1. Amir Hadžiomeragić Sarajevo, 6 June 2014
CBBH and SESOX high level seminar South East Europe in an Environment of Volatile Capital Flows
Amir Hadžiomeragić
Sarajevo, 6 June 2014

2. Capital flows to emerging markets: „Master or servant
Capital flows to emerging markets: „Master or servant?“„Benefactor or menace?“
Unprecedented volume of capital flows to emerging countries in the last 20 years
Very intensive discussion on impact of capital flows and capital account liberalization
Two strands of opinions on benefits of removing capital barriers and enabling free capital movement
how to measure direct and indirect benefits and contribution to growth?
...And very uniform view about threats and possible negative aspects of capital inflows

3. Negative impact of capital inflows can be classified into three major categories
Macroeconomic imbalances
Financial stability problems
„Sudden stop“ or reversals

4. Macroeconomic imbalances:
Excessive expansion of aggregate demand („overheating“) resulting with boom-bust growth
Exchange rate misalignment – real appreciation and loss of international competetivness
Widening current account
Increase in asset prices („bubbles“)
Inflationary pressure
Loss of monetary control

5. Financial stability problems from cross-border banking flows
Very rapid credit expansion
Underestimation of the build-up in credit risk
Deterioration of loan portfolio quality
Sharp slowdown or reversal in bank-intermediated capital flows
Risk of financial contagion from other economies and regions

6. Macroeconomic performance and capital flows
2006
2007
2008
2009
2010
2011
2012
Total Capital Flows
(net, in % GDP)
Official/gov‘t
11%
(0%)
13%
(0,3%)
(0,6%) 4%
(3,0%) 5%
(2%)
8% (2%)
7% (3%)
Real growth
5.7%
6.0%
5.6%
-2.7%
0.8%
1.0%
-1.2%
Current account deficit (in % GDP)
-7.4%
-10.2%
-15.9%
-6.5%
-6.1%
-9.7%
-9.2%
Sustainability of growth – prior to crises it was not questioned, but...
Real growth very much dependant on net capital flows
External disbalances also fueled with capital flows

7. Credit growth dependant on foreign capital flows in banking sector

8. Managing of capital flows for small open (transition) economy
Very difficult challenge („living in bathtube next to the ocean“)
Repeated episodes of large inflows and subsequent crises
Increased demand for capital inflows due to disbalance between investment and saving ratios
Global conditions are key factor driving capital inflows
increased liquidity (lower global interest rates)
risk appetite by investor, but also...
Country-specific factors also play important role for the EU accession countries,
lower risk premia associated with macroeconomic stabilization,
EU-related structural reforms

9. Managing of capital flows for small open (transition) economy
recipient economy has got very limited capacities to control and influence capital flows
Mixed results with capital controls
EU accession dictates capital account liberalization
a need to have prudent economic policies in order to reap benefits from capital inflows and mitigate related risks

10. What makes economies more resilient to a surge in capital inflows?
WEO (2013) concluded that more resiliant economies have:
more flexible exchange rate
lower government spending (counter-cyclical fiscal policy)
inflation targeting (lower inflation)
significantly better economic institutions

11. Counter-cyclical fiscal policy (Fiscal restraint) is not very likely
 „When it rains, it pours" (Kaminsky et al.2004)
Study on procyclicality and economic policies
instead offsetting capital inflows, government often contribute with even higher expenditures in periods of economic growth and capital inflows

12. Did we repeat the same mistakes
Did we repeat the same mistakes? Procyclical fiscal policy in Bosnia and Herzegovina during capital surge
"good time"
"bad time"
average real growth
Amplitude
Expenditure
10.65%
-0.85%
11.50%
Current expenditure minus interest payment
10.75%
-0.95%
11.71%
Expenditure on goods and services
8.24%
-8.16%
16.40%
Expenditure on wages and salaries
10.30%
1.43%
8.87%
Note: positive amplitude signals procyclicality

13. Conclusion
How to reap benefits from capital flows and reduce related risk?
Financial integration and economic globalization will continue
Need to be very cautious about magnitude and structure of capital flows to domestic economy
Volatility is highly unpredictable and beyond of our control
Sound macroeconomic policies and adequate prudential measures