Analysis Whether and When to Liberalize Capital Account and Financial Services



People around the world faced the new phenomenon, about international capital movements which makes controversial questions. Why should countries open up their capital accounts, especially considering that unrestricted international capital movement. This phenomenon brings many questions that have to answer. For example, many OECD countries have not eliminated their foreign exchange restrictions only until the 1980’s. If the answer is unequivocally affirmative, does it matter how fast should countries do so? Should they wait until “all essential pieces” of the policy package are in place before they eliminate all restrictions? How are international capital movements related to domestic financial sectors? Is there a difference between opening to competition an industry such as car manufacturing as compared to the banking sector? Should the opening of the banking sector be governed by different rules?

Rules about foreign exchange restrictions are already in place in the IMF Articles. Until recently, the IMF Articles only called for the elimination of foreign exchange restrictions on the current account. The ongoing discussion and the controversy about globalization that calls for the capital account liberalization introduces, therefore, a relatively new element into the whole discussion.

These questions have also implications for the World Trade Organization. It is well known, that the Uruguay Round Agreements have already provided a coverage for a number of aspects that are directly related to foreign investment. Rules established elsewhere such as in the context of changes to the IMF Articles will obviously have an important bearing for the implementation of rules agreed in the Uruguay Round. This raises a variety of other questions in the mind of some observers.

Since the 1997/98 financial crisis in Asia and other parts of the world, the current situation is that most developing countries tend to be worried about the adverse impact of international capital movements even though the risk of them facing such a crisis at present time is almost zero. But the apprehension about the Asian crisis is not only limited to developing countries. As the depth of the crisis and its contagion among different countries in and outside the region indicate, the crisis was partly brought about by rapid and panicky reactions of foreign investors. Many investors have felt that they had to act fast in order to protect the value of their investment. Negotiators in the World Trade Organization have also got rather nervous. The fact in a negotiation that an agreement on financial services was eventually reached must be seen not only as major achievement of those who actively pushed for its conclusion but also as a streak of luck that the negotiators were probably unable to fully digest the consequences of the crises. Some critics of “globalization” have pointed out that both processes – the liberalization of capital account and opening of financial sector industries – have been the outcome of external pressures. For example, that the push for liberalization of financial markets has come from the providers of financial services themselves which are only thinking of their own profits. Cynics also suggest that many developing countries have no choice but to liberalize due to pressures from international financial institutions. Thus, the countries have to open up their markets if they want to have access to external finance.

Whether and When to Liberalize Capital Account and Financial Services

I. Capital Account Liberalization

First of all, it may be useful to remind ourselves of what economists would think of as the classic economic benefits of capital mobility.

(i) Savings – Investment Imbalances.

Capital flows represent an inter-temporal trade between two countries, they allow a country that has excess savings in a given period to transfer these savings to another country which has excess investment opportunities.

(ii) Risk Diversification.

The other big source of gain from international capital movements is in terms of risk of diversification. It is important to point out that, in principle, one can have risk diversification without any net transfer of resources.

(iii) Gains from FDI.

Finally, in the economists’ classical discussion of the gains of capital mobility, one should mention separately the gains from FDI. These gains come about not so much as gains from transferring the capital, for they can be achieved even if a multinational company moves into another country and raises all the capital locally.

(iv) Other Arguments “Pro” and “Against” Full Convertibility.

Let me just mention a number of other arguments that are put forward either favouring or against capital mobility. In favour of capital mobility is a “freedom” argument: that individuals ought to be permitted to do as they see fit with their own property, so there ought not to be restrictions at the national frontier which prevent them moving their money if they want to. Secondly, there is an argument that capital mobility provides a policy discipline on countries. Indonesia is a country which liberalized its capital account way prematurely, according to the orthodox sequence (in about 1972), and the argument they always made was that this was a good policy discipline because whenever the government began doing something wrong there was a run on the currency and that meant that the economists in the government were able to rein in the technocrats. So, the economists found an open capital account a useful way of disciplining people dreaming of what the economists regarded as expensive and welfare-reducing plans.

Tax Evasion. Lets move on and talk about other objections to capital account liberalization. One is that it facilitates tax evasion. It is much easier to avoid paying taxes on income earned on one’s assets if those assets are in some domicile other than that in which one resides, especially one that is known as a tax haven. Switzerland is the best-known example: there is not usually a lot of tax paid on income-earned in Swiss banks. Tax evasion could be overcome by an international agreement on tax information-sharing, plus withholding where there is no assurance that tax has been paid.

II. Financial Services Liberalization

In terms of benefit. The first basic point to make is that financial.services.liberalization would seem to offer the same presumption of gains as from any other foreign direct investment. Foreigners generally bring in expertise when they set up businesses , and it is difficult to see why that should not be true in respect to banking institutions or other financial institutions. This is that foreign banks perform better is pretty conclusive. This means not only a presumption, but there is quite strong empirical evidence of the foreign banks bring benefits to local technical expertise in the financial system

In terms of risk. Rules which limit foreign currency exposure can be imposed symmetrically to ensure that one does not have too big a switch of funds out of a currency, as much as to avoid a big switch in. has been assumed that the system will work the bank will offer the liquidity that is important to maintain local branch afloat. However, foreign banks in Indonesia to make the decision not to do that but to freeze their exposure to foreign banks Argentina.have in this country really can fortify the country’s liquidity position in a financial emergency.

Second way in which the bank distinguished from other forms of FDI are, because of asymmetric information, there is a danger that what is called “gambling for resurrection” or “gambling for redemption.” Now, one of the dangers of opening the financial services sector that will have a some banks are only marginal coping until some much more efficient foreign banks come in if the bank in the local view this as eroding their franchise value to zero, and concluded that they must take some risks to have the opportunity to get back into the game, we can get much worse as a result of the banking entry by foreign banks. This is a risk, and something that some advocates of financial liberalization does not seem to be quite aware. Clearly the answer is to strengthen the supervision system and to strengthen the bank, which may involve recapitalising them are foreign banks that take them to the possibility of international risk diversification. Only the fact that they are foreign banks show that they are basically depositors.

In the financial crisis, people may suddenly come to the tourist attractions as it is particularly strong, and so we can experience destabilising shifted from local banks to foreign banks. Risks that must be made in your account. therefore developing countries should be allowed to ask the head office building of the bank’s presence there is necessary, as a condition of access, they provide liquidity support for the local branch even for balance-of-payments crisis. It would be a mistake to have an international agreement that is valid from the countries to restrict things such demands.


This discussion has been told about Capital Account Liberalization and Financial Services Liberalization consist of :

A country which is already investing 35 per cent of GDP and then imports capital to the tune of another 5 per cent plus and boosts investment by that much, how much does it get out of that extra capital on its growth rate compared to how much it builds up its external debt exposure? It seems to me that the impact on the growth rate from the incremental increase is going to be pretty small. Some of the rates of return on capital in East Asia in fact do appear to have gone down to quite low levels in recent years

China is another example which supports my point that prudence in opening the capital account is a wise policy. J. Stiglitz likes to make the point that if one breaks China down into its individual provinces and counts them as individual data points, then the ten fastest growing countries in the world for the last decade would all have been Chinese provinces. It is very much a high growth area. But, of course, Taiwan is the really interesting case on that list, as Taiwan did not liberalize its capital account. It has had a relatively closed capital account even though it has done all the other reforms. As a result, it came through the crisis relatively well.

Some people argue that the crisis was all because of the lack of floating exchange rates. In fact, most of the countries here had much the same exchange rate regime, which they normally described as floating despite the fact that most of them fixed more or less closely to the dollar.

In some countries absorption fell by 20 or 30 per cent of GDP. GDP may only have fallen by 10 per cent or less, but on top of that there was a big terms of trade shock and a big improvement in the current account balance, and if you add these up you get figures up to 20 or 30 per cent of GDP. So, this is a big recession

There are some countries for which, even if you could find foreign banks willing to take over banks of the size that exist in large countries, say India, the Indians would not like this. However, in some small countries they do not mind having the banking system being predominantly foreign, and in that case it may well be a way out of the difficulties just to liberalize them and rely on getting the foreign banks coming in and taking over the whole system. So I see two possibilities. One is that you clean up and make sure there is a sound banking system with good supervision. The second approach would be opening up wholesale in the expectation that foreign banks will clean up the system for you.


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