12  BIS central bankers’ speeches  Chart 5 Cross-border equity holdings (1980–2005) 1980  1985  1990  1995  2000  2005  Source: Kubelec and Sa (2010) and Bank calculations. Advanced economies  Emerging market economies  Financial centres (Hong Kong and Singapore)  Notes: Widths of links are proportional to the log dollar value of cross-border equity holdings. Each arrow denotes ownership, with the arrow pointing away from the holder of the equity and toward the issuer. Sizes of nodes are proportional to the log dollar value of the sum of all of the country’s cross-border equity holdings and liabilities issued (i.e. equal to the sum of incoming and outgoing links). BIS central bankers’ speeches  13  Chart 6 Country shares of world equity market capitalisation (1995–2010) 1995  2000  China  India  China  India  Other emerging G20  US  Other emerging G20  US  Other advanced G20  Non-G20  Other advanced G20  Non-G20  2005  2010  China  India  China  India  Other emerging G20  US  Other emerging G20  US  Non-G20  Other advanced G20  Non-G20  Other advanced G20  Source: Thomson Reuters Datastream. Note: “World equity market capitalisation” aggregates the US dollar measures of local equity market capitalisation. Chinese equity market capitalisation includes A, B and H shares. Russian equity market capitalisation not available prior to 1999. Data unavailable for Saudi Arabia.
Gross portfolio equity inflows to emerging markets surged as investors substituted out of low growth developed markets (Chart 1). Gross equity inflows to certain emerging markets were large relative to domestic market capitalisation (Chart 2). The resulting indigestion problem caused bubbly behaviour in emerging asset markets. In response, a number of countries have thrown grit in the wheels of finance through macro-prudential measures or capital flow restrictions. These surges in foreign capital flows, and associated asset market spillovers, are far from new. Through this century, a new wave of inflows to emerging markets has been building. Although halted temporarily by the financial crisis, its effect has been to buoy emerging asset prices (Chart 3). Earlier centuries have seen many similar episodes of capital flow surges into emerging markets, from the South Sea bubble in 1720 to the East Asian crisis of the 1990s (Reinhart and Rogoff (2008)). Historically, as these waves have broken they have often caused quite a splash, with sharp capital and asset price reversals (IMF (2011)). Some commentators have called those capital reversals “sudden stops” (Dornbusch, Goldfajn and Valdés (1995)). But the underlying problem may be as much the start as the stop. The seeds of emerging market crises are sown in the build-up phase, as inflows dwarf the absorptive capacity of recipient countries’ capital markets. Capturing that dynamic requires a different metaphor – the “Big Fish Small Pond” (BFSP) problem. The Big Fish here are the large capital-exporting, advanced countries.