Role of instability in affecting capital flight magnitude: An ARDL bounds testing approach

Capital flight resulting from hot money has been a popular issue recently. The effect of capital flight is unquestionably bad to the domestic economic condition. The current global economic slowdown exposes a bigger risk of capital flight to developing countries. Likewise, the causal relationship of capital flight and political stability as well as exchange rate stability is not clearly observed yet in the literature. This paper aims to analyse this issue and fill the research gap. Our paper extends previous studies by using another measure of political risk index, and also exchange rate stability has not been really examined by previous studies in the case of capital flight. A more focused study on one country may give a direct policy implication to the policymakers of the country, rather than a panel data study. We employed time-series data of Indonesia for 35 years from 1980 to 2015 and use ARDL procedure, which is really suitable for our research objectives and sample used, to analyse the data. We find that political risk plays a significant role in affecting the magnitude of capital flight. Furthermore, the results show that both capital flight and exchange rate stability are endogenous variables, and movement in one variable will affect the movement of another variable. Our main suggestion for the policy makers to prevent capital flight is to maintain political and exchange rate stability in the country. In short, preventing capital flight is all about maintaining domestic stability, either political stability or economic stability