IMF Working Papers

Emerging Market Cycles: Twin-Balance Sheet Conditions and Macro- Financial Linkages

By Soumya Bhadury, Bhanu Pratap, Jay Surti

October 24, 2025

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Soumya Bhadury, Bhanu Pratap, and Jay Surti. "Emerging Market Cycles: Twin-Balance Sheet Conditions and Macro- Financial Linkages", IMF Working Papers 2025, 216 (2025), accessed October 27, 2025, https://doi.org/10.5089/9798229029520.001

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper empirically examines the dynamic linkages between financial conditions and economic growth across 18 major emerging market economies over the last two decades and the role that fiscal and trade balances play in shaping such associations. Using a reduced-form multivariate autoregressive state-space model, we document two opposing forces – growth-enhancing and growth-inhibiting linkages – that characterize macro-financial dynamics in these countries. Easing of domestic financial conditions is associated with stronger near-term GDP growth, a growth-enhancing link, albeit this acceleration in growth is followed by a tightening of financial conditions that can adversely impact future growth outcomes, a growth-inhibiting link. Both linkages are statistically significant at high frequencies for nearly half of the countries in our sample and appear to be driven by a weak twin-balance sheets condition of high public debt and external imbalances. External factors, notably the global financial cycle, are shown to play a crucial role in amplifying this feedback loop between economic growth and financial conditions.

Subject: Emerging and frontier financial markets, Financial conditions index, Financial cycles, Financial markets, Financial sector policy and analysis, Macrofinancial linkages

Keywords: Emerging and frontier financial markets, Emerging markets, Financial conditions, Financial conditions index, Financial cycles, Global, Kalman filter, Macrofinancial linkages, Macro-financial linkages, MARSS model, Twin-deficits

Publication Details

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