Argentina’s Lying Prices Show Capital Control Limits: Currencies

Jan 28, 2014 4:43 am ET

(For a Currencies column daily alert: SALT FXCOL.)

Jan. 28 (Bloomberg) -- When Argentina decided last week to ease limits on dollar purchases, it became the latest emerging- market nation to acknowledge that capital controls usually fail in masking an economy’s flaws.

Argentina allowed the peso to plunge 15 percent after the central bank began scaling back interventions in the foreign- exchange market on Jan. 22, spurring price increases of as much as 30 percent on consumer goods as international reserves fell to a seven-year low. The black-market price in Argentina rose last week to a record 12.75 pesos per dollar, compared with the official rate of about 8, according to Buenos Aires newspaper Ambito.

“Capital controls signal that a country is very worried about preserving its foreign exchange,” Steve Hanke, professor of applied economics at Baltimore-based Johns Hopkins University and an adviser to the Argentine government in the 1990s, said in an interview. “That means bad things are in the wind.” The restrictions spawn illegal traffic in the local currency that creates “lying prices” in the economy, he said.

Restrictions on capital flow, ranging from Argentina’s tax on vacations abroad to Malaysia’s stabilizing the ringgit after the 1997 Asian crisis, have had mixed results in boosting investor confidence in a country’s economy. Capital outflow restrictions can be effective “if they are sufficiently comprehensive to slow a sudden ‘rush to the exit,’” according to a report by four International Monetary Fund researchers released this month.

Turkey Next?

“For the average country, a tightening of outflow restrictions is ineffective as net outflows increase as a result of it,” wrote Christian Saborowski, Sarah Sanya, Hans Weisfeld and Juan Yepez, authors of the IMF report.

In Turkey, pressure is building on Central Bank of Turkey Governor Erdem Basci to raise interest rates or face the prospect of the lira plunging to fresh records and government bonds extending declines. The scheduling of an extraordinary meeting with a midnight statement tonight by the central bank may signal that policy makers are planning to implement capital controls, said George Magnus, an independent senior economic adviser to UBS AG.

“The odd time does suggest, to me, something that’s going to be much more market-sensitive in that it will affect the operation of markets, not just the cost of funding,” Magnus said by phone from London yesterday.

The announcement from the bank came after the Turkish lira fell to records against the euro and dollar yesterday. The lira touched 2.39 versus the dollar before erasing losses to break a 10-day slump and close at 2.2833 in New York. The lira rose 2.3 percent to 3.1242 per euro after reaching 3.2726.

Venezuela Experience

In Venezuela, a decade of currency controls is fueling the world’s fastest inflation among the 114 economies tracked by Bloomberg and shortages of basic goods.

The official rate of 6.3 bolivars per dollar compares to the 75 bolivar rate on the black market. Official dollars therefore are the most profitable assets in the country, allowing people who have access to them enjoy a lifestyle far beyond the reach of an average Venezuelan.

“Capital controls to avoid excessive inflows have had limited success,” Ricardo Hausmann, a former planning minister in Venezuela who now teaches economics at Harvard University, in Cambridge, Massachusetts, said in an e-mail. “Capital controls to prevent outflows often postpone and amplify rather than moderate the need for adjustment. If they involve a emergence of a black or parallel foreign-exchange market, they lead to a dangerous macro and micro disaster.”

Malaysia Success

The IMF, influenced by then-U.S. Treasury Secretary Robert Rubin and his deputy Lawrence Summers, started to push Asian countries to open their financial markets and lift capital controls in the early 1990s. When the financial crisis started in late 1997, the IMF advised the region to cut budgets and raise interest rates to limit the currency depreciation.

Nobel laureate Joseph Stiglitz, then chief economist at the World Bank, opposed the IMF’s remedies, pushing for capital controls to stem the crisis, advice no Asian countries except Malaysia took.

Malaysia, faced with global investors selling the nation’s assets betting for a depreciation in the ringgit, imposed restrictions in September 1998, including making investors hold the ringgit proceeds of share sales for at least a year and banning the transfer of the local currency between offshore accounts.

‘Revitalizing’ Economy

The ringgit’s real effective exchange rate stabilized the next year, after tumbling almost 20 percent, while the nation’s foreign-exchange reserves gained following the biggest annual decrease on record.

“The restrictions provided room for the authorities to accumulate reserves amid a stable exchange rate and enact policies aimed at revitalizing the economy, such as reducing interest rates,” the Washington-based IMF researchers wrote in the report that examined capital outflow restrictions in 37 emerging markets from 1995-2010.

In Iceland, the krona exchange rate stabilized shortly after restrictions were imposed during the depths of the global financial crisis in November 2008. That gave officials room to ease monetary policy to help revive the economy, according to the report.

The IMF report concludes that capital control can be successful if “supported by either strong macroeconomic fundamentals or good institutions, or if existing restrictions are already fairly comprehensive.”

Fernandez’s Efforts

Since her re-election in 2011 when capital flight almost doubled to $21.5 billion, Argentine President Cristina Fernandez de Kirchner has tried whatever she could to keep money in the country. She implemented more than 30 measures, including blocking most purchases of foreign currencies, taxing online purchases, banning units of foreign companies from remitting dividends, and restricting imports.

Amid annual inflation of more than 28 percent, Fernandez’s controls have failed to stem the outflow of money through the nation’s widening tourism deficit, deepening a plunge in reserves from debt payments and growing energy imports.

The controls cut the total amount traded last year in the local foreign-exchange market in half from 2010, according to data compiled by Argentina’s Mercado Abierto Electronico automated trading system. Still, the robust black market for dollars shows that some Argentines are finding ways around the controls.

‘Very Dangerous’

Argentina Economy Minister Axel Kicillof said Jan. 26 the peso has reached an “acceptable level” at about 8 per dollar, a signal the central bank may continue to spend reserves to keep the rate in check. The bank sold $380 million in the official currency market to defend the price of the peso, dropping reserves to $29.1 billion.

The government also reduced some of currency controls in place since July 2012, authorizing foreign-exchange purchases for people earning a monthly wage of at least 7,200 pesos ($899). Those who qualify, less then 20 percent of the population, can buy as much as 20 percent of their average monthly salary, up to $2,000 a month.

“The problem I see in the longer run for the capital control for outflows is that it interferes with foreign direct investments, because FDI wants to take money out of the country,” Guillermo Calvo, an economist at New York-based Columbia University who was chief economist at the Inter- American Development Bank for five years until 2006, said in a telephone interview from New York. “If a country develops that reputation, it can be very negative for FDI. That’s very dangerous.”

--With assistance from Camila Russo in Buenos Aires, Anatoly Kurmanaev in Caracas, Benjamin Harvey in Istanbul and John Quigley in Lima. Editors: Kenneth Pringle, Robert Burgess