Capital Management Techniques in Developing Countries: An Assessment of Experiences from the 1990's and Lessons for the Future

Abstract

This paper uses the term, capital management techniques, to refer to two complementary (and often overlapping) types of financial policies: Policies that govern international private capital flows and those that enforce prudential management of domestic financial institutions. The paper shows that regimes of capital management take diverse forms and are multi-faceted. The paper also shows that capital management techniques can be static or dynamic. Static management techniques are those that authorities do not modify in response to changes in circumstances. Capital management techniques can also be dynamic, meaning that they can be activated or adjusted as circumstances warrant. Three types of circumstances trigger implementation of management techniques or lead authorities to strengthen or adjust existing regulations - changes in the economic environment, the identification of vulnerabilities, and the attempt to close loopholes in existing measures.

The paper presents seven case studies of the diverse capital management techniques employed in Chile, Colombia, Taiwan Province of China, India, China, Singapore and Malaysia during the 1990s. The cases reveal that policymakers were able to use capital management techniques to achieve critical macroeconomic objectives. These included the prevention of maturity and locational mismatch; attraction of favored forms of foreign investment; reduction in overall financial fragility, currency risk, and speculative pressures in the economy; insulation from the contagion effects of financial crises; and enhancement of the autonomy of economic and social policy. The paper examines the structural factors that contributed to these achievements, and also weighs the costs associated with these measures against their macroeconomic benefits.

The paper concludes by considering the general policy lessons of these seven experiences. The most important of these lessons are as follows. 1.) Capital management techniques can enhance overall financial and currency stability, buttress the autonomy of macro and micro-economic policy, and bias investment toward the long-term. 2.) The efficacy of capital management techniques is highest in the presence of strong macroeconomic fundamentals, though management techniques can also improve fundamentals. 3.) The nimble, dynamic application of capital management techniques is an important component of policy success. 4.) Controls over international capital flows and prudential domestic financial regulation often function as complementary policy tools, and these tools can be useful to policymakers over the long run. 5.) State and administrative capacity play important roles in the success of capital management techniques. 6.) Evidence suggests that the macroeconomic benefits of capital management techniques probably outweigh their microeconomic costs. 7.) Capital management techniques work best when they are coherent and consistent with a national development vision. 8.) There is no single type of capital management technique that works best for all developing countries. Indeed our cases, demonstrate a rather large array of effective techniques.

There are sound reasons for cautious optimism regarding the ability of policymakers in the developing world to build upon these lessons. In particular, we are heartened by the growing understanding of the problems with capital account convertibility in developing countries; by the increasing recognition of the achievements of capital management techniques by important figures in academia, the IMF and the business community; and by the potential for some developing countries (such as China, India, Malaysia, Chile, Singapore) to play a lead role in discussions of the feasibility and efficacy of various capital management techniques.