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Comments on Capital Control

Jorge ArbacheBrazilian Development Bank and University of Brasilia

This presentation does not reflect the views of the Brazilian Government or the board of the BNDES

Carnegie Endowment for International Peace, May 4, 2010

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Structure of presentation

1. Some evidence on capital control, capital flow, institutions and output growth

2. Brazil

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1. Some evidence on capital control, capital flow, institutions

and output growth

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Data

• Financial openness data: 0~1 • Source: Schindler 2009• Period: 1995-2005• Number of countries: 61

• Financial flows: % GDP • Source: Reinhardt 2009• Period: 1985-2008• Number of countries: 43

• Growth acceleration and deceleration: dichotomic variables• Method: Arbache and Page 2007• Period: 1980-2008• Number of countries: 162

• Institutions and policy indicators: -2.5~2.5• Source: World Bank Governance Indicators

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Some basic statisticsEmerging economies

  During growth acceleration During growth deceleration

Overall restrictions (0-1) 0.44 0.43

Shares restrictions (0-1) 0.43 0.52

Bonds restrictions (0-1) 0.39 0.51

Money market restr. (0-1) 0.42 0.45

FDI restrictions (0-1) 0.43 0.37

Debt liabilities (% GDP) 49.0 88.9

Non-financial FDI (% GDP) 25.7 13.6

Equity liabilities (% GDP) 5.8 2.2

Financial FDI liabilities (% GDP) 0.03 0.02

0 – unrestricted capital account; 1 – restricted capital account

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Is capital control more likely to be adopted in countries with weak or strong institutions?

Correlation coefficients - capital control and institutions* 1% significance level; ** 5% significance level

Overall rest.; shares; voice and accountability and regulatory quality – larger coef.

Political stability (-2.5 to 2.5) -0.21*Voice and accountability (-2.5 to 2.5) -0.33*Regulatory quality (-2.5 to 2.5) -0.30*Rule of law (-2.5 to 2.5) -0.15*Government effectiveness (-2.5 to 2.5) -0.14*Political stability (-2.5 to 2.5) -0.15*Voice and accountability (-2.5 to 2.5) -0.31*Regulatory quality (-2.5 to 2.5) -0.27*Rule of law (-2.5 to 2.5) -0.10*Government effectiveness (-2.5 to 2.5) -0.11*Political stability (-2.5 to 2.5) -0.14*Voice and accountability (-2.5 to 2.5) -0.25*Regulatory quality (-2.5 to 2.5) -0.18*Rule of law (-2.5 to 2.5) -0.10**Government effectiveness (-2.5 to 2.5) -0.06Political stability (-2.5 to 2.5) -0.11*Voice and accountability (-2.5 to 2.5) -0.16*Regulatory quality (-2.5 to 2.5) -0.17*Rule of law (-2.5 to 2.5) -0.05Government effectiveness (-2.5 to 2.5) -0.04Political stability (-2.5 to 2.5) -0.09**Voice and accountability (-2.5 to 2.5) -0.29*Regulatory quality (-2.5 to 2.5) -0.18*Rule of law (-2.5 to 2.5) 0.00Government effectiveness (-2.5 to 2.5) -0.04

Direct investments restrictions (0-1)

Overall de jure restrictions (0-1)

Shares restrictions (0-1)

Bonds restrictions (0-1)

Money market restrictions (0-1)

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Do weak institutions discourage capital inflow? Correlation coefficients - capital inflow and institutions

* 1% significance level; ** 5% significance level

Debt liabilities – no correlation

Debt liabilities (% GDP)

Political stability (-2.5 to 2.5) -0.00Voice and accountability (-2.5 to 2.5) 0.09Regulatory quality (-2.5 to 2.5) 0.08Rule of law (-2.5 to 2.5) 0.03

Government effectiveness (-2.5 to 2.5) -0.02

Non-financial FDI liabilities (% GDP)

Political stability (-2.5 to 2.5) 0.04Voice and accountability (-2.5 to 2.5) 0.15*Regulatory quality (-2.5 to 2.5) 0.33*Rule of law (-2.5 to 2.5) 0.29*

Government effectiveness (-2.5 to 2.5) 0.30*

Equity liabilities (% GDP)

Political stability (-2.5 to 2.5) -0.05Voice and accountability (-2.5 to 2.5) 0.07Regulatory quality (-2.5 to 2.5) 0.22*Rule of law (-2.5 to 2.5) 0.28*

Government effectiveness (-2.5 to 2.5) 0.36*

Financial FDI (% GDP)

Political stability (-2.5 to 2.5) 0.22*Voice and accountability (-2.5 to 2.5) 0.40*Regulatory quality (-2.5 to 2.5) 0.50*Rule of law (-2.5 to 2.5) 0.34*

Government effectiveness (-2.5 to 2.5) 0.45*

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Does capital control affect output growth? Logistic regression RE (z statistics in parentheses)

Dependent variable: Growth

deceleration

Model 1 Overall de jure restrictions (0-1) 0.69 (0.68)

Model 2 Shares restrictions (0-1) 1.63 (1.69)

Model 3 Bonds restrictions (0-1) 1.05 (1.09)

Model 4 Money markets restrictions (0-1) 1.14 (1.37)

Model 5 Direct investments restrictions (0-1) 0.19 (0.25)

Dependent variable: Growth

acceleration

Model 6 Overall de jure restrictions (0-1) 0.19 (0.45)

Model 7 Shares restrictions (0-1) -0.12 (-0.29)

Model 8 Bonds restrictions (0-1) 0.04 (0.10)

Model 9 Money markets restrictions (0-1) 0.12 (0.32)

Model 10 Direct investments restrictions (0-1) -0.04 (-0.11)

No evidence that capital control prevents growth collapse – no long term impacts

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Does capital inflow affect output growth? Logistic regression RE (z statistics in parentheses)

Dependent variable: Growth

deceleration

Model 1 Debt liabilities % GDP 0.01 (3.25)

Model 2 Non-financial FDI % GDP -0.08 (-6.40)

Model 3 Equity liabilities % GDP -0.30 (-3.45)

Model 4 Financial FDI liabilities % GDP -24.05 (-0.99)

Dependent variable: Growth

acceleration

Model 5 Debt liabilities % GDP -0.01 (-5.40)

Model 6 Non-financial FDI % GDP 0.03 (5.85)

Model 7 Equity liabilities % GDP 0.05 (3.32)

Model 8 Financial FDI liabilities % GDP -1.31 (-0.28)

Non-financial FDI and equities are associated with less growth collapses and more growth acceleration; debt liabilities: the opposite

• Capital controls: more likely in countries with weak institutions• FDI and equity capital: flow to where institutions are strong; no

relationship between institutions and debt– Debt liability probably driven by other factors

• Capital control does not prevent growth collapses– It may be effective under certain conditions– Long term impacts unlikely

• FDI and equity capital reduce growth collapses and increase growth acceleration

• Debt liability increases growth collapses and decreases growth acceleration

Capital control on short term capital: policy option

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2. Brazil

• Brazil:

– Liberalized the capital account– Adopted floating exchange rate– Adopted inflation target– Prudential financial regulations in place– Investment grade status 2008/09– Attracted a lot of foreign resources– Reserves have increased substantially

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Capital inflow has increased sharply in recent years

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Brazil has liberalized the capital account Source: Schindler 2009

0 – unrestricted capital account; 1 – restricted capital account

0

0,2

0,4

0,6

0,8

1

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

Brazil

China

Indonesia

India

Mexico

Russia

Turkey

South Africa

Recent measures on capital control

• March 2008: taxes on capital account transactions, 1.5%; several exemptions

• May 2008: coverage extended to prevent circumvention• October 2008: taxes lifted

• October 2009: 2% tax on fixed-income and equity inflows• November 2009: 1.5% tax on certain trades to prevent

circumvention

No evidence that these measures have been effective to discourage capital inflow (IMF 2010)

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Brazil: composition of financial flows Source: Central Bank

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Otherinvestments

Derivatives

Portfolio

FDI

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

2003

2004

2005

2006

2007

2008

2009

Otherinvestments

Derivatives

Portfolio

FDI

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Bonds

Equities

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

2003

2004

2005

2006

2007

2008

2009

Bonds

Equities

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External sector indicators have improved significantly… Source: Central Bank

Reserves (US$1,000)

0

50.000

100.000

150.000

200.000

250.000

300.000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Reserves (US$1,000)

0

50.000

100.000

150.000

200.000

250.000

300.000

2003

2004

2005

2006

2007

2008

2009

0

20

40

60

80

100

120

140

2003

2004

2005

2006

2007

2008

2009

Debtservice/exports(%)

Debtservice/GDP(%)0

20

40

60

80

100

120

140

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Debtservice/exports(%)

Debtservice/GDP(%)

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Public debt dollar denominated (%)

010

2030

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Net external debt of public sector - % GDP

-15

-10

-5

0

5

10

15

20

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

…but there are increasing challenges

Source: Central Bank

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Is capital control needed in Brazil?

• Exchange rate appreciation• Widening current account deficits• Export competitiveness impacts• Asset prices: Bovespa index increased more than 300% since

2005; real state at record price levels• Prices anchored on cheap imports• Inflation pressures• Effectiveness of monetary policy questionable

A more vigorous capital control is needed as a short term policy option

But more structural policies still required -- e.g. fiscal 20

Thank You

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GDP per capita growth and capital controlBrazil, China, Indonesia, India, Mexico, Russia, Turkey, South Africa

yhat = .217 + 4.555*restrictions_aggregate r = .279

gdpp

cgr

restrictions_aggregate.125 1

-14.2962

10.0045

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Brazil: GDP per capita growth and capital control

yhat = 2.975 + -2.995*restrictions_aggregate r = .371

gdpp

cgr

restrictions_aggregate.25 .833333

-1.44761

4.37872

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yhat = -8.459 + 23.737*restrictions_aggregate r = .264

gdpp

cgr

restrictions_aggregate.35 .5

-14.2962

6.87401

yhat = -10.979 + 17.665*restrictions_aggregate r = .619

gdpp

cgr

restrictions_aggregate.833333 1

2.16702

7.86755

yhat = -16.298 + 21.348*restrictions_aggregate r = .223

gdpp

cgr

restrictions_aggregate.833333 1

-5.03891

10.0045

yhat = .638 + .04*gdppcgr r = .8070000000000001

rest

rictio

ns_

aggr

egat

e 1

gdppcgr 9.701586.58729 9.7596

.875

1.02708

ChinaRussia

Indonesia India

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GDP per capita growth and capital controlNumber of countries = 61

yhat = 2.328 + .748*restrictions_aggregate r = .071

gdpp

cgr

restrictions_aggregate0 1

-14.2962

17.1139