scispace - formally typeset
Search or ask a question
Journal ArticleDOI

Partners, Not Debtors: The External Liabilities of Emerging Market Economies

01 Dec 2017-Journal of Economic Behavior and Organization (North-Holland)-Vol. 157, pp 320-337
TL;DR: This paper examined the change in the composition of the liabilities of emerging market countries from primarily debt (bonds, bank loans) to equity (foreign direct investment, portfolio) in the decades preceding the global financial crisis.
Abstract: This paper investigates the change in the composition of the liabilities of emerging market countries from primarily debt (bonds, bank loans) to equity (foreign direct investment, portfolio) in the decades preceding the global financial crisis. We examine the determinants of equity and debt liabilities on external balance sheets in a sample of 21 emerging market economies and 20 advanced economies over the period of 1981–2013. We include a new measure of domestic financial development that allows us to distinguish between financial institutions and financial markets. Our results show that countries with higher economic growth rates have larger amounts of equity liabilities. The development of domestic financial markets is also linked to an increase in equity liabilities, and in particular, portfolio equity. In addition, larger foreign exchange reserves are associated with larger amounts of portfolio equity. FDI liabilities are more common when domestic financial institutions are not well developed

Summary (1 min read)

Introduction

  • After the debt crisis of the 1980s, many emerging market nations altered the composition of the assets and liabilities that appear on their external balance sheets .
  • The advanced economies, on the other hand, continued to primarily issue debt, although there was an increase in their use of equity.
  • The rise in the share of equity liabilities on external balance sheets, therefore, is linked to increased financial development, more foreign exchange reserves, and higher growth rates.
  • Section 3 presents the data and methodology to be utilized in this study, and Section 4 reports and analyzes their results.

3. Data and Methodology

  • The test statistics include the results of tests for first-and second-order autocorrelation in the differences.
  • Negative first-order serial correlation is expected in the differences, so the appropriate test for first-order correlation in levels is for second-order correlation in the differences.
  • The probability value of the Hansen test statistic of the over-identification restrictions is also reported.

4. Results

  • These empirical characteristics are consistent with the experience of emerging markets over recent decades.
  • These countries recorded rising growth rates in the 1990s and 2000s, particularly in recent decades.
  • They accumulated large amounts of foreign reserves, particularly after the Asian crisis of 1997-98.
  • The growth of their financial markets as they deregulated their financial sectors and became integrated into global financial markets attracted the interest of foreign investors, who seek higher returns from equity when domestic returns are low.

5. Extensions and Robustness

  • The authors added other "push" variables to the estimation, such as world economic growth.
  • The authors also used other domestic "pull" variables, such as the rents from natural resources.
  • None of these were significant, and they did not change the results for the financial development variables.

6. Conclusions

  • Therefore, the composition of both sides of the external balance sheets of emerging market economies may be changing.
  • This reflects in part their own development, as domestic firms in emerging markets borrow in international capital markets while seeking opportunities for expansion in other countries.
  • These changes, however, will make their external balance sheets more pro-cyclical and vulnerable to external shocks.
  • Whether or not this represents a short-term response to extraordinarily low interest rates or an inflection point will require additional new analysis and investigation.

Did you find this useful? Give us your feedback

Figures (20)

Content maybe subject to copyright    Report

Munich Personal RePEc Archive
Partners, Not Debtors: The External
Liabilities of Emerging Market
Economies
Joyce, Joseph
Wellesley College
23 September 2016
Online at https://mpra.ub.uni-muenchen.de/73880/
MPRA Paper No. 73880, posted 25 Sep 2016 15:12 UTC

Partners, Not Debtors:
The External Liabilities of Emerging Market Economies
by
Joseph P. Joyce
Department of Economics
Wellesley College
Wellesley, MA 02481
Email: jjoyce@wellesley.edu
Tel: 781-283-2160
September 2016
Abstract
This paper investigates the change in the composition of the liabilities of emerging market
countries from primarily debt (bonds, bank loans) to equity (foreign direct investment, portfolio)
in the decades preceding the global financial crisis. We investigate the determinants of equity
and debt liabilities on external balance sheets in a sample of 21 emerging market economies and
20 advanced economies over the period of 1981-2013. We use a new measure of domestic
financial development that allows us to distinguish between financial institutions and financial
markets. Our results show that the development of financial markets is linked to an increase in
equity liabilities, and in particular, portfolio equity. FDI liabilities are more common when
financial institutions are not well developed. Larger foreign exchange reserves are associated
with larger amounts of portfolio equity. Moreover, countries with higher economic growth rates
have larger amounts of equity liabilities. Domestic credit is inversely related to the share of
equity in all liabilities. Foreign debt, on the other hand, is inversely related with the development
of domestic financial markets. Larger amounts of debt liabilities are also associated with smaller
foreign reserve holdings, lower growth rates and larger amounts of domestic credit.
JEL codes: F21, F34, F36
Keywords: equity, FDI, portfolio equity, debt

1
Partners, Not Debtors:
The External Liabilities of Emerging Market Economies
1. Introduction
After the debt crisis of the 1980s, many emerging market nations altered the composition
of the assets and liabilities that appear on their external balance sheets (Figure 1). The emerging
market economies, which had obtained external funds primarily through debt in the form of
bonds or bank loans, increasingly turned to equity, either as foreign direct investment (FDI) or
portfolio equity, for sources of finance. As a result, their equity liabilities grew steadily, both in
terms of magnitude and relative to their debt liabilities, and became the predominant component
on their balance sheets. Figure 2 presents the amounts of equity and debt liabilities scaled by
total external liabilities for a sample of 21 emerging economies during the period of 1981
through 2013. Figure 3 shows the share of equity liabilities on their balance sheets at the
beginning and end of this period, when the equity proportion rose from 14% to 57%. The
advanced economies, on the other hand, continued to primarily issue debt, although there was an
increase in their use of equity. Figure 4 presents the averages of equity and debt liabilities in a
sample of 20 advanced economies during the same period, and Figure 5 shows the change in
their balance sheets.
1
Equity liabilities rose during this period from about 18% to 36%.
This change in the composition of the external balance sheets of the emerging market
nations has been widely noted (Kose and Prasad 2010). In addition, the consequences for
economic performance of the different forms of capital have been investigated (see Section 2).
Equity is more likely to contribute to growth, and FDI is more stable during periods of financial
volatility than debt. However, the reasons for the transformation of the liabilities of the emerging
markets are not well understood.

2
This paper investigates the determinants of the increase in the issuance of equity
liabilities by emerging market economies over several decades. Our work makes several
contributions to the literature on foreign assets and liabilities. First, we use data over a 32-year
span (1981-2013) to track the evolution of the shift from debt to equity. Previous studies often
used shorter time periods that did not capture the full range of the transformation. Second, we
use a new index of domestic financial development, which allows us to distinguish between
financial institutions and markets and their impact on external liabilities. Third, the reserves of
foreign exchange held by the central banks of many emerging economies also rose during this
period. We examine whether foreign reserves affected the type of liability on a country’s
external balance sheet. Fourth, we investigate the determinants of the issuance of equity, but we
also decompose equity to FDI and portfolio equities to see how their determinants differed. Fifth,
we use a dynamic specification of our model.
Our results show that the development of the domestic financial sector, and in particular
financial markets, is linked to an increase in portfolio equity. FDI was inversely related to the
development of financial institutions. In addition, countries with larger holdings of foreign
exchange assets have more portfolio equity liabilities on their balance sheets. Higher economic
growth rates are positively associated with both forms of equity. Debt, on the other hand, does
not have a linkage with financial development, but does accompany an increase in domestic
credit. Moreover, countries that issued debt had smaller foreign exchange holdings and lower
growth rates. The rise in the share of equity liabilities on external balance sheets, therefore, is
linked to increased financial development, more foreign exchange reserves, and higher growth
rates.

3
The next section of the paper reviews theoretical analyses and empirical investigations of
the factors that can affect the composition of a country’s external liabilities. Section 3 presents
the data and methodology to be utilized in this study, and Section 4 reports and analyzes our
results. Section 5 presents extensions of the empirical analysis and tests of robustness. The last
section reviews the main findings and the latest developments on the external balance sheets of
the emerging markets.
2. Analysis and Literature Review
Lane and Milesi-Ferretti (2001b, 2007) in a series of seminal papers provided data and
analysis on the external assets and liabilities of a wide range of countries. They pointed out that
the pace of international financial integration, as measured by the amount of foreign assets and
liabilities scaled by GDP, was more gradual in emerging markets and developing countries than
the increase in the advanced economies. They also noted that the share of the emerging markets
nations’ foreign liabilities held in the form of debt peaked in the mid-1980s and then fell as the
share of equity—primarily FDI (see Figure 6)—rose. The increase in equity liabilities coincided
with an increase in external assets held as debt and foreign exchange reserves (primarily U.S.
Treasury bonds), a profile called “long debt, short equity.” The advanced economies, on the
other hand, held larger proportions of their assets in the form of equity while their liabilities were
predominantly debt, a profile of “long equity, short debt.”
A number of studies have demonstrated that the configuration of external balance sheets
affects economic performance during periods of volatility.
2
Lane (2013) has claimed that the
composition of the emerging markets’ foreign assets and liabilities served as a buffer against the
global financial crisis (GFC) of 2007-09, while the contrasting profile of advanced economies’

Citations
More filters
Journal ArticleDOI
TL;DR: In this article, the authors investigate international investment income flows in 26 emerging market countries during the period of 1998-2015 and find that both capital account and trade openness are associated with the deficits on direct investment income.
Abstract: We investigate international investment income flows in 26 emerging market countries during the period of 1998-2015. Net investment income registered a deficit for this group of countries of between 2-3% of GDP during this period. This deficit has been dominated by payments on foreign direct investment liabilities, which is consistent with the change in the composition of the external liabilities of these countries. Our results indicate that both capital account and trade openness are associated with the deficits on direct investment income. In addition, there was a small deficit in portfolio investment income, which is affected by the development of domestic financial markets and investor protection. Other investments’ income and the income from foreign exchange reserves have a negligible role in total investment income.

4 citations

References
More filters
Journal ArticleDOI
TL;DR: In this article, the generalized method of moments (GMM) estimator optimally exploits all the linear moment restrictions that follow from the assumption of no serial correlation in the errors, in an equation which contains individual effects, lagged dependent variables and no strictly exogenous variables.
Abstract: This paper presents specification tests that are applicable after estimating a dynamic model from panel data by the generalized method of moments (GMM), and studies the practical performance of these procedures using both generated and real data. Our GMM estimator optimally exploits all the linear moment restrictions that follow from the assumption of no serial correlation in the errors, in an equation which contains individual effects, lagged dependent variables and no strictly exogenous variables. We propose a test of serial correlation based on the GMM residuals and compare this with Sargan tests of over-identifying restrictions and Hausman specification tests.

26,580 citations

Report SeriesDOI
TL;DR: In this paper, two alternative linear estimators that are designed to improve the properties of the standard first-differenced GMM estimator are presented. But both estimators require restrictions on the initial conditions process.

19,132 citations

Journal ArticleDOI
TL;DR: In this paper, a framework for efficient IV estimators of random effects models with information in levels which can accommodate predetermined variables is presented. But the authors do not consider models with predetermined variables that have constant correlation with the effects.

16,245 citations

Journal ArticleDOI
TL;DR: This paper introduced linear generalized method of moments (GMM) estimators for situations with small T, large N panels, with independent variables that are not strictly exogenous, meaning correlated with past and possibly current realizations of the error; with fixed effects; and with heteroskedasticity and autocorrelation within individuals.
Abstract: The Arellano-Bond (1991) and Arellano-Bover (1995)/Blundell-Bond (1998) linear generalized method of moments (GMM) estimators are increasingly popular. Both are general estimators designed for situations with “small T, large N” panels, meaning few time periods and many individuals; with independent variables that are not strictly exogenous, meaning correlated with past and possibly current realizations of the error; with fixed effects; and with heteroskedasticity and autocorrelation within individuals. This pedagogic paper first introduces linear GMM. Then it shows how limited time span and the potential for fixed effects and endogenous regressors drive the design of the estimators of interest, offering Stata-based examples along the way. Next it shows how to apply these estimators with xtabond2. It also explains how to perform the Arellano-Bond test for autocorrelation in a panel after other Stata commands, using abar. The Center for Global Development is an independent think tank that works to reduce global poverty and inequality through rigorous research and active engagement with the policy community. Use and dissemination of this Working Paper is encouraged, however reproduced copies may not be used for commercial purposes. Further usage is permitted under the terms of the Creative Commons License. The views expressed in this paper are those of the author and should not be attributed to the directors or funders of the Center for Global Development.

5,416 citations

Book ChapterDOI
01 Jan 1977
TL;DR: In this article, the authors discuss ways in which production financed by foreign direct investment, that undertaken by multinational enterprises (MNEs), has affected our thinking about the international allocation of resources and the exchange of goods and services between countries.
Abstract: The main task of this paper is to discuss ways in which production financed by foreign direct investment, that is, that undertaken by multinational enterprises (MNEs), has affected our thinking about the international allocation of resources and the exchange of goods and services between countries. The analysis takes, as its starting point, the growing convergence between the theories of international trade and production, and argues the case for an integrated approach to international economic involvement, based both on the location-specific endowments of countries and the ownership-specific endowments of enterprises. In pursuing this approach, the paper sets out a systemic explanation of the foreign activities of enterprises, in terms of their ability to internalise markets to their advantage. It concludes with a brief examination of some of the effects which the MNE is allegedly having on the spatial allocation of resources, and on the patterns of trade between countries.

2,137 citations

Frequently Asked Questions (1)
Q1. What are the contributions mentioned in the paper "Partners, not debtors: the external liabilities of emerging market economies" ?

This paper investigates the change in the composition of the liabilities of emerging market countries from primarily debt ( bonds, bank loans ) to equity ( foreign direct investment, portfolio ) in the decades preceding the global financial crisis. The authors investigate the determinants of equity and debt liabilities on external balance sheets in a sample of 21 emerging market economies and 20 advanced economies over the period of 1981-2013.