Capital Inflows Problem in Selected Asian Economies in the 1990s Revisited: The Role of Monetary Sterilization*

Abstract

This paper develops a simple model to examine the reasons behind the capital inflow surges into selected Asian economies in the 1990s prior to the financial crisis of 1997-98. The analytical model shows that persistent uncovered interest differentials and consequent capital inflows may be a result of complete monetary sterilization, perfect capital mobility, sluggish response of interest rates to domestic monetary disequilibrium, or some combination of all three. Using the model as an organizing framework, the paper undertakes a series of related simple empirical tests of the dynamic links between international capital flows, the extent to which they are sterilized and uncovered interest rate differentials in the five crisis-hit economies (Indonesia, Korea, Malaysia, the Philippines and Thailand) over the period 1990:1-1997:5.

The Economics of the Uncovered Interest Parity Condition for Emerging Markets

“…Therefore, deviations from the UIP condition might be persistent due to monetary sterilization despite large and persistent capital inflows. In line with this argument, Cavoli and Rajan (2006) analyse persistent deviations from the UIP condition for five East Asian countries for the period preceding the 1997 crisis. They report that large capital inflows to these countries had a negligible impact on deviations from the UIP condition, and argue that given that capital is not perfectly mobile, monetary sterilization policies of central banks can explain why deviations from the UIP condition persist during the pre‐crisis period.…”

China as a reserve sink: The evidence from offset and sterilization coefficients

“…Some papers within this group include additional variables in the model such as the domestic interest rate, price level, or exchange rate (for instance, see Cavoli and Rajan, 2006;Christensen, 2004;He et al, 2005;Moreno, 1996). 16 The advantage of a VAR approach is that it allows one to trace out the time path of the various shocks on the variables contained in the VAR system (i.e.…”

Capital inflows and the interest premium problem: The effects of monetary sterilisation in selected Asian economies

“…Frankel and Okwongu (1996) proposed this as a potential problem for emerging market economies in Latin America and Asia; in the absence of sterilisation, inflows should place downward pressure on local market interest rates, leading to a convergence in interest differentials. Cavoli and Rajan (2006) …”