Capital flows and financial assets in the Philippines: determinants, consequences and challenges for the central bank

Asian emerging market economies have recently been major beneficiaries of capital flows from the developed countries. The literature suggests that the major factors that encouraged this flow of capital to emerging market economies are the sustained decline in interest rates in the industrial world, and the depth of financial development in emerging markets (Reinhart (2005) and IMF (2007a)). However, the prolonged surge in capital flows to the region has renewed concerns among policymakers on issues related to global liquidity, financial stability and capital reversals. History has provided empirical evidence that massive capital inflows in the 1980s may have contributed to the stock market bubbles in Latin America, which led to an excessive expansion in domestic credit and undermined the stability of the financial system (Calvo et al (1994)). As such, policy responses to the surge in capital have included sterilisation measures and reforms to the regulatory and supervisory frameworks, which are generally aimed at addressing the mounting pressures on the exchange rate and growing liquidity in the financial system.