Good Critical Thinking On Capital Controls To Limit Short-Term Capital Inflows
Type of paper: Critical Thinking
Topic: Finance, Banking, Capital, Investment, Control, Actions, Money, Authority
Control methods in order to limit short-term capital inflows were used in Brazil (1993-1997), Chile (1991-1998), Colombia (1993-1998), Malaysia (1994) and Thailand (1995-1997). Short term capital flows, although usually regarded as less risky in terms of individual banks and other investors, at the aggregate level is often classified as speculative and destabilizing.
Control of capital inflows has been introduced in order to reduce reliance on sterilization and in some cases - to delay other corrective actions. It is usually accompanied by other measures, including the liberalization of controls on capital outflows (Chile and Colombia), adjustment or progressive increase in exchange rate flexibility (Chile and Colombia), further strengthening prudential frameworks of the financial system (Chile, Colombia and Malaysia). In some countries maintained a tight fiscal policy (Chile and Malaysia), in the other the hardness was limited (Brazil and Thailand), and in some it remained weak, which increases the pressure on monetary policy (Colombia) (Ariyoshi, Habermeier, 2000).
In the early 1990s, the macroeconomic situation in Brazil was characterized by persistent inflation. Trying to contain it, the government used a combination of measures to control prices and wages, efforts to tighten monetary policy, raising taxes, freezing of bank deposits and sequestration of financial assets that are generally not successful.
Since the middle of 1993, the authorities began to introduce numerous control measures to reduce short-term capital inflows, with an emphasis on securities with fixed income. Control was aimed at maintaining the difference between the interest rates while minimizing the upward pressure of the exchange rate and sterilization costs.
Interest rates remained at a high level in order to control aggregate demand, to avoid future budget adjustments. The measures were aimed not only at reducing the flow of capital, but also to limit arbitrage on short-term interest rates as well as changes in the structure of the inflow - in the direction of reducing the volume of securities with fixed income to increase shares, investments in fixed assets and long-term inflows capital.
Controls took the form of numerous direct and price measures are constantly reviewed and enhanced as market participants found ways to circumvent regulatory measures through financial engineering. Initially, the authorities have increased the minimum average maturity of loans from 30 to 36 months and time income tax refunds on transfers abroad from 60 to 96 months. They changed the banking regulations to reduce dollar-denominated liabilities and an increase in dollar-denominated assets. They forbade investment obtained through authorized channels, for investment in fixed-income bonds.
When the market starts to use bonds to invest in assets with fixed incomes, the authorities banned the inflow of capital in the form of investments in bonds. Was established channel for fixed income investments in the form of Fixed Income Yield Funds (FIYF), taxable "import tax" primary currency transaction (subsequently spread to all financial loans). Once the market has adopted a strategy of derivative transactions for investment in assets with fixed-income investments through FIYF were soon banned. (Baba, Annamaria, 2011)
Thailand's economy started to show in mid-1993 signs of overheating, despite holding government austerity. Inflowing capital was mainly short-term (about 60% of the total inflow in 1993), have been reported mainly in the form of short-term loans received by the Bank (as the main channels of financial resources in the absence of a developed market for private bonds), especially through the Bangkok International Banking Facilities (BIBF).
The continuous increase in short-term capital inflows in 1995 forced the authorities in April-June 1996 to introduce a range of new measures, including the requirements for the creation of reserves (placed at the central bank). Reserve requirements at a rate of 7% were extended to non-residents in the loan baht less than one year and the new short-term offshore loans for a period of less than one year, received by commercial banks and banks BIBF. Along with the prudential measures were also increased requirements for minimum capital adequacy ratio of commercial banks. Total net capital inflows subsequently increased, but the inflow of medium- and long-term capital continued to grow, and the inflow of short-term capital (especially in the form of obtaining foreign loans by banks) decreased significantly (Baba, Annamaria, 2011)
Capital outflow controls in the Context of Financial Crises
One of the most common reasons for the imposition of controls on capital outflows during the financial crisis is the desire of the authorities to limit the downward pressure on the currency. Such restrictions were applied mainly in relation to transactions with short-term capital to counteract unsustainable speculative flows threaten to undermine the stability of the exchange rate and the depletion of foreign exchange reserves. Sometimes such restrictions serve as an alternative to rapid changes in economic policy and thus helped the authorities "buy time". They were also used to protect the real economy from the volatility of international financial markets.
Resumption of control over capital outflows during the financial crises gave authorities only temporary relief of varying lengths. In Malaysia, the control of the authorities provided some time to correct the violations of macroeconomic equilibrium and reform of the banking system. In Spain, these measures do not help to avoid re-settlement of the peseta exchange rate, although it provided some additional time to negotiate with this purpose, the exchange rate mechanism (Ariyoshi, Habermeier, 2000).
After the start of the Asian crisis in 1997 ringgit has undergone considerable pressure along with other currencies in the region. Crisis has revealed the structural weaknesses of regional banking system and contributed to the revaluation of regional credit risk. Offshore currency traders have taken a short position in the ringgit in anticipation of their impairment, and offshore ringgit rose on local courses, causing an outflow of capital from the country. Authorities temporarily severed the link between local and offshore courses by entering the limit on non-trade swap transactions with non-residents in ringgit (in August 1997). However, outflows continued through various non-limiting channels, use a significant difference in interest rates, which was due to the introduction of limits on swap transactions. Flows offshore ringgit funds contributed to an increase in domestic interest rates, accelerating the decline in economic activity and the increasing difficulties of the corporate and banking sectors.
Against this background, in an already permanent capital outflows authorities introduced in September 1998, a number of administrative measures of exchange control and capital controls, aimed mainly at curbing speculation in ringgit and the outflow of capital through the elimination of the offshore ringgit market and stabilization of short-term capital flows. The measures also included the strengthening of the independence of the monetary system and the isolation of the economy from a possible future deterioration of conditions in global financial markets. Authorities believe otherwise, interest rates can be kept at a high level for a long period, providing a detrimental impact on economic activity and the banking system (Ariyoshi, Habermeier, 2000).
In a crisis, exchange rate mechanism, which began in late 1992, the peseta underwent significant speculative pressures, reflecting not only the general tension in the exchange rate mechanism, but also the weakening of confidence in the exchange rate of the Spanish peseta. The deterioration of the budget, high unemployment and increasing balance of payments deficit on current account contributed to the decline of trust, which in turn has narrowed the space for reliable policy interest rates to protect the currency. Subsequently, 17 September 1992, the peseta was devalued within the exchange rate mechanism. In an effort to keep the currency mechanism and commitment to the European Monetary System, the authorities intended to September 22, 1992 to introduce some market-based measures to control short-term capital movements.
Controls included the introduction of non-interest bearing deposit strictly mandatory requirements for local banks. When speculative attack usually speculators are required to install the net short position in the local currency. The measures taken were designed to prevent the banks to take such a position by creating deposits at the central bank at a zero interest rate to the net short position in the local currency (or a long position in foreign currency). Special measures demanded by local banks to put in the central bank for one year interest-free deposit in pesetas equivalent to 100% of: 1) growth of 22 September long position in foreign currency against the peseta associated with the transaction - one day, with the expectation of the next day and two-day (t. e. the transactions of the "spot"); 2) growth in loans and deposits of non-residents denominated in pesetas. The measures also included a 100% reserve requirement for an increase in liabilities denominated in pesetas local banks (domestic and foreign) with their branches, subsidiaries and parent companies (Ariyoshi, Habermeier, 2000).
B. Chikako Baba and K. Annamaria, "Effectiveness of Capital Controls in Selected Emerging Markets in the 2000s" https://www.imf.org/external/pubs/ft/wp/2011/wp11281.pdf
Akira Ariyoshi, Karl Habermeier, "Malaysia's Experience with the Use of Capital Controls" in Capital Controls: Country Experiences with Their Use and Liberalization,p94-105, International Monetary Fund, May 17, 2000 http://www.imf.org/external/pubs/ft/op/op190/pdf/appendix.pdf
Marcos Chamon, "Capital Controls in Brazil: Effective?" International Monetary Fund, November 2014 http://www.imf.org/external/np/res/seminars/2014/arc/pdf/chamon_garcia.pdf
Yothin Jinjarak, Ilan Noy, Huanhuan Zheng," How effective were the 2008-2011 capital controls in Brazil?" 22 November 2012 http://www.voxeu.org/article/how-effective-were-2008-2011-capital-controls-brazil