The Impacts of Disasters on Capital Flows, International Reserves and Exchange Rates: Implications for Public Sector Financial Risk Management and Development Lenders

This study investigates empirically the effect of disasters on capital flows, international reserves and exchange rates, and discusses implications for risk management and potential mitigation strategies. We define major disaster quarters as quarterly impacts exceeding 1% losses as percent of GDP or 1% of total population affected. We find that for developing countries eligible to borrow from the World Bank Group’s International Development Association (IDA), a major disaster causes a statistically significant decline in net investment flows (portfolio and other) over three quarters and a depreciation of the real effective exchange rate. When observing nominal exchange rates for the entire sample of emerging and developing economies, an initial currency appreciation effect is offset by depreciation in the periods after in the majority of cases: a year after the disaster almost 3 out of 5 countries see their currency depreciating. Our panel dataset combines disaster losses between 2005 and 2021 with foreign exchange, economic and financial flow data for up to 66 countries. Our results provide new colour to policy makers and aid organisations attempting to deal with the increasing severity and frequency of disasters. The documented vulnerabilities of IDA countries support recent policy reform calls. These include a medium to long-term agenda to strengthen domestic savings and funding markets, more immediate efforts to strengthen the currency and interest rate risk management capacities of IDA recipient debt management offices, and a strong mandate for providers of international development finance to assist IDA borrowers to reduce currency mismatches by offering loans indexed to the local exchange rate and supporting the creation of currency risk markets.