The Effect of Capital Flow on Real Exchange Rate: Case Studies of Thailand, Korea, Malaysia, and Indonesia

Abstract

This study empirically tests the effect of capital flows on real exchange rate, and analyzes the government responses in Thailand, Korea, Malaysia, and Indonesia. The tests are carried out in econometric models to study the relationships between real exchange rates, capital inflows, and government budget surplus from 1976 to 2000, according to the availability of data for each country. The result shows that capital inflows in those four East Asian developing countries were associated with a slight appreciation of real exchange rate. However, when considering long-run effect of capital inflows on real exchange rate by using long ­run elasticity, Thailand has a considerable appreciation of real exchange. The Chow's test for Korea indicates that there was a structural break in 1997. The real exchange rate has been able to respond to the capital inflows easier than the pre-crisis period since the Asian financial crisis occurred in 1997. For Thailand and Indonesia, having more government budget surplus limits an appreciation of real exchange rate; however, it is the other way around for Korea. There is no significant effect of government budget surplus on real exchange rate for Malaysia.