1. 1 Comments on Capital Control Jorge Arbache Brazilian Development Bank and University of Brasilia This presentation does not reflect the views of the Brazilian Government or the board of the BNDES Carnegie Endowment for International Peace, May 4, 2010

2. 2 Structure of presentation 1.Some evidence on capital control, capital flow, institutions and output growth 2.Brazil

3. 3 1. Some evidence on capital control, capital flow, institutions and output growth

4. 4 Data Financial openness data: 0~1 Source: Schindler 2009 Period: 1995-2005 Number of countries: 61 Financial flows: % GDP Source: Reinhardt 2009 Period: 1985-2008 Number of countries: 43 Growth acceleration and deceleration: dichotomic variables Method: Arbache and Page 2007 Period: 1980-2008 Number of countries: 162 Institutions and policy indicators: -2.5~2.5 Source: World Bank Governance Indicators

5. 5 Some basic statistics Emerging economies During growth accelerationDuring growth deceleration Overall restrictions (0-1)0.440.43 Shares restrictions (0-1)0.430.52 Bonds restrictions (0-1)0.390.51 Money market restr. (0-1)0.420.45 FDI restrictions (0-1)0.430.37 Debt liabilities (% GDP)49.088.9 Non-financial FDI (% GDP)25.713.6 Equity liabilities (% GDP)5.82.2 Financial FDI liabilities (% GDP)0.030.02 0 – unrestricted capital account; 1 – restricted capital account

6. 6 Is capital control more likely to be adopted in countries with weak or strong institutions? Correlation coefficients - capital control and institutions * 1% significance level; ** 5% significance level Overall rest.; shares; voice and accountability and regulatory quality – larger coef.

7. 7 Do weak institutions discourage capital inflow? Correlation coefficients - capital inflow and institutions * 1% significance level; ** 5% significance level Debt liabilities – no correlation Debt liabilities (% GDP) Political stability (-2.5 to 2.5) -0.00 Voice and accountability (-2.5 to 2.5) 0.09 Regulatory quality (-2.5 to 2.5) 0.08 Rule of law (-2.5 to 2.5) 0.03 Government effectiveness (-2.5 to 2.5) -0.02 Non-financial FDI liabilities (% GDP) Political stability (-2.5 to 2.5) 0.04 Voice and accountability (-2.5 to 2.5) 0.15* Regulatory quality (-2.5 to 2.5) 0.33* Rule of law (-2.5 to 2.5) 0.29* Government effectiveness (-2.5 to 2.5) 0.30* Equity liabilities (% GDP) Political stability (-2.5 to 2.5) -0.05 Voice and accountability (-2.5 to 2.5) 0.07 Regulatory quality (-2.5 to 2.5) 0.22* Rule of law (-2.5 to 2.5) 0.28* Government effectiveness (-2.5 to 2.5) 0.36* Financial FDI (% GDP) Political stability (-2.5 to 2.5) 0.22* Voice and accountability (-2.5 to 2.5) 0.40* Regulatory quality (-2.5 to 2.5) 0.50* Rule of law (-2.5 to 2.5) 0.34* Government effectiveness (-2.5 to 2.5) 0.45*

8. 8 Does capital control affect output growth? Logistic regression RE (z statistics in parentheses) Dependent variable: Growth deceleration Model 1Overall de jure restrictions (0-1)0.69 (0.68) Model 2Shares restrictions (0-1)1.63 (1.69) Model 3Bonds restrictions (0-1)1.05 (1.09) Model 4Money markets restrictions (0-1)1.14 (1.37) Model 5Direct investments restrictions (0-1)0.19 (0.25) Dependent variable: Growth acceleration Model 6Overall de jure restrictions (0-1)0.19 (0.45) Model 7Shares restrictions (0-1)-0.12 (-0.29) Model 8Bonds restrictions (0-1)0.04 (0.10) Model 9Money markets restrictions (0-1)0.12 (0.32) Model 10Direct investments restrictions (0-1)-0.04 (-0.11) No evidence that capital control prevents growth collapse – no long term impacts

9. 9 Does capital inflow affect output growth? Logistic regression RE (z statistics in parentheses) Dependent variable: Growth deceleration Model 1Debt liabilities % GDP0.01 (3.25) Model 2Non-financial FDI % GDP-0.08 (-6.40) Model 3Equity liabilities % GDP-0.30 (-3.45) Model 4Financial FDI liabilities % GDP-24.05 (-0.99) Dependent variable: Growth acceleration Model 5Debt liabilities % GDP-0.01 (-5.40) Model 6Non-financial FDI % GDP0.03 (5.85) Model 7Equity liabilities % GDP0.05 (3.32) Model 8Financial FDI liabilities % GDP-1.31 (-0.28) Non-financial FDI and equities are associated with less growth collapses and more growth acceleration; debt liabilities: the opposite

10. Capital controls: more likely in countries with weak institutions FDI and equity capital: flow to where institutions are strong; no relationship between institutions and debt –Debt liability probably driven by other factors Capital control does not prevent growth collapses –It may be effective under certain conditions –Long term impacts unlikely FDI and equity capital reduce growth collapses and increase growth acceleration Debt liability increases growth collapses and decreases growth acceleration Capital control on short term capital: policy option 10

11. 11 2. Brazil

12. Brazil: –Liberalized the capital account –Adopted floating exchange rate –Adopted inflation target –Prudential financial regulations in place –Investment grade status 2008/09 –Attracted a lot of foreign resources –Reserves have increased substantially 12

13. Capital inflow has increased sharply in recent years 13

14. 14 Brazil has liberalized the capital account Source: Schindler 2009 0 – unrestricted capital account; 1 – restricted capital account

15. Recent measures on capital control March 2008: taxes on capital account transactions, 1.5%; several exemptions May 2008: coverage extended to prevent circumvention October 2008: taxes lifted October 2009: 2% tax on fixed-income and equity inflows November 2009: 1.5% tax on certain trades to prevent circumvention No evidence that these measures have been effective to discourage capital inflow (IMF 2010) 15

16. 16 Brazil: composition of financial flows Source: Central Bank

17. 17 External sector indicators have improved significantly… Source: Central Bank

18. 18

19. …but there are increasing challenges Source: Central Bank 19

20. Is capital control needed in Brazil? Exchange rate appreciation Widening current account deficits Export competitiveness impacts Asset prices: Bovespa index increased more than 300% since 2005; real state at record price levels Prices anchored on cheap imports Inflation pressures Effectiveness of monetary policy questionable A more vigorous capital control is needed as a short term policy option But more structural policies still required -- e.g. fiscal 20

21. Thank You 21

22. 22 GDP per capita growth and capital control Brazil, China, Indonesia, India, Mexico, Russia, Turkey, South Africa

23. 23 Brazil: GDP per capita growth and capital control

24. 24 China Russia Indonesia India

25. 25 GDP per capita growth and capital control Number of countries = 61