Developing countries should retain some capital controls

If anything, the recent currency turmoil in ASEAN countries has focused attention on the volatility and instability of international financial markets. This has raised questions as to the wisdom of South countries in moving toward full capital account convertibility and financial liberalisation which are being pushed by the IMF, the US and the European Union.

by Chakravarthi Raghavan

THE latest bout of volatility in international capital and exchange markets, with foreign exchange operators and speculators having won the round against ASEAN central banks and treasuries, has once again underscored the unwisdom of developing countries giving up their defensive weapons and moving to full capital account convertibility and/or premature liberalisation of their financial services sectors.

Efforts to push the ASEAN and other Asian countries, as well as some in Latin America, to commit themselves to full, though phased over a five-year period, liberalisation of financial sectors - through a financial services accord at the World Trade Organisation are under way, with the US and the EU mounting a joint assault.

Simultaneously, there are also the moves from the International Monetary Fund (IMF) to bring about full capital account convertibility in developing countries. The IMF Managing Director advocated this at the 50th anniversary meeting (1994) of the Fund-Bank Governors, and has been pushing it since then, even after the Mexican peso crisis. The IMF has won a mandate at the interim committee meeting this year, to study the issue and propose changes to the IMF Articles of Agreement, particularly Art. VI, Sec. 3 (which enables countries to maintain and exercise capital controls), and Sec.I of the same Article (which precludes IMF members from seeking IMF funds to finance large or sustained capital outflows).

And developing countries are willy-nilly moving towards this - and more and more of their finance ministers are announcing their aim to achieve this over the next few years - India being the latest to join this madness, with its Reserve Bank and Finance Minister talking of achieving this over the next four to five years.

Perhaps the latest experience of ASEAN countries would make everyone rethink and keep some controls over capital movements and monitor such movements.

The currency turmoil and devaluation of the once strong and stable currencies in ASEAN, has again focused attention on the volatility and instability of international financial markets, and their particular adverse effects on developing countries and their development prospects.

Strong words from the Malaysian PM

The crisis and its effects, have given rise to some strong words - with Malaysian Prime Minister Dr Mahathir Mohamad raising his voice against currency speculators (mentioning George Soros and his 'Quantum Fund' for speculative attacks to punish ASEAN countries over their policies towards Myanmar) and calling for international actions to make such speculation and 'sabotage' a criminal offence.

There has also been a strong defence of Soros and his activities by the US Secretary of State, Madeleine Albright, the US Under-Secretary for Economic Affairs, Stuart Eizenstat, and the State Department spokesman, Nicholas Burns. Burns has called Soros 'a man of courage.... whom we admire very much'. Eizenstat said that market movements are not 'dominated' by currency speculators and that 'consistent, sound policies are the most important foundations for financial market stability' and Burns added that currency problems 'can almost always be traced to the policies of the governments involved or to economic forces that happen to be at play'.

Whether Soros is responsible or someone else, there is little doubt that the turmoil in ASEAN currency markets is due to speculative movements of funds and, until recently, the 'tiger economies' of ASEAN were receiving praise for their macro-economic management and trade and economic policies.

The case for the Tobin tax

And while the incursions into economic theory by Burns, Eizenstat and Albright may not stand much scrutiny even at the hands of college-level economic students, they reflect the political stance of the US.

This will discourage dusting up ideas to discourage currency speculations through some international transaction tax (as the Tobin tax) or other measures to punish speculators.

Without outright dismissing these ideas and proposals, UNCTAD suggests that developing countries could individually do more through direct limits and restrictions on capital transactions.

The OECD countries, under their Code of Liberalisation of capital movements, have subjected themselves to self-imposed restraints regarding use of capital restrictions - which was a common feature of their ping countries do not have such constraints, the Trade Development Report 1996 notes, and are subject only to the IMF articles - about the obligation under Art. VIII not to impose restrictions on payments and transfers for current financial transactions without the Fund's approval, and under Art. XIV for transitional arrangements for countries not yet ready to move towards current account convertibility under Art.VIII.

Under the current international legal regime, developing countries have considerable latitude regarding controls over international capital movements, UNCTAD has argued, and thus indirectly supports the view that they should retain such controls at least for the foreseeable future.

UNCTAD economists say they have not found any reason since last year's Report to revise their views. If anything, recent events have suggested the need for caution. And some controls, and mechanisms to monitor movements, would also enable them to discriminate amongst types of transactions so as to levy some tax on hot money transactions (and thus discourage them).

But such a course would require developing country finance ministers to stop blindly endorsing the policy advice relayed to them by the IMF management.

Their finance ministers, at the last interim committee meeting, endorsed the management and G-7 view that the IMF be given the mandate to cover capital accounts and for amending the Articles to make promotion of capital account liberalisation a specific objective of the IMF and give it jurisdiction over capital movements.

At the July high-level segment of the ECOSOC, where the IMF Managing Director relayed to the foreign ministers and foreign office officials who normally staff that meeting, the latest '11 commandments' (in the September 1996 Interim Committee Declaration), and hinted at the 12th under way - the moves towards capital account convertibility. (TWR No. 86, October 1997)

Chakravarthi Raghavan is the Chief Editor of the South-North Development Monitor (SUNS) from which the above article first appeared.