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‘Too Much of a Good Thing’
Policymakers in a large set of developing countries deployed capital controls to mitigate the financial fragility and vulnerabilities induced by the large capital inflows that they received during much of the global crisis. In several country settings, controls were ‘dynamic’ (as per Epstein et al. 2004) such that policymakers tightened, broadened, or layered new controls over existing measures as new sources of financial fragility and channels of evasion were identified and/or when existing measures proved too tepid to discourage undesirable financial activities. Controls were also removed as circumstances changed.
Brazil is a notable exemplar of dynamic capital controls. The country is an interesting case because the government (particularly former Finance Minister Guido Mantega) staked out a strong position on policy space for controls throughout the crisis, and because the IMF’s response to the country’s controls exemplifies the evolution and equivocation in the views of Fund staff.
In late October 2009, Brazil began to utilize capital controls by imposing a tax on inflows of portfolio investment. They were intended to slow the appreciation of the currency in the face of significant capital inflows. Brazil imposed a 2 percent tax on money entering the country to invest in equities and fixed-income investments and later a 1.5 percent tax on certain trades involving American Depository Receipts, while leaving FDI untaxed. The IMF’s initial reaction to Brazil’s inflow controls was mildly disapproving. A senior official said: “These kinds of taxes provide some room for maneuver, but it is not very much, so governments should not be tempted to postpone other more fundamental adjustments. Second it is very complex to implement those kinds of taxes, because they have to be applied to every possible financial instrument,” adding that such taxes have proven to be ‘porous’ over time in a number of countries (cited in Subramanian and Williamson 2009). In response, Subramanian and Williamson (2009) indicted the IMF for its doctrinaire and wrongheaded position on the Brazilian controls, taking the institution to task for squandering the opportunity to think reasonably about capital controls. A week later the IMF’s then Managing Director Dominique
Strauss-Kahn reframed the message on Brazil’s controls. The new message was, in a word, stunning: “I have no ideology on this”; capital controls are “not something that come from hell” (cited in Guha 2009).
The Brazilian government continued to strengthen and layer new controls over existing measures during October 2010 and July 2011. These included controls that specifically targeted derivative transactions and others that closed identified loopholes as they became apparent. For example, in October 2010 the tax charged on foreign purchases of fixed-income bonds was tripled (from 2 to 6 percent), the tax on margin requirements for foreign exchange derivatives was increased, and some loopholes on the tax on margin requirements for foreign investors were closed. Despite an array of ever increasing controls, IMF economists called its use of controls ‘appropriate’ in an August 2011 review of Brazil (Ragir 2011). Brazilian policymakers began to narrow some capital controls in December 2011, though at the same time continued to extend others.
Many other developing countries implemented and adjusted controls on outflows and especially on inflows during propitious economic times. Some strengthened existing controls, while others introduced new measures. For some countries (such as Argentina, Ecuador, Venezuela, China, and Taiwan) these measures are part of broader dirigiste approaches to policy. For most other countries (e.g., Brazil, South Korea, Indonesia, Costa Rica, Uruguay, the Philippines, Peru, and Thailand), controls were part of a dynamic, multi-pronged effort to respond to the challenges of attracting too much foreign investment and carry trade.
In December 2008 Ecuador doubled the tax on currency outflows, established a monthly tax on the funds and investments that firms kept overseas, discouraged firms from transferring US dollar holdings abroad by granting tax reductions to firms that re-invest their profits domestically, and established a reserve requirement tax (Tussie 2010). In October 2010, Argentina and Venezuela implemented outflow controls. Argentina’s controls were strengthened in October 2011. The country’s capital and exchange controls were lifted in December 2015 following the Presidential election of Mauricio Macri. Venezuelan capital and currency controls remain in force.
Peru began to impose inflow controls in early 2008. The country’s central bank raised the reserve requirement tax four times between June 2010 and May 2012. The May 2012 measures included a 60 percent reserve ratio on overseas financing of all loans with a maturity of up to three years (compared to two years previously) and curbs on the use of a particular derivative (Yuk 2012). What is particularly interesting about Peru’s measures is the way in which they were branded by the central bank. In numerous public statements the Central Bank President maintained that the country did not need capital controls even while it implemented and sustained its reserve requirement tax (Quigley 2013).
In August 2012, Uruguay imposed a reserve requirement tax of 40 percent on foreign investment in one type of short-term debt (Reuters
2012). Like Peru, its bilateral agreement with the USA could have made this control actionable. Currency pressures also induced Costa Rica to use capital controls for the first time in twenty years. The country began to use controls in September 2011 when it imposed a 15 percent reserve requirement tax on short-term foreign loans received by banks and other financial institutions (LatinDADD-BWP 2011). In January 2013, the Costa Rican President began to seek Congressional approval to raise the reserve requirement tax to 25 percent, while also seeking authorization to increase from 8 to 38 percent a levy on foreign investors transferring profits from capital inflows out of the country.
In another sign of changing sentiments during the crisis, the rating agency Moody’s recommended that South East Asian countries use controls to temper currency appreciation (Magtulis 2013). Indeed, numerous Asian countries deployed new or strengthened existing controls during good times.
For instance, in November 2009 Taiwan imposed new inflow restrictions and at the end of 2010 controls on currency holdings were strengthened twice (Gallagher 2011). In 2010, China added to its existing and largely quantitative inflow and outflow controls (Gallagher 2011). In 2013 China’s State Administration of Foreign Exchange (SAFE, which is the unit within the central bank that manages the RMB) took new steps to control ‘hot money’ flows (Monan 2013).
In June 2010, Indonesia announced what its officials termed a ‘quasicapital control’ via a one-month holding period for central bank money market securities (raised to six months in 2011) and new limits on the sales of central bank paper by investors and on the interest rate on funds deposited at the central bank. During 2011 it reintroduced a 30 percent cap on short-term foreign exchange borrowing by domestic banks, and raised a reserve requirement on foreign currency deposits (Batunanggar
2013). The awkward labeling of controls in Indonesia suggested its government was still afraid of the stigma that long attached to capital controls.
Thailand introduced a15 percent withholding tax on capital gains and interest payments on foreign holdings of government and state-owned company bonds in October 2010. In December 2012, the Philippines announced limits on foreign currency forward positions by banks and restrictions on foreign deposits (Aquino and Batino 2012).
As in Brazil, Korean authorities took a dynamic, layered approach to capital controls, while also targeting the particular risks of derivatives. But unlike Brazil, authorities reframed these measures as macroprudential and not as capital controls (see Chwieroth 2015). In 2010 Korean regulators began to audit lenders working with foreign currency derivatives, placed a ceiling on the use of this instrument, and imposed a levy on what it termed ‘noncore’ foreign currency liabilities held by banks. In 2011 Korea also levied a tax on holdings of short-term foreign debt by domestic banks, banned ‘naked’ short selling, and reintroduced a 14 percent withholding tax on foreign investment in government bonds sold abroad and a 20 percent capital gains tax on foreign purchases of government bonds (Lee 2011; ADB 2011).