Governments should test capital controls, agree experts

The debate over whether capital controls work remains inconclusive, even as emerging market countries attempting to head off inflows of hot money. However the frosty attitude of institutions such as the International Monetary Fund to such controls is thawing.

  • 04 Nov 2010
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The adamant opposition of international agencies such as the International Monetary Fund (IMF) to capital controls is beginning to wane in the face of the capital inflows targeting several emerging markets.

There remains a lack of empirical data about the effectiveness of capital controls. However the types of control being considered in recent months are generally more subtle than those that were imposed during the Asia financial crisis. This has led experts to believe that their introduction will be more rationale and less potentially destructive than previously believed.

There is mild consensus that controls on inflows do not affect volumes of net flows, although in the short term they can impact the composition, according to HSBC research.

“There is little statistical evidence that having capital controls reduces financial vulnerability... In the long term, it appears that markets tend to find way to circumvent the controls,” HSBC said. It concluded in its report that such controls provide emerging markets with a “line of defence”.

In an interview with, Frederic Neumann, co-head of Asian economic research at HSBC, said that the meeting of the G20 in Seoul next week should actually focus on establishing good principles of practise for capital controls.

“It’s not only about removing the uncertainty of investments but the other big advantage about multilateral co-ordination is that it reduces the risk of beggaring thy neighbour,” Neumann said.

His thoughts tie in with the general change in attitude. Far from being tools that instigate huge volatility into the market, the IMF—once a standard bearer for open capital accounts—now accepts that they can promote financial stability.

Dominique Strauss-Kahn, the IMF’s managing director, said on October 18 in China that preventing crises “is a pragmatic issue, not a matter of ideology. Countries have a number of policy options in their toolkits—lower interest rates, reserve accumulation, tighter fiscal policy, macro-prudential measures and sometimes capital controls”.

The reality is that capital controls are here to stay for some time. The US Federal Reserve said yesterday it intends to purchase US$600 billion of longer-term treasuries, slightly on the higher side of expectations (albeit at a slower pace than thought).

The US quantitative easing should lead to greater capital flows to developed and emerging market nations, common economic theory suggests. This would place even greater pressure on countries such as Thailand, which saw US$16.5 billion of foreign reserves pile up in October alone, while foreign investments in its bond and stock markets have greatly increased of late.

  • 04 Nov 2010

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