7 - Effectiveness of Capital Controls: Evidence from Malaysia and Thailand

Summary

Capital liberalization have been implemented in most emerging Asian countries since the late 1980s. Restrictions have been gradually phased out during this period with the aim of enhancing a country's capacity to derive benefit from capital flows. However, the evidence related to the impact of such liberalization over the past two decades has led to doubts about the scale of the net gains of such policy in capitalreceiving countries. Particularly, it has been blamed as a key factor precipitating the boom and bust cycle experienced in many emerging countries, including the sudden reversal of capital inflows inherent in the Mexican crisis of the early 1990s and Asian financial crisis in the late 1990s.

In the early 2000s, capital inflows gathered momentum again in emerging countries worldwide, including Asia. Central banks in many countries re-introduced capital restrictions to guard against the build-up of inflows, while preserving their monetary autonomy and extensively intervening in foreign exchange markets. For example, in Thailand, the unremunerated reserve requirement on fixed income flows was introduced in September 2006 after unsuccessful measures to limit the build-up in non-resident holdings of baht accounts had been taken place in 2003. Chinese authorities restricted the borrowing of dollars by foreign bank branches in the People's Republic of China (PRC) in September 2006. Such a restriction was also introduced in Korea and India in April and August 2007, respectively.

Over the past two decades, a number of empirical studies have examined the effectiveness of capital account policies introduced in emerging countries, but the results are still mixed and vary according to the particular countries and periods sampled. Tamirisa (2004), for example, shows that capital account policies introduced in Malaysia during the Asian crisis could help the central bank to gain monetary autonomy. By contrast, Edison and Reinhart (2001) revealed evidence of the ineffectiveness of capital control policy in Thailand in 1997, whereas Coelho and Gallagher (2010) found that capital controls introduced in the 2000s were modestly successful in reducing the overall volume of inflows in Thailand.