Are price-based capital account regulations effective in developing countries?

Abstract

In this article, we evaluate the effectiveness of policy measures adopted by Chile and Colombia aiming to mitigate the deleterious effects of pro-cyclical capital flows. In the case of Chile, according to our GMM analysis, capital controls succeeded in reducing net short-term capital flows, but did not affect long-term flows. As far as Colombia is concerned, the regulations were capable of affecting total flows and also long-term ones. In addition, our cointegration models indicate that the regulations did not have a direct effect on the real exchange rate in the Chilean case. Nonetheless, the model used for Colombia did detect a direct impact of the capital controls on the real exchange rate. Therefore, our results do not seem to support the idea that those regulations were easily evaded.

Notes

¹In mid-1995, for instance, the controls were extended, especially to secondary market ADRs and portfolio flows in order to close loopholes and make the regulations more restrictive Nonetheless, it is widely recognized in the literature that after those extensions FDI became a channel for the entrance of portfolio flows, which suggests an element of mere change of labels regarding the composition of flows. Despite this fact, there is no evidence that evasion of the capital account regulations was not merely marginal. Gallego et al. (2002) estimate that in the whole 1991 to 1998 period, the total reserve deposit implied by the URR was on average 1.9% of Chile's GDP.

²In order to obtain a rough estimate of the importance of US capital flows to Chile, consider that bank loans from the US amounted to 46% of total bank loans to Chile in 1994 according to BIS data and between 1990 and 1999, an average of 49.1% of Chilean long-term debt was denominated in US dollars according to World Bank's GDF data. In addition, 24.5% of total bank loans to Colombia originated in the US in 1994 according to BIS data and 57.5% of Colombia's total long-term debt was denominated in US dollars on average during 1990 to 1999 period, according to the World Bank's GDF dataset.

³In addition, regarding the data on short-term flows, one has to note that ‘Banks include their liabilities and claims on foreign branches and other affiliates that arise out of normal banking business; brokers and dealers exclude items that represent inter-company balances. Also excluded from all respondents' reports are direct investments, positions arising from equity securities and debt issues with original maturity of more than one year, contingent items; and off-balance sheet contracts, including unsettled spot and forward foreign exchange contracts, options, and warrants’ (see the TIC website at www.ustreas.gov).

⁴Some authors tried to take into account the fact that players in financial markets will try to evade the regulations imposed and therefore, the restrictions would ‘loose power’ some time after implemented. De Gregorio et al. (2000) and Gallego et al. (2002) constructed an index that takes the value of 1 each time a new regulation is implemented (or the scope of previous regulations extended) and decays thereafter. The rate of decay chosen is purely arbitrary in those cases.

⁵The results reported are robust to different definitions of the tax equivalent.

⁶The sample period was chosen to ensure that we use data over a single policy regime (to avoid structural breaks) and because of data availability.

⁷Once again, the sample period was chosen because of data availability and to avoid structural breaks.

⁸One has to bear in mind that it is important to estimate the cointegration relationships using data from a single macroeconomic policy regime, since it is likely that the parameters of the cointegration relationship would be unstable otherwise. There is a serious risk of inconsistency of estimates when the wrong cointegration relationships are imposed, since imposing wrong cointegration parameters will make the system converge to an incorrect equilibrium in the long-run and also bias short-run dynamics.

⁹In order to account for the move towards a floating exchange rate regime.

¹⁰The critical values were 43.7 and 97.2, respectively, indicating rejection of the null hypothesis of no co-ntegration at the 5% level. The null of at most 1 cointegration relationship was not rejected (critical values 24.8 and 53.5).

¹¹The critical values were 42.9 and 91.1, respectively, indicating rejection of the null hypothesis of no cointegration at the 5% level. The null of at most 1 cointegration relationship was not rejected (critical values 22.9 and 48.1).