The research conducted by Professor Stephany Griffith-Jones and Professor Jose Antonio Ocampo argues that capital account liberalization involves significant risks as developing countries, and especially low-income ones, are subject to strongly pro-cyclical capital flows….
The research conducted by Professor Stephany Griffith-Jones and Professor Jose Antonio Ocampo argues that capital account liberalization involves significant risks as developing countries, and especially low-income ones, are subject to strongly pro-cyclical capital flows. The financial instability, real macroeconomic instability and limited policy space for counter-cyclical policies that capital flows generate is a strong argument of why low-income countries should be very cautious in the capital account liberalization process. So, their lag in this regard should be seen as an advantage rather than a disadvantage. If they decide to liberalize, they must previously put in place strong domestic financial and capital account regulations, including of a macro-prudential type.
The analysis of experiences with the use of capital account regulations (CARs) in emerging economies indicates that they are a good financial stability tool, and can also serve as useful macroeconomic policy instruments. In terms of financial stability, they help improve debt profiles and reduce the vulnerability associated with dependence on reversible capital flows.
More specifically, the experience with CARs indicate that regulations on either inflow or outflows can work , but the authorities must have administrative capacity to manage them, which includes acting on time to close loopholes and respond to “innovations” by private agents aimed at circumventing regulations. As a result of the link with administrative capacity, permanent regulatory regimes that tighten or loosen CARs in a countercyclical way is the best alternative. This seems of particular relevance to low-income countries, with more limited administrative capacity.
More generally, there is an important case for low-income countries to maintain or establish CARs, as crises can be so fiscally and developmentally costly, and as such costs are so unacceptable for poor countries, with large numbers of poor people, many of whom can be hurt by crises. CARs on private flows should be complemented by careful limits on foreign private debt incurred by the public sectors in low-income countries, to avoid crises originating in those flows. Deepening domestic capital markets, to provide local currency debt, thus avoiding foreign currency mismatches is key for low-income countries.
Perhaps most importantly, CARs are a complement to sound countercyclical macroeconomic policies, and not a substitute for them. Therefore, they must be part of an integral component of a policy package aimed at guaranteeing macroeconomic stability in a broad sense.