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Real Exchange Rates and Cap Flows 011011

Real Exchange Rates and Cap Flows 011011

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Capital Flows, Exchange Rate Flexibility,and the Real Exchange Rate
 Jean-Louis Combes, Tidiane Kinda, and Patrick Plane
WP/11/9
 
 
© 2011 International Monetary Fund WP/11/9
IMF Working Paper
African Department
Capital Flows, Exchange Rate Flexibility, and the Real Exchange Rate
 
Prepared by Jean-Louis Combes, Tidiane Kinda, and Patrick Plane
1
 
Authorized for distribution by Mauro MecagniJanuary 2011
Abstract
 
This Working Paper should not be reported as representing the views of the IMF.
 
The views expressed in this Working Paper are those of the authors and do not necessarily represent thoseof the IMF or IMF policy. Working Papers describe research in progress by the authors and are publishedto elicit comments and to further debate.
 This paper analyzes the impact of capital inflows and exchange rate flexibility on the realexchange rate in developing countries based on panel cointegration techniques. The resultsshow that public and private flows are associated with a real exchange rate appreciation.Among private flows, portfolio investment has the highest appreciation effect—almost seventimes that of foreign direct investment or bank loans—and private transfers have the lowesteffect. Using a de facto measure of exchange rate flexibility, we find that a more flexibleexchange rate helps to dampen appreciation of the real exchange rate stemming from capitalinflows.JEL Classification Numbers: F21, F31, F32Keywords: Private capital flows, real exchange rate, exchange rate flexibility, emergingmarkets, low-income countries, pooled mean group estimator Author 
1
Jean-Louis Combes and Patrick Plane are with CERDI, Université Clermont 1. Tidiane Kinda is at the IMF.The authors acknowledge helpful comments and suggestions from Andrew Berg, Hamid Davoodi, Jaime deMelo, Gérard Duchêne, Mauro Mecagni, Brett Rayner, participants at the 58
th
French Economic Association(AFSE) annual conference, participants at the IMF (AFR) external sector network seminar, participants at theEuropean Research Group (GDR) Workshop on exchange rate in emerging and transition economies, and theBangko Sentral ng Pilipinas. Anne Grant provided useful editorial comments.
 
 Contents PageI. Introduction ............................................................................................................................3
 
II. Composition of Capital Inflows, Exchange Rate Regime, and The Real Exchange Rate ...4
 
A.
 
Composition of Capital Inflows and the Real Exchange Rate ...........................4
 
B.
 
Exchange Rate Regime and the Real Exchange Rate ........................................6
 
III. External Financing in Developing Countries .......................................................................7
 
IV. Econometric Model ...........................................................................................................10
 
V. Econometric Results ...........................................................................................................15
 
A.
 
Composition of Capital Inflows and the Real Exchange Rate .........................15
 
B.
 
Exchange Rate Regime and the Real Exchange Rate ......................................18
 
VI. Conclusion .........................................................................................................................20
 
References ................................................................................................................................21
 
Appendix ..................................................................................................................................27
 
Figures1 External Financing in Developing Countries ....................................................................92 The Real Exchange Rate and Capital Inflows ................................................................103. Index of Exchange Rate Flexibility ................................................................................15A.1. External Financing in Emerging Market Economies ......................................................29Tables1
 
Composition of Capital Inflows and the Real Exchange Rate ........................................172
 
Capital Inflows, Exchange Rate Flexibility, and the REER ...........................................19A.1. List, Definitions, and Sources of Variables ....................................................................27A.2. Summary Statistics..........................................................................................................28A.3. Unit Root Tests ...............................................................................................................30A.4. Composition of Capital Inflows and the Real Exchange Rate (LICs) ............................31A.5. Robustness Check: Exchange Rate Flexibility and the Real Exchange Rate .................32A.6. Exchange Rate Flexibility Index .....................................................................................33

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