Abstract

In the current complex global economic background, international capital flows are becoming more frequent. Based on this, this paper takes international portfolio investment as the research object and empirically tests the causal relationship and control channel between international portfolio flows and macrofinancial risk in emerging economies. It selects the panel data of emerging economies from 2001 to 2020, constructs macrofinancial risk indicators by using contingent claim analysis and the entropy-based TOPSIS method, tests the effect of international portfolio flows on macrofinancial risk by using the panel distributed lag regression model, and explores the management effect of foreign exchange reserves and capital controls on the risk effect by using the panel threshold regression model. The results show that long-term international portfolio flows help reduce macrofinancial risk, but short-term capital flows appear to increase macrofinancial risk. In addition, both foreign exchange reserves and capital controls effectively reduce the risk effect of portfolio flows. However, when considering different types of portfolios, we find that foreign exchange reserves do not effectively control the risk effect of equity securities flows, while stricter capital controls do. This paper argues that emerging economies should be more open to international long-term portfolio flows, focus on the monitoring of short-term portfolio capital flows and equity securities flows, and coordinate the use of foreign exchange reserves and capital control instruments to manage the risk effects of portfolio flows. This paper verifies the risk effect of international portfolio investment flows through empirical analysis, tests the effectiveness of foreign exchange reserves and capital controls, and provides a decision-making reference for emerging economies to timely identify, effectively manage, and prevent the risk effect of international capital flows.

Introduction

In the context of the current COVID-19 pandemic and the Russia-Ukraine conflict, recessionary expectations of “high inflation” and “weak growth” in the United States, Europe, and other advanced economies have continued to rise, and global economic activities have been severely impacted [1]. Advanced economies, represented by the United States, implemented quantitative easing and fiscal stimulus policies to stabilize financial markets and protect economic development in response to the resulting economic recession. As high inflation continued to rise under the policy mix, the Federal Reserve began to reduce inflation by significantly increasing interest rates and tightening liquidity. Emerging economies have historically risen with the wave of industrialization through industrial transfer, aided by ample international capital liquidity. However, the Fed’s persistent policy of increasing interest rates has resulted in a stronger US dollar and depreciating currencies in emerging economies [2]. When expectations of a decline in the short-term exchange rate rise, the willingness of cross-border capital to invest weakens further, and there is a sudden halt in capital inflows or even capital flight, resulting in a cascade of asset price declines. Under the negative feedback spiral, the wealth of the household sector decreases significantly, corporate solvency declines, and the bank nonperforming loan ratio rises, resulting in heightened instability in the real economy and financial markets. The current complex and volatile international economic environment increases the frequency and unpredictability of cross-border capital flows, which will cause significant volatility on the financial markets of emerging economies [3].

International capital contributes significantly to the growth of emerging economies, but it is also extremely vulnerable to macrofinancial instability. In every financial crisis, we can see unusual global capital fluctuations. Emerging economies’ financial systems are flawed and have insufficient defenses against shocks from global capital flows. Emerging economies are additionally more susceptible to external capital shocks due to internal factors like a high external debt ratio and a mismatch in debt maturities [4]. Considering the current complex global economic context, to investigate how cross-border capital flows affect macroeconomic stability in emerging economies, this paper selects highly speculative international portfolio investment flows as the research object, discusses the effect of international portfolio flows on macrofinancial risk in emerging economies, and further explores how to effectively manage such risk. By revealing the evolution of macrofinancial risks under external shocks and the efficient control tools for identifying the risks of capital flows, it is of great theoretical significance and practical value for emerging economies to identify, manage, and prevent the impact of global capital shocks.

Conclusion

Since the 1990s, the process of economic globalisation has accelerated. Emerging economies have gradually assimilated into the global financial market, growing in popularity with foreign capital that prefers the better growth prospects of emerging economies to advanced economies that have finished industrializing. Although international portfolio capital inflows have helped fuel the market boom, they have also caused some worry about the emerging economies’ financial stability. Emerging economies’ growth is significantly influenced by foreign capital. Open capital accounts in emerging economies make them particularly susceptible to significant shifts in international capital flows, which can either precipitate financial crises there or have a more muted resolution [58]. To explore how international portfolio investment flows affect macrofinancial risk in emerging economies and how to manage this risk effect, this paper develops macrofinancial risk indicators by using contingent claims analysis and the entropy-based TOPSIS method to conduct this study, empirically investigates the short- and long-term effects of international portfolio investment and macrofinancial risk by using a panel distribution lag model, and investigates how capital flow affects the management of macrofinancial risk under capital flow from the standpoint of foreign exchange reserves and capital control by using a panel threshold model.

This paper demonstrates, through an examination of the relationship between macrofinancial risk and international portfolio investment flows, that international portfolio investment flows will increase the macrofinancial risk of emerging economies in the short term but reduce it in the long term. From the perspective of the components of international portfolio investment, high-risk and speculative international speculative capital will have a negative effect on the real economy [51]. Furthermore, this paper examines the management effects of foreign exchange reserves and capital control to mitigate the damage that the risk may cause. This paper argues that foreign exchange reserves can play a positive moderating role in international portfolio flow and macrofinancial risk, but only to a limited extent. Capital controls are tougher, but risk controls work well. Both foreign exchange reserves and capital control have effective risk management capabilities. When equity capital flows frequently, capital control works better at managing macrofinancial risk.