Partners, Not Debtors: The External Liabilities of Emerging Market Economies

This paper investigates the change in the composition of the liabilities of emerging market countries from primarily debt (bonds, bank loans) to equity (foreign direct investment, portfolio) in the decades preceding the global financial crisis. We investigate the determinants of equity and debt liabilities on external balance sheets in a sample of 21 emerging market economies and 20 advanced economies over the period of 1981-2013. We use a new measure of domestic financial development that allows us to distinguish between financial institutions and financial markets. Our results show that the development of financial markets is linked to an increase in equity liabilities, and in particular, portfolio equity. FDI liabilities are more common when financial institutions are not well developed. Larger foreign exchange reserves are associated with larger amounts of portfolio equity. Moreover, countries with higher economic growth rates have larger amounts of equity liabilities. Domestic credit is inversely related to the share of equity in all liabilities. Foreign debt, on the other hand, is inversely related with the development of domestic financial markets. Larger amounts of debt liabilities are also associated with smaller foreign reserve holdings, lower growth rates and larger amounts of domestic credit