Why is capital flowing out of China?

Using quarterly balance-of-payment data over the period 1993:1–2003:4, this paper examines the determinants of Chinaʹs capital flight. The long run relationship and dynamic interactions among the variables are examined using cointegration and innovation accounting methodology. We find that changes in external debts spur changes in capital flight, implying that Chinaʹs capital flight is virtually financed by foreign borrowings. On the contrary, real GDP growth and rising foreign investor confidence are inversely related to capital flight. Thus, capital flight can be curbed only if Chinese authorities equalize financing conditions of local and foreign-related firms, and separate the foreign borrowings that lead to capital flight from regular foreign debt flows.