Capital controls

The entire premise of the IMF’s conditionalities imposed on our economy in 1989, dubbed the “Washington Consensus”, was that with the liberalisation of our financial sector – meaning removing all controls from the flow of funds to and from our financial institutions – we would be more attractive to funds for development. At the time, because of our debilitating lack of foreign reserves, we had imposed stringent capital controls over our financial system in a desperate effort to keep our national financial head above water.
The same conditionalities had been imposed over much of the developing world, beginning with Latin America, that had borrowed much of the funds garnered by OPEC and intermediated by the western banks. But by the end of the nineties, these countries discovered that this unrestricted capital flow was a double-edged sword. While it could stimulate growth in the economy, it can also cause it to implode if investors can decamp at the first signs of ‘trouble’.
The Asian financial crisis of the late 1997-98 was a painful reminder of how foreign capital can severely exacerbate an emerging financial crisis. Following a run-up in asset prices, which were fuelled by foreign investment, the economies of Indonesia, Thailand, and South Korea, for example, saw their currencies depreciate sharply as foreign credit abruptly fled their troubled financial systems. Cyprus has been the latest victim of this phenomenon and has been forced to impose capital controls in an effort to stop the haemorrhaging of funds from its banking system.
Cyprus had enjoyed extraordinary sustained growth rates starting in the 1990’s when  its liberalized financial sector and attractive interest rates pulled in funds seeking  high return without any controls. It became a safe haven especially for Russians who had suddenly found a bonanza with their country’s embrace of capitalism. This became even more accentuated with Cyprus’ accession to the EU in 2004. But when the bubble burst as the intertwined Greek economy imploded last year, it was only a matter of time for Cyprus to follow suit.
But as Brazil and several other countries in Latin America discovered rather early on as the initial guinea pigs of the Washington Consensus, there are many other deleterious effects of unrestricted capital flow on a host economy. For one, it will cause the local currency to appreciate in value and make the local products more expensive in the global marketplace. This has been the basis of the struggle in the last decade between the US, on one hand, and emerging giants like China and Brazil on the other hand, on monetary policy.
They accuse the US of artificially keeping its interests hovering around zero, forcing its hordes of investors to pump their funds into their economies/financial systems which in turn appreciate their currencies. Capital controls may take the form of a tax on foreign capital inflows or quotas on investment. Host countries can also limit volatility inflows by requiring that a certain percentage of foreign investment be held in reserve for a specified number of days at the receiving country’s central bank. This type of control, called a “lock-in” policy, prevents sudden withdrawals of capital.
All of this should become of interest to local policy-makers as our economy shows signs of sustained growth, as opposed to the rest of the Caricom economies. While the capital base of investors might not be very large by international standards, because of our comparatively extremely minuscule economy, a sudden influx of these funds can be disruptive. In the last few months, we have had two large Jamaican financial conglomerates, Grace Kennedy and billionaire investor Michael Lee Chin’s Portland Holdings, express interest in investments in our financial sector and agriculture.
While agricultural investments should be welcomed with open arms, we should have capital controls in place to deal with the downside of unrestricted financial flows. Even the IMF now approves.