How Effective are Capital Controls in Asia?: Thailand Case Studies

1. JuthathipJongwanich School of Management (SOM) Asian Institute of Technology (AIT) How Effective are Capital Controls in Asia?: Thailand Case Studies The presentation is based on the paper entitled “How Effective are Capital Controls in Asia? Maria Socorro Gochoco-Bautista (ADB) JuthathipJongwanich (SOM, AIT) Jong-Wha Lee (Korea University) Available at ERD Working Paper Series No. 224

2. Introduction • The global financial crisis of 2008 leads to the revival of the debate on the role capital control in ensuring macroeconomic and financial stability. • In particular, the strong and quick recovery of emerging Asian countries results in noticeable capital inflows into the region. • There are fear that capital inflows will inundate Asia and threaten currency, and macroeconomic and financial stability. • Particularly, currency appreciation leads to a debate between exporters and policymakers

3. Central banks in the region closely monitor capital flows movements, intervene in FX market, and some introduce new measurement of controls (IMF itself now appears to be taking a more nuanced position) • Most central banks encourage residents to invest abroad to reduce the pressure of currency appreciation (early 2000s). • However, whether the controls would be effective is still unclear

4. Objective of the presentation • We aim to examine the effectiveness of capital controls, which had been introduced in Thailand since the early 2000s. • Effective in terms of • Control capital inflows • Reduce pressure on (real) currency appreciation

5. In fact, there are two parts in the paper • In the first part, we examine the effectiveness of capital controls for 9 emerging Asian countries (i.e. China, HK, India, Indonesia, Korea, Malaysia, Philippines, Singapore, and Thailand), using panel estimation. • The capital control is based on Schindler (2009), that use IMF’s Annual Report on Exchange Rate Arrangements and Exchange Restrictions (AREAER) to conduct “capital control index”

6. In the second part, we examine two case studies in-depth. - Forms and effectiveness of capital control measures differ greatly across Asian economies. - All cross-country studies are based on annual data analysis, limiting capturing the effects of changes in capital restriction policy to a year. - Malaysia and Thailand are chosen because of their contrasting capital account policies after the early 2000s. Thailand introduced a number of capital inflows restrictions since 2003 while encourage capital outflows from Thai residents. Malaysia, which introduced strict capital control measures during the Asian crisis, has gradually lifted the restrictions.

7. Outline of the Presentation • Movements of Capital Flows • Brief literature survey • Capital control indexes • Empirical model • Results • Conclusions and policy inferences

8. Figure 1: Financial Account Flows (% of GDP), Emerging Asia

13. % of Nominal (/US$) appreciation (- appreciation)

14. % of REER appreciation (+ appreciation)

15. Literature • There are four key reasons to introducing capital control measures • Reduce the volume of capital inflows and alter the composition of flows in favor of longer maturities • Reduce real currency appreciation • Reduce the degree of nominal and real exchange rate volatility • Give monetary authorities the ability to implement more independent monetary policy

16. Capital controls can be classified into two broad measures • Administrative or direct controls (intend to affect the volume of cross-border transactions by imposing administrative obligation) • The use of outright prohibitions on the transfer of funds and associated payments • Explicit quantitative limits or approval procedures • - Indirect or market-based control • (work on the price or volume of a financial transaction or both by increasing • costs of transaction) • Tobin tax (explicit tax) • Implicit tax (reserve or deposit requirement at the central bank, URR) • Multiple exchange rate system

17. Example of Capital Controls on Inflows, 1990s

18. The evidence is mixed as regards the effectiveness of capital controls • Ariyoshi et.al (2000): controls were only temporarily able to drive wedge between foreign and domestic interest rate and to reduce pressures on the exchange rate in Brazil, Chile, Colombia, Malaysia and Thailand in the 1990s • Cardenas(2007): controls did not have an independent effect on total net private capital inflows • Galindo (2007) and Concha and Galindo (2008): controls had a temporary effect on net private capital inflows but not on the real exchange rate Measures, timing and country-specific matters

19. Control Measures in Thailand, 2000s

20. The Capital Restriction Indexes • Capital restriction indexes are constructed based on the information from notifications, press releases and speeches related to foreign exchange and capital account (published formally by the central banks). • Measures are conducted by different asset types

21. 1. Assign two dummy variables as follows: • + 1 is assigned to any measure that relaxes inflows and facilitate outflows (regardless who conduct the flows, residents or non-residents) • - 1 is assigned to any measure that restricts inflows as well as outflows (regardless who conduct the flows, residents or non-residents) • 2. Weight is assign to the regulations. Weight is set between 0-2 and the higher the number the severity of the restrictions on key variables is expected. The key criteria for applying the weight is as follows: • Regulations which are involved with the money: • < US$ 5 million = 0.5 • US$ 5 million - US$ 10 million = 1.0 • US$ 11 million - US$ 50 million = 1.5 • > US$ 50 million = 2.0 • Note that if the regulators just changed the scope of activities (+ types of investors) involved from the previous regulations, the weight is assigned only 0.25-0.5

22. Words criteria - URR/ Tax/prohibit/lift = 1.5-2.0 - Request/require/allow/relax = 1.0 - Provide option/flexibility/seek for cooperation = 0.5 3. The numbers are sequentially accumulated overtime to arrive at the indexes for each asset class (examples)

23. Example net inflows (Thailand)

24. Example net outflows (Thailand)

25. 4. Re-weight and adjust all the index to lie between 0 and 1 by 1 = liberalization 0 = Restrictions Note that the weight is recalculated to be comparable across asset types and periods. This is applied for both ‘net inflows restrictions’ and ‘net outflows restrictions’. 5. To be able to compare with IMF control index, the index is adjusted by 1 = Restrictions 0 = Liberalization Note that for total control index, we use both simple average and weighted average (results are not much different)

26. Thailand

27. Our indexes differ from IMF (Schindler (2009)) Thailand

28. Key variables in the VAR Model Exo: G3GDP and Shareprices Capitals (seasonally adjusted) are divided into - net inflows (total) and - net outflows (total) (Increases show more movement of capitals) Both net inflows and outflows are disaggregated into - FDI; - port-folio (equity and debts) and - other investment (bank) The data are from 2000-2010

29. Capital restriction indexes (our indexes lie between 0 and 1) • The higher the value, the increase the restrictions • Real Effective Exchange Rate (both BOT and BIS) • - Increase reflects appreciation • Real interest rate differentials • The difference between the Thai policy rate and the US 3-month Treasury bill rate, each adjusted by CPI inflation • (sensitivity for choices of interest rates) • Manufacturing production index (BOT, 2000=100) • (sensitivity for realGDP)

30. Impulse Responses of Key Variables to Capital Inflows Restriction: Thailand (c) inward FDI (d) Net equity flows (e) net debt security inflows (d) other investment

32. Impulse Responses of Key Variables to Capital outflows Restriction: Thailand

33. Malaysia(a.1) Liability (a.2) Assets

34. Malaysia

35. Impulse Responses of Key Variables to Capital Inflows Restriction in Malaysia

36. Conclusions and Policy Inferences • Restrictions have no significant effect on net inflows but especially effective for net outflows, especially FDI • Switching effect makes the controls (debts and bank) become less effective • Because of this, the effectiveness of controls on RER is limited. (FDI makes RER appreciation) • Design of capital control matters for their effectiveness • Controls are temporary and have a negative impacts on MPI

37. Encouraging outflows are more effective, especially FDI. • Insignificance for other flows could be because of home bias • Under current situation, capital flows have begun to show its effect >= current account since 2010Q2. • Baht appreciation: reduce volatility + find the reasons why most of exporters do not hedge • Closely monitor capital inflows --- concerns on stability of financial market (well design controls matter)

38. Similarity Index (with Thailand)