CAPITAL OUTFLOW & EXCHANGE RATE

CHAPTER 1
1.1

Introduction

Malaysia is a middle-income country, has transformed itself since the 1970s from a producer
of raw materials into an emerging multi-sector economy . Nowadays , Malaysia is attempting
to achieve high-income status by 2020 and to move farther up the value-added production
chain by attracting investments in Islamic finance, high technology industries, biotechnology,
and services. Economic Transformation Program (ETP) is a series of projects and policy
measures intended to accelerate the country's economic growth . The government has also
taken steps to liberalize some services sub-sectors. The administration also is continuing
efforts to boost domestic demand and reduce the economy's dependence on exports.
Nevertheless, exports in particularly of electronics, oil and gas, palm oil and rubber which is
remain a significant driver of the economy . As an oil and gas exporter , Malaysia has
profited from higher world energy prices , although the rising cost of domestic gasoline and
diesel fuel , combined with sustained budget deficits , has forced government to begin to
address fiscal shortfalls , through initial reductions in energy and sugar subsidies and the
announcement of the 2015 implementation of a 6% goods and services tax . The
government is also trying to lessen its dependence on state oil producer Petronas . The oil
and gas sector supplies about 32% of government revenue in 2013. Bank Negara Malaysia
(central bank) maintains healthy foreign exchange reserves, and a well-developed regulatory
regime has limited Malaysia's exposure to riskier financial instruments and the global
financial crisis. Nevertheless, Malaysia could be vulnerable to a fall in commodity prices or a
general slowdown in global economic activity because exports are a major component of
GDP . But on March 2015,according to Bank Negara Malaysia (BNM) Governor , Tan Sri Dr
Zeti Akhtar Aziz,she said Malaysia is better positioned to face volatile capital flow.
Besides that , refer from some sources indicate that Malaysia's economy in 2014-2015 was
one of the most competitive in Asia, ranking 6th in Asia and 20th in the world, higher than
countries like Australia, France and South Korea. In 2014, Malaysia's economy grew 6%, the
second highest growth in ASEAN behind Philippines' growth of 6.1%.The economy of
Malaysia (GDP PPP) in 2014 was $746.821 billion, the third largest in ASEAN behind more
populous Indonesia and Thailand and the 28th largest in the world. In 2009, the PPP GDP
was US$383.6 billion, about half the 2014 amount, and the PPP per capita GDP was
US$8,100, about one third the 2014 amount . The anchor for a real exchange rate is found in

the real productive sector of an economy because an exchange rate reflects a countrys
international competitiveness. So, as a starting point, there may be a presumption that
exchange rates should have the capacity to adjust over time, in response to shocks or
(gradually) in response to the changing productive capacity of an economy . This view that a
countrys real exchange rate or international competitiveness finds its basic fundamentals in
its capacity to produce tradeable goods and puts the focus on the goods and services
components of the external account. Even where there are external capital flows or cyclical
changes in policy settings, these cause temporary departures from the anchor-point
provided by the fundamentals .
1.2

Matter Of Study

The matter considered in the study of money demand is the capital outflow and exchange
rate of the country. This paper investigates the empirical relationship between capital
outflows and nominal exchange rates.
1.21

Balance Of Payments

The balance of payment is a complete tabulation of the total market value of

goods,services,and financial assets that domestic residents,firms, and governments
exchange with residents of other nations during a given period . A nations balance of
payments ia a system that accounts for flows of income and expidenture and the flow of
financial assets.
A balance of payments act as a double-entry bookkeeping system record of any two-party
transaction with two separate and offsetting entries which is a debit entry and debit entry.The
result is that the sum of all the debit entries,in absolute value,equal to the sum of all the
credit entries.The balance of payments system is like a typical double-entry accounting
system in that every transaction results in two entries being made in the balance of payment
accounts.The function of debit entry is to record a transaction that result in a domestic
resident making a payment abroad.And debit entry has a negative value in the balance of
payment accounts.While the credit entry record a transactions that in a domestic resident
receiving a payment from abroad and it has a positive value in the balance of pament
accounts.
All countries exchanged a vast array of good,services, and financial assets.Because of
that,economist group these transaction by type.There are different categories for each type
of transaction,with various categories combined together to form accounts.Therefore,the
balance of payment system consists of a number of different accounts.We can easily

understand the balance of payments by just focusing on three main account which is the
current account,the private capital account,and the official settlements balance.
The current account is used to measure the flow of goods,services,and income across
national borders.It also includes transfers or gifts from the domestic government.The three
basic categories within the current account are trade,services and transfer accounts.
The capital account summarizes the buying and selling of assets between
countries,including anything that can be owned and that has value such as land, real
estate,companies, bank deposits, stocks and shares, treasury bills, government
bonds,foreign currency . In the capital account , if foreign ownership of the domestic assets
increases more quickly than domestic ownership of foreign assets,then there is more money
leaving the country rather than coming in . This situation is called a capital account deficit . In
the other hand , if domestic ownership of foreign assets increases more quickly than foreign
ownership of domestic assets,then there is more money leaving the country instead coming
in and this situation is capital account deficit .
The third and the final account is official settlement balance,it function is to measure the
transactions of financial assets and deposits by official government agencies.Typically,the
central banks and finance ministries,or treasuries of national governments conduct these
types of financial transactions.It is common for foreign central banks and government
agencies to keep deposit accounts with other central banks.Normally,central bank reserves
consist of foreign currency and gold to overcome the balance of payment surplus or balance
of payment deficits.
1.22

DEFICITS AND SURPLUS IN THE BALANCE OF PAYMENTS

The amount when we sum all of the debits and credits that appear in the current account
,capital account and official statements balance , the total should be zero . However , this
process is happen only in practice . A number of transactions are missed in the accounting
process or hidden from the process intentionally.For example , illegal transactions are
hidden from government agencies and legal transactions may be hidden from government
agencies , such as customs officials in order to avoid taxes . Besides that , it may also
happen when government statisticians make errors in the tabulation of credit and debit .
The sum of the credits and debits in the current account,capital account and official
statement balance is not zero,then an offsetting entry appears in the balance of payments .
Economist called this as an offsetting entry the statistical discrepancy .

For our information , a balance of payments deficit refer to a situation in which the official
settlement balance is positive . Ignoring a statistical discrepancy , if the sum of the credits
and debits in the current account and the private capital account is negative , private
payments made to foreigners exceeds private payments received from foreigners. In this
case , the official statements balance must be positive and is called a balance of payment
deficit.A situation where the sum of the debits and credits in the current and private capital
account is positive means that private payments receive from foreigners exceed private
payments made to foreigners.In this case,the official statements balanced is negative and is
called a balanced of payments surplus.To correct its balance of payments by adding to
foreign reserves would occur if there is a trade surplus.While to correct its balance of
payments deficit ,a nation might implement a major depreciation of its currency or other
policies to encourage export .

1.3

MOTIVATION OF STUDY

There are one motivation in this study. The details of each motivation are presented at
below.
1.3.1

What is the relationship between capital outflow and exchange rate?

Capital outflow is the movement of assets out of a country. Capital outflow is considered
undesirable and results from political or economic instability. It occurs when foreign and
domestic investors sell off their assets in a particular country because they no longer
perceive it as a safe investment. The capital is withdrawn from the country (flows out) and
may end up in another country or back in the investor's home country.While net capital
outflow that also known as a net foreign investment is to make reference to the difference
between the acquisition of foreign assets by domestic residents and the acquisition of
domestic assets by non-residents.Therefore , it has to do with savings and
investment(loanable funds) and foreign currency exchanged rate. An exchanged rate
expresses the value of one currency relative to another country.It expresses the number of
units of one currency required to purchase one unit of another country and thereby converts
the value of this transactions into local currency terms. Edwards (1989, 1994), Williamson
(1994), Hinkle and Montiel (1999), Edwards and Savastano (2000), and Maeso-Fernandez,
Osbat, and Schnatz (2004) provide comprehensive surveys of the extensive literature on
determinants of the real exchange rate.Other than that , several number of studies look at
the impact of capital flows on the real exchange rate . Capital inflows generate higher
demand for both tradables and nontradables and lead to a higher relative price of

nontradables and to appreciation of the real exchange rate. This is necessary so that
domestic resources will be diverted to production of nontradables to meet the increased
demand. The impact on the real exchange rate holds .
The relationship between net capital outflows and foreign currency exchange can be easily
seen by using a model that will be discuss in the next section.

1.4

OBJECTIVE

The objectives of this research will be divided into two parts which is general objectives and
specific objectives.
1.4.1

GENERAL OBJECTIVE

The general objective of this research is to investigate the relationship between capital
outflow and exchange rate in the context of open economy . As we stated before ,this
relationship have been analyses by using a model which analyses the market for loanable
funds and the market for foreign currency exchange, in the context of an open economy. The
link between these two markets will be net capital outflows.

Ni link utk mklumat relationship http://www.policonomics.com/loanable-funds/

# sory ya kawan2 ,wat dalam bi ni lemah kit..xtau nak explainapa2 gtau blk..salah ka apa
ka.. yg bwah ni ad link gak ngan tjuk

Edwards (1989, 1994), Williamson (1994), Hinkle and Montiel (1999), Edwards and
Savastano (2000), and Maeso-Fernandez, Osbat, and Schnatz (2004) provide
comprehensive surveys of the extensive literature on determinants of the real exchange rate.
A number of studies look at the impact of capital flows on the real exchange ratethe
transfer problem. Capital inflows generate higher demand for both tradables and
nontradables and lead to a higher relative price of nontradables and to appreciation of the
real exchange rate. This is necessary so that domestic resources will be diverted to
production of nontradables to meet the increased demand. The impact on the real exchange
rate holds. As Lane and Milesi-Ferretti (2004) put it, based on an econometric analysis of 48
countries, net external liabilities go hand in hand with depreciation of the real exchange rate.
Lee, Milesi-Ferretti, and Ricci (2008) show that higher net foreign assets cause the real
exchange rate to appreciate. In other words, external capital allows expenditure to exceed
income, generating excess demand for nontradables. Portfolio investment flows, foreign
borrowing, aid and income flows are generally found to significantly affect the (real)
exchange rate, while flows related to foreign direct investment were not found to influence
the (real) exchange rate significantly (Brooks et al. (2001) and Bakardzhieva et al. (2010).
Lucas (1990) examines international capital movements from the perspective of rich and
poor countries. Under the standard assumptionssuch as countries producing the same

goods with the same constant returns to scale production function, the same factors of
production, and the same technologyand where there is free capital mobility, new
investment will occur only in the poorer economy, and this will continue to be true until the
returns to capital in every location are equalized.

Link
https://www.google.com.my/url?
sa=t&rct=j&q=&esrc=s&source=web&cd=8&cad=rja&uact=8&ved=0CEwQFjAH&url=http
%3A%2F%2Fworktogetherjtp293.blogspot.com%2F2014%2F01%2Fthe-balance-ofpayments.html&ei=e6cCVeq6DcjnuQTl7YGYBQ&usg=AFQjCNH87avahQGRD8LfUnASQgzaXnPdw&sig2=Ktm8He6KBu6CiYdA_cMEiQ&bvm=bv.88198703,d.c2
E
https://books.google.com.my/books?id=4d8SCN-YGsC&pg=PA18&lpg=PA18&dq=capital+outflow+and+exchange+rates+of+malaysia&source=
bl&ots=Zoos4qmJxM&sig=w4Q4KVTqKWH1JbTJZZgCERV_OeQ&hl=en&sa=X&ei=IpIBVbu
_JdONuASYooCIAw&ved=0CEAQ6AEwBg#v=onepage&q=capital%20outflow%20and
%20exchange%20rates%20of%20malaysia&f=false
https://asiaandthepacificpolicystudies.crawford.anu.edu.au/acde/publications/publish/papers/
wp2003/wp-econ-2003-02.pdf
market exch
http://www.policonomics.com/loanable-funds/
de
http://www.bernama.com/bernama/v8/bu/newsbusiness.php?id=1116172
http://www.economicsonline.co.uk/Managing_the_economy/Balance_of_payments.html
https://www.boundless.com/users/233416/textbooks/money-banking-and-internationalfinance/the-international-financial-system-15/the-international-financial-system-36/financingbalance-of-payments-deficits-and-surpluses-128-15226/