Fiscal stance, foreign capital inflows and the behavior of current account in the Asian countries

Abstract

This paper investigates the causality relationship between budget and current account deficits for 14 Asian countries. The major findings based on bootstrap Granger causality tests in heterogenous mixed panels are: First, investments (and foreign capital inflows) have a notable impact on the current account prior to the Asian financial crisis of 1997–1998. Second, we detect direct causality between the budget and the current account imbalances before but not after the crisis. The data suggest that the current account targeting hypothesis, that is, the reverse causality, prevails after the crisis. Third, budget deficits have a significant influence on both investment and foreign capital inflows in the second period. Fourth, Asian countries are less susceptible to the influence of FDI inflows in the aftermath of the crisis. Finally, structural break turns out crucial in assessing the causal patterns of the twin deficits nexus in the Asian countries.