Determinants of Capital Flight in Malaysia (1975 – 2015)

Cheang, Si Xian (2018) Determinants of Capital Flight in Malaysia (1975 – 2015). Final Year Project (Bachelor), Tunku Abdul Rahman University College.

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Abstract

In recent decades, the outbreak of financial crises have been most accountable for the series of capital flight phenomenon occurred in developing countries, including Malaysia. During these crises, Malaysia possesses the following traits: accumulated external debt, liberalised capital market and overvalued real exchange rate. This has captured much interest and attention of many researchers. This paper is aimed to examine empirically the determinants of capital flight in Malaysia, namely external debt, net inflow of foreign direct investment (FDI) and real exchange rate during 1975-2015, on a yearly time series. In this study, capital flight in Malaysia is defined as unrecorded capital outflows from the country, which was computed using World Bank residual method. Vector Error Correction Model (VECM), Johansen-Juselius co-integration test and Granger Causality test were applied to determine the factors affecting capital flight in Malaysia. Our empirical results indicated that there is a long run relationship among the variables. The rising external debt was found to be fueling capital flight while increasing net FDI inflow resulted in reduction of capital flight. Interestingly, there is a unidirectional causality from net FDI inflow to external debt. This study suggests that the government should promote more FDI into Malaysia while maintaining external debt at a manageable level in effort to reduce capital flight in Malaysia.