Capital Controls

Capital controls are a type of restriction imposed by the government of any country on the movement of capital. Capital controls are practised to prevent a country’s capital from moving freely in and out of the economy. Policies are taken to restrict foreign investment in the financial market, foreign direct investment on business or property are good examples of capital controls. Capital controls are a recent topic adopted by several economies of the world.

Reasons for adopting capital controls

Limitations on capital inflows and outflows are referred to as capital controls. According to an IMF report, the reason for capital control can be explained as the need to impose a macroeconomic policy that suggests an increase in capital inflows and a decrease in capital outflows. Capital controls are mainly exercised on short term capital dealings to defy estimated flows of capital that threaten to weaken the stability of the exchange rate and in turn diminish foreign exchange reserves.

If any country faces fixed exchange rate then capital controls can be used to merge inconsistent policy objectives and stable exchange rate to respond to the fluctuations in the economy. The best argument in favour of capital controls goes like, maintaining independent monetary policy and also reducing pressure on the exchange rate. Capital controls can aid in securing monetary and financial constancy even during unrelenting capital flows. Capital controls play an exclusive role during huge capital inflows and when banks or financial institutions improperly evaluate their risk. For the execution of cheap financing for government budgets and priority sectors, capital control provides full support.

What type of Capital controls must be adopted

Capital controls exercise various type of control depending on the economy of the country. Capital restrictions imposed in any economy can be classified in two broad forms:

• “Administrative” or direct controls
• “Market-based” or indirect controls

Administrative or direct controls are absolute restrictions imposed on any type of capital dealings and related payments. These types of controls are planned to directly influence the degree of foreign financial transactions. These controls are directed towards the administrative rules of any country’s banking system in order to regulate the flow of capital.

Market-based or indirect controls are intended to make any kind of capital transaction costly, which limits the flow of capital. Market-based or indirect controls can be imposed on exchange rate systems in the form of dual or multiple policies, on cross-border capital flows in the form of open taxation policies and indirect policies. Market-based or indirect capital controls exercises indirect regulatory controls on capital flows.

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