Joining the Club? Procyclicality of Private Capital Inflows in Low Income Developing Countries

Using a newly developed dataset this paper examines the cyclicality of private capitalinflows to low-income developing countries (LIDCs) over the period 1990-2012. Theempirical analysis shows that capital inflows to LIDCs are procyclical, yet considerablyless procyclical than flows to more advanced economies. The analysis also suggests thatflows to LIDCs are more persistent than flows to emerging markets (EMs). There is alsoevidence that changes in risk aversion are a significant correlate of private capital inflowswith the expected sign, but LIDCs seem to be less sensitive to changes in global riskaversion than EMs. A host of robustness checks to alternative estimation methods,samples, and control variables confirm the baseline results. In terms of policyimplications, these findings suggest that private capital inflows are likely to become moreprocyclical as LIDCs move along the development path, which could in turn raise severalassociated policy challenges, not the least concerning the reform of traditional monetarypolicy frameworks.