August 12, 2013

Balancing Foreign Capital Flow

Emerging markets are the target of foreign capital. The goal of the economies is to increase capital inflow without increasing capital outflow. According to the study conducted by Asia Development Bank (ADB), authored by Bautista and Francisco (2011), capital restriction reduces Foreign Direct Investment (FDI) inflow and increases the outflow. That is, based on the study it is not recommended to use capital restriction in managing foreign capital in emerging markets.

The reason why capital restriction is not an effective tool in managing capital flows is due to the fact that it sends negative message to the investors. Restriction as it sounds affects the degree of liquidity of the investment. Even thou investors perceived that their investment will grow in the emerging markets; still, if they found that they will have difficulty of liquidation, they will not take the risk to invest.

Thus, rather than use restrictive policies, it is recommended to use macroeconomic fundamentals in balancing capital flows.

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