Abstract
We study exchange market pressures (EMP) and using international reserves by emerging markets (EMs) during the 2000s. We find that financial considerations dominated trade factors. The impact of gross short-term external debt quintuples during the crisis. Capital outflows and deleveraging was the force behind EMP rise during the global financial crisis. Greater FDI (greater portfolio debt) inflows prior to the crisis were associated with a lower (higher) crisis EMP, respectively. The severity of the financial shock was exacerbated by financial ties to the U.S., while the trade shock was more severe in EMs with a larger commodity export share.
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Notes
See Stock and Waston (2002) for analysis of the Great Moderation hypothesis. Recent observers refer to 1987–2007 as the “Great Moderation” period.
The literature dealing with EMP in emerging countries during the crisis includes Rose and Spiegel (2009) and Frankel and Saravelos (2010), focusing on the degree to which leading indicators of financial crises had been useful in assessing country vulnerability; and Aizenman et al. (2010) investigating in a cross country study the extent to which the crisis caused external market pressures in emerging markets, and whether the absorption of the shock was mainly through exchange rate depreciation or the loss of international reserves.
A positive (negative) EMP indicates a net excess demand (supply) for foreign currency, alleviated by a combination of reserve loss (gain) and depreciation (appreciation).
The definition of EMs varies across studies. The EM sample of Tanner (2002) includes 32 countries while another popular definition of emerging markets follows Morgan Stanley Capital International (MSCI) Emerging Markets Index which includes 23 countries. Compared to the country list in MSCI (as of December 31, 2009), the Balakrishnan et al. (2009) includes five additional countries as EMs: Argentina, Pakistan, Romania, Slovak Republic and Slovenia. As evident from the scatter plots in Figures 4–7 show, the addition of these countries does not affect our main findings.
See Table A1 in NBER Working Paper # 16447 for details on the construction of EMP indices.
Balakrishnan et al. (2009) incorporate this measure into a more comprehensive Financial Stress Index (IFS).
Further details on sources and variable construction are provided in NBER Working Paper # 16447, Table A1.
Note that IFS GDP series are not PPP adjusted.
We include income as a control in the EMP regressions following Frankel and Saravelos (2010).
Inflation and domestic credit are included as controls following Tanner (2002) who finds that higher EMP is associated with real depreciation and loose monetary policy (as proxied by the expansion of domestic credit).
Country spreads (EMBI) were excluded from the main regressions because of the lack of statistical significance. If we exclude Change in Gross Short-Term External Debt (% GDP) from the regressions, then the EMP regression coefficients on EMBI during the 2008:Q1-2009:Q2 and 2008:Q1-2009:Q1 periods are positive and significant. We interpret this as further evidence that EMs absorbed the financial stress through quantity (not price) adjustments in the debt markets.
These results are consistent with the view that during “flight to quality,” in less liquid markets, elasticities get smaller in absolute terms, forcing a greater ER adjustment.
Figure 4b supplements this analysis of EMP and gross short-term external debt deleveraging with a pre-crisis and crisis period scatter plot (2007:Q4 and 2008:Q4 data). This year over year comparison eliminates any potential seasonal effects. NBER Working Paper # 16447, Table A3 lists the emerging markets in our sample along with the three letter country codes.
Figure 5b supplements this analysis of EMP and portfolio debt deleveraging with a pre-crisis and crisis period scatter plot (2007:Q4 and 2008:Q4 data). This year over year comparison also eliminates seasonal effects.
By construction, a percentage increase (decrease) in the commodity terms of trade measure is approximately equal to the aggregate net trade gain (loss) relative to GDP from changes in real individual commodity prices (see Spatafora and Tytell (2009)).
Specifically, we calculate the product \( \beta_k^T\sigma_k^T \), where T denotes either 2000:Q1-2007:Q1 or 2008:Q1-2008:Q4 time window, and k denotes the variable of interest.
The variable choice follows Frankel and Saravelos (2010), with minor modifications. Values for all stock variables were taken at 2007:Q4, and the quarterly flow variables were aggregated from 2007:Q1through Q4. Additional variables for cross-sectional regressions are described in NBER Working Paper # 16447, Table A2.
We also considered EM pre-crisis sovereign debt spreads as an additional explanatory variable. If emerging economies that undertook fiscal improvement measures that resulted in the drop of EMBI during the Great Moderation where less vulnerable to the crisis, we would expect a negative coefficient on pre-crisis EMBI in the regression on the crisis EMP. It turned out that EMBI was insignificant under all specifications (results omitted for brevity), indicating once again that fiscal consolidation measures had little if any effect of reducing the vulnerability of EMs to a global deleveraging crisis.
Since the U.S. was the epicenter of the 2008–09 crisis, the consequences of tight economic links to the U.S. may have different implications for the vulnerability of emerging markets to the shocks than their overall economic integration into the world economy. Thus, we consider the financial and trade exposure to the U.S. separately.
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The views expressed herein are those of the authors and should not be attributed to the Bank for International Settlements, the IMF, its Executive Board, or its management. We thank George Tavlas for his comments. Any errors are ours.
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Aizenman, J., Lee, J. & Sushko, V. From the Great Moderation to the Global Crisis: Exchange Market Pressure in the 2000s. Open Econ Rev 23, 597–621 (2012). https://doi.org/10.1007/s11079-011-9228-y
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DOI: https://doi.org/10.1007/s11079-011-9228-y