Capital Controls by Nur Ain Najihah and Nur Izzati

Capital Controls 

by Nur Ain Najihah and Nur Izzati

Capital controls are residency-based measures such as transaction taxes, other limits, or outright prohibitions that a nation's government can use to regulate flows from capital markets into and out of the country's capital account. These measures may be economy-wide, sector-specific (usually the financial sector), or industry specific (for example, “strategic” industries). They may apply to all flows, or may differentiate by type or duration of the flow (debt, equity, direct investment; short-term vs. medium-and long-term).

Types of capital control include exchange controls that prevent or limit the buying and selling of a national currency at the market rate, caps on the allowed volume for the international sale or purchase of various financial assets, transaction taxes such as the proposed Tobin tax, minimum stay requirements, requirements for mandatory approval, or even limits on the amount of money a private citizen is allowed to remove from the country. There have been several shifts of opinion on whether capital controls are beneficial and in what circumstances they should be used.

The Latin American debt crisis of the early 1980s, the East Asian financial crisis of the late 1990s, the Russian ruble crisis of 1998-99, and the global financial crisis of 2008, however, highlighted the risks associated with the volatility of capital flows, and led many countries, even those with relatively open capital accounts, to make use of capital controls alongside macroeconomic and prudential policies as means to damp the effects of volatile flows on their economies.

Capital control mechanisms might be an appropriate way of solving the problems

Capital Controls On
Capital Inflows Ø  Correct a Balance of Payments Surplus Ø  Prevent Potentially Volatile Inflows Ø  Prevent Financial Destabilization Ø  Prevent Real Appreciation Ø  Restrict Foreign Ownership of Domestic Assets	Capital Outflows Ø  Generate Revenue/ Finance a War Effort Ø  Financial Repression Ø  Correct a Balance of Payments Deficit Ø  Preserve Savings for Domestic Use

Pros and Cons

PROS (+)

CONS (-)

In certain circumstances capital controls are effective in reaching the intended aim : 1.      Controls may help to support a weak financial system. 2.      Controls on Inflows seem to make monetary policy more independent, alter composition, reduce real exchange rate pressures. 3.      Controls on Outflows seem to be effective in reducing capital outflows and making monetary policy more independent.

Disability of international capital flows : 1.      Capital controls might reduce a country’s ability to receive multifaceted benefits (technology, access to international networks). 2.      High administrative costs of imposing capital controls. 3.      Possible prevention of adaptation to changing international circumstances. 4.      Necessary adjustments in policies in the context of financial globalization might be postponed. 5.      Negative market perceptions: it may be more difficult and more costly for countries with capital controls to access foreign funds. 6.      No discretionary policy.