a = capital controls imposed; b and c = capital control strengthened.
Source: IMF, (2004a).
Figure 12.B, however, highlights a major problem in studying the effects of controls on debt profiles. The crucial question is: what is the counterfactual? Is it a matter of controls being effective because they reduced the share of short-term debt vis-à-vis its own historical trend, or were they effective because they helped the countries that adopted capital account regulation (Chile, in this case) to avoid the trend of rising shares of short-term debt experienced by other developing countries that did not impose controls?
As it happened, vis-à-vis its own trend, until 1995 capital controls seem to have had little lasting effect in Chile, but a significant effect after the strengthening of controls in that year.25 However, if the comparison is made vis-à-vis the trend followed by countries that did not impose similar controls, such as Thailand and Brazil, then controls in Chile seem to have had quite a remarkable effect from the very beginning. In fact, in Chile the share of short-term debt was at a similar level to Thailand’s before the imposition of controls (about one quarter of the total), but by 1995 Thailand had a share twice as large as Chile’s. Furthermore, at the beginning of the Plano Real and full financial liberalization in Brazil in 1994, Chile actually had a share of short-term debt five percentage points higher than that of Brazil; however, by 1998 Brazil’s share was nearly four times higher than Chile’s.
In the case of Malaysia following its 1994 controls, a new wave of debt accumulation developed in that country, but the debt profile was kept at more prudential levels than in other Asian countries that were hit by the 1997 crisis (Kaplan and Rodrik, 2002; Palma, 2000a).
F. Effects on asset price dynamics
Finally, Figures 13 and 14 show that, in the three countries, capital account regulations had sufficient capacity to slow down and, in some cases, to pierce asset bubbles.
FIGURE 13
a = first democratic government after Pinochet; b = second democratic government; c = Mexican crisis; d = East Asian crisis; and e = Russian default.
a and b = progressive opening of the capital account; c = Mexican crisis; d = East Asian crisis; and e = Russian default.
a = East Asian crisis.
Source: DataStream.
As is clear from Figure 13.A, Chile was experiencing an asset bubble in its stock market in early 1991: in the four quarters preceding the first imposition of controls, the index had jumped more than three-fold; the 1991 and 1992 regulations stopped this trend for about seven quarters. However, as with the levels of net private inflows and the broader macroeconomic effects studied above, this effect soon ran its course and together with the huge new increase in inflows in 1994 the index jumped again, this time more than two-fold. This time the strengthening of controls in 1995 had an immediate impact on this new bubble, bringing the index down considerably; and when it began to recover again in early 1997, with the new increases in inflows, its progress was halted by the mid-1997 East Asian crisis.
Something similar, but even more pronounced, took place in real estate after 1995 (see Figure 14).
FIGURE 14
Quarterly Real State Index
a = first democratic government after Pinochet; b = second democratic government; c = Mexican crisis; d = East Asian crisis; and e = Russian default.
a = East Asian crisis.
Source: DataStream.
In this market, Chile was facing another bubble when capital controls were imposed in 1991. In this case, the (short-term) reduction in net private inflows that came with inflow-controls did not have such an immediate effect as on the stock market. However, the strengthening of regulations in May 1992 coincided with the interruption of the real estate boom, which by then had already increased close to five-fold in just six quarters. Nevertheless, as in the stock market, the respite was only temporary, and this index doubled again between the end of 1993 and the strengthening of capital controls in the third quarter of 1995 (following the renewed increase in inflows). The subsequent fall is remarkable (more so than in the stock market), even though the economy continued to grow rapidly until 1998.26
In Colombia, booming capital inflows since 1992, partly fuelled by growing capital account liberalization, led to a seven-fold increase in stock prices. This process was sharply reversed by the August 1994 controls and the accompanying monetary policy. A similar reversal took place after the controls adopted in early 1997, but here the preceding boom had not reached its peak. Although no similar indices exist for real estate prices, partial evidence in this regard (the evolution of housing rents) indicates that a similar reversal took place, coinciding with the 1994 regulations.
Figure 13 also shows the remarkable jump in stock prices at the time of the surge in inflows in Malaysia in 1993. Before the imposition of controls, this index jumped more than two-fold in just four quarters. During the three quarters that these controls lasted in full, this index fell by 30%; it then began to recover somewhat erratically, almost reaching its previous peak again in the last quarter of 1996.27
A rapid bubble in real estate prices in Malaysia also took off in the four quarters before the imposition of controls in 1994. As in Chile, the piercing of this bubble was not as immediate as the one in the stock exchange. However, in contrast to Chile, the return of inflows in 1995 pushed this index back up with a vengeance. One major difference between the two countries was the level of interest rates. As Table 1 indicates, interest rates remained relatively high in Chile two years after the July 1995 controls. The return of inflows, low deposit rates and little life in the stock exchange (by pre-crisis standards), together with low mortgage rates, set in motion another real estate bubble: in just four quarters the index jumped again more than two-fold.
IV. CONCLUSIONS
Overall, the experiences of Chilean, Colombian and Malaysian regulations on capital inflows indicate that they served as useful instruments for improving debt profiles and the macroeconomic trade-offs faced by the authorities, and for restraining asset bubbles. However, the macroeconomic effects, including those on asset prices, depended on the strength of the regulation and tended to be temporary -- operating more as ‘speed bumps’ than as permanent speed restrictions. The basic advantage of the price-based instrument used by Chile and Colombia is its non-discretionary character, whereas quantity-based controls in Malaysia proved to be stronger in terms of short-term macroeconomic effects. Thus, when immediate and drastic action is needed, quantitative controls are more effective.
The dynamics of capital flows must be taken into account when analysing the overall and relative virtues of the different types of regulations. Interestingly, given the links between the dynamics of capital flows and current account deficits in Latin America vis-à-vis East Asia discussed in part II of the paper, the policy prescription should perhaps have been the opposite of what actually happened: quantitative controls for Latin America (where ‘exogenous’ inflow-surges dominate) and price controls for East Asia (a region in which inflow-surges have tended to be mostly ‘endogenous’).
In any case, it must be emphasized that these systems were designed for countries that had initially chosen to be fully integrated into international capital markets, but later decided to ‘fine-tune’ this integration -- at least temporarily. Traditional exchange controls and capital-account regulations -- when applied effectively and transparently -- may thus be superior if the policy objective is significantly to reduce domestic macroeconomic sensitivity to volatile and unregulated international capital flows, as the experiences of China, India and Taiwan indicate.
APPENDIX: Results of the ‘Granger-predictability’ test between net private capital inflows and current account.
In all Latin American countries the test spans the period from 1950 to 2002, and the source of the data is ECLAC’s Statistical Division. Due to lack of data, for the East Asian countries it was only possible to study the period 1975-2002; the source of these data was IMF (2004a). Following the ‘Perron-sequential procedure’, unit root tests indicate that all series of net private capital inflows and current account in both regions have a unit root; furthermore, with the (significant) exceptions of Chile and Malaysia, all series cointegrate. Therefore, the Granger-test for Argentina, Brazil, Colombia, Mexico, Korea and Thailand was done in levels, while for Chile and Malaysia it was done in first differences. The specification of the regressions (i.e., the number of lags) within which the null hypothesis (of no ‘predictability’) was tested both ways was determined by the rule of choosing the minimum number of lags that would produce a residual that was not serially-correlated.
|
‘p’ of T1
|
‘p’ of T2
|
Lags T1
|
lags T2
|
‘p’ of Q T1
|
‘p’ of Q T2
|
Argentina
|
1.9E-08
|
0.50630
|
2
|
2
|
0.138
|
0.361
|
Brazil
|
0.00610
|
0.32485
|
2
|
2
|
0.375
|
0.784
|
Colombia
|
3.1E-07
|
0.16296
|
2
|
2
|
0.505
|
0.862
|
Mexico
|
0.07166
|
0.15202
|
2
|
2
|
0.503
|
0.871
|
|
|
|
|
|
|
|
Korea
|
0.32344
|
0.06342
|
2
|
2
|
0.291
|
0.640
|
Thailand
|
0.12219
|
0.01066
|
2
|
2
|
0.307
|
0.099
|
|
‘p’ of T1
|
‘p’ of T2
|
Lags T1
|
lags T2
|
‘p’ of Q T1
|
‘p’ of Q T2
|
Chile
|
0.08340
|
3.6E-05
|
2
|
2
|
0.844
|
0.995
|
Malaysia
|
0.73646
|
0.10611
|
1
|
1
|
0.978
|
0.869
|
T1 = test of the null hypothesis that net private capital inflows do not ‘Granger-predict’ the current account. T2 = test of the null hypothesis that the current account does not ‘Granger-predict’ net private capital inflows. ‘p’ of Q = is the level of significance at which the null hypothesis of no autocorrelation up to order 3 is rejected using the ‘Ljung-Box Q-statistics’.
The results of the Granger tests (in levels) indicate that in Argentina, Brazil, Colombia and Mexico net private capital inflows are a good predictor of the current account, while in Korea and Thailand there is evidence of predictability the other way around. In Chile (tested in first differences), there seems to be a two-way predictability phenomenon; in Malaysia, meanwhile, (also in first differences and up to a 10% level of significance) the null hypothesis of no predictability cannot be rejected either way; however, if the level of significance is increased to 10.7%, the test indicates that Malaysia seems to follow the same pattern as Korea and Thailand.
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