Do foreign portfolio capital flows affect domestic investment? Evidence from Brazil

Although there are several direct and indirect theoretical channels through which foreign capital flows may affect domestic investment, empirical evidence remains inconclusive. In this paper, we employ a VARX framework to assess the impact of Equity Foreign Portfolio Investment (EFPI) on domestic investment growth, employing monthly series of capital flows and gross capital formation for the Brazilian economy. Our results suggest that EFPI played a non-negligible role in explaining aggregate investment fluctuations, but only before the 2008 global financial crisis. After the crisis, a period marked first by a shift in economic policy in 2008-09, with substantial increases in government intervention, followed by deterioration in the institutional outlook and political stability in 2014-15, mostly against the backdrop of the Petrobras corruption scandal, unexpected shocks to EFPI no longer led any real effects on investment growth. Whilst, in general, our results vouch for beneficial effects of equity capital flows on investment, this virtuous relationship is likely disturbed by interventionist policies and political unrest.