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Managing Foreign Capital Flows: The Experience of Korea, Thailand, Malaysia, and Indonesia

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  • Yung Chul Park

    (The Jerome Levy Economics Institute)

  • Chi-Young Song

    (The Jerome Levy Economics Institute)

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    Abstract

    Between 1990 and 1994 developing countries in Asia posted $261 billion in net capital inflows, an amount equivalent to about half the total inflows to all developing countries. Although foreign direct investment accounts for the largest portion of net inflows to Asia, the share of portfolio investment has been steadily rising, from an average of 8 percent of net inflows between 1983 and 1989 to 24 percent between 1990 and 1994. Suggested reasons for the increase in portfolio investment have been a high demand for capital coupled with favorable growth prospects, deregulation and liberalization of capital accounts, domestic financial reform (which has facilitated foreign investment in domestic securities), lower interest rates, and international portfolio diversification. Capital inflows have been important in supporting high rates of investment, particularly in Indonesia, Malaysia, and Thailand, but short-term capital inflows also have threatened macroeconomic instability by inducing volatility of key financial variables such as the exchange rate. Threats to stability have, in turn, led countries to install direct control measures to dampen large swings in short-term capital inflows. In this working paper, Yung Chul Park, of Korea University and the Korea Institute of Finance, and Chi-Young Song, of the Korea Institute of Finance, analyze the experiences of Korea, Thailand, Malaysia, and Indonesia in managing these capital inflows. Park and Song found that for each of the four countries, following the surge in capital inflows, inflation rates rose (although they note that there is not necessarily a causal relationship between the two events) and real effective exchange rates declined (the result of a gradually rising share of investment to GDP and fiscal discipline). Moreover, there appeared to be no long-term rise in financial market volatility as compared to the period preceding the rise in capital inflows. The authors attribute this to policies of exchange rate sterilization, monetary stabilization, and fiscal restraint. In particular, exchange rates likely remained stable because each country adopted a similar interventionist policy to prevent rapid appreciation of the nominal rate.

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    File URL: http://128.118.178.162/eps/mac/papers/9807/9807002.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Macroeconomics with number 9807002.

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    Length: 81 pages
    Date of creation: 14 Jul 1998
    Date of revision:
    Handle: RePEc:wpa:wuwpma:9807002

    Note: Type of Document - Acrobat PDF; prepared on IBM PC; to print on PostScript; pages: 81; figures: included
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    Web page: http://128.118.178.162

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    1. Donald J. Mathieson & Liliana Rojas-Suárez, 1992. "Liberalization of the Capital Account," IMF Working Papers 92/46, International Monetary Fund.
    2. Reinhart, Carmen & Khan, Mohsin, 1995. "Capital Flows in the APEC Region," MPRA Paper 8200, University Library of Munich, Germany.
    3. Barry Eichengreen, James Tobin, and Charles Wyplosz., 1994. "Two Cases for Sand in the Wheels of International Finance," Center for International and Development Economics Research (CIDER) Working Papers C94-045, University of California at Berkeley.
    4. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1993. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 108-151, March.
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