Capital flows to emerging economies: Minsky in the tropics

Capital inflows to emerging economies have a significant exogenous component, they are very large when scaled to the size of the domestic financial sectors of recipients and they have large real macroeconomic effects. They also sow the seeds for the ensuing sudden stops, or capital flow reversals, observed in financial crises in emerging markets. This paper tests the implications of applying the Kindleberger-Minsky model of financial crises to capital account reversals in emerging economies, or sudden stops as they have been called in the recent literature. It uses a panel-probit framework with heterogeneous unobserved country effects. The most important variables that account for sudden stops are preceding capital surges, the share of flows other than foreign direct investment, the size of the current account deficit, contagion from sudden stops in other emerging markets and the ratio of external debt to exports. The main policy conclusion is that emerging economies need specific policies to deal with capital surges. In addition, macroeconomic policies geared toward preserving sustainable macroeconomic balance may be necessary to avoid sudden stops but they are clearly insufficient. © The Author 2010. Published by Oxford University Press on behalf of the Cambridge Political Economy Society. All rights reserved.