IMF on Capital Controls: For Them Before It Was Against Them?

Earlier this month the IMF published a working paper that examined the financial barriers between members of the East African Community (Burundi, Kenya, Rwanda, Tanzania, and Uganda).  The barriers could include the transaction costs inherent in the difficulty of finding a buyer, seller, or broker of a financial product, or the risk that a party to a financial transaction would default on a loan or otherwise fail to live up to contractual obligations.  The East African Community (EAC) economies are still maturing, so these barriers are expected.  However, the author of the paper chose to zero in on the controls placed on the international flows of capital in the EAC countries and urged that they be put on the chopping block:

Efforts can be made by EAC members to remove and lower their existing financial barriers. The fact that EAC countries have agreed to abolish existing capital controls [among themselves] by the year 2015 is a step in the right direction.

This paper comes just months after the IMF released a staff position note that suggested that “controls on inflows of foreign capital can be one tool in broad policy toolkit.”  In the paper, it noted that

policymakers are again reconsidering the view that unfettered capital flows are a fundamentally benign phenomenon and that all financial flows are the result of rational investing/borrowing/lending decisions. Concerns that foreign investors may be subject to herd behavior, and suffer from excessive optimism, have grown stronger; and even when flows are fundamentally sound, it is recognized that they may contribute to collateral damage, including bubbles and asset booms and busts.

To be fair, this paper criticizing capital controls in the EAC is an IMF “Working Paper”, which does not necessarily represent the views of the IMF like the previous “IMF Staff Position Note”.  Nevertheless, this paper on EAC suggests that the IMF may be drifting back to its old ways merely two years after the worst financial crisis since the Great Depression.

The EAC countries are no strangers to rapid flows of massive amounts of capital.  In June 2008, Kenya’s largest cell phone service provider Safaricom held an initial public offering (IPO) of its shares.  Strong demand from foreign and local investors alike pushed share prices high immediately following the IPO.  Many small Kenyan investors took out loans to purchase the stock.  When the global financial crisis came to a head in late 2008, though, the stock price collapsed as foreign investors sold their shares, and local investors were burned.

For a discussion of how capital controls could run afoul of WTO rules (how to fix WTO rules to prevent this) see our recent memo here.