Shock! Emerging capital controls may just be working
Do capital controls work? After years of telling us that they do not, the IMF and World Bank reluctantly conceded last year they may not be all that bad and indeed in some cases they may actually help keep away some of the speculators who have in recent years been pouring into emerging markets.
Developing countries for the most part like foreign capital, indeed they rely on it for development. What they don’t like is hot money — short-term speculative flows which are widely blamed for causing past emerging market crises. So starting from October last year several of them slapped controls on some of this cash. There are signs these may be working.
Take the experience of two large emerging markets, Brazil and Indonesia. Brazil shocked foreign investors last October with a 2 percent tax on all flows to stocks and bonds. Nine months on, investors are still putting their cash there and Brazil has raked in millions of dollars thanks to the tax. But many fund managers, like HSBC’s Jose Cuervo, who runs a $6 billion portfolio of Brazilian stocks, are buying American Depositary Receipts (ADRS) of Brazilian firms rather than stocks listed in Sao Paulo. Because ADRs are in dollars and listed in New York, investors are getting exposure to Brazil but sidestepping the tax. Brazilian firms continue to receive investment but Brazil’s currency is not appreciating like it was last year. A win-win all around.
Indonesia’s measures, introduced in June, are relatively mild in comparison — as part of its aim to push speculators out of short bonds and into less volatile longer-dated debt, it now requires foreigners to hold these bonds for a minimum 28 days. That is bad news for hot-money investors who like to move in and out of a market quickly. The result — by mid-July there had been a 37 percent surge in foreign ownership of longer debt and yields on the short bonds rose as foreigners pulled out. So most foreign fund managers haven’t been scared off at all — foreign holdings of Indonesian bonds recently hit record highs.
Indeed emerging markets have been lacklustre this year. Not really due to the capital controls but because people are worried about state of the U.S. and euro zone economies and prefer to keep their cash closer to home. But the Institute for International Finance says the fear of more capital controls is one reason investment flows to emerging economies are likely to be lower this year than originally forecast.
Fund managers acknowlege there is a psychological impact to capital controls. The success of Brazil’s step has bred fear that it may increase the size of the levy especially if its real currency starts rising again, says Brett Diment who oversees $5 billion in emerging bonds at Aberdeen Asset Management. “So from that point of view (the tax) has been a successful
measure in that it is limiting currency appreciation,” he says.
What do the multi-lateral lenders say? A paper by IMF economists a few months back acknowleged “an effect on the
composition of inflows rather than the aggregate volume” resulting from such curbs — just the result the emerging
economies are looking for.