Factors affecting capital flight in asean countries from 2010 to 2021

Capital flight, poses a considerable challenge to the stability and economic growth of nations. In the context of the Association of Southeast Asian Nations (ASEAN), a regional economic community comprising ten member states, understanding the factors that contribute to capital flight is of utmost importance. The ASEAN region has experienced remarkable economic growth and integration over the past few decades. However, despite its overall progress, several member states have faced significant challenges related to capital flight. This phenomenon has begun since 1980s in the developing countries and they faced with a very remarkable rate of capital flight over the past three decades (Alam and Quazi, 2003, Johannesen and Zucman, 2014).

FOREIGN TRADE UNIVERSITY FACULTY OF INTERNATIONAL ECONOMICS

-*** -INTERNATIONAL FINANCE REPORT

Factors affecting capital flight in ASEAN countries

from 2010 to 2021

Credit class : TCHE414

Lecturer : Assoc Prof PhD Mai Thu Hien

Ha Noi, 2023

TABLE OF CONTENTS

CHAPTER I INTRODUCTION 4

1.1 Rationale of research 4

1.2 Aims and objective 4

1.3 Scope of the research 5

1.4 Research method 5

1.5 Structure of the research 6

CHAPTER II LITERATURE REVIEW 7

2.1 Theoretical framework 7

2.1.1 Overview of capital flight 7

2.1.1.1 Definition 7

2.1.1.3 Capital Flight Consequences 10

2.1.2 Factors impacts on capital flight 11

2.2 Literature review 15

2.2.1 On Capital Flight from the ASEAN-8 Countries: A Panel Data Estimation (Navik Istikomah, Indra Suhendra, Cep Jandi Anwar ,2020) 15 2.2.2 Analyzing Effective Factors of Capital Outflow from the Middle East and North African Countries (MENA) (Heydari, Hassan and Jariani, Farzaneh, 2020) 15 2.2.3 The Effect of Ease of Doing Business on Capital Flight: Evidence from East Asian Countries (Zahra Dehghan Shabani , Sara Parang, 2018) 16

2.2.4 Determinants of Asian capital flight and the impact of 1997 economic crisis

16 (Pornchai Chunhachinnda and Kulpatra, 2007) 16

2.2.5 Determinant of capital flight from the selected ASEAN countries

17

CHAPTER III MODEL SPECIFICATION 18

3.1 Methodology in the study 18

3.2 Theoretical model specification 19

3.2.1 Introduction to the model 19

3.2.2 Derive the model 19

CHAPTER IV ESTIMATION RESULT 21

4.1 Descriptive statistic 21

4.2 Choosing the estimated model 22

4.3 Model estimation result 23

4.4 Model test for heteroskedasticity 24

4.5 Model test for multicollinearity 25

4.6 Model test for auto - correlation 25

4.7 Hypothesis testing 26

CHAPTER V IMPLICATIONS AND CONCLUSION 27

REFERENCES 31

TABLE OF FIGURES

Table 3.1: Sources of data 18

Table 3.2: Explanation of the variables 19

Table 4.1: Statistical description of variables 21

Table 4.2: Coefficient correlation between variables 21

Table 4.3: Breusch - Pagan test and Hausman test result 23

Table 4.4: Model estimation result 23

Table 4.5: Breusch - Pagan test result 24

Table 4.6: Variance inflation factor 25

Table 4.7: Autocorrelation test result 25

Table 4.8: Hypothesis testing 26

CHAPTER I INTRODUCTION 1.1 Rationale of research

Capital flight, poses a considerable challenge to the stability andeconomic growth of nations In the context of the Association of SoutheastAsian Nations (ASEAN), a regional economic community comprising tenmember states, understanding the factors that contribute to capital flight is ofutmost importance The ASEAN region has experienced remarkableeconomic growth and integration over the past few decades However, despiteits overall progress, several member states have faced significant challengesrelated to capital flight This phenomenon has begun since 1980s in thedeveloping countries and they faced with a very remarkable rate of capitalflight over the past three decades (Alam and Quazi, 2003, Johannesen andZucman, 2014)

There are many concerns in the developing countries regarding thecapital flight due to its devastative effects thereof on the economic growth,welfare, macroeconomic stability, income distribution, illegal activities andother social development issues, including Asean countries (Zheng and Tang,2009) According to the researchers, the capital flight can be considered as aworrying matter which implicitly denotes and indicates the illegal movement

of capital from a country to another one (Adesoye et al., 2012)

1.2 Aims and objective

By employing statistical techniques, econometric models, and utilizingrelevant data sources, this study aims to provide a comprehensiveunderstanding of the drivers behind capital flight within the region It seeks toidentify the macroeconomic indicators, policy variables, and external factorsthat significantly influence capital flight in ASEAN countries Byunderstanding the factors that affect capital flight, governments canimplement targeted measures to strengthen their economies, enhance investorconfidence, and promote sustainable growth

1.3 Scope of the research

Space: ASEAN countries including: Brunei Darussalam, Cambodia,Indonesia, Malaysia, Myanmar, Vietnam, Lao PDR, Singapore, Thailand,Philippines

Time: Analysis was conducted by collect data of the factors affectingcapital flight in ASEAN countries during 2010 to 2021

Introspective Approach: The study will gather information fromreferences, articles, and research conducted by experts on humandevelopment in ASEAN countries The study will analyze and synthesize theinformation collected to identify factors affecting capital flight in the region

Quantitative Methods: The study will collect information fromstatistical documents on websites, including data from the World Bank, andnational statistical agencies, and review econometric models from previousstudies

Qualitative Methods: The study will visualize the relationship betweenelements in the structure of capital flight in ASEAN countries and generalizethe relationships of things The study will use this approach to provide aholistic understanding of the factors affecting capital flight in the region

The research methodology aims to provide a comprehensive analysis ofthe factors affecting capital flight in ASEAN countries, using a combination

of information collection and processing methods The study will use avariety of approaches to gather information and analyze the data, providingpolicymakers and researchers with evidence-based recommendations to crub

capital flight,

promote economic stability and foster sustainable development in ASEAN countries

1.5 Structure of the research

The structure of research including 5 chapters:

Chapter I: IntroductionChapter II: Literature review Chapter III: Model specificationChap IV: Estimation resultsChap V: Implications and Conclusion

An additional definition of capital flight was given by Khan and Haque(1987), who defined capital flight as all capital outflows from developingcountries which lead to the loss of potentially available capital resources andeconomic growth, regardless of the background of the occurrence of the flow

of capital from within the country

However, in this study, we use the first suggested definition for capitalflight from the World Bank (Erbe, 1985) Capital flight is calculated as aresidual, which is the difference between capital inflow and the use of capital.Capital inflow consists of increases in external debt and foreign directinvestment, while the use of capital is to cover the current account deficit andchanges in foreign exchange reserves The residual reflects the net invoices ofthe private sector abroad and at home

2.1.1.2 The measurement of capital flight

There are some different standards which have been presented formeasuring the rate of capital flight with regards to the different definitionsinto the capital flight Generally, there are three approaches to measure capitalflight: the computational approach to balance of payments (Cuddington,

1986),

the residual approach (Erbe, 1985), and the bank deposit approach Thecomputational approach to the balance of payments is a traditional approachfocusing on the balance of payments component The residual approachestimates capital flight as residual Meanwhile, the bank deposit approach is acapital flight measure based on the increase in foreign bank deposits reported

by domestic residents So, there are some changes for every one of themwhich may lead to some small changes The payment balance figures andstatistics can be considered as a starting point for the entire methods(Claessens et al., 1993)

World Bank Residual Method

Since 1985, the World Bank has used a residual approach to measurecapital flight (Erbe, 1985) In this approach, capital flight is calculated by thedifference in residual between capital inflows (in the form of increasedforeign direct investment and foreign debt) and capital outflows (deficits inrelation to current accounts and changes in foreign exchange reserves), so thatthe residual of both is indicated as capital flight The residual approach as ameasurement of capital flight remains relevant, particularly in developingcountries, where most development funds rely on foreign debt and foreigndirect investment, including the ASEAN

The equation, which is derived from the balance of payments, isapproximated as follows:

CF = [ΔED + FDI] – [CA + ΔR]

Where CF stands for capital, ∆ED indicates the change in external debt,FDI indicates net foreign direct investment, CA indicates the current accountdeficit, and ∆R indicates the change in international reserves The model isbased on a deduction and inference on the capital flight and on the paymentbalance statistics If the sources of capital inflows namely the (Net) increase

in the foreign debts and liabilities and the (Net) increase in the Foreign DirectInvestment (FDI) are more than using the capital inflows which means the

country’s current account deduction and foreign reserves increase accordinglythis matter could be done due to the capital transfer to the foreign countriesand by the private sector (Individuals) This balance is because of the capitalflight rate (Johannesen and Pirttilä 2016) In the residual method, the budgetsources are more than the budget consumptions The budget sources includethe net official inflows (An increase in the government’s foreign debts andliabilities) and the net current of the foreign direct investment The budgetconsumptions involve the current account deduction and the reserves increase.The capital flight abroad will be done when the budget sources are more thanthe budget consumptions and contrary to this manner will be done for capitalflight to the country itself

The residual method has been widely applied by internationalorganizations such as the World Bank and the United Nations Organization(Claessens and Naudé 1993; UNDP 2011) and also the Academic Studies(Pastor 1990; Boyce 1992; Lensink et al., 2000; Al-Fayoumi et al., 2012Genda and Yimer, 2016; Mpenya et al., 2016; Efobi and Asongu, 2016) formeasuring the capital flight values and also specifying the economic andpolitical factors thereof This method broad coverage and intuitive nature,minimizing the scope of potential biases in narrower measures and possiblereplications (Cheung and Qian, 2010; Quan and Rishi, 2006)

In the study of Analyzing Effective Factors of Capital Outflow from theMiddle East and North African Countries (MENA) (Heydari, Hassan andJariani, Farzaneh, 2020), authors used net fdi, out flow to estimate capitalfight Also, in the model of this research, instead of the capital flight variable,the net variable of foreign direct investment is used to represent the value ofcapital flight for ASEAN countries

CF = FDIINFLOWS − FDIOUTFLOWSWhere in:

CF: foreign direct investment, net outflow

FDIINFLOWS: Foreign direct investment, net inflows (% of GDP)

FDIOUTFLOWS: Foreign direct investment, net outflows (% of GDP)

2.1.1.3 Capital Flight Consequences

The case studies which have been prepared in relation to the capitalflight from developing countries can be indicative of some outstanding andvarious economic consequences that the said capital flight can lead to theeconomic and political uncertainty as disclosed below:

Putting some Effects on Economic Growth: The capital flight can be ahindrance for economic growth, increasing the government’s expenses andpoverty decrease In other words, there is a negative contact betweeneconomic growth and capital flight (Ajayi, 2012; Ndiaye, 2014) Moreover,they also stated that capital might affect economic growth both in the longand short runs negatively Besides, according to Carp (2014), it was observedthat in economic and financial crises, financial globalization could cause arise in capital flow volatility, disturbing economic growth and developmentfor economies in Central and Eastern European Countries (CEECs)

Putting some Effects on the Domestic Investment: Increasing thecapital flight may reduce the appropriate chances for performing the domesticand international investments (Fofack and Ndikumana, 2010; Yalta, 2010;Adetiloye, 2012; Ndikumana, 2014) The study of Atoko Kasongo (2002)show an inverse relationship between capital flight and domestic investment

In the long run, the impact of capital flight on domestic investment is moresignificant than the short-run impact, indicating that a persistent outflow ofcapital has a negative cumulative effect on domestic investment over time

Income and Welfare Distribution (Poverty increase, reduction in thepublic and social expenses especially water, health, sanitation and education):Capital flight increase has put some remarkable effects on the rate of socialand public expenses and therefore the economic and social inequalities willappear more than ever by the capital flight augmentation (Boyce and

Ndikumana,

2012; Ndikumana and Boyce, 2011a; Boyce and Ndikumana, 2012; AfDBand GFI, 2013; Ndikumana, 2016)

Current Account Deduction: Current account deduction must be done

by the private sector (Individuals) due to the transference of capital to theforeign countries (Johannesen and Pirttilä, 2016; Geda and Yimer, 2016;Ayamena et al., 2016; Al-Fayoumi and et al.,2016)

Financial Prosperity: Capital flight may cause failure in the financialimprovement on the economic growth and the reduction of destitution inAfrica (Ndikumana and Boyce, 2011a; Boyce and Ndikumana, 2012; AfDBand GFI, 2013)

Financial Prosperity: According to paper "Capital Flight and FinancialDevelopment: Evidence from Sub-Saharan Africa," published in the Journal

of African Economies in 2020, capital flight has a negative impact onfinancial development in Sub-Saharan Africa The study found that capitalflight reduces the volume of deposits in the banking sector, which in turnreduces the availability of credit to finance investments This leads to adecline in overall financial development, which can negatively affecteconomic growth Furthermore, the study also found that capital flight ispositively correlated with corruption and weak institutions, which canexacerbate the negative impact on financial development

2.1.2 Factors impacts on capital flight

Some various factors have been recognized as capital flight reasons.Most of the researchers maintain that the foreign debts and liabilities, shortterm investment and financing can reinforce and boost the capital flight(Saxena et al., 2005; Chipalkatti and Rishi, 2001; Beja, 2006; Ndikumana andBoyce, 2008) However, other ones believe that the factors such as the realgrowth of Gross Domestic Product (GDP), foreign direct investment, interestrate difference, inflation rate, foreign exchange rate and the lack ofconfidence, assurance and unreliability can play the important roles as well

(Hermes and

a haircut, for example Whatever the context, inflation represents how muchmore expensive the relevant set of goods and/or services has become over acertain period, most commonly a year (International Monetary Fund).

Inflation as measured by the consumer price index reflects the annualpercentage change in the cost to the average consumer of acquiring a basket

of goods and services that may be fixed or changed at specified intervals, such

as yearly (World Bank)

Increasing inflation, those individuals who have domestic assets reactinto their wealth value resolution through investing abroad, therefore, therewill be a kind of positive and meaningful relationship between inflation andcapital flight (Pastor, 1990; Geda and Yimer, 2016; Ndikumana, 2016;Muchai and Muchai, 2016; Moulemvo, 2016; Ayamena et al., 2016;Ramiandrisoa, 2016; Murinde et al, 1996; Lensink et al., 1998; Nyoni, 2000;Ndikumana and Boyce, 2003)

Given the average level of capital flight flows and the high andsustained inflation rates in some postwar economies, the overall effect could

be substantial The implication is that low inflation helps to curb capital flight

in postwar economies (Victor A.B Davies, 20008)

GDP growth

Gross domestic product (GDP) is the sum of gross value added by allresident producers in the economy plus any product taxes and minus anysubsidies not included in the value of the products As a broad measure of

2015 prices, expressed in U.S dollars (World Bank).

The gross domestic product growth is one of the most significanteffective factors on the capital flight rate (Ndikumana and Boyce, 2003,2008) The negative effect of GDP growth on capital flight implied that byincreasing GDP growth, fewer capital outflows are made (Heydari, Hassan,and Jariani, Farzaneh, 2020)

Exchange rate

The exchange rate is the price of a country’s currency in relation toanother country's currency An exchange rate is “fixed” when countries usegold or another agreed-upon standard, and each currency is worth a specificmeasure of the metal or other standard An exchange rate is “floating” whensupply and demand or speculation sets exchange rates (conversion units) If acountry imports large quantities of goods, the demand will push up theexchange rate for that country, making the imported goods more expensive tobuyers in that country As the goods become more expensive, demand dropsand that country’s money becomes cheaper in relation to other countries’money Then the country’s goods become cheaper to buyers abroad, demandrises, and exports from the country increase

Exchange rate volatility and declining capital inflow are importantpolicy issues that inform macroeconomic policies and strategies of developingcountries The "Exchange Rate and Capital Flight: An Empirical Analysis

"research states that the exchange rate positively influences capital outflow inEast African states (Shem Otieno, Naftaly Mose, John Thomi, 2022) Thepositive effect of currency change on capital outflow implied that capitaloutflow was sensitive to currency depreciation

External debt growth

External debt is the portion of a country’s debt that is borrowed fromforeign lenders, including commercial banks, governments, or internationalfinancial institutions These loans, including interest, must usually be paid inthe currency in which the loan was made To earn the needed currency, theborrowing country may sell and export goods to the lending country

In some cases, external debt takes the form of a tied loan, which meansthat the funds secured through the financing must be spent in the nation that isproviding the financing For instance, the loan might allow one nation to buyresources it needs from the country that provided the loan

The research "External Debt and Capital Flight in East Africa" reportedthat external debt had a positive and significant effect on capital flight in EastAfrican countries (Shem Otieno, Naftaly Mose, Erickson Matundura, 2022)

Differences in interest rate

The difference in interest rate is the difference between the domesticdeposit interest rate in country and the treasury bill interest rates in the UnitedStates

Several studies have found a positive relationship between interest ratedifferentials and capital flight Higher interest rate in one country relative toanother can incentive investor to move their capital to the country offeringhigher returns, leading to increase capital flight

Political stability index

The Political Stability Index and Absence of Violence/Terrorismmeasures perceptions of the likelihood that the government will bedestabilized or overthrown by unconstitutional or violent means, includingpolitically- motivated violence and terrorism

Political risks and dangers (War, civil conflicts, terrorism: civil andinternational one and uncertainty and instability), the unpredictability of thepolitical conditions, regime change and political events, civil, regional and

international tensions and conflicts, all are effective in the capital flightprocess (Lensink et al., 1998; Collier et al., 2001; Ndikumana and Boyce,2003; Ndiaye, 2009; Vespignani, 2009; Cerra et al., 2005)

as average inflation in the ASEAN-8 countries remains relatively stable

2.2.2 Analyzing Effective Factors of Capital Outflow from the Middle East and North African Countries (MENA) (Heydari, Hassan and Jariani, Farzaneh, 2020)

The objective in this study is to analyze effective factors of capitaloutflow from the Middle East and North African countries Despite a highrate of unemployment, budget deficits, low per capita income, foreign debtsand high inequality, the MENA countries are now facing with capital outflowproblem, so it is necessary to work out a solution for this problem andrecognize the factors which affect In this research, they have postulated thevariables showing economic conditions including Gross Domestic Product

(GDP)