Updated July 6, 2023
Capital Controls Meaning
Capital controls are regulations in the form of taxes, restrictions, or other measures that a government takes to restrict the flow of capital in and out of a country. Taxes, tariffs, laws, volume restrictions, and market-based rules are a few of these restraints.
For example, during the Asian Financial Crisis in 1997-98, many countries imposed control regulations. Countries like Korea, Thailand, and Indonesia asked their banks to stop issuing debt financing to foreign countries. The imposition of these measures prevented the economies from collapsing.
Governments put it to limit the amount of money that can go out of a country or come into the country. Governments use this measure to keep their currency from appreciating too quickly and hurting exports. Either the home country can implement these controls, or an international regulation can apply them.
Key Highlights
- It is a set of regulations that restrict the flow of capital in and out of a country
- Governments use these to protect their currency from being exchanged. It can also be a form of economic sanction against other countries
- It helps to prevent financial crises by limiting the flow of money and helping stabilize the economy
- The significant disadvantages can be that it can lead to black markets and discourage foreign investments.
How do Capital Controls Work?
Government bodies practice capital controls to manage the flow of money that moves in and out of a country’s financial account and its markets. These restrictions may be cost-effective for a particular industry or sector. Most developing economies have tight controls, with smaller and more volatile capital buffers.
Economies can accomplish it through monetary policy, which limits the types of transactions that may take place. For example, restricting transactions only between domestic banks or imposing limitations on international transactions.
They may also impose restrictions on domestic residents’ ability to acquire assets abroad (known as capital outflow controls) or on foreigners’ ability to acquire assets within their own country (known as capital entry controls).
Real World Examples
Example #1: Europe & Greece
During Europe’s sovereign debt crisis, the European Central Bank froze assistance for Greece on June 29, 2015. Greece closed its banks and implemented capital controls from June 29 to July 7, 2015, in response to the ECB’s action, out of concern that its citizens might start a massive bank run or capital outflow.
Financial controls placed limits on daily withdrawals from banks, international money transfers, and credit card payments. Greece’s finance minister announced on July 22, 2016, that the nation could relax its capital controls to boost trust in Greek banks. They then loosened the measures to increase the sums of money that Greek banks had set aside.
Example #2: Argentina
The Argentinean government took measures in December 2001 to limit and attempt to control the outflow of sizable bank deposits. It was known as the Corralito. There was a constraint on the amount of cash that savers could withdraw from banks. In short, the corralito worked to stop the banking system from failing.
Example #3: Other Nations
In India, many import duties, taxes, and surcharges are applied at the border, making it expensive to import goods. In contrast, China has strict rules on transferring yuan overseas and stringent limits on how much can be taken out of the country annually (currently $50,000 per person). On the other hand, Bangladesh restricts how much Bangladeshi taka (BDT) individuals can take abroad through residential remittance facilities banks.
Importance
- Such controls help support an economy by preventing excessive currency inflows or outflows, which can cause inflation or deflation
- Governments use it to control the flow of foreign currency flowing in their economy during periods of economic or political volatility
- The capital controls design control export, import, and exchange rates.
Advantages & Disadvantages
|
Advantages |
Disadvantages |
| This imposition can prevent economic collapse due to exchange rate pressures | It can lead to inflation which results in higher prices and decreased purchasing power |
| It can help stabilize the economy | Discourages foreign investment by restricting the outflow of capital |
| It can lead to the growth of the domestic economy and provide investment opportunities for domestic investors. | It can lead to black markets for goods, such as food, clothes, electronics, etc. |
Final Thoughts
Capital controls are crucial to the government’s economic growth and stability strategy. They allow governments to regulate percent of the money that leaves the country based on domestic needs. In addition, it prevents high cash outflows, which may decrease the value of the local currency.
Frequently Asked Questions(FAQs)
Q1. What are capital controls? What is its purpose?
Answer: It is a measure designed to restrict the flow of capital (money, investments, or other financial assets) to or from a country. The purpose is to slow down the amount of money that goes out of a country. Countries employ these when they face a risk of sudden withdrawal of capital during an economic crisis that can lead to destabilization.
Q2. What do capital controls prevent?
Answer: Any action taken by a government, central bank, or other regulatory body to restrict the flow of foreign capital into and out of a domestic economy is capital control.
They can prevent speculative attacks and devaluation of the currency. It can also prevent economic collapse in case of inflation or deflation.
Q3. What are capital controls in Russia?
Answer: To control inflation, Russia has imposed several monetary policies. They are also planning to put a limit on the interest rates in the coming years. The government also opposed any bank transactions of large amounts. There is even a pause on exporting goods in high quantity.
Q4. Name the list of countries with capital controls.
Answer: Numerous countries apply it for various reasons. Some of the major countries include Russia, India, and China. Some other countries that follow these controls are Brazil, Thailand, and Malaysia.
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