Joining the club? Procyclicality of private capital inflows in lower income developing economies

• Published in: Journal of international money and finance 2017-02, Vol.70, p.157-182
• Main Authors: Araujo, Juliana D., David, Antonio C., van Hombeeck, Carlos, Papageorgiou, Chris
• Format: Article
• Language: English
• Subjects: Capital flows; Cyclicality; Low-income developing countries
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2016.08.006

•This paper examines the cyclicality of private capital inflows to low-income developing countries.•Capital inflows to LIDCs are procyclical, yet considerably less procyclical than inflows to more advanced economies.•The analysis also suggests that inflows to LIDCs are more persistent than inflows to emerging markets (EMs).•Changes in risk aversion are also a significant correlate of private capital inflows, but LIDCs are less sensitive to changes in global risk aversion than EMs.•Private capital inflows are likely to become more procyclical as LIDCs move along the development path, which could render the conduct of countercyclical monetary and fiscal policies more challenging. Using a newly developed dataset this paper examines the cyclicality of private capital inflows to low-income developing countries (LIDCs). The empirical analysis shows that capital inflows to LIDCs are procyclical, yet considerably less procyclical than flows to more advanced economies. The analysis also suggests that flows to LIDCs are more persistent than flows to emerging markets (EMs). There is also evidence that changes in risk aversion are a significant correlate of private capital inflows with the expected sign, but LIDCs seem to be less sensitive to changes in global risk aversion than EMs. A host of robustness checks to alternative estimation methods and control variables confirm the baseline results. In terms of policy implications, these findings suggest that private capital inflows are likely to become more procyclical as LIDCs move along the development path, which could render the conduct of countercyclical monetary and fiscal policies more challenging in these economies.