bank flows (McQuade and Schmitz 2016).

**Heightened uncertainty.** Political uncertainty has increased in many EMDEs since the 2008‐09 global financial crisis (Figure 9). This has reflected geopolitical tensions in Eastern Europe, security challenges and conflicts in the Middle East, and acute domestic political tensions in several large EMDEs. Even in major AEs and EMDEs without significant political tensions, major policy shifts have often been accompanied by policy uncertainty. For example, bouts of policy uncertainty—e.g., government shutdowns and political stalemates in the United States, the Taper tantrum episode associated with the U.S. Federal Reserve Bank’s policy plans, concerns around the future of the Euro Area during the Euro Area crisis, the U.K. referendum vote to leave the European Union (EU), and reforms related to financial markets and currency regime in China—have been a source of global financial market volatility further weighing on investor sentiment.

**Rapid credit growth and debt overhang.** On average, private credit in both commodity exporters and importers has increased by near 20 percentage points of GDP from 2000 to 2015 (Figure 10). The share of EMDEs with private credit‐to‐GDP ratios exceeding 60 percent had reached about one‐fifth by 2015, the highest share since 1990. Historically, during the three decades prior to the 2008‐09 crisis, about 40 percent of all credit booms have overlapped with investment surges within one or two years. Credit booms since 2010, however, have been unusually “investment‐less”: virtually none of the post‐crisis credit booms in EMDEs have been accompanied by investment surges. In several countries, rapid credit growth instead fueled above‐average consumption growth. In the past, when such investment‐less credit booms unwound, output contracted more than when the credit boom had been accompanied by an investment surge.

# **4. Factors associated with the investment slowdown**

A series of econometric exercises is conducted to estimate the relative importance of these external and domestic factors to investment growth. First, in a panel regression, investment in 73 EMDEs and 26 AEs for 1998‐2015 is modelled following the standard framework implying that the level of investment is chosen such that the marginal return on capital matches the risk‐adjusted cost of capital. Specifically, the regression model includes as explanatory variables the proxies for the drivers of investment, including the marginal return to capital (e.g., output growth and terms of trade growth) and the risk‐adjusted cost of capital (e.g., measures of uncertainty, FDI inflows, and the private credit‐to‐GDP ratio).<sup>5</sup> These also are the factors that have shaped the macroeconomic backdrop as previously discussed.

Second, the analysis drills down into the short‐term effects of uncertainty and weak activity in major advanced economies on EMDE investment growth using time‐series methods. This is done in two sets of vector autoregressions tailored to examine each factor in detail. The need for quarterly data restricts the cross‐country dimension of the sample (to 18 EMDEs) used in these exercises.

> 5 A large cross‐country dataset for investment growth is only available for aggregate gross fixed capital formation, which includes both private and public investment. The correlates of investment modelled here are mainly those relating to private investment whereas public investment is assumed to be mostly subject to discretionary policy decisions. In EMDEs, private investment on average constitutes about 70 percent of total investment. To mitigate concerns about endogeneity, output growth prospects are proxied by lagged output growth, in line with other studies (see Annex 1).

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