- Giovanni Dell'Ariccia, Paolo Mauro, Andre Faria, Jonathan Ostry, Julian Di Giovanni, Martin Schindler, Ayhan Kose, and Marco Terrones
- Published Date:
- December 2008
|OECD ||Non-OECD ||Middle-Income ||Low-Income ||Advanced Economies ||Emerging Market Countries ||Developing Countries |
|Austria||Brunei Darussalam||Argentina||Burkina Faso||Austria||Brazil||Bangladesh|
|Canada||Hong Kong SAR||Brazil||Ghana||Canada||China||Bolivia|
|Denmark||Israel||Bulgaria||India||Hong Kong SAR||Colombia||Botswana|
|France||Malta||China||Kyrgyz Republic||Finland||Dominican Rep.||Congo, Rep. of|
|Germany||Qatar||Costa Rica||Pakistan||France||Ecuador||Costa Rica|
|Greece||Saudi Arabia||Czech Republic||Tanzania||Germany||Egypt||Gabon|
|Iceland||Singapore||Dominican Rep.||Togo||Greece||El Salvador||Gambia, The|
|Italy||United Arab Emirates||Egypt||Uzbekistan||Ireland||India||Guatemala|
|Japan||El Salvador||Yemen, Republic of||Italy||Indonesia||Kenya|
|United States||Mauritius||Switzerland||Tunisia||Trinidad and Tobago|
|Moldova||United States||República Bolivariana de Venezuela|
|República Bolivariana de Venezuela|
All capital controls indices in this paper, and essentially all existing cross-country indices in the broader literature, are based on information contained in the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). Until 1995, the AREAER summarized a country's openness to capital flows using a simple 0/1 dummy variable, where 1 represents a restricted capital account and 0 represents an open capital account. In 1995, the AREAER started providing information on restrictions on capital transactions in 11 categories: shares or other securities of a participating nature; bonds or other debt securities; money market instruments; collective investment securities; derivatives and other instruments; commercial credits; financial credits; guarantees, sureties, and financial backup facilities; direct investment (including liquidation of direct investment); real estate transactions; and personal transactions. For each of these categories, the AREAER's new methodology distinguishes between restrictions on residents and those on nonresidents.1 For each of these specific types of restrictions, binary indicators were compiled.2 More aggregate indicators for each country were then calculated as simple averages of the respective subcategories. For example, restrictions on equity inflows are the average of the restriction dummies on “purchase locally by nonresidents” and “sale or issue abroad by residents,” and the equity inflows index can thus take three values, 0, 0.5, or 1. The broadest index for an individual country is the average of 18 dummies. The resulting index and its subcomponents are the most comprehensive and detailed indices of capital controls currently available. Compared with broad binary dummies, the new indices provide a more precise measure of controls, and permit analysis of various types of controls. This said, like all AREAER-based measures, the index cannot reflect differences in enforcement or economic relevance of controls across countries.
For the purposes of this paper, the focus is on a subset of these categories, namely, equity, money market, bond, collective investment and direct investment. These categories broadly correspond to the standard decomposition of de facto financial flows.
Restrictions on capital transactions are coded as a 0 (not restricted) if they consist merely of registration or notification requirements. They are also coded as 0 if a country is generally open but imposes restrictions on investments in a small number of selected industries, for example, for national security purposes, or if it is generally open but excludes a small number of countries, typically for political reasons. Using a binary index at this level facilitates consistency in coding across countries and years, though it requires abstracting from differences in the form of controls (prohibition, limitation, taxation, or registration requirements). Schindler (2008) provides additional detail on the data construction and makes the dataset publicly available.
Using a variety of case studies on countries' experiences with financial account liberalization, it is possible to illustrate some of the findings reported in Section VI. This appendix summarizes a variety of previously published case studies prepared by IMF staff and the IMF's Independent Evaluation Office.1 Countries covered include eight advanced countries, 22 emerging market economies, and two developing countries (see Appendix Table A3.1). Countries' experiences are grouped along two dimensions: (1) depending on whether a country experienced a currency or debt crisis after it liberalized the financial account; and (2) whether a country is above the median in at least three of the four factors emphasized in Section VI, namely trade openness (imports plus exports, divided by GDP), the soundness of macroeconomic policies (government expenditures divided by revenues), institutional quality (the average index from the International Country Risk Guide, Political Risk Services), and domestic financial development (private credit/GDP).
|Country||Pace, Sequencing, and Institutional Anchor of Liberalization||Financial Sector Policies and Context||Macroeconomic Policies and Context|
|Countries above the median in at least three out of four factors at the time of liberalization: No currency or debt crisis after liberalization|
|Austria 1986–91||Gradual. Long-term flows liberalized before short-term flows. OECD accession.||Sound and well-supervised financial sector.||Stable macroeconomic environment.|
|Chile 1985–98||Gradual and selective. Liberalization of longer-term inflows and outflows, with selective capital controls on inflows that were later broadened because of circumvention. Focused initially on liberalizing inflows, though with strong restrictions on liquidation of FDI and repatriation of profits. Capital outflows gradually liberalized. Introduction of market-based capital controls (URR) on new foreign borrowing (except trade credits) and foreign currency deposits to limit short-term credit inflows.||Restructuring of banking system: the banks achieved low levels of nonperforming loans, comfortable level of provision for bad loans, compliance with BIS capital adequacy ratio. Central bank becomes independent and in charge of stability of financial system. Development of the stock exchange, money and exchange markets, and local security markets.||Fiscal consolidation. Modification of exchange rate regime to allow for greater flexibility of the rate within a crawling band exchange arrangement to ensure orderly real appreciation of the currency. Restrictive monetary policy conducing to a reduction of inflation from more than 25 percent to 4 percent a year. High output growth. Progressive trade liberalization.|
|Czech Republic 1995||Fast. With the exception of some outflows, almost all controls removed by the end of 1995. FDI liberalized first. Inflows liberalized before outflows. Outflows by nonresidents fully liberalized in 2001. Five-year program to eliminate controls in outflows in the context of accession to OECD 1995-2001.||Weak banking system.||Expansionary fiscal policy. Fixed exchange rate regime.|
|Estonia 1994||Fast Almost all controls removed by 1994. Pension funds' investments last to be liberalized.|
|France 1983–90||Gradual. Controls on FDI first to be eased. Last flows to be fully liberalized concerned bank lending in local currency to nonresidents and residents' ownership of foreign exchange accounts. All controls abolished by January 1, 1990. Liberalization in the context of the transition to the European Monetary System (EMS). Safeguard clauses with respect to European Economic Community (EEC) liberalization obligations were abolished.||Major deregulation of financial sector in stages, with abolishment of quantitative credit controls.||Disinflation process. Reduction of current account deficit.|
|Hungary 1989–2001||Gradual. FDI liberalized first. Long-term flows liberalized before short-term flows. OECD accession.||Rapid financial sector reforms. Foreign bank participation encouraged early.||Macroeconomic stabilization following 1995 crisis.|
|Lithuania 1994–95||Fast. Real estate and pension funds' investments last to be liberalized.|
|Slovak Republic 1990–2004||Gradual. Long-term flows liberalized before short-term flows; inflows before outflows; FDI and portfolio before financial credits. Most restrictions eliminated to meet EU requirements. OECD accession was also an important anchor.|
|Slovenia 1999–2002||Gradual. After having introduced capital controls in 1995-99, credit operations liberalized first. Long-term flows liberalized before short-term flows. Portfolio flows last to be liberalized.|
|Spain 1986–93||Gradual with occasional reversals. Controls on inflows abolished in February 1992 and temporarily reintroduced in 1992-93 during the EMS crisis. Liberalization in the context of admittance to the then EEC.|
|Tunisia 1995–||Slow. Step-by-step approach effectively started in 1995. FDI inflows and resident-export-related transactions liberalized first. Many restrictions on inward portfolio investment and outward non-export-related capital transactions remain. In 1995, Tunisia signed an association agreement with the EU that implied the goal of full trade liberalization and capital account convertibility.||Banking sector restructuring (early 1990s), though still fragile. Undeveloped financial markets.||Macroeconomic stability. Prudent macroeconomic policies. Trade gradually liberalized (reduction of quantity restrictions on imports). Adopted full currency convertibility (1993).|
|Countries above the median in at least three out of four factors at the time of liberalization: Crisis after liberalization (currency or debt crisis, or both)|
|Indonesia 1989–96||Gradual, partial, and with reversals. Gradual liberalization of FDI, though domestic ownership requirements were kept in place. Portfolio equity investment by foreigners allowed up to 49 percent (1989). Elimination of quantitative limits on bank borrowing from nonresidents, partially reverted later in 1991 to control surging capital inflows. Liberal regime for capital outflows by resident individuals and juridical entities, while prohibiting lending abroad by banks and financial institutions.||Liberalization of interest rates and partial removal of direct credit controls on the banking system. Enhancement of banking supervision, development of money market. Opening up to foreign banks, other financial institutions, and insurance firms. Strengthening of domestic capital markets.||Large current account deficit. Rising inflation. High interest rates. Exchange rate against the U.S. dollar allowed to fluctuate within a narrow band. Partial liberalization of tariff system. Corruption and cronyism during the 1990s.|
|Malaysia 1986–97||Gradual, with interruptions in 1994 (controls on portoflio inflows re-enacted for one year) and in 1998 (controls on outflows). FDI inflows actively encouraged (although with restrictions in some sectors). Outward FDI unrestricted. Unrestricted portfolio inflows. Borrowing abroad and lending to residents and nonresidents by authorized entities were unrestricted, but subject to prudential limits (de facto limits on foreign currency borrowing by residents).||Structural weaknesses in the banking system led to deterioration in the asset quality of banks, despite improvements in the legal and regulatory framework and supervisory and prudential practices.|
|Sweden 1980–92||Gradual, but accelerated in late 1980s. Long-term flows generally liberalized before short-term flows.||Extensive domestic liberalization but with inadequate supervision.||Expansionary macroeconomic policies leading to an unsustainable credit and asset price boom.|
|Thailand 1985–96||Rapid opening to inflows with partial reversal at later stage. Gradual liberalization of outflows. In 1995, short-term capital inflows were restricted with the imposition of a 7 percent URR on banks' nonresident baht accounts to control the growing proportion of short-term inflows. In 1996, these restrictions were extended to cover new foreign borrowing of less than one year.||Oligopolistic structure in banking system and other weaknesses despite improvements on supervision. Banks had inadequate loan provisioning and large exposure to property sector. Development of stock market.||Large current account deficit. High interest rates. Rising inflation. De facto fixed exchange rate.|
|Countries below the median in at least two out of four factors at the time of liberalization: No currency or debt crisis after liberalization|
|China 1994–||Slow. Capital controls favor longer-term over shorter-term inflows.||Financial sector still suffers from some weaknesses: classification, provisioning, accounting standards, internal controls and risk management systems are all relatively weak.||Fixed exchange rate regime.|
|India 1991–||Slow. Capital controls designed to reduce reliance on short-term and debt-creating flows. FDI inflows first to be progressively liberalized, followed by porfolio equity investment by nonresidents. Strict control of short-term borrowing (except for trade-related purposes). More strict controls for outflows than for inflows, for residents than for nonresidents, for individuals than for corporations.||Steady progress toward more open and market-oriented financial system. Strengthening of prudential regulation and supervision of banking system. Problems remain: large state-controlled banking system, despite increased foreign bank participation. Reform of securities markets.||Increased exchange rate convertibility (1994). Exchange rate regime: managed float. Large public sector deficits and large net domestic public debt. Large accumulation of reserves. Reduction in trade barriers.|
|Japan 1979–||Gradual.||Gradual and partial approach to domestic financial market deregulation. Supervisory and risk-management practices did not keep pace with increased appetite for risk leading to a fall in credit standards. Asset price bubble.|
|Latvia 1994–95||Fast. Real estate and pension funds' investments last to be liberalized.||Weak regulatory system.||De facto peg to SDR.|
|New Zealand 1984-85||Rapid. Before liberalization, most controls aimed at limiting outflows (particularly of portfolio investment).||Deregulation of financial system, with abolishment of controls on interest rates and credit growth.||Fiscal consolidation and reform of product and labor markets lagged behind capital account liberalization and reforms in financial sector.|
|Peru 1990–91||FDI liberalized first.||Abolishment of interest rate controls. Tighter prudential regulation and enforcement. Increased foreign bank participation.||Tight monetary policy and sound fiscal policy. Adoption of floating exchange rate regime. Structural reform and trade liberalization.|
|United Kingdom 1979||Rapid. All capital controls were abolished in four months, from June to October.||Strong market discipline and prudential policies.||Encompassing policy package aimed at increasing efficiency, and improving the functioning of the labor market. Growth did not improve during the 1980s and inflation fell.|
|Countries below the median in at least two out of four factors at the time of liberalization: Crisis after liberalization (currency or debt crisis, or both)|
|Argentina 1991||Rapid. Convertibility plan.||Started with good and innovative banking supervision (BASIC), though prudential regulations to discourage use of dollarized debt were not in place. Privatization of 50 percent of state-owned banks and allowed entry of foreign banks (mostly Spanish). To address fiscal problems, government weakened banking regulation to allow banks to hold more government bonds.||Fiscal imbalances: debt to GDP ratio rose from 29.2 to 41.4 percent, with most of debt denominated in dollars. Currency board. Low growth after a period of high growth (1991-94). Rigid labor and product markets.|
|Brazil 1988–97||Gradual with temporary reversals. From 1993 to 1996, controls on inflows to avoid fiscal costs associated with massive sterilization. In 1997, capital controls on inflows relaxed.||Well-developed financial markets.||Trade liberalization.|
|Italy 1988–90||Gradual. In 1988, only restrictions on short-term transactions. All controls lifted by July 1, 1990. Liberalization in the context of the transition to the EMS. EEC liberalization directive adopted in 1988.||Deregulation of domestic financial markets.||Large fiscal deficits.|
|Korea 1985–97||Gradual and partial. Liberalization favored short-term debt flows and kept relatively more restrictions on long-term flows, in particular on FDI. OECD accession.||Weaknesses in the financial sector. Deficiency in credit allocation. Poor governance, high leverage and liability dollarization (chaebols).||Sound macroeconomic policies, with low inflation and stable public finances (though with high contingent liabilities). De facto pegged exchange rate.|
|Kenya 1991–95||Gradual and partial.||Liberalization of financial sector. Weak prudential supervision and enforcement.||Expansionary monetary policy. External payments arrears.|
|Poland 1990–2002||Gradual. Long-term flows liberalized before short-term flows; inflows before outflows; FDI and portfolio before financial credits. Liberalization sped up during OECD accession negotiations (1994-96).|
|Mexico 1989–94||Gradual. FDI liberalized first. Short-term capital flows substantially liberalized. Capital account greatly liberalized (though restrictions remained) by May 1994. North American Free Trade Agreement and OECD accession.||Poor supervision and lack of of adequate regulatory standards and accounting practices, together with fixed exchange rate regime encouraged liability dollarization. Lack of competition in banking sector (foreign banks not allowed).||Tightly managed exchange rate regime (de facto peg to the U.S. dollar) and high current account deficit in a context of high interest rates.|
|Paraguay 1989–94||Gradual, on top of a relatively open capital account. Incentives to FDI.||Financial sector liberalization but in the context of a weak prudential framework.||Strengthening of macroeconomic policies and subsequent settlement of public sector external arrears. Significant trade liberalization measures. No significant macro-economic imbalances and high level of official international reserves.|
|South Africa 1995–||Gradual. Cautious approach. Restrictions on nonresidents' capital flows liberalized first. Capital controls on residents have been lifted gradually.||Well-capitalized banks. Steps to strengthen prudential regulation and supervision.||Sound macroeconomic policies: substantial reductions on inflation and fiscal deficit. Trade reforms.|
|Turkey 1988–91||Fast. Almost all controls removed between 1988 and 1991. FDI and portfolio equity investment were liberalized first. Turkey submitted itself to the obligations of the OECD code in the context of its OECD accession.||Weak risk management, despite bank reform and improved supervision: high dollarization and maturity mismtach of banks' balance sheets.||Weak macroeconomic fundamentals. High inflation environment and large budget deficits led to high and volatile nominal interest rates. Trade liberalization. Crawling peg (2000).|
As shown below, the overall picture that emerges is that countries with relatively sound macroeconomic policies and well-developed domestic financial systems are less likely to face crisis than countries without these characteristics. While the predicted pattern holds on average, a few countries experienced crises despite faring relatively well with respect to sound policies and domestic financial development, and some countries with policy and institutional shortcomings nevertheless avoided crises.
As shown in the case studies, for the sample of countries covered, whether the pace of liberalization is fast, gradual, or slow does not appear to have a significant impact on the likelihood of crisis. On the whole, crisis propensity seems primarily related to whether financial account liberalization is part of a broader package aimed at the development and appropriate regulation of the domestic financial sector and sound macroeconomic policies (including external imbalances that are not excessive).
|Above the median in at least three out of four factors at the time of liberalization||Yes||11||4|
Countries that liberalized their financial account while suffering from weaknesses in the financial sector, in particular in the banking sector—as was the case for a number of countries affected by the Asian crisis—seem to be more likely to suffer crisis than countries that improved prudential policies before liberalizing the financial account. Countries with increasing current account deficits, rising inflation, and expansionary fiscal policies also seem more likely to suffer a currency or debt crisis when compared with countries with low current account deficits, low inflation, and solid public finances. Countries tied to a credible external anchor appear to be able to liberalize their financial account without suffering currency or debt crisis despite some weaknesses in the financial sector and/or macroeconomic imbalances, as was the case for some of the transition countries in their accession process to the European Union.
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233. Germany's Three-Pillar Banking System: Cross-Country Perspectives in Europe, by Allan Brunner, Jörg Decressin, Daniel Hardy, and Beata Kudela. 2004.
232. China's Growth and Integration into the World Economy: Prospects and Challenges, edited by Eswar Prasad. 2004.
231. Chile: Policies and Institutions Underpinning Stability and Growth, by Eliot Kalter, Steven Phillips, Marco A. Espinosa-Vega, Rodolfo Luzio, Mauricio Villafuerte, and Manmohan Singh. 2004.
230. Financial Stability in Dollarized Countries, by Anne-Marie Gulde, David Hoelscher, Alain Ize, David Marston, and Gianni De Nicolò. 2004.
229. Evolution and Performance of Exchange Rate Regimes, by Kenneth S. Rogoff, Aasim M. Husain, Ashoka Mody, Robin Brooks, and Nienke Oomes. 2004.
228. Capital Markets and Financial Intermediation in The Baltics, by Alfred Schipke, Christian Beddies, Susan M. George, and Niamh Sheridan. 2004.
227. U.S. Fiscal Policies and Priorities for Long-Run Sustainability, edited by Martin Mühleisen and Christopher Towe. 2004.
226. Hong Kong SAR: Meeting the Challenges of Integration with the Mainland, edited by Eswar Prasad, with contributions from Jorge Chan-Lau, Dora Iakova, William Lee, Hong Liang, Ida Liu, Papa N'Diaye, and Tao Wang. 2004.
225. Rules-Based Fiscal Policy in France, Germany, Italy, and Spain, by Teresa Dában, Enrica Detragiache, Gabriel di Bella, Gian Maria Milesi-Ferretti, and Steven Symansky. 2003.
224. Managing Systemic Banking Crises, by a staff team led by David S. Hoelscher and Marc Quintyn. 2003.
223. Monetary Union Among Member Countries of the Gulf Cooperation Council, by a staff team led by Ugo Fasano. 2003.
222. Informal Funds Transfer Systems: An Analysis of the Informal Hawala System, by Mohammed El Qorchi, Samuel Munzele Maimbo, and John F. Wilson. 2003.
221. Deflation: Determinants, Risks, and Policy Options, by Manmohan S. Kumar. 2003.
220. Effects of Financial Globalization on Developing Countries: Some Empirical Evidence, by Eswar S. Prasad, Kenneth Rogoff, Shang-Jin Wei, and Ayhan Kose. 2003.
219. Economic Policy in a Highly Dollarized Economy: The Case of Cambodia, by Mario de Zamaroczy and Sopanha Sa. 2003.
218. Fiscal Vulnerability and Financial Crises in Emerging Market Economies, by Richard Hemming, Michael Kell, and Axel Schimmelpfennig. 2003.
Note: For information on the titles and availability of Occasional Papers not listed, please consult the IMF's Publications Catalog or contact IMF Publication Services.