Capital controls can be useful in dealing with volatile movements of capital, but they are difficult to administer and must be used in conjunction with proper macroeconomic policies, according to a new IMF staff report. At a press briefing held on January 11, to announce the release of the report, Stefan Ingves, Director of the IMF’s Monetary and Exchange Affairs Department, emphasized that this conclusion in no way negates the IMF’s position that “free capital flows are good for everyone in the long run.”
Akira Ariyoshi, Assistant Director in the department’s Exchange Regime and Market Operations Division, described the objectives of the report, Country Experiences with the Use and Liberalization of Capital Controls. These, he said, include examining why some countries have imposed capital controls and why others have liberalized, the form the controls have taken, the effectiveness of controls, and the costs of adopting them. The 14 countries covered in the report are grouped by similarity of purpose to permit the authors to draw more generally applicable conclusions. In addition, Ariyoshi noted, the report studies the link between prudential policies and capital controls to show how better prudential policies and accelerated financial sector reforms could address the risks in cross-border capital flows.
Discussing motivations for adopting capital controls, the report explains that countries have imposed such restrictions for a variety of reasons: to improve economic welfare by compensating for financial market imperfections; to allow monetary policy to pursue domestic objectives; to reduce pressures on the exchange rate; to protect monetary and financial stability in the face of persistent capital flows; and to support policies of financial repression to provide cheap financing for government budgets and priority sectors.
The design of controls has varied among the countries. Some have taken the form of administrative controls, which usually prohibit cross-border capital transactions outright or stipulate an approval procedure for such transactions. Others have been market-based or indirect controls, which attempt to discourage particular capital movements through taxes or taxlike measures. These affect the price or volume of a given transaction, or both. Although the effectiveness of controls has been mixed, according to the report, the country experiences invariably showed that capital controls provided no benefits when underlying policies, especially macroeco-nomic policies, were inconsistent or ill conceived. Countries that used controls effectively on outflows, Ariyoshi said at the press briefing, gained “some temporary breathing space in which to adopt and implement sound economic policies and reforms.” Even when controls seem to be effective, he cautioned, it is difficult to disentangle their contribution from those of the other policies a country is implementing.
When countries adopt capital controls or reimpose controls after having liberalized transactions, the report states, they can incur a number of costs whether or not the controls are effective. First, restrictions on capital flows may interfere with desirable capital and current transactions along with the undesirable ones. Implementing controls may also involve administrative costs, particularly when the measures must be broadened to prevent market participants from finding ways to circumvent the controls. A third cost is that imposing controls may delay a country’s implementation of necessary reforms. Finally, controls may cause market participants to view the country in a negative light, making it more difficult and expensive for the country to access foreign funds.
The report draws a number of tentative conclusion from the 14 case studies that the authors believe may prove useful in formulating policy:
- • No single capital control measure is effective across all countries at all times.
- • Controls on specific transactions may effectively limit those transactions, but market participants will find ways, especially in sophisticated markets, of circumventing the controls through unrestricted channels. Thus, to be effective in the longer run, controls generally need to be comprehensive and strictly enforced.
- • The need for controls to be comprehensive implies that more effective controls are also more distortionary and hence more costly.
- • Administrative capacity to implement the controls and the level of financial market development will influence the choice of controls and their effectiveness.
- • The evidence is mixed on whether capital controls can correct financial market imperfections and serve a prudential purpose.
- • Strong prudential policies were found to play an important role in orderly and successful capital account liberalization and in reducing a country’s vulnerability to external shocks.