- Akira Ariyoshi, Andrei Kirilenko, Inci Ötker, Bernard Laurens, Jorge Canales Kriljenko, and Karl Habermeier
- Published Date:
- May 2000
This paper aims to develop a deeper understanding of the role that capital controls may play in coping with volatile movements of capital, and of complex issues surrounding capital account liberalization. It provides a detailed analysis of specific country cases to shed light on the potential benefits or costs of capital controls, including those used in crisis situations. It also considers the important link between prudential policies and capital controls, including the improvement of prudential practices and accelerated financial sector reform to address the risks involved in cross-border transactions. Chapter II reviews the experience of selected countries with the use or removal of capital controls based on a detailed review and comparison of the experience of a group of 14 countries that used various types of capital controls, often to manage episodes of unsustainable capital flows. Chapter III examines the prudential approach to managing the risks associated with capital flows, and Chapter IV provides some conclusions.
The review of country experiences in Chapter II is organized around five key themes. These themes include the use and effectiveness of controls on capital inflows in limiting the potentially destabilizing effects of short-term capital flows and preserving monetary policy autonomy under tightly managed exchange rate systems (involving formal or de facto peg arrangements); the potential benefits and costs of reimposing selective controls on capital outflows to reduce pressures on the exchange rate, including in the context of currency or banking crises, as well as of extensive exchange controls that may entail restrictions on both capital and current international transactions; long-standing and extensive capital controls and their role in reducing financial vulnerability; and the benefits and costs of rapid and wide-ranging liberalization of previously restrictive exchange control regimes. For each group, two to five countries were selected for case studies that provide recent and diverse experiences.1
For the first four key themes above, the study examines the motivations of countries to limit capital flows; the role that the controls may have played in coping with particular situations; the nature and design of the control measures; and their effectiveness with respect to influencing targeted flows and activities and realizing their intended objectives. The study also seeks to identify the factors that may have influenced the effectiveness of the controls, as well as the potential costs that may have been associated with their use. Brief descriptions and assessments of each country’s experience can be found in Chapters V–IX, and these form the basis for the analyses in Chapter II. Appendices I–III provide a more detailed study of three countries that have received widespread attention in terms of their capital control measures: Chile, India, and Malaysia. In the case of the benefits and costs of liberalization, the discussion also focuses on the underlying reasons that have motivated countries to rapidly liberalize capital flows, and the factors that may have impinged on the effectiveness of the liberalization strategies.
In analyzing the effects of capital controls, drawing conclusions from econometric and statistical analysis is inherently problematic, not least because of the difficulty in quantifying the capital control measures, the quality of capital account data, and the confluence of policy and the external environment influencing the volume of capital flows. This paper adopts a descriptive approach, and concentrates on the effectiveness of capital controls and the costs associated with their use. While every effort has been made to provide an objective account and analysis of the developments, the country episodes may be open to different interpretations.
The prudential approach to managing the risks involved in cross-border transactions is described in Chapter III. This area has only recently received more widespread attention, and the prudential standards themselves are under development. The chapter reviews progress in establishing prudential standards for cross-border flows and issues in their implementation, and discusses their limitations and the conditions for their effectiveness. The chapter also examines the link between capital controls and prudential policies.
The analysis throughout the main paper takes as its starting point the observation that economic performance—and the volume, composition, and volatility of international capital flows—will depend to a large extent on the mix of policies. The effectiveness of particular measures or institutions is usually gauged in the first instance with respect to the objectives of a country’s economic policy. These objectives may differ across countries, and so will the appropriate policy mix. Limiting macroeconomic and financial instability is among the most widely shared objectives, and macroeconomic policies, capital controls, and prudential measures may all have a role to play in achieving this goal. Although there is no unique best approach, the analysis in this paper underscores that some types and combinations of policies tend to be more effective than others, and have fewer undesirable side effects.