Essays on capital movements : the case of China

• Main Author: Sun, TianHui
• Format: Dissertation
• Language: English
• Published: University of Portsmouth 2017

Capital flight and speculative capital inflow have become important causing factors to economic crises, especially for emerging market economies in the 20th century. The financial crisis in Mexico during the 1980’s and the East Asian crisis in the 1990’s had a detrimental impact on those regions’ economies as well as on the global financial market. Their blunt financial liberalisation reform process and fast growing credit market attracted large amounts of capital inflows, followed by sudden capital withdrawal and domestic capital outflow that led to the collapse of asset prices, drastic movements in exchange rates and widespread panic in financial markets (Athukorala & Rajapatirana, 2003). These developments challenged the previous consensus of financial liberalisation’s impact on an emerging market economy, also emphasising the importance of an adequate control mechanism for capital movements. Motivated by the intensity and magnitude of capital movements in emerging market economies, this thesis presents three essays that fall under the broad topic of international economics and finance, with a particular focus on the investigation of the composition, determinants and behaviours of China’s capital flight and China’s short-term capital inflow. The first essay seeks to investigate the time-dependent determinants of China’s capital flight over the period from 1990 Q1 to 2013 Q4. Through splitting the sample into two subsamples (1990 Q1 – 2004 Q4, 2005 Q1- 2013 Q4), the study provides new evidence on the determinants of China’s capital flight. In addition, regression results support the hypothesis that in a heavily regulated domestic financial market, China’s capital flight is driven by profit seeking and investment diversification strategy. Additionally, the observed pattern of China’s capital flight coincides with its economic structural reform and financial market liberalisation process which began in 2004. Furthermore, the inclusion of new explanatory variables such as household wealth, abroad investment income and profit can significantly improve the model’s goodness of fit and forecast ability. Moreover, despite the considerable previous studies on capital flight, it is only recently that a handful of them suggest a nonlinear relation between capital flight and its determinants. There has been no study investigating China’s capital flight by means of a nonlinear model. The second essay of this thesis investigates the regime-dependent determinants of China’s capital flight by using the Markov-switching model with two regimes in the conditional mean, the variance and in both the mean and variance. This study sheds light on the sensitivity of China’s capital flight to China’s financial market liberalisation, changes in the exchange rate, and international trade. By employing the non-linear model, this study identifies a low volatility regime before 2005 and a high volatility regime thereafter. In addition, explanatory variables have different impacts in different regimes supporting the hypothesis that different regimes of China’s capital flight are determined by different explanatory variables. Finally, in the third essay, I investigate the interaction among China’s short-term capital inflow with changes in China’s real effective exchange rate, the stock market, and the housing market by means of a vector error correlation model (VECM) model and a quantile regression over the period from 2002 M1 to 2014 M12. I aim at filling the gap in the few studies considering the relation of these variables with China’s capital inflow simultaneously. The findings suggest that China’s short-term capital inflow has a direct effect on its stock market returns and is very sensitive to changes in the real effective exchange rates; the housing market plays the alternative investment channel to the stock market for the inflow of speculative capital. Moreover, the empirical results are consistent with the expectation that China’s short-term capital inflow contributes to an increase in the stock market price as well as the price increase in the housing market. Finally, the quantile regression results support that the short-term capital inflow is attracted to China’s housing market and the stock market as the housing market price is significant for both higher and lower level quantiles of the short-term capital inflow (25%, 75%, and 95%). Whereas stock market is a significant determinant of China’s capital inflow only at its higher level quantile (75%, 95%). Overall, this thesis presents some important empirical investigations on both China’s capital flight and short-term capital inflow. It contributes to the existing evidence on the determinants of capital flight as well as short-term capital inflow in the case of China. These results are important not just for China’s economic policy maker, such as the People’s Bank of China, but also applicable to other emerging market economies’ policymakers, especially when undergoing economic and financial market liberalisations reforms.