Changing Patterns of Capital Flows
Abstract
This report analyses the changing patterns in the composition and dynamics of capital flows and discusses the macroeconomic and, in particular, the financial stability implications of these changes. It finds that global factors have played a significant role in driving capital inflows to EMEs in particular. There has been an abundance of global liquidity since the GFC, fuelling international investors’ pursuit of yield. Shifts in risk appetite have also had an important effect, especially in response to the Covid shock. That said, with improvements in EMEs’ macroeconomic fundamentals and institutional frameworks, investors are becoming more selective. Due to EMEs’ structural achievements, cyclical factors have become more significant drivers of capital flows and the distinctions between advanced economies and some EMEs are blurring.The report also assesses the effectiveness of policy tools for managing the risks associated with extreme shifts in capital flows. It concludes that, even for countries with strong structural policies and sound fundamentals, there are circumstances in which additional policy tools, particularly macroprudential measures, occasional foreign exchange intervention and liquidity provision mechanisms, can help mitigate capital flow-related risks. However, these tools are no substitute for reforms aimed at strengthening the resilience of the economy and financial system. In addition, the Covid-19 crisis highlighted the critical role played by the global financial safety net, as well as the importance of developing a better understanding of the joint impact that policy tools have on capital flows.