International Financial Spillovers To Emerging Market .
K.7International Financial Spillovers to Emerging MarketEconomies: How Important Are EconomicFundamentals?Ahmed Shaghil, Brahima Coulibaly, and Andrei ZlatePlease cite paper as:Ahmed Shaghil, Brahima Coulibaly, and Andrei Zlate (2015).International Financial Spillovers to Emerging MarketEconomies: How Important Are Economic Fundamentals?International Finance Discussion Papers rnational Finance Discussion PapersBoard of Governors of the Federal Reserve SystemNumber 1135April 2015
Board of Governors of the Federal Reserve SystemInternational Finance Discussion PapersNumber 1135April 2015International Financial Spillovers to Emerging Market Economies:How Important Are Economic Fundamentals?Shaghil Ahmed, Brahima Coulibaly, Andrei Zlate*NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulatediscussion and critical comment. References to International Finance Discussion Papers (otherthan an acknowledgment that the writer has had access to unpublished material) should becleared with the author or authors. Recent IFDPs are available on the Web atwww.federalreserve.gov/pubs/ifdp/. This paper can be downloaded without charge from theSocial Science Research Network electronic library at www.ssrn.com.
International Financial Spillovers to Emerging Market Economies:How Important Are Economic Fundamentals?Shaghil Ahmed, Brahima Coulibaly, Andrei Zlate*April 2015AbstractWe assess the importance of economic fundamentals in the transmission of international shocks tofinancial markets in various emerging market economies (EMEs). Our analysis covers the socalled taper-tantrum episode of 2013 and six earlier episodes of severe EME-wide financial stresssince the mid-1990s. Cross-country regressions lead us to the following results: (1) EMEs withrelatively better economic fundamentals suffered less deterioration in financial markets during the2013 taper-tantrum episode. (2) Differentiation among EMEs set in quite early and persistedthroughout this episode. (3) Controlling for economic fundamentals, we also find that, during thetaper tantrum, financial conditions deteriorated more in those EMEs that had earlier experiencedlarger private capital inflows and greater exchange rate appreciation. (4) For earlier episodes, wefind little evidence of investor differentiation across EMEs being explained by differences in theirrelative vulnerabilities during EME crises of the 1990s and early 2000s. (5) That said,differentiation across EMEs based on fundamentals does not appear to be unique to the 2013episode. Differences in economic fundamentals played a role in explaining the heterogeneousEME financial market responses during the global financial crisis of 2008, and the role offundamentals appeared to progressively increase through the European crisis in 2011 andsubsequently the 2013 taper tantrum.Keywords: Emerging market economies, financial spillovers, economic fundamentals,vulnerability, depreciation pressure, taper tantrum, financial stress.JEL classifications: E5, F3.*Shaghil Ahmed (shaghil.ahmed@frb.gov) and Brahima Coulibaly (brahima.coulibaly@frb.gov) areeconomists in the Division of International Finance, Board of Governors of the Federal ReserveSystem, Washington, D.C. 20551 U.S.A. Andrei Zlate (andrei.zlate@bos.frb.org) is a financialeconomist in the Department of Supervision, Regulation, and Credit at the Federal Reserve Bank ofBoston, 600 Atlantic Avenue, Boston, MA 02210, U.S.A. We thank Steve Kamin, Prachi Mishra,Patrice Robitaille, as well as participants at the American Economic Association 2015 annualmeetings and the Federal Reserve Board conference on “Spillovers from Accommodative MonetaryPolicies since the GFC” for very useful comments. We also thank Zina Saijid and Julio Ortiz foroutstanding research assistantship. The views expressed in the paper are those of the authors andshould not be interpreted as reflecting the views of the Board of Governors of the Federal ReserveSystem or any other person associated with the Federal Reserve System.
1IntroductionStarting in May 2013, on news that the Federal Reserve could soon start tapering its large scaleasset purchases (LSAPs), nancial conditions in emerging market economies (EMEs) deterioratedsharply. Investors withdrew capital, currencies depreciated, stock markets fell, and bond yieldsand premiums on credit default swaps rose. This so-called taper-tantrum episode sparked debateon how foreign economies may be a ected— and which economies, especially among the EMEs,may experience the most adverse e ects— once the process of U.S. monetary policy normalizationbegins.Indeed, one intriguing feature of the “risk-o ” episode during the summer and fall of 2013was that it did not have a similar e ect on all EMEs. While some countries experienced acutedeteriorations in nancial conditions, others were much less a ected. The varied experiences of thedi erent EMEs have spawned research on whether the heterogeneous response of EME nancialmarkets during the taper tantrum can be explained by di erences in economic fundamentals acrossthese economies. (See, for example: Prachi et al., 2014; Eichengreen and Gupta, 2014; Aizenman etal., 2014; and Sahay et al., 2014.) And, these experiences have also focused attention on whether,more broadly, the e ects of U.S. monetary policy shocks on EMEs over a longer period have beenrelated to these economies’own vulnerabilities (Bowman et al., 2014).In this paper, we seek to contribute to this sparse but growing literature. Speci cally, we addressthree questions: First, to what extent did investors di erentiate among the EMEs based on theireconomic fundamentals during the “risk-o ”episode of 2013? Or, can the heterogeneous responsesacross EMEs be explained by other factors, such as whether those economies that initially receivedthe heaviest capital in‡ows were also the ones from which investors receded the most during theepisode, a possibility raised by some researchers such as Aizenman et al. (2014). Second, duringthe taper-tantrum stress episode, when exactly did di erentiation across EMEs begin and howpersistent was it? Did investors initially display herd behavior and pull back indiscriminatelyfrom all EMEs, and then only begin di erentiating over time as the shock persisted? Or did theydiscriminate across EMEs from the early stages of the episode? Third, is the di erentiation acrossEMEs by investors a relatively recent phenomenon, or does the application of our methodologysuggest that investors have always distinguished among EMEs to some extent according to theireconomic fundamentals?1
Research to date has not appeared to reach a consensus on the rst question— the importanceof fundamentals in explaining the heterogeneous EME responses. Using an event study approach,Prachi et al. (2014) analyze the reaction of nancial markets to the Federal Reserve’s LSAPstapering announcements in 2013 and 2014, including the episode that we examine in this study.They nd evidence of market di erentiation among EMEs based on macroeconomic fundamentals.In addition, they nd that EMEs with deeper nancial markets and tighter macroprudential policyprior to the stress period experienced relatively less deterioration in nancial conditions.In contrast, Eichengreen and Gupta (2014) do not nd evidence that better macroeconomicfundamentals— such as a lower budget de cit, lower public debt, a higher level of international reserves, and higher economic growth— provided any insulation. They do nd, however, that EMEswhose exchange rates appreciated more earlier and whose current account de cits widened moreexperienced a larger e ect. But they conclude that the heterogeneous reactions most importantlyowed to the size of each country’s nancial market; larger markets experienced more pressure, as investors were better able to rebalance their portfolios in these EMEs with relatively large and liquid nancial markets. Similarly, Aizenman et al. (2014) nd no evidence that stronger macroeconomicfundamentals helped the EMEs weather the taper tantrum better, but their study focuses only onthe very short-term responses of nancial indicators after taper news. Classifying EMEs into twocategories (“fragile” and “robust”) based on their current account balances, levels of internationalreserves, and external debt, they nd that news of tapering from Fed Chairman Bernanke wasassociated with sharper deterioration of nancial conditions in the “robust” EMEs compared withthe “fragile” ones in the very short term (24 hours following the announcement). The authors rationalize their results by conjecturing that EMEs with stronger fundamentals received more capitalin‡ows during the expansionary phase of the Federal Reserve’s conventional and unconventionalmonetary policy and accordingly experienced sharper capital out‡ows and deteriorations in nancial conditions on news of an impending tapering. This hypothesis is not explicitly tested in theirstudy, and the authors acknowledge that, over a longer window than they considered in their eventstudy, the fragile EMEs may have su ered more than robust EMEs after the taper news.We approach the rst question in a somewhat di erent manner from these previous studies.Rather than looking at market reactions on days when news may be coming in about the FederalReserve’s tapering of asset purchases as Prachi et al. (2014) do, we treat the taper tantrum as asingle episode, de ned by the observed “peak-to-trough”behavior of nancial markets surrounding2
the period when concerns about tapering came to the forefront. And unlike Aizenman et al. (2014),but consistent with Prachi et al. (2014), we exploit ner cross-section di erences in vulnerabilitiesacross the EMEs rather than divide the EMEs into two groups based on the behavior of only threevariables. Using a sample of 20 emerging market economies and cross-section regression analysis,we assess the role of economic fundamentals in the heterogeneous cumulative performance of EME nancial markets over the whole episode from May 2013 through August 2013.We nd that EMEs that had relatively better fundamentals to begin with— as measured bya host of individual variables capturing vulnerability as well as an aggregate index of relativevulnerabilities across EMEs that we construct— su ered less deterioration during the taper-tantrumepisode as measured by a broad range of nancial variables, including exchange rate, depreciationpressure, and government bond yields, as well as EMBI and CDS spreads. Our results are consistentwith those in Prachi et al. (2014), but contrast with those in Aizenman et al. (2014) and Eichengreenand Gupta (2014). We also nd that nancial conditions deteriorated more in those EMEs that hadearlier experienced larger private capital in‡ows and exchange rate appreciations, consistent withthe “more-in-more-out” hypothesis that EMEs that experienced larger in‡ows prior to the tapertantrum also experienced larger out‡ows once the episode began. Also, we nd some evidencethat the structure of the nancial markets— such as the size of the capital market, the level offoreign investor participation, the extent of capital account openness, or revisions to the growthoutlook— shaped the heterogeneous responses of some nancial indicators, as in Eichengreen andGupta (2014). However, the strength of economic fundamentals explains much more of the variationin responses across EMEs compared with other factors, such as the previous runup in ‡ows or thestructure of nancial markets.On the second question, related to the timing and persistence of di erentiation, the conventionalwisdom seems to be that early in the taper tantrum, investors did not di erentiate much amongEMEs according to their vulnerabilities, but such di erences emerged when concerns about taperingpersisted. (See, for example, Sahay et al., 2014). However, our evidence suggests that di erentiationaccording to relative vulnerabilities set in relatively early during the stress episode and persistedfor some time, although the extent of di erentiation was less pronounced in the rst few weeks.Turning to the third question of the extent to which investors also discriminated among EMEsin the past, we use our methodology to identify six previous episodes of severe nancial stress in theEMEs over the past 20 years: the European sovereign debt crisis (2011), the global nancial crisis3
(GFC, 2008-09), the Argentine crisis (2002), the Russian crisis (1998), the Asian crisis (1997-98),and the Mexican crisis (1994-95). For each of these episodes, we examine the role of economicfundamentals in driving any heterogeneous cumulative reaction of asset prices over the full episodeacross EMEs. We nd little evidence of di erentiation based on economic fundamentals in the1990s and the early 2000s, consistent with literature on herding behavior of investors toward EMEsand contagion during that period, such as Dornbusch et al. (2000) and Calvo and Mendoza (2001).However, the results also suggest that di erentiation was not unique to the taper tantrum in 2013.In fact, it appears that fundamentals played a role in explaining the heterogeneous reaction ofEME asset prices during the GFC in 2008, and that their role increased during the Europeansovereign crisis in 2011, and then increased further during the taper tantrum in mid-2013. Theseresults that di erentiation has occurred among EMEs since the GFC are consistent with thosefrom a complementary approach taken in Bowman et al. (2014): identifying monetary policyrelated shocks to U.S. interest rates, rather than episodes of severe nancial stress as we do, they nd that the e ect of such shocks on EME interest rates have been larger in the relatively morevulnerable EMEs in the recent past as well, and that there is no di erence in this respect betweenthe e ects of conventional and unconventional U.S. monetary policy.Taken at face value, our results suggest that international investors may have moved from herdbehavior in the past— such as during the 1990s and the early 2000s— to progressively di erentiatingmore and more among EMEs according to their economic fundamentals through the GFC, theEuropean debt crisis, and the taper tantrum. It remains an open question, however, whetherour results are perhaps driven by di erent sources of the shock. The stress episodes since theGFC, during which we nd evidence of di erentiation among EMEs, emanated primarily from theadvanced economies, whereas the crises of the 1990s and 2000s, during which we nd little evidenceof di erentiation, emanated to a much larger extent— although not exclusively so— from shocksoriginating in the EMEs themselves.The remainder of the study is organized as follows: In section 2, we describe the data andthe estimation strategy. Then, section 3 presents our results of di erentiation across EMEs duringthe 2013 taper-tantrum episode, and section 4 shows the results for di erentiation in previouswell-recognized EME nancial stress episodes. section 5 concludes.4
2Econometric speci cation and choice of variablesFor each EME stress episode identi ed, we regress performance in selected nancial markets acrossEMEs over the duration of the stress period on a set of variables capturing economic conditions thatexisted prior to the beginning of the stress episode and other control variables. Our cross-sectionregression is represented by the following equation:F inV ari;k c Xi;j Xi;j "i(1)jNote that each i denotes a particular country, and each k denotes a particular nancial variablewith its performance over the stress episode represented by. Xi;j are a set of explanatoryvariables j speci c to country i measured in the year prior to the onset of the stress period, ’s areparameters to be estimated, and "’s are error terms. Data availability across countries and timelimits our sample to 20 EMEs.1Note that the cross-section observations in each regression arethe countries, and a separate regression is run for each dependent variable k and each sub-set ofexplanatory variables j.Among the dependent variables measuring nancial performance, we consider the percentchange in the country’s bilateral nominal exchange rate against the dollar, the change in the localcurrency bond yields on 10-year government bonds, the percent change in the stock market index, and the change in EMBI and CDS spreads between the peak and trough of each episode (forexample, from April to August for the 2013 episode) using monthly data.2 Pressures on nancialmarkets may not necessarily be re‡ected in the exchange rate if the central bank intervenes inforeign exchange markets to prop up the currency or raises the policy rate to contain capital ‡ight.For this reason, we also consider a depreciation pressure index that is a weighted average of thechange in the exchange rate and the foreign exchange reserves, following Eichengreen et al. (1995),with the weights given by the inverse of the standard deviation of each nancial indicator measuredin the cross section.31Argentina, Brazil, China, Chile, Colombia, Indonesia, India, South Korea, Malaysia, Mexico, Peru, Paraguay,the Philippines, Pakistan, Russia, South Africa, Taiwan, Thailand, Turkey, and Uruguay. Although data for somecountries were available, we exclude euro-area countries, dollarized economies, and the EMEs with hard peg exchangerate regimes.2The monthly data re‡ect end-of-month values for exchange rates, foreign exchange reserves, and policy interestrates, and average monthly values for bond yields, stock market indices, and EMBI and CDS spreads.3Alternatively, we also constructed a depreciation pressure index based on the changes in exchange rates, foreignexchange reserves, and the policy rates between April and August 2013. Since the two indexes behave similarlyduring the taper-tantrum episode, our results are mostly based on the standard depreciation index based on changes5
We consider several di erent types of independent variables: those that might be capturingthe macroeconomic fundamentals and policy choices of a country (category 1), those that mighthelp identify how much capital might have been ‡owing in prior to the episode so we can testthe “more-in-more out” hypothesis (category 2), and those that might be capturing aspects of acountry’s nancial structure such as openness and nancial development (category 3), which areincluded as other control variables.Potential candidates for category 1 include the following six variables re‡ecting the strengthof macroeconomic fundamentals: the current account balance as a percent of GDP; foreign exchangereserves as a percent of GDP; short-term external debt as a percent of foreign exchange reserves;the gross government debt as a percent of GDP; the average annual in‡ation over the past threeyears; and the runup in bank credit to the private sector, measured as the change in the ratioof bank credit to GDP over the ve years prior. To mitigate concerns over endogeneity, each ofthese is taken as of the year prior to the one in which the episode occurs. For the 2013 event,we also use the revisions to the outlook for economic activity as an additional variable capturingfundamentals since analysts were, at least anecdotally, pointing to this as an important factor.The revisions to the outlook are measured as the change between January and May of 2013 in theoutlook for annual average real GDP growth for 2013 provided by Consensus Economics. Finally,we account for the monetary policy and exchange rate frameworks through two indicator variableswith the rst variable equal to 1 for countries operating under an in‡ation targeting regime and 0if not, and the second variable equal to 1 for countries with ‡oating exchange rate regimes basedon the classi cation in the IMF’s Annual Report on Exchange Rate Arrangements and ExchangeRestrictions, and 0 otherwise. Given the rela
International Financial Spillovers to Emerging Market Economies: How Important Are Economic Fundamentals? Shaghil Ahmed, Brahima Coulibaly, Andrei Zlate* April 2015 . Abstract . We assess the importance of economic fundamentals in the transmission of international shocks to financial markets in various emerging market economies (EMEs).
Aug 02, 2018 · conventional monetary policies. We employ a novel approach to compare the international spillovers of conventional and balance sheet policies undert aken by the Federal Reserve. In principle, conventional monetary policy affects bond yields and financial
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Figure 6. Financial Integration of Emerging and Developing Economies .45 Figure 7. Financial Exposures of Emerging to Advanced Economies .46 Figure 8. Financial Linkages between Advanced and Emerging Economies.47 Figure 9.
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