and potential covariates)external capital structure and potential covariates)
External Capital Structure: CrossExternal Capital Structure: Cross--SectionSection1996 and 20041996 and 2004
CrossCross--section: section: larger, more open economies with a better larger, more open economies with a better institutional quality score and a greater reliance on natural reinstitutional quality score and a greater reliance on natural resource source production have a greater equity share in external liabilities production have a greater equity share in external liabilities Time series: Time series: shift towards equity financing is stronger among those shift towards equity financing is stronger among those countries that have undertaken a greater degree of domestic countries that have undertaken a greater degree of domestic financial reform; importance of gradual adjustmentfinancial reform; importance of gradual adjustmentNext steps: Next steps: which are the most important institutional changes and which are the most important institutional changes and dimensions of financial reforms?; impact of financial globalizatdimensions of financial reforms?; impact of financial globalization on ion on domestic financial sectors; verify whether an increase in the eqdomestic financial sectors; verify whether an increase in the equity uity share of liabilities is indeed associated with improved internatshare of liabilities is indeed associated with improved international ional risk sharing and greater financial stabilityrisk sharing and greater financial stability
What explains why country A invests in country B?What explains why country A invests in country B?Country ACountry A’’s propensity to invest overseass propensity to invest overseasCountry BCountry B’’s general attractiveness as a destinations general attractiveness as a destinationBilateral linkages between A and BBilateral linkages between A and B
―― Important for Important for ‘‘investor baseinvestor base’’―― Important for transmission of shocksImportant for transmission of shocks―― Important for risk analysisImportant for risk analysis―― Important for asset pricing and return Important for asset pricing and return comovementscomovements
Bilateral LinkagesBilateral Linkages
Optimal diversification has a bilateral dimensionOptimal diversification has a bilateral dimension―― Trade riskTrade risk―― GDP / return riskGDP / return risk•• Information frictionsInformation frictions―― Gravity variables (Distance, Language, Colonial Ties Gravity variables (Distance, Language, Colonial Ties …… ))―― Also Trade volumeAlso Trade volume•• Bilateral trading costsBilateral trading costs―― Bilateral exchange rate stability, language, common Bilateral exchange rate stability, language, common
Asset holdings significantly correlated with trade linkagesAsset holdings significantly correlated with trade linkagesDistance also matters (more so for FDI, banks than Distance also matters (more so for FDI, banks than portfolio flows)portfolio flows)Institutional similarityInstitutional similarityAsset holdings less influenced by Asset holdings less influenced by ‘‘return hedgingreturn hedging’’ factorsfactorsStrong impact of currency union (EMU) Strong impact of currency union (EMU) –– on equity; on equity; portfolio debtportfolio debtMore generally, More generally, ‘‘regionalregional’’ policies matterpolicies matter
Determinants of Net External PositionsDeterminants of Net External Positions
LongLong--Term Capital Movements:Term Capital Movements:Level of income per capitaLevel of income per capitaDemographic factorsDemographic factorsLevel of public debtLevel of public debtDomestic Financial Sector (?)Domestic Financial Sector (?)Structural differences more influential, with Structural differences more influential, with decline in investor home biasdecline in investor home bias
New Systemic ViewsNew Systemic Views
Outsourcing of financial intermediationOutsourcing of financial intermediationImperative to maintain Imperative to maintain ‘‘undervaluedundervalued’’ exchange rate in exchange rate in order to facilitate exportorder to facilitate export--driven growthdriven growthRestrictions on private capital flows to prevent arbitrageRestrictions on private capital flows to prevent arbitrageBrettonBretton Woods IIWoods IISimilar sentiment: Caballero, Similar sentiment: Caballero, FarhiFarhi, , GourinchasGourinchas; ; Mendoza, Mendoza, QuadriniQuadrini, Rios, Rios--RullRull
Temporary FactorsTemporary Factors
Differences in business cyclesDifferences in business cyclesRecovery from 1990s financial crisesRecovery from 1990s financial crisesCommodity price boom (especially oil)Commodity price boom (especially oil)(Global savings glut and/or weak investment)(Global savings glut and/or weak investment)Offsetting factors: excess reserves, domestic spending Offsetting factors: excess reserves, domestic spending pressures, domestic reformpressures, domestic reformDomestic financial Domestic financial liberalisationliberalisationEMUEMU
Sustainability of US positionSustainability of US position
Role of valuation channelRole of valuation channelAnalysis of Portfolio AdjustmentAnalysis of Portfolio AdjustmentLooking to the FutureLooking to the Future
Valuation effectsValuation effectsEuro area, Japan, and U.S., 2002Euro area, Japan, and U.S., 2002--20052005
Factor → NFA at end-2001
Change in NFA
2001-05
Cumul. trade
balance
Cumul investm. income
Valuation changes
Effects of growth
Other factors 1/
Term in eq (2) →
01b 05 01b b− 2005
2002t
t
bgst=∑
20051 1
2002
A Lt t t t
t t
i A i LY
− −
=
−
∑
2005
2002
t
t t
KGY=
∑2005
12002 (1 )(1 )
t tt
t t t
g bg
ππ −
=
+− + +
∑2005
2002t
t
ε=∑
Euro Area -7.2 -7.2 3.3 -2.0 -9.2 2.7 -1.9
Japan 32.5 0.8 5.7 7.1 -7.4 -2.9 -1.7 United States -23.8 2.3 -20.6 0.9 17.2 4.5 0.4
SummarySummary
US made large net returns on its external US made large net returns on its external portfolio over 2001portfolio over 2001--20052005Continued in 2006: large equity market Continued in 2006: large equity market return differentialreturn differentialSustainable?Sustainable?
Sources of Net Valuation GainsSources of Net Valuation Gains
Composition effect (long equity, short debt; maturity Composition effect (long equity, short debt; maturity structure)structure)Return differentials within categoriesReturn differentials within categoriesPortfolio returnsPortfolio returnsFDI returnsFDI returnsDifferentials and currency movementsDifferentials and currency movementsBehavior of international investorsBehavior of international investors
Exchange rates and rates of returnExchange rates and rates of return
1 1
1 1
A Lt t t t t
A Lt t t
t tt t t
R E T r A r L
R E T r rA LR E R R E R R E R
− −
− −
= −
∂ ∂ ∂= −
∂ ∂ ∂
Overall effect depends onOverall effect depends onScale of foreign asset and liability holdingsScale of foreign asset and liability holdingsRelation between RER and rates of return on Relation between RER and rates of return on foreign assets and liabilitiesforeign assets and liabilitiesWill depend on composition (e.g. equity v debt; Will depend on composition (e.g. equity v debt; domestic currency v foreign currency)domestic currency v foreign currency)
Liabilities mostly in domestic currency; assets have high Liabilities mostly in domestic currency; assets have high FC componentFC componentDepreciation generates net capital gainDepreciation generates net capital gainBut interest rate parity kicks in if depreciation expectedBut interest rate parity kicks in if depreciation expectedTiming: Timing: GourinchasGourinchas--ReyRey find US dollar depreciates when find US dollar depreciates when US net external liabilities cyclically largeUS net external liabilities cyclically largeLucas critique: nonLucas critique: non--exploitable policyexploitable policyMonetary policy driven by domestic concernsMonetary policy driven by domestic concerns
Emerging MarketsEmerging Markets
Devaluations raise dom.Devaluations raise dom.--currency payouts on foreign currency payouts on foreign liabilitiesliabilities——balancebalance--sheet effectssheet effects!!Trend real appreciation?Trend real appreciation?Improve riskImprove risk--sharing: FDI and equity promote closer link sharing: FDI and equity promote closer link between dom. econ. performance and rates of return; between dom. econ. performance and rates of return; increase levels of FC reservesincrease levels of FC reservesAlternative forms of debt? Alternative forms of debt?
DomesticDomestic--currency bond marketcurrency bond marketGDPGDP--indexed bonds; other indexation schemesindexed bonds; other indexation schemes
Erosion of home bias and demand for dollar assetsErosion of home bias and demand for dollar assetsSymmetry in reduction in home bias?Symmetry in reduction in home bias?High returns in US?High returns in US?
Evidence on returns suggest importance of factors such Evidence on returns suggest importance of factors such as portfolio compositionas portfolio composition
Investor Investor BehaviourBehaviour and the US Positionand the US Position
The US external portfolio (net)The US external portfolio (net)US net external position: underlying components (ratio of GDP)
Relative returns heavily influenced by exchange rateRelative returns heavily influenced by exchange rateIncreases in US external liabilities associated with Increases in US external liabilities associated with subsequent depreciationsubsequent depreciationDecline in relative returns associated with subsequent Decline in relative returns associated with subsequent decline in equity/FDI flows but increase in debt flowsdecline in equity/FDI flows but increase in debt flows
Returns and Portfolio FactorsReturns and Portfolio Factors
Regress return differentials on (i) NFA position; Regress return differentials on (i) NFA position; (ii) share of US in outstanding portfolio; (iii) (ii) share of US in outstanding portfolio; (iii) share of US in lagged capital flowsshare of US in lagged capital flows
Partition between exchange rate and other Partition between exchange rate and other return componentsreturn components
Capital Flows and Portfolio FactorsCapital Flows and Portfolio Factors
Regress capital flows on lagged returns Regress capital flows on lagged returns and outstanding US portfolio shareand outstanding US portfolio share
Allow for persistence in capital flowsAllow for persistence in capital flows
Table 6. Rate of Return Differentials and The Real Exchange Rate
Looking to the FutureLooking to the FutureIs foreign capacity to absorb US liabilities declining?Is foreign capacity to absorb US liabilities declining?
1.1. Decline of equity inflowsDecline of equity inflows2.2. Within debt, increased reliance on official flowsWithin debt, increased reliance on official flows
However, However,
1.1. Limits to official flowsLimits to official flows2.2. Limits to valuation channel as an adjustment Limits to valuation channel as an adjustment