- Luiz Vieira, Project Coordinator, Bretton Woods Project
- Gurnain K. Pasricha, Senior Financial Sector Expert, IMF
- Chenai Mukumba, Ag. Executive Director, TJNA
- Jane S. Nalunga, Executive Director, SEATINI-Uganda
Watch the session recording here.
Luiz (moderator): The context of this debate today is the polycrisis. There is the climate emergency, rising inequality, the consequences of the pandemic, plus the war in Ukraine. We are in a difficult environment, plus there is a general frustration with the multilateral system, of which there are many calls for reform. These are not unrelated to support for an economic transformation over the last few decades, a transformation that hasn’t happened. According to UNCTAD (United Nations Conference on Trade and Development), commodity dependence has increased, not decreased over the last few decades, and this perpetuates the inequality between states. Also according to UNCTAD, the Sustainable Development Goals (SDGs) may be out of reach; there is increased financial instability, and decreased ODA (official development assistance).
The rationale for this panel is to explore the link between liberalised capital flows and the general dynamics of this underdevelopment crisis, as capital controls may be more consequential than widely realised.
Gurnain: The Fund (IMF) has an Institutional View (IV) on the liberalisation of capital controls. They reviewed the institutional view last year, and there are also recent developments. The IV was adopted in 2012, and forms the framework for policy advice. It is not obligatory, but it underpins staff advice to countries, to mitigate risk of these flows. It has been shaped by the crises of the 1990s and 2008.
Capital account liberalisation is the removal of Capital Flow Management measures (CFMs). The IV recognises that capital flows can be beneficial, but pose some risks.
The direct benefits are that capital flows allow capital to move from where it is less productive to where it is more productive, and allow the sharing of risks through borrowing and allowing lending countries to smooth spending over time.
There are indirect benefits as well, but also evidence about the risks of capital controls. The risks of capital flows are that any country that is more open is more affected by shocks. How the economy reacts to those shocks depends on the overall policy framework, and on its macroeconomic policies. If these are not strong enough, this can lead to crises and needs to be managed.
The IV is that countries can benefit from liberalisation, but there is no IV presumption that liberalisation is appropriate for all countries at all times. Liberalisation needs to be timed and sequenced. Foreign direct investment (FDI) and long term debt should be liberalised first.
An integrated approach to the liberalisation of capital flows is recommended.
The 2012 IV stated that the temporary reinstatement of CFMs could be justified during an inflow surge or an (imminent) outflow crisis. But the capacity of a country to absorb the flows of these CFMs needs to be considered. The IV states that these capital controls should not substitute for macroprudential measures.
The 2022 IV stated that currency mismatches could make countries vulnerable to flow crises. It also allowed special treatment for certain CFMs, for national and international security, for example from international prudential frameworks like anti-money laundering (AML) or combating the financing of terrorism (CFT). There are also measures from the international standard against avoidance and evasion of taxes.
The IV advice on managing capital outflows is that they should only be used in a crisis or an imminent crisis, or when a capital account is prematurely liberalised. They can be used as part of a broader package.
There have been declining net inflows to developing economies since 2007. Who is taking money out of developing economies? There has been a lot of pressure on Emerging Market and Developing Economies (EMDEs) taking money out of those economies.
In 2022, and since 2016, there has been a trend of declining policy rate differentials; the compensation investors get for risk has been declining, which means there is less incentive to invest in those countries, and inflation has sharply increased. In 2022, there has been a nominal decline in currencies vs USD, but in real terms they are appreciating.
There is probably scope for macroeconomic adjustment for the countries in this sample. So the International Monetary Fund (IMF) view is that CFMs are probably not warranted.
Chenai: Gurnain’s presentation showed different dimensions of capital flight.
Tax Justice Network Africa (TJNA)’s work highlights the issue of capital flight by high net worth individuals and international corporations. This presentation will cover:
- Scale of illicit capital flight from the continent;
- the drivers of these flows;
- the role of capital controls;
- the need for international cooperation.
The scale of illicit financial flows are significant. Africa loses about $90 billion annually.
Countries with high flows spend about 25 per cent less on health, and about 50 less on education, so high capital flight is associated with negative developmental impacts. Alternative methods for financing development is not available now, and the pandemic saw aid contract.
GS countries need to start to look at domestic resource mobilisation (ie. taxation) and close loopholes, etc. Africa needs $200 billion to plug its development gap, and closing these holes could fill about half this need.
The drivers of these capital flows are both push and pull factors.
The push factors include weak regulatory structures, excessive tax incentives, and governance is an enabler for drivers for international financial flows. Pull factors include financial secrecy and tax havens, which help drive these flows.
In this context, capital controls can play a role in preventing capital flight. Measures that restrict the movement of capital across borders, when used well, can be effective in limiting financial flows. There is a role for capital controls in limiting illicit capital flight, to help drive African development.
Fostering international cooperation to combat these flows is essential, as no measure at national level is enough without international cooperation. Reform of the international financial architecture is needed to curb these flows.
The development of global rules are necessary, but the lack of participation of Global South (GS) countries in making global rules is one of the reasons why the current system does not serve GS interests. There should be more stress on developing countries having a say in the making of international rules. TJNA sees an increased role for international cooperation in crafting these measures.
Jane: There’s no two ways about it, there is a need for capital controls in Africa.
Look at the context in Africa, and the challenges they face, and look at how trade and investment interact with investment flows. There has been a push to liberalise the financial system but this should serve the structural transformation Africa needs. There are also serious challenges, including pandemic related issues, the Ukraine war, health, etc.
In Africa, the challenges after the pandemic just exacerbated challenges that already existed. The post-covid situation allows an opportunity to rethink the global financial and trade architecture that has resulted in poverty and marginalisation.
Mobilising adequate resources for development is a huge challenge in Africa, there are many challenges, and Africa needs resources to confront them.
Commodity dependence is a huge issue in Africa, the continent exports raw materials and imports finished products. There is also a trade deficit, and it keeps going up… they are borrowing just to fund expenditures and development. This is a vicious cycle. There are not enough resources to develop, and now there are a number of countries in debt distress. Some countries are spending over 40 per cent of their domestic resources to finance their loans.
There is large-scale extraction of resources from Africa, a huge haemorrhage from Africa. The continent exports finance but imports capital (profit seeking finance) in terms of loans, FDI, etc. African countries need to be able to have the policy space to direct resources to where they need to go. Africa has signed so many bilateral investment treaties, and needs investment to develop key sectors. These bilateral treaties allow investors to repatriate 100 per cent of profits. The convertibility of African currencies is low, so money going out is in dollars. Capital controls can be used to stop this outflow. But capital controls aren’t one size fits all, and are not only useful in a crisis or an imminent crisis… but then Africa is already in a crisis.
Africa was prematurely liberalised under Structural Adjustment Programmes (SAPs) in the 1980s and 1990s, there were trade agreements, and the continent opened up completely to trade and capital flows. We need to look at this policy holistically, and how capital controls can help Africa develop. Africa is already in a very very deep crisis, African states need policy space to get out of the crisis they are in.
Luiz: Gurnain says the literature supports financial liberalisation, but commodity dependence and the development issues raised by the speakers argue to the contrary. First question: What is the difference between resident and non-resident flows?
Gurnain: Resident means flows commissioned by those who live in the countries. Acquiring foreign assets is a gross inflow, and this is by residency, not necessarily by tax residency.
Indebtedness is an issue at the forefront in Africa, it is now a big concern. The IMF supported the Debt Service Suspension Initiative (DSSI) and debt restructuring, and a lot of that is public debt. How could inflow controls in the past have prevented that public debt? What is needed? Capital controls or raising tax revenues?
There is high inflation and monetary policy hasn’t kept pace with the situation. There are other measures necessary, macroeconomic adjustment is needed to stem inflows. In each situation we need to think of the situation.
Capital controls do encourage illicit transfer of funds. The errors and omissions in capital accounts rise, even in countries with strong capital controls, and money extracted by over and under invoicing of trade.
Luiz: Think of the current situation with development finance in Africa. Has it served its purpose? There has been increased commodity dependence, which indicates finance hasn’t necessarily worked.
Jane: Capital controls are not a panacea for challenges Africa is facing, but they are a critical tool that should be left to African countries to decide for themselves how to use. They need a mix of tools that can be used at different times, and capital controls should be in the policy space of African countries.
Should this wait till Africa is in a crisis? But it’s in a crisis now.
Africa is facing a debt crisis. Previous solutions to the debt crisis didn’t prevent further crises, after previous initiatives they are in a worse crisis… Africa needs to stop being commodity dependent, mobilise resources and direct it to building a self sustaining economy. The resources Africa receives from loans are conditional, they must be used for this, not that, etc.
Finance should be a tool for structural transformation. Africa has been liberalised since the late 1980s… So what is and what isn’t working?
Chenai: Countries with high capital controls see high illicit financial flows, but countries that lose more are the countries that are more liberal. So capital controls may be a contributor, but are not the main motivating factor for illicit flows. So capital controls are a tool countries can use to address tax avoidance and evasion.
Capital controls should be able for use by African countries, which are now in a crisis. They are a tool for the economic policy toolkit.
Gurnain: The IV does have a number of circumstances when it considers controls to be appropriate.
But has liberalisation of financial flows served the development of Africa? The commodity curse does exist, but countries have to have robust frameworks to manage commodities, eg. Chile. The literature says domestic governance and institutions, and the macroeconomic frameworks, determine how much countries benefit from financial liberalisation.
Questions & answers:
Barry Herman: On residency, we shouldn’t make too much of a fuss about it.
Malaysia found that capital controls in bad times can overwhelm the capacity of central banks to manage them.
Gurnain: Individual cases are discussed in individual surveillance reports.
Jorge Campos: (for Jane) Capital controls don’t provide the solutions they intend to provide, the real issue is trust… and trust is about whether capital can be invested in other countries. Capital controls make it more difficult to trust. Mexico has a highly open capital system, investors trust that they can change currency. In Argentina and Venezuela, bad policy has destroyed the trust.
Jane: African experiences indicate that it shouldn’t be one size fits all, it should be about the nature of the economy and its challenges. Capital controls are part of the tool kit, and that shouldn’t be denied to governments.
Uganda liberalised its banking sector, and now there are only foreign banks left; when the central bank issues a directive, it is mostly ignored. Financial policies should be a tool for transformation, not disempowerment.
Some of foreign banks in Uganda are African banks, the IMF offers capacity development to help countries develop those markets. If they don’t use CFMs, then you need strong fiscal discipline and strong monitoring. If you don’t have that, capital flows need to be managed to prevent a crisis.
Benjamin, from the Africa Centre for Energy Policy: The more regulation you have on restricting private and public funds and behaviour, the more room there is for people to make money on the side. This is true of the extractive sector, the system can be used to facilitate illicit flows. If there are no systems to put controls in place, then there is an incentive for people to make money.
Africa needs to build institutions that matter and can govern. Many can subvert the rules. So what is the institutional capacity required to govern well and stop illicit flows?
Chenai: Capital controls are not the answer to everything, but they can be part of the solution.
In Nigeria in 2015, the economy was stabilised through capital controls. Capital controls are not a panacea, but economies may not be ready for full liberalisation.
Jane: Argument that there isn’t institutional capacity? But what comes first, the policy or the institutional capacity? It’s a vicious circle, you don’t have the institutional capacity, the policies can’t be put in place, but the policies can’t be put in place because there is no institutional capacity. Let them put policy in place and then build the institutional capacity!
Gurnain: Capital outflow controls in the past were used with financial repression tools, to allow the governments to borrow at lower rates. But is the government going to use that money wisely? Capital controls do require administrative infrastructure and enforcement, and they can provide incentives for rent seeking and corruption.
Few countries find it desirable for complete capital controls, all the different tools have benefits and costs, the most robust solution is to develop administrative capacity, macroeconomic frameworks, etc.
Anonymous: How do CFMs work with AML, how do you prevent illegal activities?
Gurnain: Capital controls can discriminate based on residency, external financial institutions can be banned from interacting with residents of certain countries.
Anonymous: The extraction of capital, who is responsible? Are we engaging in a blame game?
Jane: Economic systems in Africa are extractivist… they export raw coffee, and get it back in processed form. This isn’t attributing blame, it’s just the policies they have, and they are weak… the trade agreements they have signed are weak, and IMF/WB conditionalities pushed for liberalisation.
This opens up economies to international competition, but the industries were not competitive, so they have collapsed. They need policy space, they need trade policies, macroeconomic policies, etc, space that governments can use to work in different situations. A lack of capacity shouldn’t necessarily stop them using particular tools.
Chenai: In addressing capital flight, national and international measures need to be coordinated.
Luiz: What is China’s policy on capital controls?
Mihaela Siritanu, BWP: What about the vicious circle on policy vs administrative capacity… ?
Gurnain: An integrated approach to liberalisation is needed. There is a sequence of liberalisation, it is not a one shot thing, it is a process… Short term banking flows can be liberalised earlier than other kinds of flows.
The enforcement of controls is always problematic. Capital controls do leak. That doesn’t mean they don’t work, they aren’t perfect. And who benefits from them? They will be effective but not completely effective.
Anonymous: (for Chenai) Is Extractive Industries Transparency Initiative (EITI) a good example of cooperation?
Chenai: There are 54 african countries, they are not all the same. There are differences, big differences!
EITI is a great initiative, but which countries are determining the rules? African countries don’t participate directly in setting the rules. This is like shifting the global conversation on tax to the UN, this is the cooperation needed.