# **Evolution of uncertainty in EMDEs since the 2008‐09 crisis**

In most EMDEs, political and policy uncertainty were higher post‐crisis (2010‐2015) than pre‐crisis (2003‐ 2008), as indicated by the ICRG‐based political uncertainty and EPU‐based policy uncertainty measures (Figure 2.1). Political risk increased in more than four‐fifths of EMDEs and policy uncertainty increased in all four major EMDEs for which data are available. In contrast, financial market volatility, as measured by the standard deviation of domestic stock market indexes, declined in most EMDEs, reflecting exceptionally accommodative monetary policies and record‐low interest rates globally. The generally low post‐crisis financial market volatility was disrupted by several bouts of global financial market uncertainty. The VIX, which in normal circumstances tends to fluctuate in the 10‐30 range, surged to above 40 basis points during periods of intense market concerns about the future of the Euro Area (March‐June 2010 and May‐ September 2011) and about the stability of Chinese equity markets and growth prospects (July‐August 2015).

# **Impact of uncertainty on investment in EMDEs**

To assess the effects of uncertainty on investment during 1998Q1‐2016Q2, a series of vector autoregressive models were estimated for 18 EMDEs. Two sources of uncertainty were distinguished: domestic and global. Global financial market uncertainty was captured by the VIX. Global policy uncertainty was captured by the EPU for the United States and the EU. Domestic policy uncertainty was captured by the EPU for Brazil. Details of the estimation are presented in Annex 1B.

- _Global financial market uncertainty._ Global financial market uncertainty shocks, as measured by spikes in the VIX, significantly reduced EMDE investment, in line with findings of earlier studies (Carriere‐Swallow and Cespedes 2013). Specifically, a 10 percent increase in the VIX reduced average EMDE investment growth by about 0.6 percentage point within a year (Figure 2.2). Financial market uncertainty was the key source of the slowdown in EMDE investment growth in 2008‐09. Bouts of global financial market uncertainty (such as during the Euro Area crisis, the 2013 Taper Tantrum, and the 2016 Brexit) also weighed on EMDE investment.

- _Global policy uncertainty._ Policy uncertainty in major AEs could also generate significant spillovers to EMDE investment. Policy uncertainty in the EU had an especially sizable impact on investment in EMDEs in Europe and Central Asia: a 10 percent increase in EU policy uncertainty reduces their investment growth by 0.6 percentage point within a year (Figure 2.3). During the Euro Area crisis in 2010‐12, EU policy uncertainty may have reduced investment growth in EMDEs in Europe and Central Asia by 0.6‐1.3 percentage points with a certain time lag.

- _Domestic policy uncertainty._ For those EMDEs for which the EPU is available, domestic policy uncertainty also appears to have been accompanied by significantly lower investment: a 10 percent increase in Brazil’s EPU may have reduced investment growth by around 0.8 percentage point within a year.

# **Conclusion**

The post‐crisis rise in political and policy uncertainty in most EMDEs has contrasted with a decline in financial market uncertainty amidst benign global financing conditions until late 2016. Low global financial market uncertainty has supported EMDE investment. In contrast, increased policy uncertainty in the EU has significantly reduced investment in EMDEs in Europe and Central Asia.

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