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 liberalization of financial services sectors, which are being pushed by the IMF, and the US and EU at the WTO.

by Chakravarthi Raghavan

GENEVA: 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 5-year period, liberalisation of financial sectors - through a financial services accord at the World Trade Organization 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 4-5 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 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, has 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.

The Hungarian-born US financier, with his investment hedge funds, who had earlier issued public statements in the US decrying ASEAN in going ahead to admit Myanmar into its ranks, since Mahathir's attack, has made a statement in New York to the effect that he had wanted Malaysia and Thailand to oppose Myanmar's entry into the ASEAN, and that he continued to think the acceptance of that regime into ASEAN is a threat to the region's prosperity and stability, but "I do not believe that the cause of freedom in Myanmar would be advanced by linking it to currency speculation." And on 22 July, he has been quoted as saying that his funds "have not made any sales of Malaysian ringgit or Thai baht over the past two months, with the exception of one trade on 16 June, when we sold $10 million of Thai Baht."

On the face of it, these statements repudiate the charges of Dr Mahathir, but they are also equivocal - and could mean that the speculation against them are not related to his views on Myanmar. There has also been a strong defense 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 some one 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.

The case for the Tobin tax has been renewed in the UNCTAD Review 1996, by David Felix, emeritus professor of economics of Washington University, St. Louis, who has shown that financial globalization has done little to reallocate real resources around the globe, and has harmed the global economy - attenuating the linkage of foreign exchange transactions with growth in value of world trade, but without pulling up the volume of that trade and rather, resulting in the reverse þ and giving rise in countries for business pressures for administrative protection from foreign competition.

Felix dismisses as "the most fanciful", the IMF proposals (to deal with the problem) by requiring all member countries to lift all controls on international capital movements, and the lessons the IMF drew from the Mexican crisis of need for better surveillance. The IMF proposals not only ignore the inter-war experience with "hot money" that shaped the Bretton Woods agreement, but the post-Bretton Woods evidence showing that financial markets have built-in destabilizing properties.

He suggests that a small Tobin tax could easily be instituted by agreement of the seven major centres (UK, US, Japan, Singapore, Switzerland, Hong Kong and Germany). With 80% of all forex transactions conducted from these centres, an agreement among the seven to levy and supervise the collection of the tax would suffice to keep the offshore relocation threat a relatively distant one. Booking deals offshore, which could be done at little cost, could also be readily controlled by home authorities since the various island havens are mere booking addresses that function because mainland authorities have tolerated such evasive tactics by their banks and transnational corporations (TNCs). Felix shows that a small 0.25% tax on all spot and forward transactions would not distort the market signals, and would discourage speculation, particularly short-term parking of funds.

A cross-border payments tax

A variant of the Tobin tax proposals is advocated by Rudi Dornbusch, Prof of Economics and International Management at MIT, Massachusetts (in Vol VIII of the International Monetary and Financial Issues, the G-24 research paper series, published by UNCTAD) who suggests that even without an international agreement as the Tobin tax needs, a cross-border payments tax that each country could institute would domesticate capital flows, and "change the temperature of capital flows", without necessarily affecting capital investments. The cross-border payments tax (a foreign exchange tax), according to Dornbusch, would manage the pace of cross- border flows (rather than aim at volatility of stock and bond prices) and would fall completely within the jurisdiction of the country levying it. Every purchase or sale of foreign exchange and every cross-border payment, under the proposal, would be taxed at a rate of 0.25% - whether it be a goods transaction, a services deal or a financial operation. Even if a TNC borrows abroad, to avoid the cost of the tax, it would not matter: when the borrowing is repatriated from abroad it would be taxed. And if administered in a comprehensive way, by registration of capital transactions, where they do not cross the foreign exchange market and by stiff penalties, the system will be most effective.

But the UNCTAD Trade and Development Report 1996 discusses some of the practical problems that a Tobin tax would face, including if a major financial centre already used by many traders, such as London, did not join the scheme. The Dornbusch tax would bear disproportionately on current, rather than capital transactions.

Without outrightly 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 Liberalization of capital movements have subjected themselves to self-imposed restraints regarding use of capital restrictions - which was a common feature of their policy frameworks till recent years.

South should retain control over capital movements

But the developing 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 advise 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 liberalization 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), hinted at the 12th under way - the moves towards capital account convertibility.(TWE No. 167, 16-31 August 1997)

The above article was originally published in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.