Will G20 Take Collective Stand On Capital Controls?
By Kavaljit Singh
10 November, 2010
Countercurrents.org
Leaders of the G20 will meet in Seoul on Nov. 11 and 12 to discuss a
myriad of issues concerning global financial stability and economic
recovery. In many ways, the G20 Seoul Summit is significant because
for the first time it is hosted by a non-G8 nation and one in Asia
too.
The two-day Seoul summit covers an expansive agenda, ranging from
global safety nets to new rules on bank capital and liquidity
requirements to reforming the International Monetary Fund (IMF).
It remains to be seen how much of this agenda could be accomplished
given the sharp differences among G20 member countries on key issues.
The summit is likely to be overshadowed by the ongoing “currency war.”
Despite an initial understanding reached at G20 finance ministers'
meeting at Gyeongju, disagreements on currencies have widened among
members with the announcement of a $600 billion injection plan by the
U.S. Federal Reserve on Nov. 3.
It appears that the U.S. has either underestimated or ignored the
potential impact of $600 billion plan of buying government long-term
bonds on the exchange rates globally.
Several G20 nations including China, Brazil and South Korea have
expressed serious concerns that this move may flood their financial
markets with new money leading to asset price bubbles and higher
inflation.
With interest rates near-zero in several developed economies such as
U.S. and Japan, investors have started pumping money into emerging
markets in search of higher yields.
The potential costs associated with putting new liquidity into the
global economy should not be underestimated and therefore emerging
markets should adopt a cautious approach toward such capital inflows.
In the absence of any international agreement or coordination,
emerging markets will have to resort to capital controls to regulate
potentially destabilizing capital inflows which could pose a threat to
their economies and financial systems.
Post-crisis, there is a renewed interest in capital controls as a
policy response to curb “hot money” inflows. It is increasingly being
accepted in policy circles that due to the limited effectiveness of
other measures (such as higher international reserves) capital
controls could insulate the domestic economy from volatile capital
flows.
In June, South Korea announced a series of currency controls to limit
the risks arising out of sharp reversals in capital flows. Indonesia
quickly followed suit when its central bank deployed measures to
control short-term capital inflows.
In October, Brazil raised the tax on foreign purchases of fixed income
securities to 6 percent. Thailand imposed a 15 percent withholding tax
on foreign purchases of Thai bonds in the same month.
South Korea is also contemplating the reintroduction of tax on foreign
purchases of Korean bonds. In the coming months, more and more
countries may opt for capital controls to protect their economies from
volatile flows.
Contrary to popular perception, capital controls have been extensively
used by both the developed and developing countries in the past.
Capital controls were regarded as a solution to the global chaos in
the 1930s. They were extensively used in the inter-war years and
immediately after World War II.
Although most mainstream economic theories suggest that capital
controls are distortionary, rent-seeking and ineffective, several
successful economies (from South Korea to Brazil) have used them in
the past.
China and India, two recent “success stories” of economic
globalization, still use capital controls today. A restricted capital
account has protected both economies from financial crises.
An overarching objective of capital controls is to bring both domestic
and global finance under regulation and some degree of social control.
Even the IMF these days endorses the use of capital controls, albeit
temporarily, and subject to exceptional circumstances.
In the present uncertain times, imposition of capital controls becomes
imperative since the regulatory mechanisms to deal with capital flows
are national whereas the capital flows operate on a global scale.
Yet, capital controls alone cannot fix all the ills plaguing the
present-day global financial system. Rather they should be used in
conjunction with other regulatory measures to maintain financial and
macroeconomic stability.
Surprisingly, the issue of capital controls has never been under
discussion at G20 despite many member countries (from South Korea to
India to Brazil) currently using a variety of such controls.
Given its long history of successfully using capital controls in
conjunction with other policy measures, South Korea should take a lead
in putting this substantive issue on the agenda of G20. Other member
nations such as China, India and Brazil could support this policy
initiative.
Kavaljit Singh is the author of “Fixing Global Finance.” This book is
available for free download at www.madhyam.org.in .
This article was originally published in The Korea Times (Seoul) on November 10, 2010.
