Why do emerging markets liberalise capital-outflow controls? Fiscal versus net capital flow concerns

Joshua Aizenman, Gurnain Pasricha

02 May 2013



Recent years have seen a re-emergence on the capital controls policy debate:

  • Opponents of capital controls argue that they lead to the local and global misallocation of resources, perpetuate global imbalances (by allowing countries to maintain undervalued real exchange rates), encourage corruption and that they have been found to be of limited effectiveness in reducing the size of net capital inflows.
  • Proponents of capital controls have argued that capital controls are macroprudential measures. They are deemed to be an important tool in preventing the buildup of financial-sector risks and in reducing the damage associated with sudden stops.1

Most notably, the IMF softened its longstanding opposition to capital controls, now suggesting that such controls may be a valid tool of macroeconomic and macroprudential management when other tools have been exhausted, as outlined by Blanchard and Ostry (2012).

What’s missing from the debate?

The debate on what emerging economies should or should not do has two key missing elements:

  • A fact-based analysis of the macroeconomic and financial pressures to which emerging markets' policymakers most often respond when imposing capital controls.2
  • The potential use of capital-outflow controls in response to net capital inflows pressures.3

Because net capital inflows are the difference between capital inflows and outflows, countries that have existing outflow controls have another potential tool to reduce net capital inflows: the liberalisation of outflows.4 This tool was discussed in the literature on managing capital flows in the 1990s, but it has been missing from the recent debate. Research in Pasricha (2012) documents that in 22 emerging-market economies between 2004 and the onset of the 2008 financial crisis, outflow controls were liberalised more frequently than inflow controls were tightened. The pre-2008 crisis period saw a surge in net capital inflows to emerging-market economies of a magnitude comparable to the post-2008 crisis surge, yet inflow tightening measures became a primary tool of restricting net capital inflows only after the crisis (Figure 1).5

Figure 1. Number of outflows easings peaked in 2007, along with net capital inflows

Note: Net capital inflows/GDP is the unweighted sum of NKI to the 18 EMEs in sample divided by the unweighted sum of their nominal GDPs. Net outflows easings are the number of easings of outflows less number of tightening of outflows. Net NKI restricting measures are the sum of net outflows easings and net inflows tightenings. For more details, see our working paper.

The use of outflow liberalisation in net capital inflows management policy is constrained by the fact that outflow controls exist not only for reasons of managing capital flows but also to reduce fiscal pressures. Sustained capital-outflow controls allow governments to lower the domestic cost of borrowing for themselves and for their preferred sectors by keeping domestic savings at home. Controls on outflows facilitate the use of other measures constituting ‘financial repression’ (such as interest-rate ceilings, high reserves requirements, etc.) by preventing capital flight in response to these restrictions. This allows governments to further depress their borrowing costs. The revenues from financial repression can be substantial, as shown by Giovannini and de Melo (1993).6

In Aizenman and Pasricha (2013), we examine the various macroeconomic and fiscal factors that were at play when outflow controls were liberalised. To accomplish this, we have built up two novel datasets:

  • First, we extend the dataset presented in Pasricha (2012) to cover the period 2001-2010.

This dataset comprises all changes in capital account regulations in 22 large emerging-market economies and provides a de jure assessment of capital controls.

  • Second, we estimate the revenue from external financial repression that, following Giovannini and de Melo (1993), is defined as the fiscal revenue obtained by preventing residents from freely investing abroad.

It is measured as the difference between (effective or ex-post) external and domestic interest rate on government debt. Our updated measure of external repression revenues is available for 15 countries.7

External repression revenues in the 2000s

We find that in contrast to the 1980s, when many emerging-market economies were found to be earning significant revenues from external repression (averaging 1.4% of GDP), emerging-market economies in the most recent decade earned negative (and statically insignificant) revenues from external repression on average (Figure 2).8

Figure 2. Mean external repression revenues, % of GDP

Notes: The 1980s mean is from Giovannini and De Melo (1993) and covers the countries in their sample that overlap with ours. The 1980s values are in fact over those years between 1974 and 1987 for which the Giovannini and de Melo estimates are available. The 1990s estimates are for the years 1995-99, or the years for which data for each country is available. Repression revenues including debt revaluation costs incorporate the impact of exchange-rate changes on the principal repayable in computing the effective external-interest rate. Repression revenues excluding debt revaluation costs only incorporate the impact of exchange-rate changes on interest payable in computing the effective external-interest rate.

The negative revenues imply that emerging-market economy governments faced lower borrowing costs in foreign markets (even after accounting for costs imposed by exchange-rate fluctuations) than in the domestic market. The decline in external repression revenues has occurred despite the fact that emerging economies continue to maintain significant restrictions on capital outflows (notwithstanding liberalisations over time).

There are several interpretations of the negative external repression revenues found in our study. An emerging-market economy government with positive revenues from repression may stand to lose those revenues by liberalising outflows to manage the concerns posed by surging net capital inflows, but may find it easier to do so when there are no fiscal revenues to be lost. In fact, net capital inflows did liberalise outflow policy substantially in the 2000s. Most of the outflow liberalisations took place in the years of surging net capital inflows (putting downward pressure on domestic interest rates) and rapid economic growth (leading to increasing fiscal revenues from other sources), which suggests that fiscal concerns did not pose a binding constraint for emerging-market economies in this period. Another interpretation of the negative external repression revenues is that, while many of these emerging-market economies could have borrowed even more in markets abroad in the last decade, they refrained from doing so. That they chose not to borrow more abroad even at favourable interest rates may reflect concerns about greater balance-sheet exposure (as most can borrow only in hard currencies) and the fear of a sudden stop. Finally, emerging markets may be willing to temporarily accept negative repression revenues to preserve the future repression tax base.

The importance of fiscal versus net capital inflows in determining outflow policy

Concerns related to net capital inflows took predominance over fiscal concerns in the decision to liberalise capital-outflow controls in the 2000s. This argument finds support in our empirical exercise. Emerging-market economies tightened outflow controls after sudden stops, and high net capital inflows volatility, while they eased when net capital inflows, real exchange-rate appreciation pressures, and reserves accumulation were high – all pointing to concerns about foreign exchange valuation and domestic overheating. Unlike the 1980s, we find very limited importance of fiscal variables in explaining liberalisation of capital-outflow controls – only in sub-samples of relatively closed and non-inflation targeting countries do we see a negative association of greater external repression revenues with easing of outflows. This lack of association is consistent with the decline in repression revenues for emerging-market economies in the 2000s. This decade saw the growth accelerations of emerging markets, which led to a decline in their risk premia. The 2000s were also a decade of few adverse external shocks, real exchange-rate appreciation pressures in emerging-market economies and an overall improved stance in their fiscal policies.9 Revenues from repression therefore became less important in the decision to liberalise outflows.

The remarkable decline in the fiscal reliance on external repression is good news given that it was accompanied by deeper tax collection from a broader base. However, it begs questions of the future of financial repression. History suggests that one should be cautious in extrapolating from recent trends. The growth acceleration of China and India, and the illusive great moderation prior to the global crisis of 2008-09 probably contributed to the declining reliance on repression revenues. Yet, a reversal of favourable trends frequently changes attitudes towards financial repression (Reinhart, Kirkegaard and Sbrancia 2011). History also suggests that emerging-market economies may rely on financial repression as a contingent tax in the wake of realised ‘bad tail’ events (as evidenced by the experience of Argentina in the early 2000s).

Disclaimer: The views expressed here are those of the authors and do not necessarily represent those of the institutions with which they are affiliated.


Aizenman, Joshua and Gurnain Kaur Pasricha (2013), “Why do emerging markets liberalize capital outflow controls? Fiscal versus net capital flow concerns”, NBER Working Paper No. 18879.

Aizenman, Joshua and Yothin Jinjarak (2009), “Globalisation and Developing Countries – a Shrinking Tax Base?”, The Journal of Development Studies 45(5), 653-671.

Bird, Richard and Pierre-Pascal Gendron (2011), The VAT in Developing and Transitional Countries, Cambridge University Press.

Dooley, Michael P (1996), “A Survey of Academic Literature on Controls over International Capital Transactions”, IMF Staff Papers 43(4), 639-687.

Eichengreen, Barry (2001), “Capital Account Liberalization: What do Cross-Country Studies Tell us?”, The World Bank Economic Review 15(3), 341-365.

Fratzscher, Marcel (2012), “Capital Controls and Foreign Exchange Policy”, European Central Bank Working Paper No. 1415, February.

Giovannini, Alberto and Martha de Melo (1993), “Government Revenue from Financial Repression”, The American Economic Review 83(4), 953-963.

Hutchison, Michael, Pasricha, Gurnain and Nirvikar Singh (2012), “Effectiveness of Capital Controls in India: Evidence from the Offshore NDF Market”, IMF Economic Review 60(3), 395-438.

Klein, Michael W (2012), “Capital controls: Gates and walls”, Brookings Working Paper, September.

Pasricha, Gurnain Kaur (2012), “Measures to manage capital flows in emerging market economies”, North American Journal of Economics and Finance, special issue on “International Finance in the aftermath of the 2008 Global Crisis”, 23(3), 286-309.

Patnaik, Ila and Ajay Shah (2012), “Did the Indian capital controls work as a tool of macroeconomic policy?”, IMF Economic Review, September.

Reinhart, M Carmen, Jacob F Kirkegaard, and M Belen Sbrancia (2011), “Financial Repression Redux” Finance and Development 48(1), 22-26.

Warnock, Francis E (2011), “Doubts about capital controls”, report, Council on Foreign Relations, April.

1 South Korea’s “President Lee Myung-Bak, in an interview with the Financial Times published on Oct. 29, said any measures that a country may take to smooth cross-border capital flows should not be interpreted as capital controls but 'macro-prudential policies'.” Factbox – South Korean Policymakers’ remarks on capital controls, Reuters, 12 November, 2010.

2 The empirical literature assessing emerging-market motivations for capital controls is scant. Recent work by Fratzscher (2012) examines this question for overall capital account openness in a broad sample of emerging and advanced economies over the period 1984-2009. He finds that foreign exchange policy objective and overheating concerns have been the two main motives for capital controls, particularly since 2000.

3 Most of the recent policy debate has focused on tightening of capital inflow controls in response to surges in net capital inflows. See, for example, Ostry et. al. (2011), Klein (2012), Hutchison et. al. (2012), Patnaik and Shah (2012) and Warnock (2011).

4 NKI are measured as the difference between inflows by non-residents and net outflows by residents. Therefore both lower net inflows by non-residents and higher net outflows by residents would lead to a decline in NKI.

5 The figure sums net inflow tightening measures over all EMEs so that net inflow tightening in one country would be cancelled by net inflow easings in another. However, the conclusion that EMEs were liberalising outflows more than they were tightening inflows remains even if one looks only at NKI reducing measures, i.e. inflow tightenings in all countries and outflows easings in all countries only. For more details, see our working paper and Pasricha(2012).

6 Giovannini and de Melo, in a 1993 paper published in the The American Economic Review, found that revenues from repression for EMEs during 1970-80’s averaged about 9 percent of total government revenue from taxes. This result suggests that the decision to liberalise outflow controls in response to surging inflows could potentially involve weighing the benefits of reduced NKI against the loss of revenues from financial repression.

7 The 15 EMEs are Argentina, Brazil, Chile, China, Colombia, Egypt, India, Indonesia, Malaysia, Mexico, Philippines, Peru, South Africa, Thailand and Turkey.

8 Note that the average revenues of 1.4% of GDP are for all the EMEs in Giovannini and de Melo’s sample. Figure 2 averages over the part of their sample that overlaps with ours. “Repression revenues including debt revaluation costs” incorporate the effect of exchange-rate changes on the value of principal repayable in the effective external-interest rate. Repression revenues excluding debt revaluation costs only incorporate the impact of exchange-rate changes on interest payable in computing the effective external-interest rate. For more information, see our working paper.

9 Among the intriguing developments has been the relative decline in the role of ‘easy taxes to collect’ (like tariff and inflation taxes), and the rise of the role of Value Added Taxes (Aizenman and Jinjarak, 2009 and Bird and Gendron, 2011).



Topics:  International finance Monetary policy

Tags:  fiscal policy, capital outflow

Dockson Chair in Economics and International Relations, USC, and Research Associate, NBER

Senior Analyst at the Bank of Canada