Can capital inflows reduce financing costs in emerging economies? Firm-level evidence from China and Malaysia

Abstract

We examine how changes in unrecorded capital inflow affect financing costs of firms in China and in Malaysia, which share a capital control system that escorted them through the financial crises in 1997 and in 2007. Utilizing a firm panel of the 2006–2014 period, we find that capital inflows into China reduce the financing cost of state-owned firms (SOEs), and city commercial banks (CCBs) help enhance this effect. An increase in capital inflow also reduces the financing cost of firms in Malaysia, especially that of foreign firms. To verify the effect of capital inflows, we utilize the China-U.S. interest rate gap and U.S. inflation as the IVs for capital inflows and find robust results. A difference-in-differences (DID) analysis of the unexpected decrease in capital inflow amid the COVID-19 pandemic also confirms the finding. We contribute by hand-collecting novel city and bank data to examine the unrecorded capital inflows that were rarely studied, and by using an unwanted decrease in capital inflow to identify the effect of capital inflows in a DID analysis.