Capital Account Openness and Financial Stability in Asian Emerging Markets

Abstract

Post the Global Financial Crisis (GFC) of 2008, there has been an increased focus on financial stability along with the growth objectives. The role of capital flow measures like capital controls and macroprudential regulations has gained prominence in increasing the resilience of the financial system of an economy. In this context, this paper examines the ramification of capital account openness on the financial stability indicators with controls for macroeconomic fundamentals, for the Asian Emerging Markets using the annual data of seven economies from 1980 to 2019. The methodology in the paper employs panel data cointegration techniques along with Augmented Mean Group (AMG) estimation to control for cross-sectional dependence, cross-sectional heterogeneity, and nonstationarity. The results indicate that capital account openness and trade openness increase financial instability in the economy while global risk shows mixed results. The economic development of the country, proxied by the size of the economy has a mitigating effect by reducing volatility in the financial sector.