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FINANCE: Ahead of G-20 Summit, Capital Controls Gain New Currency

Marwaan Macan-Markar

BANGKOK, Nov 5 2010 (IPS) - South Korea’s closing of ranks with Asian countries that have recently embraced capital controls signifies that such measures will be up for discussion at next week’s summit of the world’s 20 major economies in Seoul.

This move by South Korea, on the eve of the G-20 summit on Nov. 11-12, reflects Asian economies’ worries about the pressure on their currencies – and their financial sectors – caused by the disruptive flood of short-term foreign capital in recent months.

The imposition of capital controls by Thailand, Taiwan, China, South Korea and Indonesia gives new legitimacy to what was seen after the 1997 economic crisis as a radical measure that undermines free-market policies. South Korea itself was among the countries badly hit by that crisis.

“The government believes it needs to turn away from the perception that controlling capital flows is always bad and consider introducing measures to improve the macroeconomic prudence,” South Korea’s ministry of strategy and finance said in a Nov. 4 statement.

Indeed, “several developing countries are countering excessive capital inflows (and pressures for currency appreciation) either by intervention in the currency market, or by capital controls such as taxes on certain types of foreign capital entering the country,” wrote Martin Khor, executive director of the South Centre, a Geneva-based developing world think tank, in a recent commentary.

“The governments concerned have a good case when they argue that these measures are needed to protect their countries from the damaging effects of speculative capital inflows, and that they are not manipulating their currencies,” he added in his assessment made after the October meeting of G-20 finance ministers and central bank governors in South Korea.

Thus far, several Asian economies have imposed different forms of capital controls to deal with the unsettling impact of huge amounts of capital coming from developed economies.

In October, the Thai government introduced a 15 percent tax on short-term inflows into its bond market. Earlier in June, Indonesia introduced what financial analysts describe as a “quasi-capital control measure” by making short-term investment less attractive to foreign funds.

The South Korean government has moved to stabilise the won by limiting assets accessible to foreign capital, while Taiwanese officials have made some bank deposits off limits to foreign investors.

Asian economies hope these measures can manage the capital inflows that they have been receiving and putting pressure on their currencies, driving their appreciation and prompting exporters to cry foul.

The Japanese yen has appreciated the most, reaching a 15- year high against the U.S. dollar in August, followed by the Thai baht, whose appreciation in October hit a 13-year high against the dollar, media reports say.

Under renewed pressure to address the perceived undervaluation of its currency, China has allowed the yuan to appreciate by more than 2 percent since June. Financial experts predict continued pressure on Asian currencies in the near future.

It is actually these Asian economies’ financial health following the global financial crisis, which began in late 2008 in the United States, that is helping prompt this West- to-East capital flight.

“Asian economies are back on track. They are the world’s growth driver, the emerging centre of economic gravity,” says Nagesh Kumar, chief economist for the Economic and Social Commission for Asia and the Pacific (ESCAP), a Bangkok-based U.N. regional body. “The massive inflow of short-term capital reflects the confidence in the region’s emerging markets.”

“Even at the height of this crisis, Asia and the Pacific displayed a newfound resilience,” stated ESCAP in its annual ‘Economic and Social Survey of Asia and the Pacific 2010’. “Its developing economies achieved an annual growth rate of four percent, making it the fastest-growing region in the world.”

Such impressive numbers, heavily shaped by China’s GDP growth of 8.7 percent and India’s 7.2 percent in 2009, has ESCAP forecasting that the region’s developing economies will grow by 7 percent in 2010 compared to 4 percent in 2009, “led by the self-sustaining motors of China, growing at 9.5 percent, and India at 8.3 percent”.

But amid concerns by Asian economies that their excessive liquidity would lead to inflationary pressure, asset price bubbles and job losses in the export sector, they are turning to capital controls as their rallying cry.

In fact, in the run-up to the G-20 summit, ESCAP convened a meeting of its over 50 member states to support the use of such controls. “The message we sent was that the G-20 should support member states to use mechanisms to control capital flows,” Kumar told IPS. “Capital controls will protect the countries against currency appreciation and will help moderate the volatility of capital inflows, which are causing the problems.”

Even the International Monetary Fund (IMF), at one time a resolute opponent of such intervention, has been warming up to the idea of capital controls. In 2010, an IMF study praised its role in reducing the impact of the global economic crisis on the developing world.

This rethink by the IMF marks a dramatic shift from its position in the wake of the 1997 Asian financial crisis, when it opposed then Malaysian Prime Minister Mahathir Mohamad’s use of capital controls to protect the Malaysian currency and economy.

Mahathir was vindicated after his country became the first success story to rise out of South-east Asia’s economic meltdown. Indonesia and Thailand, which went with IMF prescriptions that avoided capital controls and included strict austerity measures, suffered longer.

Yet some caution against a rush toward capital controls. “This is a global issue, a systemic issue. If many countries introduce capital controls, where will this global liquidity flow?” asks Masahiro Kawai, head of the Asian Development Bank Institute, a Tokyo-based think tank for the regional financial institution.

“It is not a global solution; capital controls may be okay for smaller economies,” Kawai said in a telephone interview from Manila. “This global liquidity has to be neutralised. And many countries must allow their currencies to appreciate in an equal and even way.”