How Effective are Capital Controls in Asia?: Thailand Case Studies The presentation is based on the paper entitled “How Effective are Capital Controls in Asia? Maria Socorro Gochoco-Bautista (ADB) Juthathip Jongwanich (SOM, AIT) Jong-Wha Lee (Korea University) Available at ERD Working Paper Series No. 224 Juthathip Jongwanich School of Management (SOM) Asian Institute of Technology (AIT)

Introduction The global financial crisis of 2008 leads to the revival of the debate on the role capital control in ensuring macroeconomic and financial stability. In particular, the strong and quick recovery of emerging Asian countries results in noticeable capital inflows into the region. There are fear that capital inflows will inundate Asia and threaten currency, and macroeconomic and financial stability. Particularly, currency appreciation leads to a debate between exporters and policymakers

Central banks in the region closely monitor capital flows movements, intervene in FX market, and some introduce new measurement of controls (IMF itself now appears to be taking a more nuanced position) Most central banks encourage residents to invest abroad to reduce the pressure of currency appreciation (early 2000s). However, whether the controls would be effective is still unclear

Objective of the presentation We aim to examine the effectiveness of capital controls, which had been introduced in Thailand since the early 2000s. – Effective in terms of Control capital inflows Reduce pressure on (real) currency appreciation

In fact, there are two parts in the paper In the first part, we examine the effectiveness of capital controls for 9 emerging Asian countries (i.e. China, HK, India, Indonesia, Korea, Malaysia, Philippines, Singapore, and Thailand), using panel estimation. – The capital control is based on Schindler (2009), that use IMF’s Annual Report on Exchange Rate Arrangements and Exchange Restrictions (AREAER) to conduct “capital control index”

In the second part, we examine two case studies in-depth. - Forms and effectiveness of capital control measures differ greatly across Asian economies. - All cross-country studies are based on annual data analysis, limiting capturing the effects of changes in capital restriction policy to a year. - Malaysia and Thailand are chosen because of their contrasting capital account policies after the early 2000s. Thailand introduced a number of capital inflows restrictions since 2003 while encourage capital outflows from Thai residents. Malaysia, which introduced strict capital control measures during the Asian crisis, has gradually lifted the restrictions.

Outline of the Presentation Movements of Capital Flows Brief literature survey Capital control indexes Empirical model Results Conclusions and policy inferences

Figure 1: Financial Account Flows (% of GDP), Emerging Asia

$13.2, $6.3

2.5 billion$

% of Nominal (/US$) appreciation (- appreciation) (Jun05-July07)REER (2009- Sep 2010)REER (2010- Sep 2010) China Chinese Taipei Hong Kong Indonesia Korea Malaysia Philippines Singapore Thailand

% of REER appreciation (+ appreciation) (Jun05-July07)REER (2009- Sep 2010)REER (2010- Sep 2010) China Chinese Taipei Hong Kong India Indonesia Korea Malaysia Philippines Singapore Thailand

Literature There are four key reasons to introducing capital control measures – Reduce the volume of capital inflows and alter the composition of flows in favor of longer maturities – Reduce real currency appreciation – Reduce the degree of nominal and real exchange rate volatility – Give monetary authorities the ability to implement more independent monetary policy

Capital controls can be classified into two broad measures – Administrative or direct controls (intend to affect the volume of cross-border transactions by imposing administrative obligation) The use of outright prohibitions on the transfer of funds and associated payments Explicit quantitative limits or approval procedures - Indirect or market-based control (work on the price or volume of a financial transaction or both by increasing costs of transaction) Tobin tax (explicit tax) Implicit tax (reserve or deposit requirement at the central bank, URR) Multiple exchange rate system

Example of Capital Controls on Inflows, 1990s Direct measuresIndirect measures Brazil Direct control (prohibition of nonresident purchases of money market securities and nontrade- related swap transactions with nonresidents Explicit entrance tax Chile URR Colombia URR Malaysia1994 Thailand Multiple FX

The evidence is mixed as regards the effectiveness of capital controls – Ariyoshi et.al (2000): controls were only temporarily able to drive wedge between foreign and domestic interest rate and to reduce pressures on the exchange rate in Brazil, Chile, Colombia, Malaysia and Thailand in the 1990s – Cardenas(2007): controls did not have an independent effect on total net private capital inflows – Galindo (2007) and Concha and Galindo (2008): controls had a temporary effect on net private capital inflows but not on the real exchange rate Measures, timing and country-specific matters

Control Measures in Thailand, 2000s 2000 August - DecemberMeasures to limit capital inflowse.g. limit baht credit to non-residents 2002 September Encourage residents to invest abroad e.g. increase limit for purchasing immovable assets increase limit for purchasing foreign shares 2003 September and OctoberMeasures to limit capital inflows e.g. Onshore financial institutions are required to limit the total daily outstanding balance of nonresident baht accounts to no more than B300 million per nonresident 2005 April and December Encourage residents to invest abroad e.g. investment in securities abroad by institutional investors is relaxed and increase limit of Thai direct investment and lending to a business abroad 2006 April-December Encourage residents to invest abroade.g. Relax investment securities abroad; Measures to limit capital inflows e.g. 30% URR (1 year --- or 2/3 will be refunded) 2007 January - December Encourage residents to invest abroad e.g. increase amount of thai direct investment Relax capital inflows restrictions Option to apply for URR or hedge against FX risks 2008-Feb 2010 Encourage residents to invest abroad e.g. increase amount of FDI and lending abroad Relax capital inflows restrictionse.g. lift URR (Feb 2008)

The Capital Restriction Indexes Capital restriction indexes are constructed based on the information from notifications, press releases and speeches related to foreign exchange and capital account (published formally by the central banks). Measures are conducted by different asset types Net capital inflows (liabilities) Net capital outflows (assets) FDI Port-folio (equity + Debt) Other investment (bank loans) FDI Port-folio (equity + Debt) Other investment (bank loans)

1. Assign two dummy variables as follows: + 1 is assigned to any measure that relaxes inflows and facilitate outflows (regardless who conduct the flows, residents or non-residents) - 1is assigned to any measure that restricts inflows as well as outflows (regardless who conduct the flows, residents or non-residents) 2. Weight is assign to the regulations. Weight is set between 0-2 and the higher the number the severity of the restrictions on key variables is expected. The key criteria for applying the weight is as follows: Regulations which are involved with the money: 1.< US$ 5 million = US$ 5 million - US$ 10 million = US$ 11 million - US$ 50 million= > US$ 50 million = 2.0 Note that if the regulators just changed the scope of activities (+ types of investors) involved from the previous regulations, the weight is assigned only

Words criteria - URR/ Tax/prohibit/lift = Request/require/allow/relax = Provide option/flexibility/seek for cooperation = The numbers are sequentially accumulated overtime to arrive at the indexes for each asset class (examples)

Example net inflows (Thailand) Measures (net inflows --- Securities) +1/-1Weight 2003Sep The amount of Thai baht that on-shore financial institutions can borrow short-term from non-residents without underlying trade or investment is limited to no more than 50 million baht Nov The Bank of Thailand seeks cooperation from financial institutions not to issue and sell Bill of Exchange in Baht for all maturities to non- residents. 0.5 Dec All foreign transactions, except those related to trade in goods and services, repatriation of investment abroad by residents and FDI, are required to deposit 30% of foreign exchange with BOT as an URR. 30% of capital will be refunded after funds have remained within Thailand for a period of one year. If funds are repatriated before one year, only two-third of the amount will be refunded Jan The BOT provides additional option for the following inflows to either withhold URR or to hedge against FX risks Feb URR measures are lifted 12 The rule for domestic financial institutions' baht borrowing from nonresidents is revised, reducing the limit for transactions with no underlying trade for all maturities to no more than B10 million outstanding balance per group of nonresidents. Thai baht liquidity by domestic financial institutions to nonresidents is limited to no more than B300 million

Measures (net outflows --- Securities)+1/-1Weight 2003July Institutional investors are allowed to invest more in foreign securities and their establishment of mutual funds to invest in Asian bond is promoted. Total amount was limited US$ 500 million in Soveriegn or Quasi-soveriegn debt securities April The BOT relax investment in securities abroad by institutional investors (6 Institutions). In addition to debt securities, the BOT extended to include investment units issued by foreign mutual fund (- --- limit not more than US$ 1500 million) April The BOT relax investment in securities abroad by institutional investors (6 Institutions). In addition to debt securities, the BOT extended to include investment units issued by foreign mutual fund (- --- limit not more than US$ 2,000 million) August Increase types of institution investors by allowing juristic persons that are registered under Thai law with assets of at least Baht 5,000 million to invest in securities abroad 10.5 Example net outflows (Thailand)

4. Re-weight and adjust all the index to lie between 0 and 1 by 1 = liberalization 0 = Restrictions Note that the weight is recalculated to be comparable across asset types and periods. This is applied for both ‘net inflows restrictions’ and ‘net outflows restrictions’. 5. To be able to compare with IMF control index, the index is adjusted by 1 = Restrictions 0 = Liberalization Note that for total control index, we use both simple average and weighted average (results are not much different)

Thailand

Our indexes differ from IMF (Schindler (2009)) Thailand

Key variables in the VAR Model Capitals (seasonally adjusted) are divided into - net inflows (total) and - net outflows (total) (Increases show more movement of capitals) Both net inflows and outflows are disaggregated into - FDI; - port-folio (equity and debts) and - other investment (bank) The data are from Exo: G3GDP and Shareprices

Capital restriction indexes (our indexes lie between 0 and 1) – The higher the value, the increase the restrictions Real Effective Exchange Rate (both BOT and BIS) - Increase reflects appreciation Real interest rate differentials -The difference between the Thai policy rate and the US 3-month Treasury bill rate, each adjusted by CPI inflation (sensitivity for choices of interest rates) Manufacturing production index (BOT, 2000=100) (sensitivity for realGDP)

(a) Total net capital inflows(b) Real exchange rate Impulse Responses of Key Variables to Capital Inflows Restriction: Thailand (c) inward FDI (d) Net equity flows (e) net debt security inflows (d) other investment

Total net capital outflows**(b) Real exchange rate Manufacturing production index** (d) Outward FDI** (e) Net portfolio outflows (f) Other investment outflows Impulse Responses of Key Variables to Capital outflows Restriction: Thailand

Malaysia (a.1) Liability(a.2) Assets

Malaysia

(a) Total net capital inflows(b) Real exchange rate(c) Real GDP (seasonally adjusted) (d) Inward FDI**(e) Net port-folio inflows**(f) Other investment Impulse Responses of Key Variables to Capital Inflows Restriction in Malaysia

(a) Total net capital outflows(b) Real exchange rate(c) Real GDP (seasonally adjusted)* (d) Outward FDI (e) Net port-folio outflows(f) Other investment Impulse Responses of Key Variables to Capital Outflows Relaxation in Malaysia

Conclusions and Policy Inferences Restrictions have no significant effect on net inflows but especially effective for net outflows, especially FDI Switching effect makes the controls (debts and bank) become less effective Because of this, the effectiveness of controls on RER is limited. (FDI makes RER appreciation) Design of capital control matters for their effectiveness Controls are temporary and have a negative impacts on MPI

Encouraging outflows are more effective, especially FDI. Insignificance for other flows could be because of home bias Under current situation, capital flows have begun to show its effect >= current account since 2010Q2. Baht appreciation: reduce volatility + find the reasons why most of exporters do not hedge Closely monitor capital inflows --- concerns on stability of financial market (well design controls matter)

Similarity Index (with Thailand) ChinaHKIndiaIndonesiaMalaysia PhilippinesKoreaSingaporeVietnamSrilanka