Capital Inflows and Investment in Developing Countries: The Case of Indonesia

This study reviews the capital flows and investment in an open economy with the highest degree of capital account openness, managed exchange rate regime and high economic growth. We employ generalized error correction model to estimate the short-run and long-run relationships. The free capital mobility could be confirmed from the close relationship between domestic and benchmark interest rate. Interestingly, we find that investment moved one to one with saving. In this sense, the amount of capital inflows was not correlated with domestic investment. Net factor income from abroad offset capital inflows. Therefore, simplistic policy to attract capital inflows may not always be the optimal solutions for developing countries. The net resource flows should be taken into account. Not only interest payment for foreign debt, income payment for direct investment might also cause a high burden on the economy. Developing countries should design policies to improve domestic productivity.