The economic, political, strategic and cultural dynamism in Southeast Asia has gained added relevance in recent years with the spectacular rise of giant economies in East and South Asia. This has drawn greater attention to the region and to the enhanced role it now plays in international relations and global economics.

The sustained effort made by Southeast Asian nations since 1967 towards a peaceful and gradual integration of their economies has had indubitable success, and perhaps as a consequence of this, most of these countries are undergoing deep political and social changes domestically and are constructing innovative solutions to meet new international challenges. Big Power tensions continue to be played out in the neighbourhood despite the tradition of neutrality exercised by the Association of Southeast Asian Nations (ASEAN).

The Trends in Southeast Asia series acts as a platform for serious analyses by selected authors who are experts in their fields. It is aimed at encouraging policy makers and scholars to contemplate the diversity and dynamism of this exciting region.

Foreign direct investment (FDI) inflow in emerging Asian economies has risen noticeably over the past three decades, with interruptions arising from the dot-com bubble crunch (2001–2) and the global financial crisis (2008–9) (see Figure 3.1). FDI not only directly provides additional capital funds to a host country, but also the superior technology associated with multinational enterprise (MNE) affiliates which can spill over to the local non-affiliated firms (Caves 1974; Sjöholm 1999; Wang and Blomstrom 1992). FDI is potentially able to both increase market competition and influence the performance of incumbent firms. It can also create linkages to upstream and downstream industries. Identifying the factors determining FDI inflows has become crucial and has received considerable attention from policymakers in emerging Asian countries. This chapter aims to examine such determinants of inward FDI in selected Asian countries.

Interestingly, along with an increase in FDI in the region, the crossborder dispersion of component production/assembly within vertically integrated production processes, or so-called international product fragmentation, has become an important feature of the structural interdependence of the world economy. Rapid advances in production technology and technological innovations in transportation and communication have allowed companies to “unbundle” the stages of production so that different tasks can be performed in different places. This dynamic has resulted in a shift in the composition of trade towards intermediate (parts and components) goods. Although production sharing is now a global phenomenon, there is evidence that it is far more important for emerging Asian countries than elsewhere (Athukorala 2008). The share of the parts and components trade in the region has generally increased over the past two decades, although countries in South Asia still remain a minor player in global production networks. Figure 3.2 shows that the share of parts and components in manufacturing imports emanating from emerging Asian countries increased from less than 30 per cent in 1992 to 40 per cent in 2014, while on the export side, the share of parts and components in manufacturing exports rose to 32 per cent from less than 20 per cent during the same period. MNEs from the US, Europe, Japan and recently foreign investors from East Asian newly industrialized economies (NIEs) have played a pivotal role in linking countries in the region to regional and global production networks.

The issues concerning non-foreign direct investment (non-FDI) capital flows, i.e., portfolios (both equity and debt securities) and other investments, including bank loans, in developing Asia are not new and, indeed, received considerable attention during the Asian financial crisis. The reversal of capital inflows, which went hand-in-hand with a massive depreciation in exchange rates and a significant contraction in economic growth, resulting in doubts regarding the determinants and benefits of cross-border non-FDI capital flows (e.g. Kose et al. 2006; Wei 2006). Figure 5.1 shows that these inflows to developing Asian countries began in the latter half of the 1980s and accelerated with the onset of the 1990s. The contribution of other investment, especially bank loans, and portfolio investment in total capital inflows increased noticeably during this period. The share of bank loans jumped to 12 per cent in 1995 from less than 1 per cent in 1990, while that of portfolio investment increased from 1.5 per cent to 16 per cent during the same period. However, the Asian financial crisis interrupted non- FDI capital inflows into developing Asian countries. Portfolio inflows and other investments declined substantially during 1998–2002 and the latter actually registered a negative value during this period. Note that during the Asian crisis, capital outflows remained relatively flat. The squeezed market size resulting from the financial crisis resulted in a slowdown in capital outflows.

Issues related to non-FDI capital flows received attention once again when the current global financial crisis caused pullbacks in capital inflows across the region. After the Asian crisis, non-FDI capital inflows escalated once again from 2002 until the subprime mortgage crisis of late 2008 (see Figure 5.1). The crisis resulted in the dramatic decline of non-FDI capital inflows throughout the region. The decline in capital inflows during this period was even more dramatic than that experienced during the Asian financial crisis. As mentioned in Chapter 2, capital inflows declined from US$1,038 billion in 2007 to US$61 billion in 2008, while during the Asian financial crisis the decline of capital inflows was around US$387 billion in the period 1997–98. Portfolio and other investment inflows contributed substantially to such a slump.

Appendix

Orthodox thinking on capital account convertibility during the Bretton Woods era maintained that capital account opening should be expedited cautiously and only after substantial progress has been made in restoring macroeconomic stability, liberalizing the trade account and establishing a strong regulatory framework to foster a robust domestic financial system. Any abrupt opening of capital accounts at an early stage in the reform process without achieving these pre-conditions was thought to constitute a recipe for exchange rate overvaluation, financial fragility and eventual economic collapse (Edwards 1984; Corbo and de Melo 1987; Michaely et al. 1991; McKinnon 1993).

There was, however, a clear shift in policy emphasis in favour of a greater volume of capital account openings from about the late 1980s, with the International Monetary Fund (IMF) and the US Treasury adopting such an emphasis as a basic tenet of their policy advocacy concerning developing countries (Bhagwati 1998; Rodrik 2011). This new policy shift was reflected in a major decision by the IMF to pursue capital account opening as one of its operational objectives. A milestone in capital liberalization arrived with the achievement of Article VIII of the IMF in the early 1990s. Private capital inflows to the developing Asian countries began in the latter half of the 1980s and gathered momentum in the early 1990s (see Figure 1.1). The contribution of non-foreign direct investment (non-FDI) inflows, especially bank loans, in other investment inflows increased noticeably during this period (see Figure 1.2).

The push towards opening capital accounts, however, was subject to serious reconsideration following the onset of the Asian financial crisis (1997–98). The fact that the countries which succumbed to the crisis had for some years benefited from substantial flows of foreign capital, especially non-FDI in terms of bank loans, has raised questions about the role of capital inflows in creating the conditions that generated the crisis, or at least favoured its dissemination.

This chapter looks at trends and patterns in capital flows within emerging Asian countries1 in the midst of the Asian financial crisis and on through the subsequent period. There have been three distinct waves of private capital inflows into developing Asian countries over the past two decades. The first began in the latter half of the 1980s and gathered momentum in the early 1990s, before abruptly ending with the Asian financial trauma of 1997. The second wave ran through 2002 to 2007. However, the global financial crisis pronounced in late 2008 precipitated a deceleration in cross-border capital flows in developing Asia. The third wave commenced from 2009 until recent years, when such flows swiftly rebounded and started to bounce back. Thus, the first sub-section of this chapter discusses the first wave of capital inflows and how they were in response to the Asian crisis. Section 2.2 considers the second wave of capital inflows, especially their distinctive after the Asian financial crisis. Section 2.3 reviews how the current global financial malaise has affected trends and patterns in capital flows and whether the effects have been different from those during the Asian financial crisis. Section 2.4 turns to characterizing the third wave of capital flows. The final section uncovers our conclusions.

First Wave of Capital Inflows (1990–97) and the Asian Financial Crisis

Private capital inflows to developing Asian countries began in the latter half of the 1980s and accelerated at the onset of the 1990s (see Figure 2.1). Huge capital inflows during this period could be attributed to capital liberalization policies introduced by many central banks in the region in 1990–94. A landmark in capital liberalization came with the launch of Article VIII of the International Monetary Fund (IMF) in the early 1990s. Capital control measures previously imposed were progressively relaxed or removed entirely. For example, in Thailand commercial bank net foreign liabilities increased from 20 per cent to 25 per cent; while the central bank allowed authorized dealers to lend foreign exchange currency to non-residents without any limit and lifted the limit of US$5 million per individual on commercial bank lending to non-residents.

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