Recent Experiences with Capital Controls: Is There a Lesson for Turkey?

Abstract

Capital flows in the 1990's and their sudden reversals and the resulting turmoil created in financial markets together with big financial losses, revived the interests in capital controls. There are inherent destabilizing factors in international financial system and Tobin had seen that as early as 1972 when he suggested levying a tax on financial transactions as a way of smoothing out destabilizing factors, even though in its original formulation it was not applied anywhere due to its impracticality. Various capital inflow and outflow control experiences and recent crisis indicated that controls, even though are only second best, can be resorted temporarily, provided that the time gained is productively used for making the necessary adjustments in the inconsistent policy mix that brought about the controls in the first place. In such a context, for countries with high domestic debt like Turkey, where, even the intervention itself can be a source of speculation, an exchange rate band, in which the limits of the band is defended through taxing the violators of the band rather than central bank intervention can be an alternative. Such a strategy would be beneficial if Turkey uses the time to address the structural issues, rather than relaxes under the protective cushion of the tax. This method is advantageous to the sterilized intervention presently used to decrease exchange rate volatility arising from speculative inflows, first because, it will keep the central bank reserves intact, second it will force the violators of the exchange rate band to share the responsibility of their violation. If temporary controls are very carefully coordinated with the appropriate supporting policies, they could replace IMF programs with financial assistance, at least till the new and improved international financial system becomes operational.