Abstract
First, we establish that the R/US$ exchange rate depreciation shocks lead to a transitory increase in a capital flow sudden stops episode, whereas the capital flow surges episodes decline. The R/US$ exchange rate depreciation also leads to domestic investors’ retrenchment. Hence, a stable exchange rate matters. Second, high inflation is a deterrent factor to capital inflows. Evidence suggests that inflationary shocks transitorily increase risk aversion, sudden stops episodes and a significant decline in net purchases of shares by non-residents. Therefore, stable inflation is important for domestic and non-resident investors’ activities. Evidence shows that sudden stops and VIX propagate the negative effects of high inflation in the GDP growth response. Furthermore, VIX and domestic investors’ capital flow retrenchment have a bigger impact in propagating inflationary pressures due to the R/US$ exchange rate depreciation shock. On the other hand, increased capital flow surges, retrenchment episodes and increased net purchases due to the appreciation in the R/US$ lower the inflation rate, thus leading to a lower level of the repo rate. Similarly, increased net purchases through the appreciation of the R/US$ exchange rate dampen the repo rate responses to positive inflation shocks.
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Retrenchments occur when domestic investors liquidate their foreign investments and capital flight which occurs when domestic investors send large amounts of capital abroad. This also means that domestic investors are not cut off from global capital markets. Domestic investors have ample access to these markets and utilise them by moving their domestic funds abroad (Forbes and Warnock 2011). What could possibly trigger the latter episode of capital flows? This might happen if domestic investors with superior information foresee a negative shock to the local market. In anticipation of this shock, they shift their money to global markets. This leads to net capital inflows decline, but the difference is that this decline is not prompted by foreign investors (Rothenberg and Warnock 2011).
References
Dahlhaus, T., and Vasishtha, G. 2014. The Impact of U.S. Monetary Policy Normalization on Capital Flows to Emerging-Market Economies. Bank of Canada Working Paper 2014-53.
Forbes, K.J., and Warnock, F.E. 2011. Capital Flow Waves: Surges, Stops, Flight, and Retrenchment. NBER Working Paper No. 17351, August 2011.
Rothenberg, A.D., and Warnock, F.E. 2011. Sudden Flight and True Sudden Stops. Review of International Economics, 19, 509–24.
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Gumata, N., Ndou, E. (2019). Do Investors’ Net Purchases and Capital Retrenchment Activities Impact the Monetary Policy Response to Positive Inflation Shocks?. In: Capital Flows, Credit Markets and Growth in South Africa. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-30888-9_16
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DOI: https://doi.org/10.1007/978-3-030-30888-9_16
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