Macro-Financial Effects of Portfolio Flows: Malaysia’s Experience

This paper studies the causes and effects of portfolio flows in Malaysia. We use
Structural Vector Autoregression (SVAR) and Autoregressive Distributed Lag (ARDL)
models to analyse the interactions among portfolio flows, global and domestic macro and
financial variables within a common empirical framework. Three findings emerge: First,
the SVAR estimations show that global and domestic factors play transitory roles in
driving Malaysia’s net portfolio flows. A subsample analysis from the ARDL model
highlights that domestic factors play an increasingly important role in attracting portfolio
inflows as Malaysia liberalised its exchange rate regime and capital flow restrictions.
Second, higher net portfolio flows lead to exchange rate appreciation, higher equity
prices and credit expansion. The effects are visible in the exchange rate, followed by
equity prices and credit. Third, in the transmission of higher portfolio flows to growth, the
positive effects from higher equity prices and credit are partially offset by the dampening
effect from the appreciating exchange rate on output. While the contribution of portfolio
flow’s effects on output variance is low, the impulse responses of output does change to
portfolio flow shocks, suggesting that portfolio flows are tail risks to growth and that the
risks magnify when the flows are large and volatile.