Uncertainty, capital flows, and maturity mismatch

Output growth in emerging markets is significantly more volatile than in advanced economies. The distribution of growth rates in emerging markets is also more negatively skewed, with occasional sharp contractions that are not offset by comparable growth surges. I show that the interaction of two aspects of the financial environment in emerging economies, volatile capital inflows and pervasive maturity mismatch, can generate these patterns. When firms must borrow short-term to finance long-term projects and are uncertain about the future availability of foreign borrowing, an increase in capital flow volatility prompts firms to reduce long-term investment. Aggregate investment falls and the share of resources allocated to less productive short-term projects rises. This composition effect contributes to the elevated volatility of aggregate total factor productivity in emerging markets. Using monthly-frequency capital flows data, I find that the volatility of portfolio debt flows negatively affects output by dampening investment, while the volatility of portfolio equity flows has no effect. This, along with the fact that the negative impact of volatility is mitigated by financial market development, suggests that maturity mismatch acts as an important channel through which uncertainty shocks affect the real economy. JEL Classification: E22,F32,F43,G31,G32,C2