Sequencing Of Capital Account Liberalization In Developing Countries

AbstractThe explosive growth of international financial transactions and international capital flows is one of the single most profound and far-reaching economic developments of the late twentieth and early twenty-first centuries. The financial deregulation and innovation as well as other forces have made the free capital movements across aboard an irreversible trend. Capital account liberalization, and financial liberalization more generally, is essentially inevitable for all countries wishing to take advantage of the substantial benefits of broad participation in the open world economic system in this modern age of technology and communications. While the industrial countries as a whole liberalized their capital account by 1995, most developing and transition economies are still in the experimental process of liberalizing. Among them, China has liberalized its current account but still maintained its extensive restrictions on capital account transactions. Given the barriers from existent domestic trade and banking system, capital market and legal infrastructure, the liberalizing of capital account may remain the core of financial reform in the foreseeable future.The combination of theoretical and practical methods has been adopted in several chapters throughout the research paper. The paper first makes a contrast analysis between the capital control and capital liberalization, indicating the positive and negative influence each one may cause. Then the whole process of liberalization in two typical countries is examined, of which general rule is drawn out for the emerging economies. Finally, the rule is applied to China in quest for the appropriate approach China can take with respect to international financial liberalization.The structure of the paper is as follows:Chapter 1 "Recent trends in capital flows". The paper starts from the recent trends in capital flows since 90's,and elaborates on the role of technology in stimulating the growth of international financial transactions. It documents the far-reaching consequences of these developments.Chapter 2 "Capital liberalization vs. Capital control". This section examines what economic theory has to say about the benefits and costs of capital mobility and capital control. It concludes with the observation that, despite experiences with serious financial crises in a number of cases, the decisions of many countries to proceed with financial liberalization are important evidence that such liberalization, including capital account liberalization, is generally beneficial when carried out under appropriate safeguards.Chapter 3 "Lessons from the experiences in Chile and Thailand". The paper assess countries' practical experience with capital account liberalization by reviewing studies of the effects of capital account convertibility on economic growth, cyclical stability, and susceptibility to crises. This leads to the question of how to liberalize the capital account in an appropriate way.Chapter 4 "Sequencing of capital account liberalization in developing countries". This chapter discusses the key issues in capital account liberalization, such as models, preconditions, order and macroeconomic policies, which makes itself the emphasis of the whole paper.First, it describes the two models of liberalization: Cold Turkey and Gradualism, and concludes that the later should be adopted by those developing countries. Then, it lays out the preconditions of sequencing. Those are a sound macroeconomic policy framework, strong domestic financial system and timely,accurate and comprehensive data disclosure. It also discusses the optimal order of the liberalization, which Ronald Mckinnon concluded as Finance control→domestic finance liberalization→Foreign exchange liberalization. Third, it focuses on the role of policy under the capital mobility, mainly the sterilization, floating exchange rate and taxes and tax equivalents. The core question is what prudential measures are necessary to limit systemic risks that may arise more easily i...