The Interactions of Short-Term Capital Flow and Its Key Determinant Factors Under Heavy Capital Controls

Abstract

The objective of this study is to analyze the effects of short-term capital flows or hot money to the key determinant factors that consists of interest rate differentials, THB/USD spot exchange rate, level of capital controls, relative returns on overall Thai and US stock market and the THB/USD forward rate. And this paper also studies whether the key economic factors attract short-term capital flows to Thailand by using monthly data from January 1999 to December 2007 with the Vector Autoregression Model (VAR). The sophisticated and integrated financial world causes significant changes in behaviors and patterns of capital mobility. A distinction between long-term and short-term capital flows in recent year is not easily classified from the flow’s explicit label. Several techniques are employed to distinguish short-term capital flow (hot money) from long-term flow (cool money). In the end, short-term flow in this study is confined to private capital flows that consist of equity, debt securities and foreign currency and deposits. The results demonstrate that hot money or short-term flow has not shown significant interaction with its key determinant factors, including capital control measures as previously led to believe by the Bank of Thailand. Specifically, US forward rate and covered interest differential are also not found to attract hot money to Thailand. The findings also reveal that capital control measures aimed to restrict hot money are drastically intensified as the Baht is strengthened during 2006-2007. On the contrary, long-term capital flow does show to have small effects but significant to the Baht appreciation suggesting that the BOT may attack the wrong culprit in its struggle to slowdown the Baht rise.