A rising tide of capital controls
Easy money in the United States, a falling dollar and growing flows of funds seeking better returns in emerging markets are touching off a new round of capital controls in hot emerging markets, a trend that could accelerate and will at the very least increase market volatility.
It shouldn’t be a surprise, really; loose money in the developed world is helping to spur investment into emerging markets, driving currencies up and making local exports less competitive for countries which, unlike China, aren’t hitching a free ride as the dollar declines.
Inflation may be a threat for many of these, but with the global economy still struggling, it certainly won’t feel that way to policy makers.
Russia on Wednesday joined the list of countries eyeing new measures to stem currency speculation and appreciation. Moscow was careful to say it would not impose actual capital controls, which seek to regulate flows of funds into or out of an economy, but the measures they are considering would have exactly that effect, making it tougher or more expensive for money borrowed abroad to be brought into Russia.
Kazakhstan, which has been intervening actively to slow the ascent of its tenge currency, has introduced legislation allowing capital controls, but so far has not used them.
Indonesia said this week it will consider curbs on foreign holdings of short-term official debt, sending its rupiah into a brief swoon until central banker Hartadi Sarwono damped things down by saying currency moves based on such flows were so far manageable.
Elsewhere all across developing Asia central banks have been intervening to cap gains in the value of their currencies, with Taiwan going so far as to ban foreign funds from investing in local time deposits.
Brazil last month announced a 2 percent tax on foreign investment in stocks and fixed-income securities to limit the strengthening of the real.
International Monetary Fund chief Dominique Strauss-Kahn gave the fund’s standard line to the Financial Times: “The IMF would not recommend them as a standard prescription … as they carried costs and were usually ineffective”.
FIGHTING OVER SCRAPS
Ineffective over the long run they may be, but tempting they are in the short term. The very fact that India and China have emerged relatively well from the crisis and have resumed growth in strong fashion gives courage to those considering their own measures. And really, the very idea of an orthodox allegiance to free flowing markets ensuring the best outcome for all now looks pretty 1999. Malaysia attracted a firestorm of criticism when it imposed controls in the wake of the Asian crisis in the 1990s. There was much talk of how investors would go away and not come back, how development would be retarded and Malaysia ultimately would rue the day. None of that has come to pass, and those same investors proved quite willing to come back if the returns looked good enough, as indeed they did.
But Malaysia, along with Chile, were outliers when they imposed capital controls. What will it mean if it becomes not a tool of desperation but a standard policy when hot money flows? There must be a risk that capital controls become part of an escalating series of beggar-thy-neighbor steps taken by countries fighting over the scraps of a diminished U.S. and European appetite for imported goods.
If, in other words, these controls are a temporary phase to ease the transition to stronger currencies, the risks might not be that high. I’d worry that developed market interest rates are going to stay low for a very long time. That means that the grand emerging markets carry trade of borrowing in dollar to speculate for appreciation elsewhere will, as it did in Japan, build and build.
At the same time you have to look at why interest rates will stay so low for so long. My bet is that it is because consumption in the developed world will be under structural pressure as debts are repaid. So the money flows into emerging markets and drives up currencies, but unless domestic consumption in China and India really takes off there will not be a very good market for exports. That will make newly strong emerging market currencies all the harder for those countries to tolerate, economically and politically. If China does not do its part and allow its currency to appreciate, the argument will be all the more stark.
It may or may not be a good idea, but one thing I would not count on is coordinated and globally sanctioned capital controls, as espoused by Arvind Subramanian, a senior fellow of the Peterson Institute.
The U.S. simply won’t wear it.
Look then for more unilateral controls and more volatility as speculation of all kinds grows.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)