UN ESCAP Working Paper on Crises, private capital flows and financial Instability in Emerging Asia

Working paper29 Dec 2009

Asia was faced with a sudden and sharp crisis in 2008-2009, the proximate cause of which was reversals in foreign capital flows, not unlike the regional crisis a decade ago. How different has this boom and bust cycle of international capital flows been from the previous one? The paper examines the balance of payments dynamics in emerging Asia to understand the magnitude and types of private capital flows to and from the region between 1990 and 2008.

Attention is paid to both the crises periods of 1997-1998 as well as 2007-2008 along with the patterns of capital flows pre and post Asian crisis. While the region’s capital reversals in 1997-1998 were due to “other investments,” i.e. short-term bank lending, those in 2008-2009 were largely due to portfolio flows.

It is not surprising that these two components are often referred to as “mobile capital” and are seen by many as a source of financial instability in comparison to foreign direct investment (FDI) which is viewed as a more stable form of external finance. However, such a conclusion needs to be tempered somewhat in view of the fact that a greater share of FDI inflows has been in the form of mergers and acquisitions (M&As) as opposed to Greenfield. The paper also discusses selected policy issues relating to liquidity and reserve adequacy, regional cooperation, exchange rate coordination and financial stability.