Capital flows in Montenegro: SVAR model

Analysing push and pull determinants of capital flows has become increasingly important with global financial crisis. Namely, global financial crisis has shown that large and volatile capital flows can pose risks, especially, for small and open economies. In this paper we are particularly interested to analyse the vulnerability of capital flows in country with limited monetary policy. We are focused on Montenegro, the country that unilaterally adopted euro in 2002 and regained independence in 2006. Since then, Montenegro has become very attractive for investments and has received significant amounts of foreign capital. Thus, in this paper we are assessing how global shocks could be dangerous for such a small open economy. In addition, we are interested in investigating whether domestic factors can influence capital flows due to the full euroization. In order to answer these questions, we have applied structural vector autoregressive model of the determinants of two main components of capital flows, foreign direct investments and portfolio investments separately, using quarterly data from 2005 to 2017. We provide evidence that mainly push factors, such as foreign output, interest rates and euro area risk sentiment, significantly explain the variation of capital flows. Furthermore, domestic factors are found to play little role for capital flow developments in Montenegro.