At the World Bank/IMF annual meetings in Hong Kong three years ago the powerful interim committee gave the IMF a green light for yet another mission. The fund was keen to promote unrestricted international capital movements.
But those were the days when money had just started to stampede out of Asia’s crisis countries. It was a memorable case of bad timing.
During the crisis attitudes towards the free movement of capital hardened. Those who believe that capital account convertibility (CAC) would bring huge growth benefits to developing countries were on the defensive.
Officials concluded that India and China – two Asian countries with controls – escaped the crisis precisely because they don’t have CAC.
Now with the crisis over some thinkers are debating the subject. An IMF paper released in May suggests that the truth is far more complicated than capital controls being either good or bad.
The difficulty is that CAC is not just a matter of economics but of politics too.
Malaysia, for example, imposed temporary controls on September 1, 1998, blocking the withdrawal of financial capital for one year.
And the government arrested Anwar Ibrahim the very next day. Some commentators suspect that the purpose of Malaysia’s controls was to avoid capital flight triggered by the arrest.
“The provisional conclusion is that controls on capital outflows can help prevent a panic,” says John Williamson of Washington’s Institute for International Economics. “In that sense, Malaysia got away with it, but remember that the Malaysians didn’t keep their controls on very long and that was important.”
Chile is one country that has experimented with capital controls for purely economic not political reasons. Lots of capital was flowing into Chile in the early 1990s. That had many benefits, of course, but officials were afraid that the peso would appreciate, leading to a loss of competitiveness, outflows and a crash.
But Chile seems to have met with only partial success, between 1991 and 1999, when it imposed a special non-interest-bearing reserve requirement on capital from abroad as well as a minimum one-year holding period for equity investments.
“The controls [in the 1990s] only altered the composition of inflows in favour of trade credit at the expense of bank loans, but the goal of reducing the total volume even of short-term funds was not achieved,” concludes Salvador Valdés-Prieto, an MIT-trained economist at the Catholic University of Chile in Santiago. “The policy also significantly raised the cost of capital, especially for small and medium-size firms.”
One reason that Chile felt safe in dropping the controls was that it no longer faced a huge tide of incoming capital.
But the authorities have kept the laws in place so that they could reimpose controls should the need arise.
“That compares with the 20-year evolution that the OECD countries went through,” says Lex RieVel of the Institute of International Finance. “When Chile is ready to join the OECD, it won’t need that residual framework.
All of the OECD countries eventually abolished similar laws after a long period of peer pressure.”
The lesson from the Asian crisis is that countries with controls in place should take their time when liberalizing. Most experts continue to think that liberalization of foreign direct investment, portfolio equity and long-term capital is beneficial for growth. But even the IMF now seems willing to admit that opening up to unlimited flows of short-term money can be harmful.
“The critical issue is for countries to feel confident that they won’t be redlined,” says Williamson. “The east Asians simply could not borrow from anybody apart from the IFIs in late 1997. Countries should be very, very careful as long as that danger remains.”
Proper sequencing is essential. “Other things need to be done before it’s safe to work with an open capital account,” warns Williamson. “Sound macroeconomic policies as well as a solvent, well-supervised financial system both should be in place.”
Williamson thinks that the Singapore approach deserves attention. The Singapore Monetary Authority must give permission for borrowings – above $5 million – by foreigners onshore in local currency. “That one control is very powerful,” he says. “Foreign institutions can’t borrow Singapore dollars and then use them to speculate against the currency.”
Chile’s approach also might be helpful, during transition. But Williamson and others like him don’t want to go back to the bad old days. “Just one or two really strategic things will be enough,” he explains.
Deputy managing director Stanley Fischer has suggested that amendments should give the IMF jurisdiction over CAC without a presumption about the speed of liberalization. “If one felt confident that the IMF had overcome its previous love affair with rapid capital account liberalization,” says Williamson. “I think that would make a lot of sense. The trouble is that many people would not feel confident that the Fund at this stage would interpret an amendment sympathetically to the needs of countries not to go too fast.”
