The Dynamics Of Foreign Capital Flows In Indonesia: Sources And Implications On Bond Market And Bank Stability

This paper investigates the determinants of foreign capital inflows and analyzes whether such inflows affect bond market and banking in the Indonesian context. We document that exchange rate depreciation and domestic interest rate benchmark tend to boost foreign capital inflows. Likewise, higher fiscal deficit reduces foreign capital inflows regardless capital inflows measurement. Moreover, higher foreign ownership in government bond is also driven by foreign capital inflows directly or through an increase in the current account. Regarding implications for banking, higher foreign capital inflows mitigate bank credit risk. Global factors such as the US interest rate benchmark and the volatility index indeed affect foreign capital inflows, although their impacts differ according to the measures of capital inflows. Eventually, in order to mitigate foreign capital reversals, this paper advocates the importance of policy mix such as fiscal deficit management, prudent monetary policy to maintain the interest rate differential between the US and domestic interest rate benchmark, as well as flexible exchange rate or inflation management. Nevertheless, identifying types of foreign capital outflows is also essential to understand what policy mix is necessary to deal with certain challenges.