IMF trend of 1990s
reverses:
Emerging market economies cut interest rates, impose capital controls
By Jon Fernquest
Thailand made the news after capital controls were imposed in the wake of the 2006 coup (Read articles and background
information).
Before Thailand in 2006, Malaysia and Chile were the countries most
famous for imposing capital controls. Similar to the situation that emerging market economies face today, Malaysia imposed capital controls to keep foreign investment (capital) from flowing out of the country. This would have caused the currency to devaluate which in turn would make repaying foreign debt even more expensive and difficult because the currency would have been worth less.
Thailand in 2006 and Chile before that imposed capital controls because they faced currency appreciation that threatened to make their exports uncompetitive on world markets.
Recently there has been debate over whether the Bank of Thailand (BOT) should cut interest rates or not. If the BOT decides to cut interest rates by much, it may have to impose capital controls also. Capital controls are the only way a country can cut interest rates safely when foreign investment funds are leaving the country.
Imposing capital controls may leave "panic-stricken foreign investors struggling to get out." During the 1990s the IMF forced crisis-hit emerging economies like Thailand to hike interest rates. This in turn attracted foreign investment but also pushed these economies into a recession. Interest rate cuts now would aim at preventing a recession.
Foreign investors have already anticipated the possibility of capital controls. There have been record capital outflows from emerging markets recently. This is one of the main reasons why emerging market stock exchanges have lost half their value since May. Part of this outflow is due to the fear of having funds trapped by capital controls.
As the global financial crisis spread, Iceland was the first small open economy to cut interest rates and impose capital controls: "foreign currency in the country is tightly controlled, with firms limited to purchases of essentials such as food, fuel and medicine. A daily foreign exchange auction to set value to the crown [Iceland's currency] has so far only been attended by local banks -- now almost all under government control."
Other countries with large current-account deficits or debt refinancing problems have had problems. Notably, Ukraine, Hungary and South Africa have been affected. Russia has closed its stock markets for short periods after extreme volatility Taiwan has tightened the daily limit that stock prices are allowed to fall.
Vocabulary:
capital controls - controlling investment money flowing in and out of a country (See Wikipedia)impose capital controls - when a government starts using capital controls (through regulations or a law)
in the wake of Y - after the event Y
currency appreciation - when a country's currency becomes worth more (this in turn makes exports cheaper and more competitive on world markets)
currency depreciation - when a country's currency becomes worth less (this in turn makes exports cheaper and more competitive on world markets)
devaluate a currency - take steps to make a currency worth less (depreciation)
exports uncompetitive on world markets - when a country's exports are either more expensive or of less quality than other countries
panic - a sudden strong feeling of fear and confusion (See glossary)
panic-stricken - experiencing panic, hit by panic, having a panic attack
emerging market economies - economies which are developing but are not fully industrialized and prosperous (See Wikipedia)
a recession - a period of time during which an economy has slow or negative economic growth, the general price level is also often falling (deflation) (See Wikipedia)
an open economy - an economy which has extensive and largely unimpeded transactions with other countries, a closed economy that imposes severe trade restrictions (See Wikipedia)
essentials - the important basic things that are needed for daily living (food, clothes, shelter)
volatility - when some value like a price moves suddenly and unexpectedly by large amounts