Showing posts with label capital account. Show all posts
Showing posts with label capital account. Show all posts

Monday, March 4, 2013

BNM On Illicit Money Flows

It’s a fairly long explanation and directly targets the Global Financial Integrity reports with respect to Malaysia (I’ve taken the liberty of copying it in full):

Update on Measures to Address Unrecorded Financial Flows

Bank Negara Malaysia would like to provide an update on measures that have been undertaken by members of a High Level Multi-Agency Special Task Force (Task Force) to reduce illicit financial flows. The Task Force comprises of the Attorney General’s Chambers of Malaysia, Royal Malaysian Customs Department, Royal Malaysia Police, Malaysian Anti-Corruption Commission, Inland Revenue Board of Malaysia, Immigration Department of Malaysia and Bank Negara Malaysia. The Task Force’s role is to spearhead more effective coordination and collaboration among key law enforcement authorities in the country as well as between local and international enforcement agencies to mitigate illicit activity and financial flows.

Tuesday, October 30, 2012

Latest GFI Report: Illicit Capital Flows Through China

The latest from Global Financial Integrity focuses on illicit outflows and inflows revolving around China (excerpt from press release):

Illicit Financial Flows from China and the Role of Trade Misinvoicing

The Chinese economy hemorrhaged US$3.79 trillion in illicit financial outflows from 2000 through 2011, according to a new report [PDF] released today by Global Financial Integrity (GFI), a Washington, DC-based research and advocacy organization. Amidst increased domestic concern over inequality and corruption, GFI’s study raises serious questions about the stability of the Chinese economy merely two weeks before the once-in-a-decade leadership transition…

Thursday, July 19, 2012

Fixed Exchange Rates: Better Close That Capital Account

In the latest round of research from the NBER, this paper describes some “surprising” results (abstract):

Pegs, Downward Wage Rigidity, and Unemployment: The Role of Financial Structure
Stephanie Schmitt-Grohé, Martín Uribe

This paper studies the relationship between financial structure and the welfare consequences of fixed exchange rate regimes in small open emerging economies with downward nominal wage rigidity. The paper presents two surprising results. First, a pegging economy might be better off with a closed than with an open capital account. Second, the welfare gain from switching from a peg to the optimal (full-employment) monetary policy might be larger in financially open economies than in financially closed ones.

Wednesday, February 29, 2012

Illicit Money Flows: Where Are They?

You might remember Global Financial Integrity’s report on illicit money flows early last year, where they reported Malaysia as being the fifth highest victim of uncategorised capital outflows in the last decade.

At the time, I partially validated their findings at least in terms of the trade mispricing channel – wildly different reported values for exports and imports between different trade partners.

So since I had a bit of time, and lots of curiosity, I decided to take a bit of a deeper look into the question of Malaysian trade mispricing, using the United Nations Commodities Trade database (Comtrade), which carries data on both imports and exports as reported by nearly every trading nation (Taiwan not included).

Did I find capital outflows? Yes, I did, and on a scale that conforms to the GFI report.

Wednesday, December 21, 2011

Illicit, Illegal, Not Quite Right

Ok, second speech, this time from Lim Guan Eng:

Pakatan blames BN for turning Malaysia into ‘king of black money’

KUALA LUMPUR, Dec 16 — Pakatan Rakyat (PR) leaders faulted the Barisan Nasional (BN) government today for bleeding the country’s coffers through corruption, saying its mismanagement of the economy had turned Malaysia into the “king of black money”.

Pointing to the Global Financial Integrity’s (GFI) findings that Malaysia had lost RM150 billion in 2009 through the siphoning of illicit money, the leaders warned of a bleak future for the country should the ruling pact be allowed to continue its reign.

Wednesday, November 16, 2011

Mundell-Fleming In Action: The Trilemma Facing China And India

In two seminal papers, Nobel Laureate Robert Mundell and Marcus Fleming extended the basic Hicks IS-LM model to incorporate an external sector. The most interesting finding is what’s called the Trilemma – a country cannot simultaneously have exchange rate stability, free capital mobility and an independent monetary policy. You can at best target two of these variables, with the third left to market forces. Trying to achieve all three is effectively impossible, as it sets up inconsistencies in the economy that can and will be exploited by economic agents (read: financial markets).

That’s the real basis for the 1997-98 Asian Financial Crisis a decade ago – you can’t have your cake and eat it too. Most of the crisis victims opted for dropping exchange rate stability; Malaysia famously choose to drop capital mobility, then in 2005 followed the others towards exchange rate flexibility as well.

However, there’s nuances to the stark choices implied by Mundell-Fleming. In this new paper highlighted at VoxEU, the Trilemma choices are evaluated for China and India (excerpt; emphasis added):

The financial trilemma in China and a comparative analysis with India
Joshua Aizenman Rajeswari Sengupta

Emerging markets face what some economists are calling a trilemma. They cannot simultaneously target exchange-rate stability, conduct an independent monetary policy, and have full financial integration. So what to do? This column looks at how Asia’s giants are responding – and in different ways...

Friday, January 28, 2011

“Illicit” Capital Outflows: We’re No 5 In The World

Not something to be proud of – Global Financial Integrity released a report yesterday on capital outflows from developing countries, and Malaysia ranks in the top ten:

Illicit Financial Flows from Developing Countries: 2000-2009

Illicit outflows increased from $1.06 trillion in 2006 to approximately $1.26 trillion in 2008, with average annual illicit outflows from developing countries averaging $725 billion to $810 billion, per year, over the 2000-2008 time period measured…

….Top 10 countries with the highest measured cumulative illicit financial outflows between 2000 and 2008 were:

  1. China: $2.18 trillion
  2. Russia: $427 billion
  3. Mexico: $416 billon
  4. Saudi Arabia: $302 billion
  5. Malaysia: $291 billion
  6. United Arab Emirates: $276 billion
  7. Kuwait: $242 billion
  8. Venezuela: $157 billion
  9. Qatar: $138 billion
  10. Nigeria: $130 billion

Wednesday, October 20, 2010

Financial Crises: Who’s Next?

I’m leaving Malaysia for a short sojourn offshore – figuratively speaking.

East Asia and others gained a salutary lesson 10 years ago during the 1997-98 financial crisis about the dangers of short-term capital flows. We’ve generally applied that lesson today, in the aftermath of the recession and the subsequent flood of liquidity aimed at emerging markets.

Some countries have responded with controls on short term capital flows, of which Thailand’s 15% withholding tax on government bond purchases last week was just the latest. Others, like Malaysia and Singapore, have generally refrained from administrative measures, instead allowing a sharper appreciation of their currencies to limit incentives for portfolio capital inflows and keep a lid on inflation.

Yet others don’t appear to have gained anything from East Asia’s experience:

Thursday, July 22, 2010

International Reserves And The Balance Of Payments

From the comments:

Wenger J Khairy said...

Dear HishamH,

Appreciate your response. Perhaps would like to comment further on the link between reserves and the BOP. The argument was presented in the book the "Dollar Crisis".

The author presented the case for the link between reserve build up and a growth in the money supply. He cited Thailand and Japan and as the example.

The thrust of the story

(a) From strict correlation point of view, reserve and credit growth was correlated for the case of Japan, Malaysia and Thailand. The lag maybe between 1-2 years.

(b) Build up of reserves act as high powered money entering into the domestic banking system.

(c) One can draw a simple flow chart how lets say surplus US dollars earned by Sime Darby gets deposited as Ringgit in Maybank, and at the same time increases Bank Negara reserves.

In the case of Thailand, their reserve build up was due to surplus on the Capital and Financial account

(d) Build up of reserves act as exogenous source of credit creation in the domestic banking system. If there was a build up of credit due to solely endogenous factors, wouldn't it be highly inflationary?

My wife told me that I’m barely comprehensible to readers who aren’t that knowledgeable about the inner workings of economics or finance, so I’m going to answer Wenger’s query in some detail – though this post will feature a little bit of double-entry accounting.

Tuesday, July 6, 2010

Recent Imposition Of Capital Controls In East Asia

An interesting piece of research has turned up on VoxEU (excerpt):

Emerging markets consider capital controls to regulate speculative capital flows
Kavaljit Singh

Despite recovering faster than developed countries, many emerging markets are struggling to cope with large capital inflows. This column discusses the recent capital controls imposed by Indonesia and South Korea. It argues that while the international community is warming to these policies, it would be wrong to view capital controls as a panacea...

...Just days before the G20 summit in Toronto, South Korea and Indonesia announced several policy measures to regulate potentially destabilising capital flows which could pose a threat to their economies and financial systems...

...Despite recovering faster than developed countries, many emerging markets are finding it difficult to cope with large capital inflows. There is a growing concern that the loose monetary and fiscal policies currently adopted by many developed countries are promoting a large dollar “carry trade” to buy assets in emerging markets.

Apart from currency appreciation pressures, the fears of inflation and asset bubbles are very strong in many emerging markets. Since mid-2009, stock markets in emerging economies have witnessed a spectacular rally due to strong capital inflows. In particular, Brazil, Russia, India and China are the major recipient of capital inflows.

The signs of asset price bubbles are more pronounced in Asia as the region’s economic growth will continue to outperform the rest of the world. As a result, the authorities are adopting a cautious approach towards hot money flows and considering a variety of policy measures (from taxing specific sectors to capital controls) to regulate such flows. In May 2010, for instance, Hong Kong and China imposed new measures in an attempt to curb soaring real estate prices and prevent a property bubble.

In emerging markets, strong capital inflows are likely to persist due to favourable growth prospects but the real challenge is to how to control and channel such inflows into productive economy.

Contrary to the popular perception, capital controls have been extensively used by both the developed and developing countries in the past. There is a paradox between the use of capital controls in theory and in practice (Nembhard 1996). Although mainstream theory suggests that controls are distortionary and ineffective, several successful economies have used them in the past (Nembhard 1996). China and India, two major Asian economies and “success stories” of economic globalisation, still use capital controls today...

...Yet it would be incorrect to view capital controls as a panacea to all the ills plaguing the present-day global financial system. It needs to be underscored that capital controls must be an integral part of regulatory and supervisory measures to maintain financial and macroeconomic stability (Singh 2000). Any wisdom that considers capital controls as short-term and isolated measures is unlikely to succeed in the long run.

The theoretical (or should I say theological) basis for an open capital account, where capital of any sort is allowed to enter and leave freely, is that capital will flow to where it can be used most productively (i.e. where capital is relatively scarce, and would then attract higher returns). An open capital account should therefore result in lower cost of capital for the recipient, which will result in an increase in investment in productive capital which then raises incomes and social welfare. That’s the free-market, neo-classical story anyway.

The problem here is that there is an underlying assumption that the country involved is big enough that capital inflows/outflows won’t have a significant impact on monetary conditions – that’s simply not true of many developing economies in the context of a relatively more massive global financial system. (I’m leaving out here the empirical “puzzle” that capital doesn’t in fact flow to capital-scarce nations – quite the opposite actually occurs. Otherwise, Africa would be the number one destination of foreign capital and investment).

There are a number of ways a country can manage outsized capital inflows and outflows – reserve accumulation as an insurance policy, as is common in East Asia and the oil-rich Middle East; sterilisation through issuance of central bank liabilities, which can get expensive; and of course capital controls.

The general practice has been that if the domestic financial sector and capital markets don’t have the capacity, breadth or depth to absorb large-scale short-term capital, then capital controls are the instrument of choice, never mind investor opprobrium. Malaysia has had more than a few brushes with capital controls, of which 1998 was just the latest.

At the moment, capital flows aren’t an overriding concern here (we’re not as “exciting” an investment story as Indonesia, China or India), but that may change if interest rates and yields in developing countries remain ultra-low for an extended period.

Technical Notes:

Singh, Kavaljit, “Emerging markets consider capital controls to regulate speculative capital flows”,, July 5 2010

Friday, March 6, 2009

Financial Fragility and the Role of Capital Flows

Via Greg Mankiw, we have this interesting story of Joseph Stiglitz being shunned by the Obama Administration. Here's why this is important:

'In a spate of books, essays and speeches dating from the early '90s, Stiglitz denounced Rubin's support for repeal of the Glass-Steagall Act, which separated commercial from investment banking for precisely the reasons we are now witnessing on Wall Street: new "full-service" banks would seek to hype companies that their stock-market side underwrote and issue loans to them even if they were not credit-worthy. "The ideas behind Glass-Steagall went back even further [than the 1929 crash] to Teddy Roosevelt and his efforts to break up the big trusts," he wrote presciently in "The Roaring Nineties" (2003). "When enterprises become too big, and interconnections too tight, there is a risk that the quality of economic decisions deteriorates, and the 'too big to fail' problem rears its ugly head." Unfortunately, Stiglitz wrote, his worries "were quickly shunted aside"' by the Clinton Treasury team. Earlier, in his book "Globalization and its Discontents" (2002), Stiglitz became the most prominent voice in Washington to say plainly that free-market absolutism, which began with the Reagan revolution and continued under Clinton (who upon being elected declared the era of "big government" was over), was ill-founded theoretically and disastrous practically. "In 1997 the IMF decided to change its charter to push capital market liberalization," he wrote. "And I said, where is the evidence this is going to be good for developing countries? Why haven't you produced some research showing it was going to be good? They said: we don't need research; we know it's true. They didn't say it in precisely those words, but clearly they took it as religion."'

I actually have both the books listed here, but have yet to read them - I'm going to make the time to do that now. What especially struck me was the last point made in the paragraph, which is something I've believed in for some time - that there is no evidence that open capital accounts make sense for developing countries, in fact just the opposite.

In layman's terms, an open capital account means that flows of capital are completely unrestricted. Theoretically, this means capital is free to flow to where returns are highest, which means capital will be allocated efficiently and total welfare increased. In practice, this does not happen. Despite all the hype about China hogging FDI and capital, the number one destination of capital in the world is...the United States. If in fact capital travels to where it will be most effectively used then most of it ought to be going to Africa, where capital accumulation is low and where the marginal productivity of capital ought to be the highest.

At this point I have to distinguish between direct investment and portfolio investment. The former is investment in the classical sense - it is used to produce goods and services. Portfolio investment on the other hand reflects changes in the ownership of productive assets. The difference is crucial - direct investment is illiquid and long term, while portfolio investment is highly liquid and short term.

From the point of view of a developing country, portfolio inflows and outflows can be highly destabilising when the domestic financial system is immature, and become positively dangerous in the presence of pegged exchange rates. The evidence for this is highly persuasive - Mexico, Argentina, Turkey, and of course the whole East Asian Crisis of 1997-98. Here's a short narrative of what typically happens:

1. High growth Developing country is 'noticed' by investors
2. Capital flows in, and placed in the banking system or stock market (which booms). the currency also appreciates, which pulls in more capital.
3. Monetary expansion follows, fully sterilised by the Central Bank until it becomes too expensive, after which the financial system becomes flush with liquidity
4. If bond markets are immature, banks can only respond to expanding balance sheet liabilities by lending aggresively
5. A commodity/real estate/stock market bubble is generated
6. Individuals and companies start borrowing from overseas as the currency has strengthened
7. Investors notice the economy overheating, and become jittery
8. At some point, a tipping point occurs where investors panic and pull out, the currency crashes
9. Net effect: the monetary base contracts sharply and real interest rates rise, banks get saddled with bad debts in speculative activities, companies and individuals with foreign debt finding their debts ballooning, output and employment drop

Sounds awfully familiar, doesn't it. The same general story has occured quite a few times over the last fifteen years in various countries.

Of course, the US capital markets and banking system are far deeper, but let me make conduct this thought experiment. Greenspan cut interest rates to 1% in 2001/2002 in response to 9/11 and the dotcom crash, while the Bush administration increased spending and engaged in the "war on terror". What if the US didn't have an open capital account at the time? Monetary expansion plus fiscal profligacy meant the US financial system would be flushed with funds, and the trade deficit would increase as consumers responded to lower costs. However, in this scenario, the trade deficit can no longer be financed through purchases of US treasuries by surplus nations. That would imply that the excess liquidity would be drained overseas rather than recycled in the domestic system, which further implies a much stronger depreciation in the USD than actually happened and further, causes inflation in imported goods prices. Also, since this source of financing is no longer available, the fiscal deficit has to be financed domestically which drains further funds from the system - we get real crowding out of private investment and consumer borrowing. Interest rates would necessarily have to rise with the increased domestic supply of treasuries, as well as because of excess money demand relative to supply. In short, the US economy would've slowed as would the rest of the global economy, and there would not have been the housing bubble - we might not be in this mess we are now.

Unlikely scenario to be sure, but it makes food for thought.