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Capital Controls: IMF

Nick Rosen

The issue of financial market liberalization has been a difficult and controversial one for the International Monetary Fund. Throughout much of the 1990s the Fund aggressively pushed nations to open their countries to the flow of international financial capital, which has expanded and become increasingly mobile, or “footloose” as a result of contemporary technological innovations. By removing barriers to foreign investment, the IMF argued, perennially capital-short developing countries could harness a powerful engine for growth, diversify risk and increase welfare while creating new investment opportunities for international investors. These convictions were so strong that in 1997 the Fund’s Executive Board launched a campaign to have the IMF charter amended to include the promotion of capital market liberalization as part of the Fund’s mandate.

In the meantime, numerous countries, including Russia and the Asian “new industrializers”, followed the IMF’s prescription for capital markets reform. Some of those countries were, with hindsight simply not ready for open capital accounts. They relied heavily on short term borrowing to finance inefficient and uneconomical investments. In July of 1997, the “chickens came home to roost.” Thailand, one of those countries running huge current account deficits and financing them with very short term external borrowing, had to abandon its fixed exchange rate regime. The baht—the Thai currency—collapsed and financial contagion spread from Thailand to South Korea, Indonesia and eventually Russia and Brazil. The bonanza of capital inflows these countries had enjoyed was quickly reversed as a stampede of panicked investors fled the region with their money. A decade of solid growth and rising incomes screeched to an abrupt halt, as bank failures, unemployment and poverty gripped the region.

In the wake of the crisis, many observers blamed the capital account policies championed by the IMF and the U.S. Treasury for opening financial markets too fast and rendering them vulnerable to unpredictable shifts in short-term capital flows. In a March, 1998 speech IMF Managing Director Michel Camdessus insisted that the blame did not rest on capital market liberalization, but nevertheless conceded that “markets are not always right,” implying that Asia’s capital account liberalization was not carried out properly and may have contributed to the crisis. “These risks are not grounds for turning away from capital account liberalization, but they are reason to proceed carefully,” Camdessus asserted.

Following the Asia crisis, the IMF has adopted a more cautious tone. Experts at the Fund have stressed the need for an “orderly” liberalization process, wherein such measures are accompanied by sound macroeconomic policy, a strong financial system, and prudent risk management by market participants themselves. These qualifications aside, the IMF remains a firm advocate of liberalizing capital accounts around the world. A December 1998 paper by IMF Research Director Michael Mussa refers to such reforms as “inevitable” for any country with ambitions for growth in the global economy. In a 1998 article in The Economist, then-IMF Deputy Director Stanley Fischer asserted that controls on capital outflows are counterproductive “as they encourage domestic evasion and capital flight and discourage foreign investors.” An April, 2000 IMF report on capital flight in Russia noted that while capital controls may have succeeded in limiting some post-crisis capital flight, such controls “result in costly distortions and should be gradually phased out” in the medium-term. Still, after the tumult in global capital markets over the last five years, plans to add capital account reform to the IMF’s charter mandate appear dead in the water. And in many cases, the IMF has actually conceded that controls on capital mobility -- particularly of the variety which curb inward flows, like that once used by Chile -- may be advisable. In a January, 2001 speech delivered in Tokyo, IMF Managing Director Horst Koehler said that “the use of capital controls, and the speed of capital account liberalization should all be considered and tailored according to a developing country's specific needs.”

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