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Removal or Exchange Controls (Capital Account Liberalization) benefits and costs - Essay Example

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When we talk about exchange controls, we mean "regulation at government level of money-flows in and out of a country" (Carew, 1996). The country and its people can invest into foreign currencies and hold them in national accounts (Neely, 1999). These exchange controls "may restrict investments by residents overseas and non-residents' investments and participation in the local market" (Carew, 1996)…
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Removal or Exchange Controls (Capital Account Liberalization) benefits and costs
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Removal of Exchange Controls (Capital Account Liberalization) Benefits & Costs Introduction When we talk about exchange controls, we mean "regulation at government level of money-flows in and out of a country" (Carew, 1996). The country and its people can invest into foreign currencies and hold them in national accounts (Neely, 1999). These exchange controls "may restrict investments by residents overseas and non-residents' investments and participation in the local market" (Carew, 1996). As seen in various world examples like by UK and Australia, these controls are abandoned to gain some economic growth (Encyclopedia Britannica, 2008). However some recent experiences show that these benefits come at a price. Let's discuss some of these benefits and costs.

Benefits
Liberating the capital accounts gives the opportunity for economic development to take place. Capital mobility
People can diversify their currency and assets portfolio by holding different currencies and investing in foreign assets (Eichengreen & Mussa, 1998)
Due to portfolio management, people can share their risks (Jalan, 1999)
Also investors can get a higher risk-adjusted rates of return by diversification
With higher rates of return, people are encouraged save more and hence invest more which eventually leads to the growth of the country (Eichengreen & Mussa, 1998)
Increases the output of the nation
Generates greater effieciency by exposing the financial sector to global competition.
Increases direct foreign exchnage contribute to an economy's growth rate by increasing the rate of capital accumulation (Wang, 2002)
A country also gains on the technological innovation when Foreign Direct Investment is done
Intertemporal optimization (in times of temporary recession, a country can borrow from the rest of the world and to smooth its consumption demands) (Wang, 2002)

Costs
As mentioned before, some recent incidents especially in Asia, Russia and Latin America have highlighted the dangers that removal of exchange controls have created for nations. (Henry, 2003)
Invites speculative hot money
An open capital account leads to investment of local savings into foreign investment which would reduce domestic investment (Jadhav, 2003)
"It would weaken the ability of the authorities to tax domestic financial activities, income and wealth" (Jadhav, 2003)
Convertibility of capital inflows would divert resources from tradable to non-tradable sectors (Cobham, 2001)
"Surge in capital inflows and a sudden reversal of capital flows can induce crises, often due to contagion & external shocks" (Kawai, 2007)
Excessive expansion of aggregate demand (Jalan, 1999)
Can cause excessive investment in risky projects if there is asymmetric information in the domestic economy (Wang, 2002)

Conclusion
As seen from the explanation of the benefits and the costs, removal of exchange controls has been very popular for countries however some nations have suffered due to implementation of Capital Account Liberalization. To reap the benefits, a country must adopt the correct policies to support the liberalization and constantly monitor the economic situation of a country in case something goes wrong.

Works Cited
1. Carew, E. (1996). Exchange Control. Retrieved January 28, 2008, from ANZ Financial Dictionary: http://www.anz.com/edna/dictionary.aspaction=content&content=exchange_control

2. Cobham, A. (2001). Capital Account Liberalisation and Poverty. Retrieved January 27, 2008, from Bretton Woods Project: www.brettonwoodsproject.org/topic/financial/f22gowithflowspt2.pdf

3. Eichengreen, B., & Mussa, M. (1998). Capital Account Liberalization and the IMF. Retrieved January 27, 2008, from IMF: http://www.imf.org/external/pubs/ft/fandd/1998/12/eichen.htm

4. Encyclopedia Britannica (2008). Exchange control. Retrieved January 26, 2008, from Encyclopedia Britannica Online: http://www.britannica.com/eb/article-9033404

5. Henry, Peter B. (2003) Capital-Account Liberalization, the Cost of Capital, and Economic Growth. Journal Article. American Economic Review, Vol. 93 no. 2, page(s) 91-96

6. JADHAV, N. (2003). CAPITAL ACCOUNT LIBERALISATION: The Indian Experience. Retrieved January 27, 2008, from IMF: www.imf.org/external/np/apd/seminars/2003/newdelhi/jadhav.pdf

7. Jalan, Bimal (1999). International Financial Architecture: Developing Countries' Perspective, Reserve Bank of India Bulletin, October.

8. Kawai, M. (2007). Capital Account Liberalization: . Retrieved January 27, 2008, from Asian Development Bank: www.iadb.org/res/includes/pub_hits.cfmpub_id=P-894&pub_file_name=pubP-894.ppt

9. Neely, Christopher J. (1999), An Introduction to Capital Controls, Federal Reserve Bank of St. Louis, December

10. Wang, Y. (2002). Capital Account Liberalization: The Case of Korea. Retrieved January 27, 2008, from United Nations: http://unpan1.un.org/intradoc/groups/public/documents/APCITY/UNPAN014168.pdf Read More
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