CAPITAL FLOW REVERSALS DURING A FINANCIAL CRISIS: DOES THE PRE-CRISIS COMPOSITION MATTER?

Record amounts of global capital flows that reached a peak in 2007 came to a sudden stop in the second half of 2008 with the spread of the financial crisis from the U.S. to the rest of the world. Theoretical assumptions considering different characteristics of various types of capital flows emphasize the higher probability for sudden stop or capital reversal episodes during financial crises in countries whose financial accounts rely more on foreign loans, rather than foreign direct investment (FDI). The aim of this paper is to test these assumptions on a sample of 75 advanced and developing countries during the recent financial crisis. The descriptive analysis revealed different reactions to the crisis and post-crisis recovery amongst various groups of emerging and developing economies. Namely, countries of Central and Eastern Europe (CEEC) and Commonwealth of Independent States (CIS), which had relied predominantly on foreign loans financing prior to the crisis, marked greater reduction in inflows comparing to more FDI reliant Latin American and Developing Asian countries. The econometric model using cross-sectional dataset confirmed that countries that in the pre-crisis period relied more on foreign loan financing, recorded more intensive withdrawal of foreign capital during the crisis. The main contribution of the paper is of an empirical nature, as it provides an insight into the determinants of capital reversals during the recent financial crisis on a sample of relatively large number of countries, and further acknowledges the importance and possible repercussions of the composition of a country’s financial account.