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The Composition Matters: Capital Inflows and Liquidity Crunch during a Global Economic Crisis

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Hui Tong
Shang-Jin Wei

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Abstract

International capital flows, while potentially beneficial, are said to increase a country’s vulnerability to crisis – especially if they are skewed to non-FDI types. This paper studies whether the volume and composition of capital flows affect the degree of credit crunch faced by a country’s manufacturing firms during the 2007-09 crisis. Using data on 3823 firms in 24 emerging countries, we find that, on average, the decline in stock prices was more severe for firms that are intrinsically more dependent on external finance for working capital. The volume of capital flows per se has no significant effect on the severity of the credit crunch. However, the composition of capital flows matters a great deal: pre-crisis exposure to non-FDI capital inflows worsens the credit crunch, while exposure to FDI alleviates the liquidity constraint. Similar results also hold when we perform an event study surrounding the Lehman Brothers bankruptcy.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15207.

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Date of creation: Aug 2009
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Handle: RePEc:nbr:nberwo:15207

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F3 - International Economics - - International Finance
G3 - Financial Economics - - Corporate Finance and Governance

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