Capital flows in East Asia since the 1997 crisis

Robert McCauley

BIS Quarterly Review, 2003

Abstract: Since the crisis hit East Asia six years ago, flows of capital between the region and the rest of the world have changed in significant ways. These changes have responded to altered economic conditions within the region and outside it. However, certain features of the new pattern of flows raise some important policy questions. First, East Asia is exporting capital on a net basis to the rest of the world in very substantial amounts. The external demand that has generated an export surplus has undoubtedly facilitated recovery from the Asian crisis. Moreover, the United States has also benefited from the related capital inflows to finance its current account deficit. Nonetheless, it is hard to believe that the region should be such a large exporter of savings in the long term, or that the US deficit can be sustained indefinitely. Second, East Asia is engaged in an international exchange of risk that is restoring and strengthening national and corporate balance sheets in the region and rendering the region’s economies more resilient. The region is doing so by exporting relatively safe capital while importing risky capital. That is, East Asia is buying high-quality US, European and Japanese government and agency securities, while selling real assets, equities, and medium- and lowquality bonds. This pattern has drawn the criticism that it has impeded the development of East Asia’s own bond markets. This special feature first reviews the net flows of capital from East Asia to the rest of the world. It then turns to the gross flows of capital, highlighting the region’s import of higher-risk capital and export of safer capital. In a third section, the criticisms that have been levelled against these patterns of capital flows are considered. The role of gross capital flows in some of the recent rapid increases in official foreign exchange reserves is emphasised. Finally, this special feature discusses policies to address the possible shortcomings in the current pattern of capital flows. These include East Asia’s finishing the restructuring of its banking and corporate sectors, developing both long-term investing institutions and bond markets, and relying less on exports to lead economic growth. A constructive response to these challenges would permit the global economy to move towards a more sustainable pattern of current account surpluses and deficits and associated capital flows.

Date: 2003
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