Spotlight G-20: It’s Time for the G-20 to Support the Use of Capital Controls

Bhumika Muchhala, Guest Blogger
Part of a Triple Crisis series leading up to the Nov. 11-12 G-20 meetings.

Ahead of the Group of 20 (G-20) industrial and developing nations summit meeting in Seoul this week, a plethora of dysfunctions and imbalances in the world economy are revealing themselves in a showdown between surplus and deficit countries.  Reaching beyond the power-play ensuing on the G-20 stage, specific fault lines come to light, such as the growth strategies pursued by emerging economies across Asia, which have come to depend excessively on international capital flows and exports to advanced economies (AEs).

A TWN paper, The Global Economic Crisis and Asian Developing Countries, summarizes the findings of ten country case studies across Asia and illustrates that the Asian exposure to shocks and contagion from the crisis has its origin in their growing financial and economic linkages with AEs, rather than their domestic macroeconomic imbalances and financial fragilities.  A tidal wave of capital inflows from the AEs, deeper integration with AE financial centers, accumulation of foreign exchange reserves, and increased asset investments in AEs have put Asian countries in a precarious position.

Global capital flows have witnessed a dizzying influx of the dollar carry trade, where investors borrow cheaply in the US and invest in higher-yielding currencies and assets in emerging market economies.  The $600 billion of liquidity created by the US Federal Reserve last week will further stimulate the volume and persistence of capital flows surging into emerging market economies.

Standard Chartered in Hong Kong estimates that global investors have poured about $8.6 billion into Indian, Indonesia, South Korean, Philippine, Taiwan, Thai and Vietnamese bonds during the first nine months of 2010, compared with just $94 million during the first nine months of 2009. However, this footloose global capital threatens the financial and economic health of Asian countries in serious ways.

First, the liquidity saturating Asian countries results in currencies appreciating to record highs, disrupting export competitiveness and affecting employment in sectors that form the backbone of many Asian economies.

Second, this excess liquidity is increasing the pressure on consumer prices, while fueling ‘asset bubbles,’ or sharp price rises in real estate and the stock market. However, sooner or later, bubbles always burst – resulting, as the world has seen in the last few years, in a lot of damage.

Third, any surge in capital inflows can lead to a reciprocal surge in outflows, causing economic disorder through currency devaluations, loan servicing problems, and balance of payments difficulties, as seen in the Asian financial crisis of 1997-98.

In response to these debilitating threats, many developing countries such as Thailand, Indonesia, South Korea, Peru, and Brazil have been getting creative with their policy toolbox by employing capital account controls.  The International Monetary Fund (IMF), which has typically opposed capital controls resolutely while advising its developing member countries to liberalize capital accounts, has had a pivotal change of mind.  The Fund now states that “capital controls are a legitimate part of the toolkit to manage capital inflows in certain circumstances.”   This is being echoed by economists, the World Bank, and the Economic and Social Commission for Asia Pacific, which convened a meeting of its over 50 member states to support the use of such regulations and controls to protect national economies and financial systems.

It is now time for the G-20, which has up to date remained silent on the problematic impacts faced by developing countries experiencing an influx of capital flows, to not only recognize the salience of capital controls in its upcoming summit this week but to also demonstrate active support for the validity of capital controls in the current global financial playing field.

Bhumika Muchhala is a Policy Analyst in the Development and Finance Programme at Third World Network (TWN).