Stock Market Crash Induced Capital Flight: Experience of an Emerging Economy

Abstract

Stock Markets of Bangladesh crashed in FY 2010-2011 after a boom. High daily turnover beforecrash brought out hundreds of billions BDT from the capital market, but neither money supply outside the banks nor money deposit in the banks changed accordingly. Overall post-crash scenario created a suspicion that the money which was withdrawn from the capital market flew out of the country. The study attempts to test the hypothesis of capital flight using daily data from August 01, 2010 to July 31, 2011 of three variables: DSE general index (DSEGI), weighted average exchange rate (EXR), and Foreign exchange reserves (FXRES). Augmented Dickey-Fuller (ADF) and Kwiatkowski-Phillips-Schmidt-Shin (KPSS) unit root tests show that variables are in different order of integration, and Johansen cointegration test shows that variables are non-cointegrated. Two variable, DSEGI and EXR, granger causality test fails to reject the hypothesis of no causality, but Toda-Yamamoto (TY) version of Granger non-causality test with a control for Foreign Reserves (FXRES) found unidirectional causality directed from DSE general index to exchange rate, foreign reserves to exchange rate, and foreign reserves to DSE general index. These causal relationships indicate that capital flight occurred and central bank might have camouflaged the issue of capital flight by foreign reserves management to keep exchange rate relatively stable.