Many economists and international financial consultants suggest that capital account liberalization is an important strategy for developing countries in order to spur economic growth. Specifically, the International Monetary Fund once called for the emerging markets and other developing countries to tap into the possibilities of capital account liberalization (Gallagher & Antonion, 2013). The positive impact to developing countries of heightened access of capital flows resulted in the less attention on the risk associated with it (Takagi, 2005). However, recent pronouncements from leading financial organizations suggests that while there are benefits derived from capital account liberalization, there are disadvantages associated from the spin off of capital flows. Thus, the need for major monetary organizations and governments to take a closer examination on the needed strategies to reduce the impact of capital spin offs, while profiting from the positive impact of capital flows.
The Benefits of Account Liberalization
Undoubtedly, account liberalization has a constructive impact in promoting economic growth. When done under the right time and condition, capital account liberalization can “enhance the efficiency of resource allocation and the competitiveness of the domestic financial sector” (Arora et al, 2012). Moreover, the process of capital flows supports the transmission of vital technological and managerial knowledge, especially in terms of foreign direct investments. It should also be pointed out that a sufficiently designed capital flows are helpful in supporting major economic goals, as exemplified by China, which now reaps the paybacks of its large inward FDI flows in the past decades (Arora et al, 2012). For countries that have attained a considerable level of financial progress, capital account liberalization serves to sustain their development even during periods of economic crises.
The Disadvantages of Capital Account Liberalization
Despite the benefits associated with capital account liberalization, there are also risks that come with it. For example, countries that have not yet achieved a considerable level of economic and financial stability are more vulnerable during periods of economic crises. Moreover, even countries that have already derived substantial benefits from capital inflows remain to be threatened by financial volatility (Arora et al, 2012). The International Monetary Fund cited that in some circumstances, “cross-border capital flows should be regulated to avoid the worst effects of capital flow surges and sudden stops” (Gallagher & Ocampo, 2013). It is also recognized that account liberalization is not suitable for all countries, thus the need to carefully analyze the different elements associated with it.
Importance of Capital Controls
While the IMF had been generally opposed to the use of capital controls, financial analyst suggests that they can be introduced as a form of prudent measures. The capital controls “were seen to be a necessary and useful instrument of economic management” (Tagaki et al, 2005). Consequently, in the late 1990s, the IMF recommended the adoption of capital controls in Estonia and Peru as a means to regulate the capital inflow speculations. While the two countries did not heed the IMF’s advice, there are other countries that imposed their capital control measures. For example, in January 2000, a 90-day minimum holding period was introduced by the Philippine authorities as a means to “limit speculative capital flows” (Tagaki et al, 2005). While the IMG expressed that these measures improve monitoring, the organization also cited the need to determine the benefits of these controls against the cost. Further, in 1995, the Slovenia implemented the “unremunerated reserve requirement on non-trade-related loans with a maturity of up to five years” (Tagaki et al, 2005). The IMF indicated approval of this measure as they saw it as a sensible response to the threat of uncertainty associated with capital flows. Accordingly, it is with these uncertainties that the IMF endorsed the implementation of Capital Flow Measures to counter possible market volatility, though the IMF still recommended these controls only as a form of secondary measures.
Based on the readings, capital account liberalization is beneficial for countries, especially those that wanted to gain from the benefits derived from capital inflows associated with engaging in the international financial markets. However, it was also found that the economic growth rate was coupled with risk associated with the economic crisis. This is in-line with the new view of the IMF where it suggested that despite the positive impact of capital inflows, there is the susceptibility to enormous losses especially during times of volatility.
Conclusion
Capital account liberalization is advantageous to the economic growth of countries. There are many developing countries that use this strategy to spur economic development through foreign investments and savings. However, the volatility of the international financial market may have a negative impact in sustaining the economic growth. There is therefore a need to use capital controls to cushion the adverse effect of market instability. Futher, major financial organizations such as the IMF and other monetary authorities must closely examine the possible methods and processes to support the participants of capital account liberalization.
References
Arora, V., Habermeier, K, Ostry, J., Weeks-Brown, R. (2012). The Liberalization and Management of Capital Flows: An Institutional View. International Monetary Fund
Gallagher, K., Ocampo, J. (2013) ‘IMF’s New View on Capital Controls’. Economic and Political Weekly. 58 (12)
Takagi, S., Chelsky, J. Armendadiz, E, Takebe, M., Kucur, H. (2005) The IMF’s Approach to Capital Account Liberalization. International Monetary Fund
