By Jerome Booth, head of research and Ousmene Mandeng, head of public sector investment advisory at Ashmore Investment Management
SUMMARY: The recent re-imposition of a financial transactions tax in Brazil has led to renewed press speculation about capital controls. Brazil has since followed with more measures to encourage capital outflows, and further market friendly measures may be announced shortly.
The experience in various countries suggests that capital controls should only be temporary. Controls among advance economies were highly selective and some affected only inflows or outflows. Emerging markets maintain on average more restrictions on capital account transactions than advanced economies. However, capital controls are no substitute for an adjustment of underlying fundamental macroeconomic polices.
Exchange rate realignment is also a necessary component for a rebalancing of the global economy, namely the U.S. would benefit from a weaker dollar to perform needed internal and external adjustments. Policy makers should therefore embrace currency realignment rather than fight it.
Emerging markets need to accept that economic power is normally accompanied by monetary proliferation. This has only been brought forward and reinforced by the global crisis. Considerations should therefore be given to whether capital account liberalisation rather than controls need to be implemented to establish conditions towards an orderly realignment of exchange rates.
