Interlinkages between external debt financing, credit cycles and output fluctuations in emerging market economies

Akhilesh Verma and Rajeswari Sengupta

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

Abstract: We examine the role of external debt financing (EDF) in shaping the credit cycle and output fluctuations in nine major emerging economies. We show that sharp fluctuations in EDF flows are significantly associated with credit surge and stop episodes in emerging market economies (EMEs). However the association is asymmetric in nature - a stop episode in EDF flows is more likely to bring about a credit stop episode compared to an EDF surge episode. We extend our framework to analyze the joint spillover of EDF flows and credit cycles on business cycle fluctuations in these EMEs. We find that EDF lows and credit together have a strong association with output growth. After dividing the sample into EDF surge and stop phases, we find evidence of asymmetric spillover of credit on output growth. Credit decline during EDF stop episode leads to a larger decline in GDP growth relative to the impact of an increase in credit growth during EDF surges. Our analysis points to the vulnerability of credit cycles of EMEs to the sharp movement in EDF flows which in turn is largely synchronized with external financing conditions. The strong negative spillover of EDF stop phases on the business cycle is a cause of concern for policymakers in EMEs who seek to insulate their economies from such external shocks.

Keywords: External debt finance; Credit cycle; Dynamic panel GMM; Business cycle (search for similar items in EconPapers)
JEL-codes: E47 E51 F34 F65 G15 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2020-04
New Economics Papers: this item is included in nep-fdg and nep-mac
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Journal Article: Interlinkages between external debt financing, credit cycles and output fluctuations in emerging market economies (2021)
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