capital controls

Developing and emerging countries need capital controls to prevent financial catastrophe

A shorter version of this letter was published in the Financial Times on 25 March 2020.

All countries currently face the unprecedented threat of a simultaneous and global health crisis, economic recession and financial meltdown. But unlike rich nations, emerging and developing countries  (DECs) lack the policy autonomy needed to confront these crises. The global currency hierarchy places DECs in the periphery of global financial markets, exposing them to sudden stops caused by triggers such as the COVID-19 crisis. The US Federal Reserve announced it would lend up to USD 60bn to the central banks of Mexico, Brazil, South Korea and Singapore. But this is not enough. Immediate capital controls, coordinated by the IMF, are needed to prevent financial disaster.

In a global financial crisis, there is a rush to hold liquid assets denominated in safe currencies, especially US dollars. This enables rich countries to respond to crises with the necessary fiscal and monetary tools. The opposite is true for DECs. Since the outbreak of the COVID-19 crisis, international investors have withdrawn large sums from DEC assets, leading to dramatic currency depreciation, especially for those exposed to falling commodity prices.

Over the past decade, ample global liquidity driven by rich country central banks, alongside sustained demand for liquid assets, has led to enormous flows of credit and equity investment into DECs, where bond and stock markets grew from about 15 trillion to 33 trillion US dollars between 2008 and 2019. ‘Frontier economies’ and DECs corporations have issued substantial volumes of foreign currency debt. With G20 encouragement, DECs opened their domestic currency bond markets to international investors. In what has been termed the second phase of global liquidity, new financial instruments and institutions, such as international funds and exchange-traded funds (ETFs), have enabled easy global trading of DECs assets, cementing the illusion of liquidity.

DECs are now confronted with a sudden stop as global liquidity conditions tighten and investors flee from risk: exposure to DECs remains a high-risk/high-return strategy, to be liquidated in times of crisis. In consequence, DECs face severe macroeconomic adjustment at precisely the moment when all available tools should be used to counter the public health crisis presented by COVID-19: some countries may be forced to tighten monetary policy in an attempt to retain access to the US dollar, while fiscal action may be constrained by fear of losing access to global markets. Foreign exchange reserves are unlikely to provide a sufficient buffer in all countries. This would have profound consequences for the global economy: DECs, both in the G20 and beyond, are now far more important for global growth and markets than even a decade ago. The failure of a large sovereign or quasi-sovereign borrower could trigger significant contagion.

There is an urgent need for action to prevent this crisis reaching catastrophic proportions in DECs. Despite long-standing calls for action, there is still no international lender of last resort. The only instruments currently available are IMF lending and foreign exchange (FX) swap lines between central banks. IMF loans typically impose fiscal tightening, which would be disastrous under current conditions. The US Federal Reserve stands ready to provide US dollars to a handful of major central banks: among DECs, only Mexico can access Fed and US Treasury swap lines under NAFTA provisions, and South Korea and Brazil have just had their arrangements re-opened. But these ad-hoc arrangements exclude a large proportion of DECs’ need for dollar liquidity.

We call for decisive action to constrain the financial flows currently transmitting the crisis to EMs. Capital controls should be introduced to curtail the surge in outflows, to reduce illiquidity driven by sell-offs in DECs’ markets, and to arrest declines in currency and asset prices. Implementation should be coordinated by the IMF to avoid stigma and prevent contagion. FX swap lines should be extended to include more DECs, in order to ensure access to US dollars. Finally, we concur with recent calls for greater provision of liquidity by the IMF using special drawing rights (SDRs) but this must take place without the imposition of pro-cyclical fiscal adjustment.

The unfolding crisis is one of the most serious in economic history. We must ensure that governments can do everything possible to protect their citizens. In our globally integrated economy, coordinated action is needed to minimise the externally-imposed constraints on developing and emerging countries as they face the triple threat of pandemic, recession and financial crisis.

Organising Signatories

Nelson Barbosa, Sao Paolo School of Economics

Richard Kozul-Wright, UNCTAD

Kevin Gallagher, Boston University

Jayati Ghosh, Jawaharlal Nehru University

Stephany Griffith-Jones, Columbia University

Adam Tooze, Columbia University

Bruno Bonizzi, University of Hertfordshire

Daniela Gabor, UWE Bristol

Annina Kaltenbrunner, University of Leeds

Jo Michell, UWE Bristol

Jeff Powell, University of Greenwich


Adam Aboobaker, University of Massachusetts Amherst

Kuat Akizhanov, University of Birmingham and University of Bath

Siobhán Airey, University College Dublin

Ilias Alami, Maastricht University

Alejandro Alvarez, UNAM, México

Donatella Alessandrini, University of Kent

Jeffrey Althouse, University of Sorbonne Paris Nord

Carolina Alves, Girton College – University of Cambridge

Paul Anand, Open University and CPNSS London School of Economics

Phil Armstrong, University of Southampton Solent and York College

Paul Auerbach, Kingston University

Basani Baloyi, South Africa 

Frauke Banse, University of Kassel, Germany

Benoît Barthelmess, Le Club Européen

Pritish Behuria, University of Manchester

Kinnari Bhatt, Erasmus University Rotterdam

Samuele Bibi, Goldsmiths University

Joerg Bibow, Skidmore College

Pablo Bortz, National University of San Martín

Alberto Botta, University of Greenwich

Benjamin Braun, Institute for Advanced Study, Princeton

Louison Cahen-Fourot, Vienna University of Economics and Business

Jimena Castillo, University of Leeds, UK

Eugenio Caverzasi, Università degli Studi dell’Insubria

Jennifer Churchill, Kingston University, London

M Kerem Coban, GLODEM, Koc University, Turkey

Andrea Coveri, University of Urbino, Italy

Moritz Cruz, UNAM, Mexico

Florence Dafe, HfP/TUM School of Governance, Munich

Yannis Dafermos, SOAS University of London

Daria Davitti, Lund University, Sweden

Adam Dixon, Maastricht University

Cédric Durand, Université Sorbonne Paris Nord

Chandni Dwarkasing, University of Siena, Italy

Gary Dymski, University of Leeds

Ilhan Dögüs, University of Rostock, Germany

Carlo D’Ippoliti, Sapienza University of Rome

Dirk Ehnts, Technical University of Chemnitz

Luis Eslava, Kent Law School, University of Kent

Trevor Evans, Berlin School of Economics and Law

Andreas Exner, University of Graz

Karina Patricio Ferreira Lima, Durham University

José Bruno Fevereiro, The Open University Business School

Giorgos Galanis, Goldsmiths, University of London

Santiago José Gahn, Università degli studi Roma Tre

Jorge Garcia-Arias, University of Leon, Spain and SOAS, University of London

Alicia Girón – UNAM-MEXICO

Thomas Goda, Universidad EAFIT, Colombia

Antoine Godin, University Sorbonne Paris Nord

Gabriel Gómez, UNAM, México

Jesse Griffiths, Overseas Development Institute

Diego Guevara, National University of Colombia

Alexander Guschanski, University of Greenwich

Sarah Hall, University of Nottingham

James Harrison, Prof, University of Warwick

Nicolas Hernan Zeolla, National University of San Martin, Argentina

Hansjörg Herr, Berlin School of Economics and Law

Elena Hofferberth, University of Leeds

Jens Holscher, Bournemouth University

Peter Howard-Jones, Bournemouth University

Bruno Höfig, SOAS, University of London

Roberto Iacono, Norwegian University of Science and Technology

Stefanos Ioannou, University of Oxford

Andrew Jackson, University of of Surrey 

Juvaria Jafri, City University of London

Frederico G. Jayme, Jr, Federal University of Minas Gerais, Brazil

Emily Jones, University of Oxford

Ewa Karwowski, University of Hertfordshire

Y.K. Kim, University of Massachusetts Boston

Stephen Kinsella, University of Limerick

Kai Koddenbrock, University of Frankfurt

George Krimpas, University of Athens

Sophia Kuehnlenz, Manchester Metropolitan University

Ingrid Harvold Kvangraven, University of York

Annamaria La Chimia, University of Nottingham

Dany Lang, Université Sorbonne Paris Nord

Jean Langlois, Le Club Européen

Christina Laskaridis, SOAS, University of London

Lyla Latif, University of Nairobi

Thibault Laurentjoye, École des Hautes Études en Sciences Sociales (EHESS), Paris

Dominik A. Leusder, London School of Economics

Noemi Levy-Orlik, UNAM, Mexico

Gilberto Libanio, Federal University of Minas Gerais, Brazil

Duncan Lindo, Vrije Universiteit Brussel

Lorena Lombardozzi, Open University

Anne Löscher, University of Siegen, Germany; University of Leeds

Birgit Mahnkopf, Prof.i.R., Berlin School of Economy and Law

Pedro Mendes Loureiro, University of Cambridge

Victor Isidro Luna, UNAM

Andrew M. Fischer, Erasmus University Rotterdam

Jonathan Marie, Université Sorbonne Paris Nord

Norberto Montani Martins, Federal University of Rio de Janeiro, Brazil

Olivia Bullio Mattos, St. Francis College, New York, USA

Andrew Mearman, University of Leeds

Monika Meireles, UNAM

Thorvald Grung Moe, Levy Economics Institute

Lumkile Mondi, University of the Witwatersrand, South Africa

Thanti Mthanti, University of the Witwatersrand, South Africa

Susan Newman, Open University

Howard Nicholas, International Institute of Social Studies, Erasmus University Rotterdam

Maria Nikolaidi, University of Greenwich

Patricia Northover, University of the West Indies, Jamaica

Cem Oyvat, University of Greenwich

Oktay Özden, Marmara University, Turkey

Vishnu Padayachee, University of the Witwatersrand 

Rafael Palazzi, PUC-Rio, Brazil

José Gabriel Palma, Cambridge University and USACH

Marco Veronese Passarella, University of Leeds

Jonathan Perraton, University of Sheffield

Nicolás M. Perrone, Universidad Andres Bello, Viña del Mar

Keston K. Perry, UWE Bristol

Mate Pesti, UWE Bristol

Karl Petrick, Western New England University

Christos Pierros, University of Athens

Leonhard Plank, TU Wien

Jose Pérez-Montiel, University of the Balearic Islands, Spain

Hao Qi, Renmin University of China

Mzukisi Qobo, Wits Business School, University of Witwarsrand

Joel Rabinovich, University of Leeds

Dubravko Radosevic, University of Zagreb

Miriam Rehm, University of Duisburg-Essen

Marco Flávio da Cunha Resende, Federal University of Minas Gerais, Brazil

Lena Rethel, University of Warwick

Sergio Rossi, C University of Fribourg, Switzerland

Maria Jose Romero, Eurodad

Roy Rotheim, Skidmore College

Josh Ryan-Collins, UCL Institute for Innovation and Public Purpose

Alfredo Saad Filho, King’s College London

Lino Sau, University of Torino, Italy

Malcolm Sawyer. Emeritus Professor of Economics, University of Leeds

Anil Shah, University of Kassel

Dawa Sherpa, Jawaharlal Nehru University 

Hee-Young Shin, Wright State University

Farwa Sial, Global Development Institute, University of Manchester

Crystal Simeoni, FEMNET, Nairobi, Kenya

Engelbert Stockhammer, King’s College London

Ndongo Samba Sylla, Dakar

Carolyn Sissoko, UWE Bristol

Celine Tan, University of Warwick

Gyekye Tanoh, Accra

Daniela Tavasci, School of Economics and Finance, Queen Mary University of London

Andrea Terzi, Franklin University Switzerland 

Daniele Tori, Open University Business School

Gamze Erdem Türkelli, University of Antwerp

Esra Ugurlu, University of Massachusetts Amherst

Ezgi Unsal, Kadir Has University

Tara Van Ho, University of Essex 

Sophie Van Huellen, SOAS University of London

Frank Van Lerven, New Economics Foundation

Elisa Van Waeyenberge, SOAS University of London

Paolo Vargiu, University of Leicester

Luigi Ventimiglia, School of Economics and Finance, Queen Mary University of London

Apostolos Vetsikas, University of Thessaly, Greece

Davide Villani, The Open University and Goldsmiths, University of London

Camila Villard Duran, University of Sao Paulo

Pablo Wahren, University of Buenos Aires

Neil Warner, London School of Economics

Mary Wrenn, UWE Bristol

Joscha Wullweber, University of Witten/Herdecke

Devrim Yilmaz, Université Sorbonne Paris Nord

MMT meets Rey’s dilemma: a balance sheet view of capital flight (coming soon to an EM country near you)

Recently, a colleague emailed with the following set of questions: ‘a balance sheet approach to defending currencies. Do you know literature that explains in detail the globally interlocking balance sheets between central banks, commercial banks and what happens when a national government has to defend its currency? What is the role of national and foreign reserves and how do they travel these balance sheets in the process of trying to defend a currency? I came back to this question when discussing the Swedish fight to defend the Dollar-pegged Krona in the early 90s and the promise of MMT? Most particularly we wondered to what extent national governments can just issue Krona and use them to buy foreign reserves or what sets the limits exactly to this attempt?’

My MMT friends do have answers to these questions (and they do spend a lot of time defending MMT from critiques that it doesnt consider balance of payment constraints to monetary sovereignty). I thought I would answer these questions a la Minsky, with balance sheets, since that’s how I teach my undegrad students about exchange rate management in emerging/developing countries. I teach by setting those questions within the broader conversations about global liquidity, global financial cycles and Rey’s dilemma – independent monetary policy is only possible if countries manage capital flows (capital controls).

  1. Start with an economy in autarchy: central bank issues reserves to banking sector for settlement purposes (banks pay each other in reserves), banks lend, create bank deposits in the process.

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2a. Commercial bank borrows abroad from parent bank/interbank market (USD/EUR/JPY)

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(this scenario played out in Eastern Europe before Lehman, when foreign-owned banks would borrow from parent/interbank markets – ending up with the Vienna Initiative)

2.b Commercial bank funding via fx swap with non-residents

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Step 1 occurs where local banks are allowed to lend retail in foreign currency. If it looks like MMT 2.0, it is not exactly that – without legal restrictions, the only constraint on banks creating foreign money (eurodollars) is their foreign currency reserves (an exogenous money story a la monetarism).

Even with restrictions on the lending in foreign currency (skipping steps 1&2), banks typically intermediate non-resident demand for local currency bonds via fx swaps (see my paper here on growing appetite for EM securities as part of shadow banking reform agenda). This is big enough that BIS has recently proposed to approach fx swaps as missing debt. Note that this is a global liquidity story:  without capital controls, non-resident demand/bank borrowing abroad reflects funding conditions in US money markets (see Bruno and Shin’s risk taking channel of monetary policy).

3. Rey’s dilemma kicks in: central bank intervenes to stem currency appreciation (for mercantilist or macroprudential reasons)

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For this commercial bank, the central bank’s policy rate is no longer a binding constraint, since it obtains local base money (reserves) by selling its fx liquidity to the central bank, rather than in the local interbank money market. When interest rate differentials are significant, this eases cost of funding (in the macro literature, this is part of the debate on the effect of financial globalisation on the effectiveness of inflation targeting central banks).  It’s global liquidity, not domestic liquidity, that determines short-term money market rates.

4. To regain monetary control, central banks issue own debt.

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This operation is known as sterilisation: that is, ‘sterilising’ the impact of fx market interventions on domestic money market rates. Central bank issues own securities (or sells government bonds, or takes deposits) in order to absorb back the reserves it created when it paid for the fx liquidity it bought from banks. Note here that this does not solve Rey’s dilemma, since banks have full discretion over how much to place in central bank securities. Rather, for banks this is an attractive carry – borrowing cheap abroad, placing it in risk-free local securities (banks can hedge fx risk).

If you think this is a theoretical exercise, think again.

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5. The limits to monetary sovereignty: global liquidity conditions tighten, capital flight ensues.

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In step 1, non-residents sell local securities – potentially triggering liquidity spirals if large, unregulated local repo market exists.  Note that by step 5, local banks with no direct links to global finance also start to suffer as interbank liquidity tightens. Cant the central bank mitigate this by reverse sterilisations, that is, by again insulating fx market interventions from domestic money market dynamics? The lessons from the 1997 Asian crisis, according to the IMF, is to segment domestic money markets, that is, to prevent local banks from lending to (non-resident) speculators:

Because a speculative attack requires the establishment of a net short position in the domestic currency, countries have employed a number of tactics to raise the costs of short positions. When sterilized intervention fails to stem capital outflows, short-term interest rates are allowed to rise, tightening conditions in financial markets and making it more costly for speculators to obtain a net short position by borrowing domestic currency. Frequently, however, an increase in short-term money market rates is transmitted quickly to the rest of the economy; it may therefore be difficult to sustain for an extended period, especially if there are weaknesses in either the financial system or the nonfinancial sector. When high short-term interest rates impose an unacceptable burden on domestic residents, countries may “split” the markets for domestic currency by requesting that domestic financial institutions not lend to speculators. Foreign exchange transactions associated with trade flows, foreign direct investment, and equity investments are usually excluded from such restrictions. In essence, a two-tier system is created that prevents speculators from getting domestic credit while allowing nonspeculative domestic credit demand to be satisfied at normal market rates. (IMF 1997)

Even if the central bank successfully protects local banks  from cross-border volatility triggered by global financial cycles, it can only defend the currency to the extent that it has foreign reserves. It will most likely not wait until it runs out. In the happy scenario, it draws on its swap lines to weather capital flight – but few central banks have that luxury (and ask yourself, how many will actually have it when Donald Trump needs to be consulted on this). The worst case scenario:  IMF/Troika/whoever will lend  – with heavy conditionality.