Global Financial Cycle, Commodity Terms of Trade and Financial Spreads in Emerging Markets and Developing Economies

TL;DR

This paper examines how global financial shocks and liquidity conditions influence emerging markets, emphasizing the role of commodity trade balances in shaping financial spread volatility and the impact of global conditions on these economies.

Contribution

It introduces a dynamic panel data model that captures the asymmetric effects of global financial conditions and commodity trade balances on financial spreads in emerging markets.

Findings

Commodity trade balances significantly influence financial spread volatility.

Global liquidity conditions impact emerging markets differently based on trade patterns.

Asymmetric effects of terms of trade on financial spreads are identified.

Abstract

We study the diffusion of shocks in the global financial cycle and global liquidity conditions to emerging and developing economies. We show that the classification according to their external trade patterns (as commodities' net exporters or net importers) allows to evaluate the relative importance of international monetary spillovers and their impact on the domestic financial cycle volatility -i.e., the coefficient of variation of financial spreads and risks. Given the relative importance of commodity trade in the economic structure of these countries, our study reveals that the sign and size of the trade balance of commodity goods are key parameters to rationalize the impact of global financial and liquidity conditions. Hence, the sign and volume of commodity external trade will define the effect on countries' financial spreads. We implement a two-equation dynamic panel data model for 33 countries during 1999:Q1-2020:Q4 that identifies the effect of global conditions on the countries' commodities terms of trade and financial spreads, first in a direct way, and then by a feedback mechanism by which the terms of trade have an asymmetric additional influence on spreads.