Academic journal article Journal of Southeast Asian Economies

Capital Mobility in Developing Asia: How Does It Respond to the Financial Crises?

Academic journal article Journal of Southeast Asian Economies

Capital Mobility in Developing Asia: How Does It Respond to the Financial Crises?

Article excerpt

I. Introduction

The issue of capital mobility in developing Asia is not new and got much attention during the Asian financial crisis. The reversal of capital inflows, which went hand in hand with massive depreciation of exchange rate and significant contraction of economic growth, resulted in the doubt upon the determinants and benefits of cross-border capital flows. A number of empirical studies examine these issues with mixed results revealed. (1) However, a number of empirical studies (e.g. Kose et al. 2006; Wei 2006) show the crisis by itself does not prove that cross-border capital flows are bad for a country. On average, a country that has integrated in the world financial market is likely to grow faster than a country that experiences financial isolation. However, the previous crisis suggests that composition of capital flows (composition hypothesis) and initial conditions of a country (threshold hypothesis) matter in reaping (redressing) the gains (costs) from cross-border capital movements.

This issue has received attention once again when the current global financial crisis has caused the pullbacks of capital flows in the region. However, the nature of current financial crisis differs from the Asian financial crisis. In particular, the former, originated from developed countries, tends to spread the effects through all regions and countries with varying degree while the latter affected a small group of countries, mostly in East and Southeast Asia. In addition, economic fundamentals, especially financial institutions, in the region have improved substantially after the Asian financial crisis. Do these factors help to limit/redress costs of cross-border capital reversal? Does the composition hypothesis, arguing that all capital flows are not equal and long-term capital tends to be more resilient to the financial crisis, still hold for the current global crisis? What are the notable distinctions between the current and the previous crises? These are key questions addressed in the paper.

In addition to examining trends and patterns of capital mobility in the region, the determinants of capital flows, especially short-term capital, are further examined. The relative importance of "external" and "internal" factors provides a quantitative support for the composition hypothesis and the response of capital movements to the current global crisis. Another important issue that can be drawn from examining the determinants is the role of investment-saving situation on capital movements in the region. Before the Asian financial crisis, an increase in investment-saving ratio went hand in hand with huge capital inflows. Huge capital inflows continued to build up after the Asian financial crisis but investment-saving ratio declined in almost all Asian countries. Does the substitutability of capital flows and saving in the region reduce? Does this situation relate to the inability to mobilize saving within a country and region? These are issues that are also explored in the paper.

To answer these questions, portfolio investment (equity and debt securities) and other investment (i.e. bank loans) are distinguished from foreign direct investment (FDI). Inflows and outflows are separately discussed since the nature of these two flows tends to be different, especially in response to the financial crisis. In contrast to capital inflows, capital outflows began to play an important role in the region after 2003, and in some countries such as the PRC and Thailand, financial policy has become more liberalized for capital outflows after 2003. Separating these two flows would provide more precise determinants of capital flows. To our knowledge, this is the first study to clearly separate between inflows and outflows as well as including investment-saving situation in the empirical model.

The paper is structured as follows: The following section briefly looks at trends and patterns of capital flows in developing Asia during the Asian financial crisis and beyond. …

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