| Abstract: |
We show that “preemptive” capital flow management measures (CFM) can reduce
emerging markets and developing countries’ (EMDE) external finance premia
during risk-off shocks, especially for vulnerable countries. Using a panel
dataset of 56 EMDEs during 1996–2020 at monthly frequency, we document that
countries with preemptive policies in place during the five year window before
risk-off shocks experienced relatively lower external finance premia and
exchange rate volatility during the shock compared to countries which did not
have such pre-emptive policies in place. We use the episodes of Taper Tantrum
and COVID-19 as risk-off shocks. Our identification relies on a
difference-in-differences methodology with country fixed effects where
preemptive policies are ex-ante by construction and cannot be put in place as
a response to the shock ex-post. We control the effects of other policies,
such as monetary policy, foreign exchange interventions (FXI), easing of
inflow CFMs and tightening of outflow CFMs that are used in response to the
risk-off shocks. By reducing the impact of risk-off shocks on countries’
funding costs and exchange rate volatility, preemptive policies enable
countries’ continued access to international capital markets during troubled
times. |