Fluctuations in the Capital Flow and Regulations for Capital Transactions in East Asia

ABSTRACT

Among the seriously effected countries, Korea deregulated mainly the capital inflow controls at the beginning of 1990s, and then relaxed mainly the capital outflow controls from 1994. Thailand, Malaysia and Indonesia relaxed rapidly inflow of direct investment since mid-1980s, and then liberalized other investments in order to attract foreign capital and grow up the domestic financial market. These liberalization policies led to the swings of capital flows resulted in the crisis. The seriousness of the crisis became far from explicable from the macroeconomic fundamentals.

The four Asian countries basically maintained the foreign exchange rate policy of giving consideration to keep the export competitiveness before crisis. The sterilized interventions were taken frequently in order to avoid the appreciation of the currencies followed by the growing capital inflow and tighter monetary policy was basically kept in order to mitigate its impact on the domestic financial market. In addition, relaxation of capital outflow, tighter fiscal policy, or strengthening of prudential regulations were also adopted for the purpose of macroeconomic stability. Still more, capital inflow controls were introduced in some cases. However, they could not avoid the breakout of the crisis lastly.

During this crisis some countries restricted temporarily the capital outflows. Malaysia showed the successful case because of the effective regulatory framework and good timing.

The lessons from recent crisis are as follows; firstly, the management of short-term capital inflow is important in order to prevent the crisis. Capital inflow control can be effective temporarily given the soundness of the macro-economy and indirect measures may be better from the point of view of the policy consistency. Secondly, capital outflow control may be possible choice of crisis management under certain conditions. The effectiveness of the capital controls depends on the domestic financial system and so on. Thirdly liberalized foreign exchange and capital transactions require the sound and effective financial system. Lastly, freecapital movement can not go with fixed foreign exchange rate and sterilized intervention. From now on, East Asian countries should be rebuild the strong financial system and adopt the pragmatic policy concerning the regulation and deregulation of foreign exchange and capital transactions with flexible foreign exchange rate system and effective monitoring system. Japan is required to take the lead of the regional safety network, because extermination of crises will be impossible.

Introduction