Abstract
This paper examines the impact of capital flows on real exchange rates in emerging Asian countries during 2000–2009 using a dynamic panel-data model. The estimation results show that the composition of capital flow matters in determining the impact of the flows on real exchange rates. Other forms of capital flow, especially portfolio investment, bring in a faster speed of real exchange rate appreciation than foreign direct investment (FDI). However, the magnitude of appreciation among capital flows is close to each other. The increasing importance of merger and acquisition (M&A) activities in FDI in the region makes these flows behave closer to other forms of capital flow. The estimation results also show that during the estimation period, capital outflows bring about a greater degree of exchange rate adjustment than capital inflows. This evidence is found for all types of capital flow. All in all, the results indicate that the swift rebound of capital inflows into the region could result in excessive appreciation of (real) currencies, especially when capital inflows are in the form of portfolio investment.
Highlights
The swift and strong rebound of capital inflows in emerging Asian countries after the current global financial crisis has added new impetus to the debate on how countries receive benefits from capital inflows and avoid costs that are associated with them
Column B reports the estimation results when net capital flows of all types (FDI, portfolio, and other investment) are divided into inflows and outflows
The estimation result clearly shows the statistical insignificance of net foreign direct investment (FDI) flows on real exchange rate (RER) in the first period, but the relationship between these two variables becomes statistically significant in the following period. This is in contrast to the results shown for net portfolio investment and other investment flows in which a 1% increase in these net inflows leads to an immediate appreciation of RER by 0.15% and 0.10%, respectively
Summary
The swift and strong rebound of capital inflows in emerging Asian countries after the current global financial crisis has added new impetus to the debate on how countries receive benefits from capital inflows and avoid costs that are associated with them. Stronger currency appreciation has become evident in emerging Asian economies in response to the strong rebound of capital inflows, portfolio investment flows. Excessive liquidity associated with the strong rebound of capital inflows began to set new levels of asset prices. Central banks in the region including in the PRC and Taipei,China have begun to tighten capital control policies, while other central banks closely monitor movements of capital flows. In the Republic of Korea; Taipei,China; and Thailand, the central banks have intervened excessively in the foreign exchange market to slow the appreciation of the currency. Central banks are still reluctant to raise policy rates even though inflation has begun to show an upward trend, so as to reduce the risks of encouraging speculative capital inflows
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