Argentine crisis raises need for capital controls, says UN expert

The Argentine crisis underscores the crucial need for capital controls as no currency regime can provide stability under conditions of freely flowing capital, says a leading UNCTAD economist.

THE Argentine crisis is but the latest in a string of financial meltdowns over the years that have vividly brought home the perils of free capital regimes and the consequent need for controls on the volatile financial flows traversing the international capital markets, the chief economist of the United Nations Conference on Trade and Development (UNCTAD) has asserted.

Drawing lessons from Argentina’s failed experiment with a fixed exchange rate system that pegged its peso to the US dollar, Dr Yilmaz Akyuz, Acting Director of UNCTAD’s Division on Globalisation and Development Strategies, stressed that no currency regime can provide stability under conditions of freely flowing capital.

‘If your capital account is open, your residents have access to foreign currency markets and foreigners have access to your domestic currency markets and if transactions among residents can be conducted in foreign currency (what we call dollarisation), there is no exchange rate regime that can give you stability,’ he emphasised.

Akyuz’s views were expressed in an interview published in the South Bulletin (No. 27, 15 January 2002), a publication of the South Centre based in Geneva.

‘You are vulnerable whether you have fixed [or] floating [exchange rates] or soft [pegs].’

Akyuz pointed out that the advice emanating from the international financial establishment with regard to exchange rate policy was ‘inconsistent, confusing and confused’. It had prescribed different currency systems for different economies while never budging from its insistence on capital account openness, with the result that financial stability proved elusive.

The episodes of violent instability that have plagued economies adopting different currency regimes can be attributed to the fact that if the capital account remains open, developing countries will be subjected to higher capital volatility regardless of the exchange rate system in place. But the dangers posed by wildly erratic financial flows have been unaddressed, given the establishment’s preoccupation with ensuring the free movement of capital.

‘We saw in 1991, 1992 and 1993 [that] capital inflows into Argentina were not sustainable. Similarly, in Turkey such inflows were not sustainable. But everyone was so happy - the governments, the [International Monetary] Fund, the [World] Bank, the international community and the rating agencies were all jubilant about the countries attracting a lot of capital. But we knew that much of that was speculative short-term capital. Has the Fund ever in its advice to the developing countries suggested imposing a tax on this highly mobile short-term capital? I do not think so. In other words, the capital account is untouchable. The objective is open capital account and full integration,’ Akyuz explained.

It is precisely this fervour for an open-door policy for capital flows that requires a rethink, Akyuz said, underlining the need for a kind of capital regime that will promote a stable exchange rate. He pointed in this regard to Chile, China and India as examples of some countries that have successfully employed capital account policies to stabilise exchange rates. ‘Now why is the Chinese soft peg working, and that of Malaysia but not Turkey? Because of the differences in the capital account regime and the extent of dollarisation.’

Dangerous path

The UNCTAD economist traced the beginnings of Argentina’s troubles to the period after the 1994-95 Mexican crisis and the subsequent emerging-markets crisis, when its peso remained pegged even as other (Mexican, Turkish and Asian) currencies were collapsing against the dollar. In 1995, UNCTAD had in fact commented that the country was on a dangerous path, only to meet with a strong protest by the Argentine government. ‘It was the first instance in my recollection of a developing country protesting against UNCTAD for writing something about it,’ Akyuz said.

Sure enough, expectations arose, as one crisis after another erupted in the emerging markets, that Argentina would not be able to maintain its peg in the face of falling exchange rates elsewhere, and the Latin American economy faced increasing spreads on its borrowings. It was then that the benefits of its fixed exchange rate disappeared, explained Akyuz, for ‘the principal benefit of the hard peg is that you are expected to pay the same interest rates as the United States on your liabilities.’

Thus it was that Argentina became no different from a country in crisis attempting to defend its currency and stem capital outflows by hiking up interest rates. It was, however, able to keep its peg owing to IMF support. Its success in maintaining the peg blinded observers to the real economic cost that the country was incurring in the shape of high unemployment. Commented Akyuz: ‘It is the Wall Street perspective that dominates [assessments of] a country’s economic performance. So, if your stocks are going up, if your currency is stable and a lot of capital is coming in, it does not matter what happens to jobs, income and wages - you are successful. As Argentina was successful in maintaining the peg, even though it started costing them a lot in terms of jobs right after the Mexican crisis, people thought this was the way to go.’

Good governance

Akyuz accordingly sees the Argentine crisis as having started three to four years ago, when the country got into a recession and unemployment soared in order to preserve the exchange rate (‘For a worker who has lost his job, that is a crisis.’). As the crisis has evolved, ‘the underlying factor of the regime has collapsed because it is no longer politically acceptable, as it was around 1995, to have that kind of unemployment, recession and contraction - simply to defend a currency regime’

It does, then, boil down to the question of good governance, Akyuz maintained, ‘but my understanding of good governance is not the same as that coming out of Washington. It does not mean minimised government but a responsible one - in social and economic activities - responsible for jobs, employment and income distribution and poverty.’

‘A good government is not one that [keeps its] hands off economic activities  by  leaving it  to  the  market. That is  not my understanding.’