Aitor Erce

Gross capital flows: dynamics and crises

This paper analyzes the joint behavior of international capital flows by foreign and domestic agents -- gross capital flows -- over the business cycle and during financial crises. The authors show that gross capital flows are very large and volatile, especially relative to net capital flows. When foreigners invest in a country, domestic agents tend to invest abroad, and vice versa. Gross capital flows are also pro-cyclical, with foreigners investing more in the country and domestic agents investing more abroad during expansions. During crises, especially during severe ones, there is retrenchment, that is, a reduction in both capital inflows by foreigners and capital outflows by domestic agents. This evidence sheds light on the nature of shocks driving capital flows and helps discriminate among existing theories. The findings seem consistent with shocks that affect foreign and domestic agents asymmetrically, such as sovereign risk and asymmetric information.

Recent episodes of sovereign debt restructurings. A case-study approach

Sovereign debt restructurings do constitute a recurrent phenomenon in emerging and developing economies. Consequently, the international community has repeatedly explored options to increase the predictability and orderliness of debt workouts, of which the debate on the Sovereign Debt Restructuring Mechanism (SDRM) proposed by the IMF in 2002 is the most recent example. Eventually, however, the most ambitious reform proposals have been systematically abandoned, thereby consolidating debt restructurings as market-led case-by-case processes. This paper reviews nine recent sovereign debt restructurings: Argentina (2001-2005), Belize (2006-2007), the Dominican Republic (2004-2005), Ecuador (1999-2000), Pakistan (1998-2001), the Russian Federation (1998-2001), Serbia (2000-2004), Ukraine (1998-2000) and Uruguay (2004). Our case study analysis reveals the lack of a single model for sovereign debt restructurings. Indeed, we find significant variations in the roots of the crises, the size of the losses undergone by investors, the speed at which an agreement was reached with creditors, the proportion of creditors accepting the terms of that agreement, or the time needed to restore access to international financial markets. There also appears to be a lack of consistency in the role played by the IMF in the various crises. This is partly due to the lack of a policy specifically designed to deal with sovereign debt restructurings in the IMFs toolkit, which has provided the IMF with flexibility to adapt to each crisis on a case-by-case basis. However, it may have exacerbated the uncertainty that tends to characterize such disruptive episodes. This paper constitutes the basis of a broader effort to identify possible options for the IMF to endow itself with a policy to streamline and systematize its role during sovereign debt restructurings.

International Reserves and Gross Capital Flows - Dynamics During Financial Stress

This paper explores the role of international reserves as a stabilizer of international capital flows during periods of global financial stress. In contrast with previous contributions, aimed at explaining net capital flows, we focus on the behavior of gross capital flows. We analyze an extensive cross-country quarterly database using event analyses and standard panel regressions. We document significant heterogeneity in the response of resident investors to financial stress and relate it to a previously undocumented channel through which reserves are useful during financial stress. International reserves facilitate financial disinvestment overseas by residents, offsetting the simultaneous drop in foreign financing.

International reserves and gross capital flows dynamics

This paper explores the role of international reserves as a stabilizer of international capital flows, in particular during periods of global financial stress. In contrast with previous contributions, aimed at explaining net capital flows, we focus on the behavior of gross capital flows. We analyze an extensive cross-country quarterly database – 63 countries, 1991–2010 – using standard panel regressions. We document significant heterogeneity in the response of resident investors to financial stress and relate it to a previously undocumented channel through which reserves act as a buffer during financial stress. A robust result of the analysis is that international reserves facilitate financial disinvestment overseas by residents – a fall in capital outflows. This partially offsets the drop in foreign capital inflows observed in such periods. For the whole sample, we also find that larger stocks of international reserves are linked to higher gross inflows and lower gross outflows. These results, which challenge current approaches to measuring reserve adequacy, call for refining such tools to better account for the role of resident investors.

Banking Crises and Sovereign Defaults in Emerging Markets: Exploring the Links

This paper provides a set of stylised facts on the mechanisms through which banking and sovereign distress feed into each other, using a large sample of emerging economies over three decades. We first define “twin crises” as events where banking crises and sovereign defaults combine, and further distinguish between those banking crises that end in sovereign debt crises, and vice-versa. We then assess what differentiates “single” episodes from “twin” ones. Using an event analysis methodology, we study the behaviour around crises of variables describing the balance sheet interconnection between the banking and public sectors, the characteristics of the banking sector, the state of public finances and the macroeconomic context. We find that there are systematic differences between “single” and “twin” crises across all these dimensions. Additionally, we find that “twin” crises are heterogeneous events: taking into account the proper time sequence of crises within “twin” episodes is important for understanding their drivers, transmission channels and economic consequences. Our results shed light on the mechanisms surrounding feedback loops of sovereign and banking stress

Fiscal Multipliers and Foreign Holdings of Public Debt

This paper explores a natural connection between fiscal multipliers and foreign holdings of public debt. Although fiscal expansions can raise domestic economic activity through various channels, they can also have crowding-out effects if the resources used to acquire public debt reduce domestic consumption and investment. These crowding-out effects are likely to be weaker when governments have access to foreign markets to place their debt, increasing the size of multipliers. We test this hypothesis on (i) post-war US data and (ii) data for a panel of 17 advanced economies from the 1980s to the present. To do so, we assemble a novel database of public debt holdings by domestic and foreign creditors for a large set of advanced economies. We combine this data with standard measures of fiscal policy shocks and show that, indeed, the size of fiscal multipliers is increasing in the share of public debt held by foreigners. In particular, the fiscal multiplier is smaller than one when the foreign share is low, such as in the U.S. in the 1950s and 1960s and Japan today, and larger than one when the foreign share is high, such as in the U.S. and Ireland today. JEL Classification: E62, F32, F34, F36, F41, F62, F65, G15, H63

Skewed Credit and Growth Dynamics after the Global Financial Crisis

A large empirical literature finds that financial development is beneficial for economic growth, although some recent evidence suggests otherwise. The paper contributes to the finance–growth literature by examining the role of credit growth skewness and long-run growth. Earlier literature found that credit growth skewness is negatively associated with economic growth. It revisits this relationship using a large and recent panel dataset that encompasses Organisation for Economic Co-operation and Development economies and the impact of the global financial crisis. While the results reconfirm an association between credit skewness and growth, the relationship is more nuanced than previously thought. It finds that the beneficial effects from lower skewness—systemic financial risks—were evident only prior to 2000. The findings help explain why boom–bust dynamics were positively associated with economic growth in emerging markets in the past and why the growth of advanced economies has been sluggish since the global financial crisis.

Linking Bank Crises and Sovereign Defaults: Evidence from Emerging Markets

We analyze the mechanisms through which bank and sovereign distress feed into each other, using a large sample of emerging market economies over three decades. After defining “twin crises�? as events where bank crises and sovereign defaults combine, and further distinguishing between those bank crises that end up in sovereign defaults and vice-versa, we study what differentiates “single�? and “twin�? events. Using an event analysis methodology, we document systematic differences between “single�? and “twin�? crises across various dimensions. We show that many of the regularities often associated with either “bank�? or “debt�? crises are present in twin events only. We further show that “twin�? crises themselves are heterogeneous events: the proper time sequence of crises that compose “twin�? episodes is important for understanding these events. Guided by these facts, we use discrete-variable econometric techniques to assess the main channels of distress transmission between crises. We find that balance sheet interconnections, credit dynamics, financial openness and economic growth are important drivers of twin crises. Our results inform the flourishing theoretical literature on the mechanisms surrounding feedback loops of sovereign and bank stress.

Debt Stocks Meet Gross Financing Needs: A Flow Perspective into Sustainability

It is well known that no single metric can provide reliable cross-country risk assessments of debt sustainability. While approaches to understanding sustainability have traditionally relied heavily on stock metrics, a consensus is emerging that debt sustainability should be linked to both stock and flow features of underlying public debt. This paper informs this debate by analysing the ability of gross financing needs, the preferred flow metric in current debt sustainability analyses by official institutions, to provide additional information to that provided by standard stock metrics of a sovereign’s likelihood of distress. Our main contribution is to document a significant negative effect from changes in gross financing needs when debt stocks are high. These results support the intuition that countries can sustain very large debt stocks if these do not generate unmanageable flow needs. Additionally, we show that sovereign roll-over needs are a critical element driving this effect. Given the role of official lending in taming the dynamics of this component, our findings also inform the literature on the role of official lending in crises resolution.

The Macroeconomic Effects of Official Debt Restructuring: Evidence from the Paris Club

This paper presents new empirical results on the macroeconomic impact of sovereign debt restructurings with official-sector creditors. Using a novel dataset on Paris Club restructurings and Local Projection methods, we find that Paris Club treatments can have a significant impact on economic growth -- 2% higher GDP growth two years after the restructuring -- when a nominal haircut is provided. At the same time, the countries that had received nominal debt relief tend to be less prudent in conducting their fiscal policy than those benefiting from a restructuring in NPV terms. Furthermore, as regards the external sector adjustment after debt restructuring, we observe an improvement in the net foreign asset position, due to the combination of less external debt and higher foreign reserves. Our study suggests that the official sector faces some short-term trade-offs between the objectives of stimulating economic growth, promoting fiscal prudence and improving a countrys position in international capital markets when designing a debt restructuring.