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VOL. 6, NO. 5
MAY 2011­­

Insights from the


Upstream Capital Flows: Why Emerging Markets
Send Savings to Advanced Economies
by Simona E. Cociuba

The recent private inflows
of capital to emerging
markets have been more
than offset by government
investments into safe
foreign assets.


merging market economic growth during the global recovery has
exceeded performance in advanced economies. This differential
has triggered a rush of private capital inflows to the emerging markets
from investors seeking to maximize returns. While capital flows typically
benefit receiving economies, sudden surges or stops may pose challenges
for economic development.1 The recent revival of private inflows has put
pressure on prices and currencies of some emerging economies, leading
them to impose capital controls. Moreover, some observers have argued
that accommodative monetary policies in advanced economies are fueling
inflows to emerging markets by making returns there seem even more
At the same time, public capital is flowing from emerging to advanced
economies. Over the past decade, the governments of major emerging
economies have channeled increasing amounts of domestic savings into
international capital markets. These investments were directed toward
the safe and liquid assets of advanced economies.2 Holdings of reserve
assets, particularly foreign exchange, by major emerging economies have
increased more than tenfold since the late 1990s.3
The recent private inflows of capital to emerging markets have been
more than offset by government investments into safe foreign assets. Thus,
on net, total capital—private and public—is actually flowing upstream:
from labor-abundant, fast-growing emerging market economies to capitalrich advanced economies.
Capital Flows and National Accounts
Capital flows are streams of surplus savings channeled into or out
of a country. To understand what this means, consider the connection

It is important to consider
both private and public
flows because they provide
a complete measure of a
country’s net borrowing
or lending.

between such flows and domestic savings, domestic investment and the current account balance.
In national accounting, a country’s current account balance equals its
domestic savings less its investment.4
Simply put, any savings not invested
domestically is sent abroad in the form
of goods and services. A country with
a current account surplus is a net lender and sends its excess savings to the
rest of the world. In exchange for this
capital outflow, the country increases
its net holdings of foreign assets by an
equal amount. Similarly, a country with
a current account deficit is a net borrower from the world; it attracts surplus
foreign savings in the form of capital
inflow to finance its domestic investment. The current account balance provides a measure of the net amount of
total capital—private and public—flowing into or out of a country.

Table 1

U.S. Saving, Investment and International Transactions
(in percent of GDP)

National Income and Product Accounts (NIPA)
Gross saving
Minus: Gross domestic investment
Plus: Statistical discrepancy
Equals: Balance on the current account
International Transactions Accounts (ITA)
Balance on current account
Plus: Capital and financial account: outflow (–); inflow (+)
Of which: U.S.-owned assets abroad
Foreign-owned assets in U.S.
Net financial derivatives*
Equals: Balance of payments











*Financial derivatives are contracts in which a financial instrument is linked to another for the purpose of trading risk
(such as interest rate risk or foreign exchange rate risk) in financial markets. There are two broad types of financial
derivatives: options and forward contracts.
NOTES: Figures may not sum to totals due to rounding. The balance on the current account differs slightly in the NIPA
and the ITA due to several data adjustments. For details, see Appendix II in “A Guide to the U.S. International Transactions
Accounts and the U.S. International Investment Position Accounts,” by Christopher L. Bach, Survey of Current Business,
Bureau of Economic Analysis, February 2010. The statistical discrepancy in the NIPA reflects measurement differences
between income and expenditure components. The Bureau of Economic Analysis views it as income that is not captured
given available data sources, and it interprets it as savings. The statistical discrepancy in the ITA is omitted from the table
because it rounds down to zero for the reported years.
SOURCE: Bureau of Economic Analysis, U.S. Department of Commerce.

EconomicLetter 2


During the 1960s and 1970s, U.S.
domestic saving and investment were
of comparable size, roughly 20 percent
of gross domestic product (GDP). This
meant that the current account balance
was quite small (Table 1). The average
from 1960 to 1979 showed a surplus of
about 0.3 to 0.4 percent of GDP. This
surplus was equivalent to a capital
outflow and a corresponding increase
in the U.S.’s ownership of foreign
assets relative to foreigners’ ownership of U.S. assets. Starting in the early
1980s, the U.S. saved less and became
increasingly dependent on outside
capital to finance its domestic investment. In 2006, the U.S. current account
deficit was at its highest, 6 percent of
GDP. The U.S. became a net borrower,
and other economies—including
emerging markets—now own a significant portion of U.S. assets.
Emerging Market Capital Flows
Increased capital inflows to
emerging economies, which have
grabbed recent headlines, involve
private capital only. However, it is
important to consider both private and
public flows because they provide a
complete measure of a country’s net
borrowing or lending.
Chart 1 shows net private capital
flows for a group of major emergingmarket economies. All flows are
expressed as a fraction of the combined GDP of the economies considered, in order to gauge their relative
magnitude. Looking at the composition
of private flows, net direct investments
are relatively stable, while portfolio and
other investments are more volatile.5
In the midst of the latest recession,
portfolio and other flows to emerging
markets sustained large reversals.
Since the first quarter of 1990,
total net private flows have been
positive—with the exception of a few
quarters—averaging about 2.2 percent of GDP. While it is true that in
the wake of the recent crisis, inflows
exceeded this average in many quarters, the level of these flows is not
unprecedented. Private inflows were

Chart 1

Private Capital Flows in Emerging Market Economies Are
Not Unprecedented
Percent of GDP (quarterly data for 42 countries)
Inflow (+); outflow (–)


Other investment
Portfolio investment
Direct investment
Total net private capital flows (four-quarter moving average)












NOTES: The emerging market economies consist of Argentina, Belarus, Brazil, Bulgaria, Chile, Colombia, Costa Rica,
Croatia, Cyprus, Czech Republic, Ecuador, El Salvador, Estonia, Guatemala, Hong Kong, Hungary, India, Indonesia, Israel,
Jordan, Kazakhstan, South Korea, Latvia, Lithuania, Malaysia, Malta, Mexico, Morocco, Peru, Philippines, Poland, Romania,
Russia, Saudi Arabia, Singapore, Slovak Republic, Slovenia, South Africa, Thailand, Turkey, Ukraine and Uruguay.
SOURCE: Balance of payments statistics, International Monetary Fund.

of similar magnitude or even larger
throughout the 1990s.
The same fact is observed when
the analysis is extended to a longer
time frame and a larger set of emerging market economies (Chart 2). Since
the early 1980s, selected emerging
economies have attracted, on average,
inflows of about 2 percent of their
combined GDP, annual data on net
private capital flows show. It is striking to note that once reserve assets
are added to private flows—in order
to obtain a measure of total capital
flows—there has been an outflow of
capital from emerging economies since
1999. The largest outflow occurred in
2006 and was 4.6 percent of emerging markets’ GDP. Equivalently, these
countries have been net lenders to
the rest of the world, running current account surpluses. Emerging
Asian economies have driven these
capital outflows and current account

There are several possible reasons
why emerging market economies have
ramped up saving at home and invested surpluses abroad. Precautionary
savings in the aftermath of the Asian
financial crisis of the late 1990s may
be one reason. The relative shortage
of safe assets in emerging markets may
also explain the increased demand for
such instruments in advanced economies. In addition, some emerging market economies accumulated substantial
foreign exchange reserves in an effort
to maintain competitive currencies and
support export-oriented growth.
Capital Flows and Imbalances
Free flows of capital across
national borders are potentially beneficial to economic development because
they help allocate the world’s savings
to its most productive uses. Standard
economic theory tells us that savings
should be transferred to developing
countries, where the marginal prod-


uct of capital (or return on an additional unit of investment) is highest.6
However, in today’s global economy,
capital seems to flow upstream. Some
advanced economies, such as the U.S.,
have run current account deficits and
are net borrowers from the rest of the
world, while emerging market economies with current account surpluses
are net lenders. This allocation of
capital away from labor-abundant, fastgrowing emerging market economies
and to capital-rich advanced economies seems puzzling and is clearly
due to factors other than return differentials. Over the past decade, emerging market governments have taken
the role of intermediaries, channeling
excess savings to international markets.
In the aftermath of the financial
crisis, discussions have intensified
about ironing out the global imbalances. This is no easy task and may
take years to implement. It requires
consistent policies to be implemented
by both economies with unsustainable
current account surpluses and economies with large trade deficits.7 In the
meantime, the recent increase in private inflows to emerging markets has
put talks about short-term capital controls back on the table. While the jury
is still out on the effectiveness of such
measures,8 the International Monetary
Fund is working on country-specific
policy tools that may help economies
manage large capital inflows as they
recover from the global crisis.
Cociuba is a research economist in the
Globalization and Monetary Policy Institute at the
Federal Reserve Bank of Dallas.

One example is the Asian financial crisis of the

late 1990s, when capital flows to these economies reversed sharply and caused macroeconomic instability.

See, for example, “Global Imbalances and

Financial Fragility,” by Ricardo J. Caballero and
Arvind Krishnamurthy, American Economic Review, vol. 99, no.2, 2009, pp. 584–88, and “The
Aggregate Demand for Treasury Debt,” by Arvind

3 EconomicLetter

Krishnamurthy and Annette Vissing-Jorgensen,

China’s threshold is 25 percent. Portfolio invest-

unpublished paper.

ment refers to transactions involving equity and

The stock of reserve assets for 57 emerging

debt securities. The category other investments

market economies (listed at the bottom of Chart

includes remaining flows such as currency and

2) was about $5 trillion in 2009, up from only

deposits, loans, trade credits, etc.

$400 billion in 1999. Foreign exchange reserve


assets consist of currency, deposits and securi-

to Poor Countries?,” by Robert E. Lucas, Jr.,


American Economic Review, vol. 80, no. 2, 1990,



Domestic saving consists of saving by busi-

See “Why Doesn’t Capital Flow From Rich

pp. 92–96.

nesses, individuals and the government. Like-


wise, domestic investment reflects both private

Financial Stability,” Banque de France, Financial

and public investments. The current account

Stability Review, no. 15, February 2011.

balance is defined as the sum of the balance of


trade in goods and services, net income receipts

and Reality—A Portfolio Balance Approach,”

and net unilateral transfers.

by Nicolas E. Magud, Carmen M. Reinhart and


Direct investment refers to investment in

See, for example, “Global Imbalances and

See, for example, “Capital Controls: Myth

Kenneth S. Rogoff, National Bureau of Economic

a subsidiary or affiliate that gives the parent

Research, Working Paper no. 16805, February

company a substantial ownership of assets. The

2011. The authors argue that, with the exception

IMF’s definition of “substantial ownership” is

of Malaysia, there is little evidence of success

10 percent or more foreign ownership in a local

in imposing capital controls. They recommend

company. Many countries follow this 10 percent

designing country-specific capital controls to

threshold, but there are exceptions. For example,

effectively influence flows.

Richard W. Fisher
President and Chief Executive Officer

Chart 2

Private Capital Inflows in Emerging Economies More
Than Offset by Reserve Outflows

Robert D. Hankins
Executive Vice President, Banking Supervision

Inflow (+); outflow (–)

Director of Research Publications
Mine Yücel

Total net private
capital flows


Executive Editor
Jim Dolmas


Michael Weiss


Associate Editor
Jennifer Afflerbach

Total net private
capital flows
and reserve assets


Helen E. Holcomb
First Vice President and Chief Operating Officer
Harvey Rosenblum
Executive Vice President and Director of Research

Percent of GDP (annual data for 57 countries)


is published by the
Federal Reserve Bank of Dallas. The views expressed
are those of the authors and should not be attributed
to the Federal Reserve Bank of Dallas or the Federal
Reserve System.
Articles may be reprinted on the condition that
the source is credited and a copy is provided to the
Research Department of the Federal Reserve Bank of
Economic Letter is available free of charge
by writing the Public Affairs Department, Federal
Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX
75265-5906; by fax at 214-922-5268; or by telephone
at 214-922-5254. This publication is available on the
Dallas Fed website,
















NOTES: The emerging market economies consist of emerging Asia: China, Hong Kong, India, Indonesia, South Korea,
Malaysia, Philippines, Singapore, Sri Lanka, Thailand; emerging Latin America: Argentina, Brazil, Chile, Colombia, Costa
Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Mexico, Panama, Peru, Uruguay, Venezuela; emerging Europe:
Bulgaria, Croatia, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovak Republic,
Slovenia, Turkey; and other emerging economies: Algeria, Azerbaijan, Belarus, Egypt, Israel, Jordan, Kazakhstan, Kuwait,
Lebanon, Libya, Morocco, Oman, Pakistan, Russia, Saudi Arabia, South Africa, Syria, Tunisia, Ukraine. Country groupings
are according to the International Monetary Fund’s World Economic Outlook classifications, April 2011.
SOURCE: Balance of payments statistics, International Monetary Fund.

Graphic Designer
Ellah Piña

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