Are capital controls necessarily bad?

Alex Lew, CFA
3 min readJan 3, 2021


The world economy is now very fragile. High unemployment rates hinder Europe’s growth, and its recovery is mainly export-based.

Investors are moving risky assets into treasury bonds; some are even thinking of cash. The crisis has now infected all emerging markets. Spreads on emerging market bonds have risen to stratospheric levels.

East Asia’s fundamentals were strong high growth, low inflation budgets in balance, and they enjoyed a surplus high savings rate. But this is no longer so, as we see the decreasing growth rates in significant growth sources such as Taiwan, Hong Kong, Singapore, which were powerhouses are growth in the 1990s.

In the 1990s, the global economy needed to build up production capacity and tightening framework to integrate into global financial markets. Instead, based on G7 ministers and the World Bank’s decision, leaders opened up their capital accounts and liberalised their economic systems. However, as the global economy opened up, some weaker nations had lagging FX controls and vulnerable banking systems.

Both the US and EU assured them that their strong macroeconomic fundamentals meant negligible risk from further liberalisation of their capital accounts. Emerging nations also found the prospect of cheap money irresistible.

Thailand was one of the countries that took on FX control liberalisation, removing most capital inflow controls. They established international banking facilities to become a channel for offshore funds into Thailand. By 1997, they had run up so much capital debt. South Korea also came under pressure to liberalise its capital controls to join OECD. Korea eased rules on short term capital to permit external borrowing by Korean banks, including greater credit trade-credit access. Domestic corporations in Thailand, Indonesia and Korea, borrowed from abroad because interest rates on the US dollar are much lower than their domestic interest rates. This led to a massive increase in external debt. Many of these companies made the fundamental mistake of borrowing short term for long term projects.

However, companies soon found that borrowing wasn’t cheap as their governments moved exchange rates. Borrowers had to repay at a higher exchange rate then the rate at the point of time of borrowing. The movement of exchange rate balanced the low rates of borrowing overseas. Private corporations believed that exchange rates would be stable. So, they borrowed in US dollars, assuming that exchange rates would remain more or less

On hindsight, Thailand, Indonesia and other East Asian countries would have been better off if the capital accounts had been liberalised more gradually in tandem with the strength of their financial systems and institutional capability. They needed a system to monitor to check and control the flow of short term speculative funds, and to ensure that the maturity of the debts and investments were properly matched.

In retrospect, governments should have been more cautious in pressing for more liberalised financial markets and free capital movements. There is an ongoing dispute amongst financial experts, whether free capital mobility is good for long term growth.

When massive amounts can flow in and out at the touch of a computer button, we see more significant economic fluctuations. The debate is still on capital account liberalisation should be more carefully calibrated. For example, Chile imposed a tax on foreign borrowing and requires portfolio investors to put a portion of their funds in non-interest bearing deposits by the central bank to discourage short term inflows.

Yes, we know that controls restricting capital mobility will increase the cost of capital and growth may be slower. This is the cost of development that’s more stable and sustainable.

On the first of September 1998, Malaysia imposed capital controls. Malaysian ringgit deposits held offshore must be repatriated within the month. Foreigners who sell Malaysian shares cannot take out the proceeds for a year. Malaysian exports and imports must be settled in foreign currency. Later, we knew that Malaysia was a safe harbour during the Asian financial crisis.

Open economies like Singapore cannot afford capital controls. Singapore cannot insulate itself from the effects of the financial turmoil.



Alex Lew, CFA