Emerging Markets: What Happens When Capital Flows Stop Suddenly?

Jul. 5.09 | About: iShares MSCI (EEM)

One of the biggest risks of investing in emerging markets is that capital inflows from advanced countries can stop suddenly. This can be due to many reasons such as political problems, higher possibility of higher return in advanced countries, over-heating of the emerging market economies, etc. When capital inflows into emerging markets stop suddenly the real economy of those countries will be affected severely for many years to come.

The following historical charts from a study by authors at IMF shows that once capital inflows stop, real growth trajectory of emerging markets is negatively impacted and it takes many years to recover and follow the normal growth that existed before the crisis.

Click to enlargeSource: The Transmission of Financial Stress from Advanced to Emerging Economies, IMF Working Paper