The recent Turkey lira crisis highlights the problem with the sudden stop of capital inflow.
The value of the currency depreciates rapidly, pushing the inflation much higher; the burden of foreign debts in real terms becomes much higher. These disruptions might drag down the financial system and dampen investors’ confidence in the real economy. Hence, a vicious cycle between a depreciating currency and a worsening real economy.
Other than that, it is also important to know what happens when the sudden stop occurs? Exactly, which kinds of capital inflow stop during the period? In the 2017 World Bank policy paper “Are capital flows fickle? Increasingly ? and does the answer still depend on type? ” Barry Eichengreen, Poonam Gupta, and Oliver Masetti have tried to investigate how different kinds of capital flows behave during a sudden stop.
Here is their result:
As you can see, on average, FDI flow remains stable and positive during a sudden stop (t=0). Portfolio equity and debt flow, on the other hand, would become outflows during the first quarter of the sudden stop. But the outflow stabilizes after one quarter.
The most rapid capital outflow, however, is in that the authors categorized as ”Others.” Included in others are flows through the banking sector (loans, deposits and banking capital), loans raised by the private sector, and trade credits.
So, maybe, in this Turkey economic crisis, we have to keep a closer look at the banking sector and other private sector outflows, if the past episodes are a good guide.