Capital control in policy making – to restrict or not?

Capital controls – the once popular method of dealing with BoP (Balance of Payments) surplus /deficits is perhaps about to make a comeback.  By definition, capital controls refer to any intervention that inhibit or act a barrier to free inflow/outflow of capital from a country. 

Historically, capital controls became the popular tool after World War II when war stricken economies resorted to inflation and fixed exchange rate regimes to ease the burden of debt repayment. Implementation of capital controls can take place in different forms.

It can be an outright tax on interest income on investments abroad as was the case for Interest Equalization Tax in the US (1963 -1974) or requiring investors to deposit some fraction of total investment which does not accrue interest with the Central Bank in question. Many countries Malaysia (between 1998 and 1999) resorted to direct monitoring of current account and capital account transactions to regulate the volume of forex inflows and outflows.

While experts are divided on the effectiveness of capital controls it can be an effective way to buying time to devise macro-Prudential strategies to prevent excessive capital outflows or inflows. However, it has been acknowledged that capital controls can have adverse effects and increase distortions in an economy that does not have strong policy or structural foundations.

In 2013 when Cyprus filed for bankruptcy, the nation had to adopt not only the tough austerity measures that have accompanied bail out packages but also having private investors to absorb losses. Capital controls played an important role in regulating outflows for the Cypriot economy where tourism was one of the largest sources of government revenue.

Fast forward to 2015, the Greek economy has been in a state of perpetual turmoil since the election of the radical left wing Syriza to power. Given that the island is a member of a monetary union traditional policies cannot be used to ease domestic concerns, in other words policy induced inflation cannot be the way out.  As the economy put in restraints on any outflow of capital outside the country and more formal method of capital control maybe required to iron out policy shortfalls.

So what are your thoughts on capital controls and its effectiveness?

The content for the blog has been sourced using:

How Greece's referendum works, How capital controls work, An Introduction to Capital Controls