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Interlinkages between external debt financing, credit cycles and output fluctuations in emerging market economies

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  • Akhilesh K. Verma

    (Indira Gandhi Institute of Development Research)

  • Rajeswari Sengupta

    (Indira Gandhi Institute of Development Research)

Abstract

We examine the role of external debt financing (EDF) in shaping the credit cycle and output fluctuations in nine major emerging economies. We show that sharp fluctuations in EDF flows are significantly associated with credit surge and stop episodes in emerging market economies (EMEs). However the association is asymmetric in nature - a stop episode in EDF flows is more likely to bring about a credit stop episode compared to an EDF surge episode. We extend our framework to analyze the joint spillover of EDF flows and credit cycles on business cycle fluctuations in these EMEs. We find that EDF lows and credit together have a strong association with output growth. After dividing the sample into EDF surge and stop phases, we find evidence of asymmetric spillover of credit on output growth. Credit decline during EDF stop episode leads to a larger decline in GDP growth relative to the impact of an increase in credit growth during EDF surges. Our analysis points to the vulnerability of credit cycles of EMEs to the sharp movement in EDF flows which in turn is largely synchronized with external financing conditions. The strong negative spillover of EDF stop phases on the business cycle is a cause of concern for policymakers in EMEs who seek to insulate their economies from such external shocks.

Suggested Citation

  • Akhilesh K. Verma & Rajeswari Sengupta, 2020. "Interlinkages between external debt financing, credit cycles and output fluctuations in emerging market economies," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2020-012, Indira Gandhi Institute of Development Research, Mumbai, India.
  • Handle: RePEc:ind:igiwpp:2020-012
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    Keywords

    External debt finance; Credit cycle; Dynamic panel GMM; Business cycle;
    All these keywords.

    JEL classification:

    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F65 - International Economics - - Economic Impacts of Globalization - - - Finance
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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