Impact of Foreign Investment Income on External Positions of Emerging Market Economies

Abstract

The impact of income from foreign investments onto the formation of external economic positions of nine emerging market economies of Central and Eastern Europe and Latin America is identified in the paper by using several approaches to assess financial stability. Constructing vector autoregression models and performing Granger causality tests reveal the negative impact of income on foreign investments onto the formation of external debt. Countries are grouped according to the extent of their dependence on external financing, based on the analysis of the coefficient of coverage of foreign investments, which is constructed as a share of the foreign direct, portfolio and other investment income repatriated by investors in the foreign capital received by the country. Countries, for which the investment income payouts are exceeding 100% of the direct investment inflows, are highlighted: Czech Republic and Poland. Investment income outflows of almost 100% of received foreign direct investments were observed in Chile and Argentina. Due to the huge amount of investment income outflows and large share of foreign currency, located outside the country's banking system, Argentina might face a new monetary and financial crisis in the nearest future. Formally, for Ukraine the ratio of investment income payments to FDI was the smallest among the studied countries, but this is explained by the active use of non-market transfer pricing in trade operations between Ukrainian affiliates and their “parent” companies that lead to a reduction of the official income of foreign affiliates in Ukraine.