TThe Bangladesh cabinet has endorsed lifting of an embargo in place since independence, on
investments in foreign countries by local businesses and individuals, under a liberalised
foreign exchange regime. A daily reported that the “preferred sectors in the new investment
criteria includes deposits in banks and investments in stocks, real estate and other industrial
units in foreign countries.”
The report quoted a senior Finance Ministry official as saying that the blanket changes are
needed “to keep pace with changed world economic order and modernise investment outlook
as decades [of] long restrictions on capital account convertibility makes no financial sense
given the country’s current buoyant reserve position.”
Alas, the senior official seems to be unaware of an increasing volume of evidence that capital
account liberalisation lies at the heart of most financial crises. Both frequency and depth of
financial crises increase with the capital account liberalisation. There is now a great deal of
consensus that capital account liberalisation together with rapid financial sector deregulation
played a large role in the Asian financial crisis of 1997-98 that punctured more than three
decades of rapid growth of East Asian economies under a regime characterised by financial
restraint and control. Malaysia could come out of the crisis only after it introduced
restrictions on foreign capital transactions.
Countries, such as China and Viet Nam that remained unaffected by the contagion, had
restrictions on capital account. The same is true of India who could largely insulated itself
from the 2008-9 global financial crisis.
Countries with liberalised capital account also are vulnerable to monetary policy changes in
advanced countries. For example, in recent years, countries that have liberalised their capital
account in the hope of overcoming their structural balance of payments deficit or savings-
investment gap through short-term capital flows, experienced sharp fluctuations in financial
markets, including sudden depreciation of their currencies when the market anticipated a shift
in the US Federal Reserve’s monetary policy.
This means the Bangladesh Bank has to have strong macro-prudential regulation to protect
our financial sector from external shocks. It must also have “very large” foreign exchange
reserves to withstand storms hitting our shores arising from changes in macroeconomic
policies abroad. But keeping large foreign exchange reserves has an opportunity cost as this
could have been invested in socially desirable sectors. Moreover, as some countries in the
region with large accumulated foreign reserves (e.g. South Korea) have found out in the wake
of the 2008-9 crisis and during the volatility caused by changes in the US monetary policy,
that their “large reserves” may also quickly disappear.
Furthermore, if the Bangladesh Bank is not extra-vigilant, the blanket deregulation of the
foreign exchange regulations act is likely to open the door for large-scale capital flight
through “legalised” channels. One just hopes that the Bangladesh Bank has the capacity to
bear this huge prudential regulatory and policy-making- as well as vigilance- burden.
It is understood that “a group of influential businessmen had long been pressing the
government to lift the ban on current capital account convertibility so that they could invest
outside the country.” However, apparently the decision was “largely dictated by the
International Monetary Fund” (IMF), a source at the Bangladesh Bank told the daily.
This, in fact, is contrary to IMF’s Article of Agreement VI (Section 3) which explicitly states,
“Members may exercise such controls as are necessary to regulate international capital
Under the leadership of IMF Managing Director, Jacques de Larosiere, the Fund stayed away
from financial globalisation or internationalisation until 1987. Jacques de Larosiere has
famously said, “We had our catechism: Thou must give freedom to current payments, but
thou must not necessarily give freedom to capital.” He further noted, “I was comfortable with
the idea that the Fund would not move toward compulsory freedom of capital. By the time I
left the Fund in 1987, I was not aware of any discussions of changing the Articles to bring the
capital account within our jurisdiction.”
Only during the 1990s, the IMF became an enthusiastic advocate of capital account
liberalisation, and its Executive Board, led by Managing Director, Michel Camdessus, sought
to amend its Articles as the status quo was portrayed and increasingly seen as anachronistic
and naïve. Thus, the IMF under his leadership began to encourage the staff to give greater
emphasis to capital account issues in Article IV consultations and technical assistance and to
promote capital account liberalisation more actively.
However, the Asian financial crisis from mid-1997 forced the Interim Committee at the
Annual Meeting in September 1997 in Hong Kong to ask for caution in the implementation
of capital account liberalisation. Although the Asian financial crisis dealt a blow to the
supporters of capital account liberalisation, it did not diminish their enthusiasm. Despite the
deepening of the Asian financial crisis and the financial crises in Russia and Brazil in 1998,
the Interim Committee renewed its call for capital account liberalisation at the 1998 Spring
Meeting of the Board.
It is argued that capital account liberalisation would see capital outflows from capital
abundant developed countries to capital-scarce developing countries. This sounds very
logical, as water flowing downstream. This is also consistent with economic theory which
states that marginal returns decline with higher stock of capital. Therefore, as capital
competes or rushes in seeking opportunities for better returns where the stock of capital is
low, the cost of capital should decline.
Paradoxically, developing countries are financing large current account deficit of the richest
country in the world, the US. With some exceptions, opening up the capital account has
facilitated capital flight, rather than inflows, especially of a long-term nature, to develop new
economic capacities. Developing countries continue to provide net financial resources to
developed economies, peaking with an all-time high of $883 billion in 2008. The lost decade
of the 1980s in Latin America, the lost two decades at the end of the 20th century in Africa,
and protracted stagnation in post- ‘shock’ transition economies have accompanied financial
liberalisation. And when capital has flowed to emerging markets, such episodes have often
been temporary and eventually reversed with devastating consequences, as in the 1997-1998
East Asian, 1998 Russian, 2000 Turkish and 2002 Argentine crises.
Not surprisingly, recent IMF research acknowledges that financial liberalisation has not
ensured higher growth. In fact, one of its recent publications attributed the rise in inequality
worldwide to capital account liberalisation (“Who Let the Gini Out?” Finance &
Development, December 2013, Vol. 50, No. 4).
Capital account liberalisation has also not ensured significantly cheaper finance. Instead, the
cost of finance rises sharply during economic downturns (forcing real interest rates to rise)
and falls during booms (involving low real interest rates). More rents have accrued to finance
in the OECD economies in recent decades. Meanwhile, financial liberalisation has led to
financial deepening which has increased the levels of intermediation and corresponding
claims to financial rents.
One can explain politicians’ enthusiasm towards the idea of local investors investing
overseas. This may be seen as a sign of maturity or progress towards becoming a developed
or capital exporting country! They can presumably take the credit for this progress. But
juxtapose this with our begging for foreign aid and loan. If we do have surplus capital that
needs invested overseas, then why not encourage our local investors to invest here to
overcome our huge deficits in infrastructure, energy and other essential services instead of
looking for foreign investors?
Why are our investors not attracted to domestic opportunities and instead pressing for
deregulating our capital account? Is that not one sure way of saying that “we do not have
confidence or stake in this country. So, we need ‘legalised’ channels to take our assets and
money to a safe-haven.”