somewhat counterintuitive result is not new in the literature and could reflect difficulties with measuring the intensity of capital account liberalization measures.

# _<u>Global Conditions</u>_

An increase in market volatility and global risk aversion, measured contemporaneously by the VIX, increases the probability of being in the lower growth and higher vulnerability (V) cluster and reduces the probability of a higher growth and higher vulnerability (H) cluster. The explanation seems obvious. Under conditions of market uncertainty, capital flows are likely to be more of a short term nature and more volatile; in turn, this increases the probability that countries will face vulnerability without growth.

# _<u>Discussion</u>_

How good is the model at predicting the actual outcome of cluster analysis? The matrix in Table 7 shows the percentage of correct predictions by the model relative to the original cluster analysis classification. Undoubtedly, the model has much to improve. Still, it correctly predicts about 55 percent of the lower vulnerability cases and about 73 percent of the higher vulnerability cases.

What conclusions can be drawn that can best position countries in a higher growth and lower vulnerability path? First, though the results suggest that increased trade openness per se could lead to an increase in vulnerability, it also appears to help a country achieve the most beneficial of the vulnerability clusters (group H). Also, the factors underlying trade openness matter; e.g., strong export performance (which in turn would depend on structural and macro policies that are not explored in this paper) reduces the likelihood of higher vulnerability outcomes. It follows that a country’s export orientation is a source of sustainable development. A similar conclusion was reached by Atoyan.

**Table 7. Model Fit (Predicted Correctly in Percent of Original Cluster Analysis Classification)**

||Low<br>vulnerability|High<br>vulnerability|
|---|---|---|
|Low growth|**52**|**74**|
|es: IMF’s World<br>ti Th hdd<br>High growth|Economic Outlook<br>ll i th 22 t<br>**56**|database and authors’<br>i flt th f<br>**72**|

Sources: IMF’s World Economic Outlook database and authors’ calculations. The shaded cell in the 2x2 matrix reflects the reference cluster, which is also been defined as the worst of all possible outcomes; that is, lower growth and higher vulnerability.

Second, the results indicate that increased financial openness is associated with increased vulnerability. While capital inflows can bring many benefits, including financing for productive investments and allowing diversification of investment risks, they can also complicate macroeconomic management and heighten vulnerabilities. In particular, they can lead to upward pressures on the exchange rate and contribute to overheating, with widening current account deficits and rapid credit growth. Moreover, often, when the flows are intermediated through the banking sector, the banking sector can play an important role in amplifying the macroeconomic challenges. Furthermore, Inflows into the banking sector that are extended as credit to the private sector can lead to the validation of demand that would otherwise be liquidity constrained and can fuel asset prices increases. In turn, the 14