Portfolio Composition and Valuation Effects in Emerging Market Economies

Gross capital inflows and outflows to and from emerging market economies (EMEs) have witnessed a significant increase since early 2000s. This rapid increase in these flows accompanied by sharp rise in volatility has amplified the complexity of macroeconomic management in EMEs. While capital inflows provide additional financing for productive investment and offer avenues for risk diversification, unbridled flows could exacerbate financial and macroeconomic instability. In this paper, the focus on the experience of 6 large emerging Asian economies (EAEs) in dealing with capital flows. Using quarterly data, we identify the waves of capital flows experienced by these economies and the efficacy of the alternative policy measures taken by these economies in response to such flows. The policy measures encompass negotiating the trilemma, intervention in the foreign exchange market, and imposition of capital flow management measures. The efficacy of these responses have been varied across countries implying that a judicious mix of these measures, along with improvement in financial and institutional development is required to effectively counter the vagaries of capital flows.