Understanding the drivers of capital flows into the CESEE countries

We analyze the relationship between global factors and country-specific capital flow dynamics in a sample of 12 Central, Eastern and Southeastern European (CESEE) countries from 1994 until 2014. We detect a pronounced time-varying pattern of capital flow volatility that mirrors well-known crisis episodes in several instances. We show that the global co-movement of macroeconomic, financial and capital flow variables is able to explain the lion’s share of volatility of gross capital inflows into CESEE economies and that it became even more important after the 2008/09 global financial crisis. In particular, global financial factors that approximate the global financial cycle explain by far the largest share of capital flow volatility, followed by the global real business cycle component. If common global factors are dominant in explaining the volatility of gross capital inflows, a combination of better international coordination of economic policies, macroprudential measures or capital flow management instruments is advisable to smooth the capital flow cycle. We also show that gross capital inflows were so sizeable in some countries between 2003 and 2008 that common global (financial) factors like the buildup of global leverage were not as dominant as in other periods – a result that could partly be the outcome of the strategic positioning of foreign banks in the region.