1 - Introduction

Summary

Orthodox thinking on capital account convertibility during the Bretton Woods era maintained that capital account opening should be expedited cautiously and only after substantial progress has been made in restoring macroeconomic stability, liberalizing the trade account and establishing a strong regulatory framework to foster a robust domestic financial system. Any abrupt opening of capital accounts at an early stage in the reform process without achieving these pre-conditions was thought to constitute a recipe for exchange rate overvaluation, financial fragility and eventual economic collapse (Edwards 1984; Corbo and de Melo 1987; Michaely et al. 1991; McKinnon 1993).

There was, however, a clear shift in policy emphasis in favour of a greater volume of capital account openings from about the late 1980s, with the International Monetary Fund (IMF) and the US Treasury adopting such an emphasis as a basic tenet of their policy advocacy concerning developing countries (Bhagwati 1998; Rodrik 2011). This new policy shift was reflected in a major decision by the IMF to pursue capital account opening as one of its operational objectives. A milestone in capital liberalization arrived with the achievement of Article VIII of the IMF in the early 1990s. Private capital inflows to the developing Asian countries began in the latter half of the 1980s and gathered momentum in the early 1990s (see Figure 1.1). The contribution of non-foreign direct investment (non-FDI) inflows, especially bank loans, in other investment inflows increased noticeably during this period (see Figure 1.2).

The push towards opening capital accounts, however, was subject to serious reconsideration following the onset of the Asian financial crisis (1997–98). The fact that the countries which succumbed to the crisis had for some years benefited from substantial flows of foreign capital, especially non-FDI in terms of bank loans, has raised questions about the role of capital inflows in creating the conditions that generated the crisis, or at least favoured its dissemination.