The Nexus of Foreign Capital Flows and Stock Index: Evidence from Indonesia

Abstract

The relationship between foreign capital flows and the stock index is mutually influential, creating a cycle. Economic growth and market stability, indicated by rising stock indexes, attract foreign capital inflows, which in turn strengthen the stock index. This study aims to explore the relationship between foreign capital flows and the Jakarta Composite Index (JCI) in Indonesia from 2010 to 2024. Based on Granger causality, foreign capital flows influence the Jakarta Composite Index (JCI), but not vice versa. This finding is supported by the VECM model analysis, using impulse response function analysis and variant decomposition. Maintaining the stability of foreign capital flows in Indonesia is crucial, as large fluctuations in foreign capital inflows or outflows can trigger or exacerbate stock market volatility. Significant capital outflows, often driven by global sentiment such as rising US interest rates or geopolitical uncertainty, can cause foreign investors to withdraw funds from the stock market, leading to weakened stock prices and a negative impact on the Jakarta Composite Index (JCI). Conversely, capital inflows can support the stock market and indicate investor optimism about a country.