Adrian Blundell-Wignall, Director, OECD Directorate for Financial and Enterprise Affairs, Special Advisor to the Secretary-General on Financial Markets
The global financial and economic crisis of 2008 left the international monetary system with vulnerabilities caused by volatile capital flows and spillovers from national policy responses, even if international co-operation helped to avoid the scale of restrictions on goods and capital flows that prolonged the Great Depression of the 1930s. The current policy environment has moved multilateral co-operation, openness and transparency to the top of the capital flow policy agenda. A new capital controls dataset suggests traditional residency-based capital controls are back in use. OECD research has also noted that measures restricting banks’ operations in foreign currency are rising. This lingering legacy is challenging a fundamental principle supporting globalisation – that economic development sooner or later requires that a country allows capital to move more freely across borders.
It is pleasing to note that major non-OECD emerging economies, and in particular the world’s second largest economy China, are opening up their capital accounts in order to participate fully in the global economy. In Latin America, Colombia and Costa Rica are following the path of their OECD neighbours Chile and Mexico, and have made credible commitments to progressive liberalisation. Brazil is participating in discussions at the OECD on capital flow management and liberalisation. South Africa is modernising its capital markets and foreign exchange regime as a general drive to financial liberalisation, while India is looking at allowing fuller capital account convertibility in the next few years.
Furthering the process of opening up capital movements will go a long way in addressing some of the structural imbalances that created frictions in the global economy prior to the 2008 crisis. Restrictions on the capital account often go hand in hand with foreign exchange interventions to perpetuate undervalued exchange rates and export-driven growth models. Currency convertibility, on the other hand, is an important contributor to the efficient allocation of global resources and economic growth. Indeed, the deepening of global foreign exchange liquidity engineered by a broad openness agenda will reduce the perceived need for macro-prudential policies that guard against key currency mismatches in crisis situations. Such policies work in the opposite direction to improved global liquidity.
Caution must be applied when employing capital flow measures (CFMs) for declared macro-prudential purposes. OECD research shows that evidence on the effectiveness of currency-based restrictions as a counter-cyclical macro-prudential buffer is not robust. Some of these restrictions can just serve the same role as traditional capital controls to neutralise the domestic credit implications of engaging in foreign exchange interventions and managing the exchange rate. Countries concerned with financial stability risks that may arise from global credit push factors could use Basel III-inspired liquidity coverage ratios and net stable funding ratios as alternatives to CFMs, while working to foster the broad openness and convertibility agenda of major new players.
”Global growth prospects have again weakened, … and this can be attributed to lacklustre investment”, stated Angel Gurría, the OECD’s Secretary-General, at the recent OECD-G20 Global Forum on International Investment. New OECD evidence using a sample of 10,000 of the world’s largest listed multinationals suggests that capital controls, far from helping business, are associated with highly significant negative effects on company capital spending, in part related to reduced FDI inflows. Similarly, countries with capital controls during the 2008 crisis did not restore liquidity or recover more rapidly than those avoiding such measures.
To reignite global growth, investment and foreign exchange need to flow seamlessly across borders in order to fund investment, improve global liquidity and to foster productivity growth via competition in the market for corporate control. Capital flow liberalisation must not be undermined as countries seek to shore up their financial systems and strengthen financial regulation. Progressive, sequenced liberalisation, mindful of vulnerabilities stemming from large and high financial flow volatility is called for, underpinned by a clear benchmark.
The OECD Code of Liberalisation of Capital Movements provides such a benchmark. A legally-binding instrument, it has provided a tried and tested process for international dialogue for over 50 years, a mechanism which is needed today more than ever. While liberalisation of trade in goods has been directed by the type of international rules and governance that the World Trade Organisation provides, globalisation in financial markets beyond the Codes’ adherent countries occurred in a more fragmented and uncoordinated manner.
Used by the 34 OECD countries including emerging economies, the Code is now open to non-OECD countries. It is a living instrument adaptable to countries at different levels of development, through built-in flexibility clauses that allow temporary suspension of commitments in times of economic distress and financial disturbance. Over time, the adherents have developed a body of well-established jurisprudence on the implementation of the Code’s rights and obligations and the conformity of individual country measures, all vetted by regular dialogues among peers.
Currently, work is underway to review the Code in light of the changing global financial landscape. The Code can provide a platform for sequencing reforms for the emerging and liberalising economies. The Code can also shed light on macro-prudential measures that are not currency flow measures and thus help to support a positive policy outcome that minimises disruptions to cross-border flows. But there is more work to do. The Code’s liberalisation standards and safeguards require review to ensure they are fit for purpose in the post-crisis environment. There is an array of views as to how far-reaching this review should be and how it should be organised. The strength of the Code is one of its key attributes but there is a need at minimum to clarify its broad scope since new forms of capital flows restrictions are on the rise. This will ultimately be a debate on the desirable features of a multilateral regime for cross-border capital movements. The OECD is well -placed to host such a debate.
Blundell-Wignall, A., Roulet, C., (2015), Evaluating capital flow management measures used as macro-prudential tools (forthcoming).
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