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Issues in Capital Account Convertibility in Developing Countries

Working papers

This paper draws on the literature and on the experience of thirteen countries in liberalizing the capital account to make five main points:
1. Capital account convertibility is desirable and inevitable as it is part of the inexorable process of globalization.
2. Capital account convertibility is accompanied by some risks. Its benefits are dependent upon the achievement of certain pre-conditions and sequencing patterns and an orderly liberalization procedure.
3. The opening up of the capital account is a more complicated procedure than often thought. It is desirable to opt for a gradual approach so that it can be embedded in the overall reform process.
4. The need to constrain short-term flows in developing countries arises because they do not have sophisticated financial markets to intermediate funds from the short to the long end and cannot therefore bear the risk of financial intermediation. The need to constrain short-term flows should diminish as financial sector development and sophistication progresses.
5. The porosity of the capital account generally points to the ineffectiveness of capital controls. The paper makes a distinction between different kinds of controls and types of transactions on the capital account and emphasizes that capital account liberalization is not an all or nothing affair. The paper makes a case for certain capital controls, which can be used in the transition phase, and those, which may be applied in the long run to contain macroeconomic instability. Three broad strategies for opening up the capital account are discussed.

Benu Schneider