LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATION José Antonio Ocampo and Bilge Erten Committee on Global Thought Columbia University "Capital Account Liberalization in China: Learning Lessons" Workshop Boston University – February 13, 2014

Medium-term cycles of capital flows to emerging markets: Recycling of petrodollars, via bank loans, to oil-importing EMs 1982, Aug.-- Mexico unable to service its debt on schedule, defaults => Start of the Latin American debt crisis, New capital flows to EMEs following 1989 Brady Plan 1994, Dec. -- Mexican peso crisis 1997, July -- Thailand forced to devalue and seek IMF assistance => Start of East Asia crisis 1998, Aug. -- Russia defaults on much of its debt => Contagion to Brazil Turkey and Argentina currency & debt crises New capital flows into developing countries 2008, Sep. – Lehman Brothers collapse => Beginning of North Atlantic Financial Crisis Post-crisis surge in capital flows to emerging markets, 2013, May -- May 2013 U.S. Fed tapering began the contraction phase

Net resource transfers to Latin America Source: Authors’ estimates based on ECLAC data 3

Major phases of liberalization and regulation Extensive FX and capital account regulations in all LA ▫Exceptions: Mexico and Venezuela Capital account liberalization in Argentina, Chile and Peru, but Brazil and Colombia remain relatively closed; Domestic liberalization in Argentina and Chile ▫ Closing of the capital account during LA debt crisis Broad-based capital account liberalization in LA, including Brazil and Colombia, but with new instruments to regulate capital flows: ▫Taxes on capital flows in Brazil, and URRs in Chile and Colombia. ▫Regulations on FX transactions, e.g. restrictions on domestic financial deposits in FX. -- Semi-dollarized systems in Argentina and Peru, hyperinflations of 1989 and 1990; but not in Brazil despite its hyperinflation in early 1990s Further liberalization in Brazil, Colombia, Chile (FTA with U.S.), but reversal of liberalization in Venezuela and Argentina ▫ Peru used differential RRs on deposits in dollars and short-term external borrowing by domestic banks vs. deposits in the domestic currency ▫ Colombia used URRs before FTA with U.S. ▫ Brazil used taxes on capital inflows after the North-Atlantic crisis

Comparison of capital account restrictiveness of Latin America vs Emerging Market Economies 5

Capital flow regulations in Latin America 6

Lessons from capital account liberalization and regulation Surges in international capital flows generate pressure to adopt pro- cyclical macroeconomic management and to liberalize capital account and financial regulations, with large destabilizing effects: ▫Both the liberalization of the 1970s/early-1980s and that of the ended up in major crises. However, not all booms end up in crises: The critical issues are current account deficits and associated currency appreciation. ▫Reduction of external debts and accumulation of reserves serve as additional buffers against capital flow volatility. ▫The domestic counterpart of the current account deficit is important: the experience of the Southern Cone during the first boom and of a broader group of countries during the second was problematic, since external financing was essentially consumed. Maintaining some capital account regulations to directly manage capital flow volatility is important. ▫Brazil, Chile, Colombia and Peru used some of these tools effectively. ▫But these regulations should be used as a complement, not as a substitute for domestic financial regulations – in some cases, their use as a substitute has made crises unavoidable and more severe. 7

Investment as a share of GDP 8 Source: Authors’ estimates based on ECLAC data

External debt as a share of GDP 9 Source: Authors’ estimates based on ECLAC data

Current account balance has deteriorated since 2002 when adjusted by terms of trade 10 Source: Authors’ estimates based on ECLAC data

LATIN AMERICA’S LESSONS FROM CAPITAL ACCOUNT LIBERALIZATION José Antonio Ocampo and Bilge Erten Committee on Global Thought Columbia University "Capital Account Liberalization in China: Learning Lessons" Workshop Boston University – February 13, 2014