Local currency bond markets, foreign investor participation, and capital flow volatility in emerging Asia

Beirne, John; Renzhi, Nuobu; Volz, Ulrich Working Paper Local currency bond markets, foreign investor participation, and capital flow volatility in emerging Asia ADBI Working Paper Series, No. 1252 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Beirne, John; Renzhi, Nuobu; Volz, Ulrich (2021) : Local currency bond markets, foreign investor participation, and capital flow volatility in emerging Asia, ADBI Working Paper Series, No. 1252, Asian Development Bank Institute (ADBI), Tokyo This Version is available at: https://hdl.handle.net/10419/238609 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/3.0/igo/ ADBI Working Paper Series LOCAL CURRENCY BOND MARKETS, FOREIGN INVESTOR PARTICIPATION, AND CAPITAL FLOW VOLATILITY IN EMERGING ASIA John Beirne, Nuobu Renzhi, and Ulrich Volz No. 1252 April 2021 Asian Development Bank Institute The Working Paper series is a continuation of the formerly named Discussion Paper series; the numbering of the papers continued without interruption or change. ADBI’s working papers reflect initial ideas on a topic and are posted online for discussion. Some working papers may develop into other forms of publication. The Asian Development Bank refers to “China” as the People’s Republic of China. The views expressed in this paper are the views of the authors and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they represent. Suggested citation: Beirne, J., N. Renzhi, and U. Volz. 2021. Local Currency Bond Markets, Foreign Investor Participation, and Capital Flow Volatility in Emerging Asia. ADBI Working Paper 1252. Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/localcurrency-bond-markets-foreign-investor-capital-flow-volatility-asia Please contact the authors for information about this paper. Email: [email protected], [email protected], [email protected] John Beirne is a Research Fellow at the Asian Development Bank Institute (ADBI), Japan. Nuobu Renzhi is a Research Associate at ADBI. Ulrich Volz is Director of the Centre for Sustainable Finance and Reader in Economics at SOAS University of London, and Senior Research Fellow at the German Development Institute. The views expressed in this paper are the views of the author and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms. Working papers are subject to formal revision and correction before they are finalized and considered published. This paper benefited from comments received by participants at a virtual workshop on monetary policy in emerging economies on 6 August 2020, jointly organized by the Asian Development Bank Institute, the Asia- Pacific Applied Economics Association, and the Central Bank of Sri Lanka. We also acknowledge comments received from an anonymous referee. Asian Development Bank Institute Kasumigaseki Building, 8th Floor 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan Tel: +81-3-3593-5500 Fax: +81-3-3593-5571 URL: www.adbi.org E-mail: [email protected] © 2021 Asian Development Bank Institute ADBI Working Paper 1252 Beirne, Renzhi, and Volz Abstract This paper examines the role of local currency bond markets (LCBMs) and foreign investor participation in these markets in capital flow volatility in emerging Asian economies over the period 1999 to 2020. Using a panel analysis and impulse response functions generated from a panel structural vector autoregression, we show that greater development of LCBMs across ten Asian emerging economies in terms of capitalization helps to mitigate against capital flow volatility, while foreign investor participation has the opposite effect, particularly for less developed LCBMs. Our findings have policy implications from a financial stability perspective, whereby continued efforts to enhance LCBMs while reducing reliance on foreign investors should be encouraged. Strengthening the local investor base and mobilizing domestic resources through LCBMs ought to be a priority for raising long-term capital that will enable the financing of sustainable investment and development. Our findings also suggest that greater efforts are needed to enhance foreign exchange hedging arrangements for foreign investors in LCBMs, particularly in times of heightened financial stress. Keywords: capital flow volatility, local currency bond markets JEL Classification: F32, F41, F62 ADBI Working Paper 1252 Beirne, Renzhi, and Volz Contents 1. INTRODUCTION ............................................................................................................ 1 2. RELATED LITERATURE ............................................................................................... 3 3. DATA AND EMPIRICAL METHODOLOGY .................................................................. 4 4. EMPIRICAL RESULTS .................................................................................................. 6 5. CONCLUSIONS ........................................................................................................... 11 REFERENCES ........................................................................................................................ 12 APPENDIX ............................................................................................................................... 14 ADBI Working Paper 1252 Beirne, Renzhi, and Volz 1 1. INTRODUCTION Local currency bond markets (LCBMs) have continued to develop in emerging Asian economies since the early 2000s in order to safeguard against currency and maturity mismatches. Reliance on foreign currency debt, while still pervasive, has declined as a result (Figure 1). Figure 1: Foreign Currency Debt and Currency Mismatches in Emerging Asia Note: Emerging Asia comprises the People’s Republic of China (PRC); Hong Kong, China; India; Indonesia; the Republic of Korea; Malaysia; the Philippines; Singapore; Thailand; and Viet Nam. The data is computed as GDP-weighted averages for the ten countries in the sample. Source: Authors’ calculations with data from International Monetary Fund (IMF), Bank for International Settlements (BIS), Institute for International Finance (IIF), and China Economic Database (CEIC). The development of LCBMs in Asia has its foundations in lessons learned from the Asian financial crisis of 1997–98, and is aimed at reducing reliance on cross-border bank-based finance through a more advanced local capital market (e.g., Park, Shin, and Tian 2018). LCBM development should also help to reduce exposure to global shocks, given the lower reliance on foreign currency borrowing.1 While the development of LCBMs has helped to address the currency mismatch issue for domestic markets, the increasing presence of foreign investors in these markets may amplify the risk of capital flow reversal in periods of heightened financial tension. Indeed, as noted by Carstens and Shin (2019), foreign participation in LCBMs equates to a shift in the currency mismatch to foreign investors, the so-called ‘original sin redux’. Therefore, the development of LCBMs can help local economies to borrow abroad in domestic currency to address the currency mismatch from the domestic perspective, having important financial stability implications as a result. However, an increasing presence of unhedged foreign investors in these markets implies that local economies may be subject to financial stability risks during periods of heightened financial tension. In particular, such episodes have been characterized as being subject to abrupt capital flow reversals. 1 Other benefits of LCBMs include the ability to better manage capital flow volatility, reduced global imbalances, alleviation of the need to hold large foreign reserves, and facilitating smoother balance sheet adjustment (thereby enabling macroeconomic policy to adjust to shocks more smoothly). See IMF (2016) for further details. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 2 Conceptually, LCBM development could either increase or decrease capital flow volatility. To the extent that LCBM development would attract greater capital inflows and hence increase integration into the global financial system, an economy may face a higher risk of a sudden reversal of capital flows and become more vulnerable to volatile capital flows. On the other hand, LCBM development should facilitate domestic resource mobilization and make an economy less dependent on foreign lending (including from foreign banks) and reduce gross borrowing from abroad.2 Moreover, LCBM development should reduce both currency mismatch (i.e., reducing foreign currency exposure) and maturity mismatch (i.e., lengthening the maturity of the stock of debt) problems, making economies less reliant on short-term or foreign debt. This paper assesses the role on capital flow volatility played by LCBMs in ten Asian emerging economies over the period 1999 to 2020, including foreign investor participation in these markets. Figure 2 illustrates Asian capital flow volatility dynamics over time relative to LCBM yields, LCBM capitalization, and foreign investor participation in LCBMs. Figure 2: Capital Flow Volatility vs Bond Yield, LCBM Capitalization, and Foreign Participation Note: The red line represents capital flow volatility. The blue line represents local bond yield in percentage. The green line represents LCBM capitalization in percentage. Black line represents foreign participation in percentage. Capital flow volatility is defined as the ratio of the standard deviation to the absolute value of the mean of the total gross capital flows relative to GDP, i.e., the sum of total inflows and outflows of FDI, portfolio flows, banking and other flows relative to GDP. Variable definitions are provided in Table A2 in the Appendix. 2 Net capital flows will of course depend on the current account balance. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 3 Our empirical analysis in this paper indicates that LCBM yields do not appear to have any statistically significant bearing on capital flow volatility. Rather, significant roles are played by both LCBM capitalization and foreign investor participation in LCBMs. Across all country groups, higher LCBM capitalization reduces capital flow volatility, while higher foreign investor participation in LCBMs increases capital flow volatility. The magnitudes of the effects are much higher for economies with less developed LCBMs. This is intuitive from an economic standpoint. Less developed LCBMs are more susceptible to financial stability risks related to capital flow reversals in times of heightened financial tension. As LCBMs become more developed, the effect of foreign investor participation on capital flow volatility diminishes—i.e., as LCBMs mature, they are less vulnerable to the external shocks that may emanate from foreign ownership. The remainder of the paper is organized as follows. Section 2 reviews the related literature on the factors underpinning the development of LCBMs both theoretically and empirically. Section 3 presents the data and empirical methodology. Section 4 presents the empirical results. Section 5 concludes. 2. RELATED LITERATURE The literature on LCBMs has tended to focus on the benefits of developing these markets from a theoretical perspective and the factors driving the development of these markets empirically, including the implications from a financial stability perspective. Our paper contributes to the strand of the literature that falls into the latter field. Studies on the determinants of LCBMs are closely related to those carried out on the drivers of capital flows to emerging market economies (EMEs), including studies on capital flow volatility (e.g., Byrne and Fiess 2016). These studies have argued that global factors tend to be more important during periods of heightened financial market stress, while domestic macroeconomic fundamentals drive capital flows to EMEs during more tranquil times (European Central Bank [ECB] 2016). Recent work by Eller, Huber, and Schuberth (2020) shows that global factors capturing macro-financial common components explain around three-quarters of capital flow volatility regardless of the type of capital flow or economic region. Csonto (2014) indicates that countries with stronger domestic fundamentals, such as fiscal sustainability, can be more resilient in the face of external shocks. As EMEs in Asia continued to develop their LCBMs in conjunction with solid macroeconomic performance, the region attracted substantial flows of foreign capital (Burger, Warnock, and Warnock 2012). This flow of foreign capital into Asia helped the region to address currency and maturity mismatches (Burger and Warnock 2007). Miyajima, Mohanty, and Chan (2015) showed that domestic factors have become increasingly important for anchoring local currency government bond yields. While local bond yields appear to have become more resilient to swings in global risk aversion, the trajectory of US bond yields continues to be an important global factor underpinning local bond yields (Belke, Dubova, and Volz 2018; Belke and Volz 2019). There is no consensus, however, on whether domestic or global factors are more important. Piljak (2013) makes the point that domestic monetary policy and inflation are the dominant drivers, while Kumar and Okimoto (2011) note that global factors have become more important as EMEs have become more financially developed and interconnected with the global financial system. The dominance of global factors can be traced back to the ‘original sin’ argument of Eichengreen and Hausmann (2009), wherein EMEs’ inability to borrow in their own currency, while international transactions typically take place in US dollars, implies that local currency bonds will be underpinned primarily by global factors. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 4 Claessens, Klingebiel, and Schmukler (2007) highlight that the depth and currency composition of government bond markets are related to domestic institutional and macroeconomic factors. More recent studies, including those by Berensmann, Dafe, and Volz (2015), Presbitero et al. (2016), and Dafe, Essers, and Volz (2018), show that LCBM development is related to country size, level of economic development, the size of banking systems, greater trade openness, the quality of regulatory frameworks and the rule of law, and financial system structure. A wide number of studies have been carried out on the emergence of local currency bonds in EMEs as a viable asset class for investors given the strong economic growth outlook, higher risk-adjusted returns, and portfolio diversification opportunities (e.g., Claessens, Klingebiel, and Schmukler 2007; IMF 2011). Indeed, foreign investor participation in LCBMs has increased sharply over the past decade. Other studies have questioned the diversification benefits of LCBMs in EMEs in the presence of high exchange rate volatility (e.g., Turner 2012). Moreover, Ebeke and Lu (2015) show that while foreign investor participation in LCBMs can help to lower yields, the volatility of yields tends to increase. The authors also show that LCBMs tend to be more susceptible to global financial shocks when foreign participation in LCBMs exceeds a given threshold. Studies on Asia have tended to focus on the extent of integration of LCBMs at the regional and global levels. For example, Tsukuda, Shimada, and Miyakoshi (2017) find that East Asian economies that are major financial centers (Singapore and Hong Kong, China) are more interconnected with the US than with other economies in East Asia. Other studies that focus on Asia have tended to examine the rationale for the development of LCBMs in the region in the aftermath of the Asian financial crisis of 1997–98 (e.g., Kawai 2007; Felman et al. 2011; Spiegel 2012). 3. DATA AND EMPIRICAL METHODOLOGY Using monthly data frequency, we estimate a fixed effects panel model over the period 1999M01 to 2020M05 across ten Asian emerging economies, including the People’s Republic of China (PRC); Hong Kong, China; India; Indonesia; the Republic of Korea; Malaysia; the Philippines; Singapore; Thailand; and Viet Nam. We also separate the sample into two sub-panels based on the level of LCBM development (the share of LCBM capitalization in GDP), the well developed and the less developed.3 We first examine the role of local currency bond markets in affecting capital flow volatility, controlling for both domestic fundamentals and global factors. Drawing on the capital flows literature, domestic macroeconomic controls include current account balance, exchange rate volatility, real GDP growth, public debt/GDP, inflation rate, financial openness, and a dummy variable representing crisis (defined as 1 where exchange rate volatility is in the top quartile and zero otherwise). Capital flow volatility is defined as the ratio of the standard deviation to the absolute value of the mean of the flows. This is based on total gross capital flows, comprising the sum of inflows and outflows of FDI, portfolio investment, as well as banking and other flows (relative to GDP). For 3 See Table A1 in the Appendix for details of groups, including definitions. In terms of preliminary analysis, the fixed effects model is justified on the basis of results from a Hausman test, while panel unit root tests (with correction for cross-sectional dependence) reject the null hypothesis of non-stationarity for the variables in our analysis. Tables A2 to A4 in the Appendix provide details on the variables used, as well as results from the preliminary analysis undertaken. We use the quadratic interpolation procedure to convert the time series into a monthly frequency. The interpolated variables include: LCBM capitalization, foreign participation, real GDP growth, current account balance, public debt, and financial openness. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 11 shock to LCBM capitalization has a statistically significant and dampening effect on capital flow volatility across our sample of Asian economies. Overall, a one percentage point rise in LCBM capitalization is associated with a fall in capital flow volatility of around 0.3 percentage points at peak after around 4 months. The magnitude of the effect recedes, and becomes insignificant at around 6 months. While we find no significant effect for the sub-panel of well-developed LCBMs, the impact of capitalization on capital flow volatility is highly statistically significant and negative across the full duration horizon for the less developed markets, with a one percentage point rise in LCBM capitalization associated with a permanent 0.2 percentage point decline in capital flow volatility. A positive one percentage point shock to foreign investor participation in LCBMs is associated with a rise in capital flow volatility of around 0.6 percentage points at peak at around 4 months, with the effect becoming statistically insignificant at around 6 months. Comparing the well developed and less developed markets reveals a much more pronounced response of capital flow volatility for the latter. A positive shock to foreign investor participation of one percentage point yields a rise in capital flow volatility in less developed markets by around 0.8 percentage points at peak. This compares to around 0.5 percentage points for well developed markets. The impulse responses remain statistically significant until around the 6-month time horizon. A similar pattern emerges with capital flow volatility responses to positive VIX shocks, with the magnitude of the response higher for less developed markets. 5. CONCLUSIONS This paper examines the impact of LCBM development and foreign investor participation in these markets on capital flow volatility. Across a sample of ten emerging Asian economies, we find that there are notable differences between well developed LCBMs and those that are less developed. In particular, economies with less developed LCBMs are more susceptible to capital flow volatility due to foreign investor participation in these markets. Thus, while LCBMs may have positive effects on financial stability through reducing currency mismatch, substantial risks to financial stability prevail through the effect on capital flow volatility. These effects are also apparent for well developed LCBMs in Asia, but with much lower magnitudes. Foreign investors in this scenario remain subject to currency mismatches, termed ‘original sin redux’ by Carstens and Shin (2019). This phenomenon can help to explain why foreign investor participation exacerbates capital flow volatility. Moreover, foreign investors in LCBMs will be more responsive to changes in global interest rates than domestic investors. A policy implication for emerging Asian economies is to develop further their capital markets, and in particular to strengthen the local investor base and develop currency hedging capabilities. This may help foreign investors to deal more smoothly with currency fluctuations and help to dampen capital flow volatility in Asian markets. Going forward, mobilizing domestic resources through LCBMs ought to be a priority for raising long-term capital that will facilitate the financing of sustainable investment and development. Finally, given that our analysis considers total capital flow volatility, future avenues of research may consider the implications of LCBM development for capital flow volatility at a more disaggregated level, as well as the impact of foreign investor participation in LCBMs on capital flow volatility for a given composition of capital flows. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 12 REFERENCES Belke, A., I. Dubova, and U. Volz. 2018. “Bond Yield Spillovers from Major Advanced Economies to Emerging Asia.” Pacific Economic Review 23(1): 109–26. Belke, A., and U. Volz. 2019. “Flows to Emerging Market and Developing Economies—Global Liquidity and Uncertainty Versus Country-specific Pull Factors.” Review of Development Finance 9(1): 32–50. Berensmann, K., F. Dafe, and U. Volz. 2015. “Developing Local Currency Bond Markets for Long-Term Development Financing in Sub-Saharan Africa.” Oxford Review of Economic Policy 31(3–4): 350–78. Bruno, V., and H. S. Shin. 2015. Capital Flows and the Risk-Taking Channel of Monetary Policy. Journal of Monetary Economics 71(C): 119–132. Burger, J. D., and F. E. Warnock. 2007. “Foreign Participation in Local Currency Bond Markets.” Review of Financial Economics 16(3): 291–304. Burger, J. D., F. E. Warnock, and V. C. Warnock. 2012. “Emerging Local Currency Bond Markets.” Financial Analysts Journal 68(4): 73–93. Byrne, J. P., and N. Fiess. 2016. “International Capital Flows to Emerging Markets: National and Global Determinants.” Journal of International Money and Finance 61(C): 82–100. Carstens, A., and H.-S. Shin. 2019. “Emerging Markets Aren’t Out of the Woods Yet.” Foreign Affairs 15 March. Choi, I. 2001. “Unit Root Tests for Panel Data.” Journal of International Money and Finance 20(2): 249–72. Christiano, L. J., M. Eichenbaum, and C. L. Evans. 1999. Monetary Policy Shocks: What Have we Learned and To What End? In: Handbook of Macroeconomics Vol. 1, edited by J. B. Taylor and M. Woodford. Amsterdam: Elsevier, 65–148. Claessens, S., D. Klingebiel, and S. Schmukler. 2007. “Government Bonds in Domestic and Foreign Currency: The Role of Institutional and Macroeconomic Factors.” Review of International Economics 15(2): 370–413. Csonto, B. 2014. “Emerging Market Sovereign Bond Spreads and Shifts in Global Market Sentiment.” Emerging Markets Review 20(C): 58–74. Dafe, F., D. Essers, and U. Volz. 2018. “Localising Sovereign Debt: The Rise of Local Currency Bond Markets in Sub‐Saharan Africa.” The World Economy 41(12): 3317–44. Ebeke, C., and Y. Lu. 2015. “Emerging Market Local Currency Bond Yields and Foreign Holdings: A Fortune or Misfortune?” Journal of International Money and Finance 59(C): 203–19. ECB. 2016. “Dealing with Large and Volatile Capital Flows and the Role of the IMF.” Occasional Paper Series 180. IRC Taskforce on IMF Issues. Frankfurt: European Central Bank. Eichengreen, B. J., and R. Hausmann. 2009. Exchange Rate and Financial Fragility: New Challenges for Monetary Policy. Kansas City: Federal Reserve Bank of Kansas City. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 13 Eller, M., F. Huber, and H. Schuberth. 2020. “How Important are Global Factors for Understanding the Dynamics of International Capital Flows?” Journal of International Money and Finance 109: 102221. Felman, J., S. Gray, M. Goswami, A. Jobst, M. Pradhan, and S. Peiris. 2011. “ASEAN5 Bond Market Development: Where Does it Stand? Where Is it Going?” IMF Working Paper No. 11/137. Washington, DC: International Monetary Fund. IMF. 2016. Development of Local Currency Bond Markets: Overview of Recent Developments and Key Themes. Staff Note for the G20 IFAWG, Seoul, June 20. ———. 2011. “Long-term Investors and their Asset Allocations: Where Are they Now?” Global Financial Stability Report. Washington, D.C.: International Monetary Fund. Kawai, M. 2007. “Asian Bond Market Development: Progress, Prospects and Challenges.” Keynote speech, High Yield Debt Summit Asia 2007, Singapore. Kumar, M., and T. Okimoto. 2011. “Dynamics of International Integration of Government Securities’ Markets.” Journal of Banking and Finance 35(1): 142–54. Miyajima, K., M. S. Mohanty, and T. Chan. 2015. “Emerging Market Local Currency Bonds: Diversification and Stability.” Emerging Markets Review 22(C): 126–39. Park, D., K. Shin, and S. Tian. 2018. “Do Local Currency Bond Markets Enhance Financial Stability?” ADB Working Paper No. 563. Tokyo: Asian Development Bank Institute. Piljak, V. 2013. “Bond Markets Co-Movement Dynamics and Macroeconomic Factors: Evidence from Emerging and Frontier Markets.” Emerging Markets Review 17(C): 29–43. Presbitero, A. F., D. Ghura, O. S. Adedeji, and L. Njie. 2016. “Sovereign Bonds in Developing Countries: Drivers of Issuance and Spreads.” Review of Development Finance 6(1): 1–15. Spiegel, M. M. 2012. “Developing Asian Local Currency Bond Markets: Why and How?” In Implications of the Global Financial Crisis for Financial Reform and Regulation in Asia, edited by Masahiro Kawai, David G. Mayes, and Peter J. Morgan, 221–47. Cheltenham: Edward Elgar. Tsukuda, Y., J. Shimada, and T. Miyakoshi. 2017. “Bond Market Integration in East Asia: Multivariate GARCH with Dynamic Conditional Correlations Approach.” International Review of Economics and Finance 51(C): 193–213. Turner, P. 2012. “The Global Long Term Interest Rate, Financial Risks, and Policy Choices in EMEs.” BIS Working Papers No. 441. Basel: Bank for International Settlements. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 14 APPENDIX Figure A1: LCBM Yields Figure A2. LCBM capitalization as a share of GDP ADBI Working Paper 1252 Beirne, Renzhi, and Volz 15 Table A1: Economy Sample Well Developed Less Developed Hong Kong, China PRC Republic of Korea India Malaysia Indonesia Singapore Philippines Thailand Viet Nam Note: Well developed refers to countries with an average LCBM capitalization/GDP larger than 55%; less developed refers to countries with an average LCBM capitalization/GDP below 55%. Table A2: Overview of Variables Used in the Empirical Analysis Variable Data Source Definition LCBM yield Bloomberg 10-year local currency government bond yield GDP growth Bloomberg and CEIC The real GDP growth rate Current account/GDP Bloomberg The current account balance to GDP ratio Public debt/GDP IMF International Financial Statistics The public debt as a share of GDP, defined as general government gross debt to GDP ratio Exchange rate BIS and Bloomberg Effective exchange rate index Foreign participation Asian Bonds Online and IIF The percentage of local currency (LCY) government bonds held by foreign investors relative to the quantity of LCY government bonds outstanding in a specific market LCBM capitalization Asian Bonds Online The share of LCBM capitalization relative to GDP Inflation rate Bloomberg Year-over-year consumer price index US bond yield Bloomberg US 10-year government bond yield VIX Bloomberg The Chicago Board Options Exchange (CBOE) Volatility Index, a measure of global risk aversion Capital flow volatility IMF The ratio of the standard deviation to the absolute value of the mean of total gross capital flows Exchange rate volatility IMF The absolute value of the growth rate of the exchange rate COVID-19 WHO Period dummy taking a value of 1 from the first confirmed case of COVID-19 and zero otherwise Crisis IMF Dummy taking a value of 1 where exchange rate volatility is in the top quartile and zero otherwise ADBI Working Paper 1252 Beirne, Renzhi, and Volz 16 Table A3: Summary Statistics Descriptive Statistics Capital Flow Volatility Obs. Mean Std. Dev. Min. Max. All economies 2,550 2.41 5.45 0 53.53 Well developed 1,275 1.25 1.52 0 14.42 Less developed 1,275 3.57 7.38 0 53.53 PRC 255 14.95 10.39 0.08 53.53 Hong Kong, China 255 2.42 2.26 0 14.42 Indonesia 255 0.89 0.65 0 5.14 India 255 1.51 1.08 0.02 5.75 Republic of Korea 255 1.95 1.59 0.01 8.31 Malaysia 255 0.45 0.40 0 4.55 Philippines 255 0.34 0.28 0 1.62 Singapore 255 0.67 0.52 0 2.42 Thailand 255 0.77 0.65 0 4.34 Viet Nam 255 0.14 0.12 0 0.7 Table A4: Preliminary Analysis Hausman Test Test Statistics P-value chi2=650.59 0.000 Panel Unit Root Test Variables Test Statistics P-value Capital flow volatility z = –8.46 0.000 LCBM yield z = –4.69 0.000 LCBM capitalization z = –3.77 0.001 Foreign participation z = –2.74 0.003 Real GDP growth z = –8.45 0.000 Current account balance z = –4.14 0.000 Public debt z = –3.66 0.000 Inflation rate z = –8.24 0.000 Financial openness z = –3.41 0.003 Exchange rate volatility z = –9.33 0.000 Crisis z = –12.73 0.000 US bond yield z = –6.17 0.000 VIX z = –9.65 0.000 Note: Panel unit root test is based on Choi (2001) with correction for cross-dependence. The maximum lag to be used for the variable is set as two, based on the AIC criterion. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 17 Table A5: Local Currency Bond Markets and Capital Flow Volatility: Panel Estimates with Foreign Investor Interaction Terms (1) (2) (3) All Well Developed Less Developed Local currency bond markets LCBM yield (%) –0.034 –0.036 –0.198 (0.119) (0.0973) (0.266) LCBM capitalization (%) –0.042*** 0.005 –0.356*** (0.016) (0.007) (0.067) Foreign participation (%) 0.035** 0.028** 0.251** (0.0162) (0.013) (0.124) Domestic factors Real GDP growth (%) –0.062 –0.005 –0.503** (0.044) (0.016) (0.234) Current account balance (% GDP) –0.025 0.032** –0.513*** (0.035) (0.014) (0.154) Public debt (% GDP) 0.057** –0.001 0.398*** (0.024) (0.013) (0.102) Inflation rate (%) –0.009 0.021 0.067 (0.052) (0.025) (0.133) Financial openness 0.261** 0.047*** 2.319* (0.121) (0.011) (1.313) Exchange rate volatility 0.138** 0.083** 0.334** (0.068) (0.039) (0.158) Foreign participation * Exchange rate volatility 0.025** 0.020*** 0.073*** (0.012) (0.003) (0.011) Crisis 1.265*** 0.937*** 1.832* (0.474) (0.201) (1.053) Foreign participation * Crisis 0.048* 0.091*** 0.088** (0.027) (0.031) (0.044) Foreign participation * Exchange rate volatility * Crisis 0.002* 0.006* 0.004*** (0.001) (0.003) (0.001) COVID-19 0.947** 1.410*** 4.001** (0.422) (0.365) (2.014) Global factors US bond yield (%) –0.610*** –0.0361 –0.208 (0.192) (0.100) (0.497) VIX (log) 0.0123 0.019*** 0.065 (0.016) (0.006) (0.043) Constant 4.756*** 0.204 3.498 (1.397) (0.856) (5.351) Observations 1,604 986 618 R-squared 0.033 0.105 0.109 Number of countries 10 5 5 Country fixed effects Yes Yes Yes Note: Standard errors in parentheses; *** p<0.01, ** p<0.05, * p<0.1. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 18 Table A6: Local Currency Bond Markets and Capital Flow Volatility: Country-specific Estimates with Foreign Investor Interaction Terms (1) (2) (3) (4) (5) CHN HKG IDN IND KOR LCBM yield –0.523 0.080 –0.018 –0.218 0.432 (2.470) (0.552) (0.048) (0.609) (0.335) LCBM capitalization –0.772*** –0.094*** 0.006 –0.127 0.076 (0.279) (0.026) (0.036) (0.122) (0.049) Foreign participation 8.787*** n/a 0.041*** –0.721 0.207* (1.669) (0.015) (0.645) (0.115) Real GDP growth –1.498* 0.107* 0.038 0.085 –0.171** (0.816) (0.057) (0.058) (0.167) (0.082) CAB 0.690 –0.105* –0.016 1.506*** 0.118 (0.937) (0.062) (0.050) (0.420) (0.111) Public debt 3.068*** –0.772** 0.044** 0.426* 0.173** (0.787) (0.364) (0.022) (0.246) (0.086) Inflation rate –0.358 0.032 0.024 –0.032 0.715*** (0.697) (0.091) (0.024) (0.131) (0.216) Financial openness n/a n/a 0.486** n/a 1.111** (0.227) (0.456) Exchange rate volatility 2.024* 0.096*** –0.029 –0.120 0.027 (1.165) (0.029) (0.035) (0.459) (0.083) Financial stress 22.49* 1.406*** –0.019 –1.818 –0.188 (11.76) (0.513) (0.299) (2.517) (0.766) Foreign participation * Exchange rate volatility 0.122** n/a 0.002* 0.066 –0.007 (0.061) (0.001) (0.136) (0.011) Foreign participation * Crisis –7.857 n/a –0.017 0.240 0.091 (5.906) (0.016) (0.857) (0.122) Foreign participation * Crisis * Exchange rate volatility 0.065 n/a 0.003** 0.032 –0.002 (0.417) (0.001) (0.049) (0.010) COVID-19 –10.86 4.546*** 3.629*** –2.552** –0.037 (8.443) (1.361) (0.641) (1.168) (1.021) US bond yield 8.911*** –0.411 0.267** 1.748*** –0.197 (2.035) (0.658) (0.112) (0.517) (0.357) VIX 0.060 0.047** 0.039*** 0.084** 0.035* (0.143) (0.023) (0.009) (0.035) (0.021) Constant –41.32* 8.518*** –3.257*** –20.44 –10.72*** (23.67) (2.410) (0.855) (21.43) (3.163) Observations 172 218 197 77 209 R-squared 0.378 0.270 0.414 0.378 0.251 continued on next page ADBI Working Paper 1252 Beirne, Renzhi, and Volz 19 Table A6 continued (6) (7) (8) (9) (10) MYS PHL SGP THA VNM Local currency bond markets LCBM yield –0.111 –0.107 0.437** 0.054 –0.048*** (0.068) (0.114) (0.195) (0.148) (0.015) LCBM capitalization 0.007 –0.099*** 0.032* –0.059** –0.025 (0.007) (0.032) (0.017) (0.027) (0.017) Foreign participation 0.006 0.207* n/a 0.126*** 0.132* (0.006) (0.120) (0.034) (0.069) Domestic factors Real GDP growth –0.012 –0.123 –0.038*** 0.016 –0.020 (0.010) (0.075) (0.013) (0.018) (0.023) CAB 0.009 0.091 0.050** 0.073*** 0.007 (0.007) (0.056) (0.022) (0.027) (0.008) Public debt –0.001 –0.072 –0.007 –0.009 0.021 (0.011) (0.059) (0.012) (0.026) (0.017) Inflation rate –0.022 –0.007 0.0537 –0.054 0.012* (0.018) (0.065) (0.033) (0.035) (0.007) Financial openness 0.044 n/a n/a 0.304* n/a (0.046) (0.159) Exchange rate volatility 0.011 0.083 0.042 –0.011 –0.005 (0.019) (0.169) (0.042) (0.034) (0.013) Financial stress –0.036 –1.173 –0.065 0.682** –0.354 (0.134) (0.850) (0.239) (0.320) (0.628) Foreign participation * Exchange rate volatility –0.001 –0.011 n/a 0.006*** 0.018 (0.001) (0.033) (0.000) (0.015) Foreign participation * Crisis –0.006 0.370* n/a 0.232*** 0.305 (0.010) (0.200) (0.071) (0.481) Foreign participation * Crisis * Exchange rate volatility 0.000 0.019* n/a 0.041*** –0.012 (0.001) (0.012) (0.009) (0.019) COVID-19 2.081*** 0.099 0.291 1.559*** 0.187** (0.201) (0.306) (0.370) (0.411) (0.076) Global factors US bond yield 0.052 0.469*** 0.051 –0.019 –0.057* (0.057) (0.150) (0.124) (0.121) (0.032) VIX 0.009*** –0.000 0.0017 0.022** 0.005 (0.004) (0.012) (0.007) (0.009) (0.003) Constant –0.107 5.771** –3.032 3.480 0.191 (0.760) (2.626) (1.891) (2.208) (0.500) Observations 230 74 156 173 98 R-squared 0.489 0.434 0.241 0.402 0.573 Note: Standard errors in parentheses; *** p<0.01, ** p<0.05, * p<0.1. ADBI Working Paper 1252 Beirne, Renzhi, and Volz 20 Table A7: Local Currency Bond Markets and Capital Flow Volatility: Panel Estimates Until 2019 (1) (2) (3) All Well Developed Less Developed Local currency bond markets LCBM yield (%) –0.029 –0.028 –0.261 (0.121) (0.098) (0.268) LCBM capitalization (%) –0.041** 0.005 –0.350*** (0.016) (0.007) (0.066) Foreign participation (%) 0.117*** 0.015** 0.232** (0.020) (0.008) (0.110) Domestic factors Real GDP growth (%) –0.087* –0.003 –0.864*** (0.045) (0.017) (0.253) Current account balance (% GDP) –0.019 0.034** –0.448*** (0.035) (0.014) (0.152) Public debt (% GDP) 0.069*** 0.004 0.382*** (0.024) (0.013) (0.101) Inflation rate (%) 0.017 0.029 0.125 (0.053) (0.025) (0.133) Financial openness 0.124* 0.058** 2.373** (0.072) (0.023) (1.133) Exchange rate volatility 0.038** 0.031*** 0.089* (0.019) (0.012) (0.047) Crisis 1.006*** 0.643*** 1.413 (0.377) (0.162) (0.907) Global factors US bond yield (%) –0.554*** –0.017 0.055 (0.192) (0.101) (0.505) VIX (log) 0.012 0.020*** 0.068 (0.016) (0.006) (0.044) Constant 4.188*** –0.082 6.158 (1.400) (0.865) (5.332) Observations 1,574 971 603 R-squared 0.032 0.073 0.112 Number of countries 10 5 5 Country fixed effects Yes Yes Yes Note: Standard errors in parentheses; *** p<0.01, ** p<0.05, * p<0.1.