Stocks, Flows and Valuation Effects of Foreign Assets and Liabilities: Do They Matter?

Large holdings of foreign assets and liabilities, along with increasing relevance of valuation effects—capital gains or losses—have characterized global financial integration. In this paper, we assess empirically the implications of stocks, flows and valuation adjustments in external crises (current-account reversals, sudden stops and currency crises), sovereign credit ratings and the longrun real exchange rates (RER), in both industrial and developing economies. We find support for the view that foreign assets and liabilities are rather distinctive external holdings with different implications in the occurrence of external crisis. Valuation adjustments have an impact on crises, although quantitatively not very large. Portfolio liabilities (particularly equity) increase the probability of current-account reversals and currency crises, while the likelihood of sudden stops increases with the stock of foreign direct investment (FDI) assets. In the case of sovereign credit ratings, we find a noteworthy effect of the stock and flows of FDI liabilities on improving sovereign ratings. Finally, as for the RER, gross assets and liabilities appear equally important, but components of external holdings have considerably different effects. While the cumulative current account is associated with real depreciation, the valuation effect is strongly linked with real currency appreciations in developing economies.