What Is Capital Control?
Capital control represents any measure taken by a government, central bank, or other regulatory body to limit the flow of foreign capital in and out of the domestic economy. These controls include taxes, tariffs,legislation,volume restrictions, andmarket-based forces. Capital controls can affect many asset classes such as equities, bonds, and foreign exchange trades.
Understanding Capital Controls
Capital controls are establishedto regulate financial flows from capital markets into and out of a country's capital account. These controls can be economy-wide or specific to a sector or industry. Government monetary policy can enact capital control. They may restrict the ability of domestic citizens toacquireforeign assets,referred to as capital outflow controls,or foreigners' ability tobuydomestic assets, known as capital inflow controls.
Tight controls are most often found in developing economieswhere the capital reserves are lower and more susceptible to volatility.
Key Takeaways
- Capital control represents any measure taken by a government, central bank, or other regulatory body to limit the flow of foreign capital in and out of the domestic economy.
- Policies may restrict the ability of domestic citizens toacquireforeign assets,referred to as capital outflow controls.
- Capital inflow controls limit foreigners' ability tobuydomestic assets.
- Critics believe capital control inherently limits economic progress and efficiency, while proponents considerit prudent because they increase theeconomy's safety.
The Debate Over Capital Controls
Critics believe capital controls inherently limit economic progress and efficiency while proponents considerthem prudent because they increase thesafety ofthe economy. Most of the world's largest economies have liberal capital controlpolicies and have phased out stricter rules from the past.
However, most of these same economies have necessary stopgap measures in place to prevent a mass exodus of capital outflows during a time of crisis or a massive speculative assault on the currency. Factors such asglobalization and the integration of financial markets have contributed to an overall easing of capital controls.
Opening up an economy to foreign capital typically provides companies witheasier access to funds and can raise the overall demand for domestic stocks.
Real World Example
Capital controls are often established after an economic crisisto prevent domestic citizens and foreign investors from extractingfunds froma country. For example, on June 29, 2015, the European Central Bankfroze support to Greece during the European sovereign debt crisis.
Greece responded by closing its banks and implementing capital controlsfrom June 29 through July 7, 2015,out of fear that Greek citizens would initiate a run on domestic banks. The monetary capital controls put limits on allowable daily cash withdrawals at banks and placed restrictions on money transfers and overseas credit card payments.
On July 22, 2016, Greece's Finance Minister reported that the countrywould ease itscapital controls to increase confidence in Greek banks. The easing was expected to increase the amount of money held at Greek banks.
According to The Guardian, while Greece was putting the worst of the economic crisis behind it as it exited the bailout program. The government loosened the limits on cash withdrawals and increased the allowance for business cash transfers.
FAQs
Capital control represents any measure taken by a government, central bank, or other regulatory body to limit the flow of foreign capital in and out of the domestic economy. These controls include taxes, tariffs, legislation, volume restrictions, and market-based forces.
What do capital controls prevent responses? ›
Facing an imminent crisis, temporary capital controls on outflows may help prevent a free fall of the exchange rate, preserve foreign exchange (FX) reserves and liquidity in the financial system, and provide breathing space while needed macro-financial policies are implemented.
What is the information content of capital controls? ›
Capital controls, residency-based or currency-based measures used to regulate cross-country financial flows, are increasingly considered part of the standard financial stability policy toolkit for many emerging markets and developing economies (EMDEs).
What are exchange controls and capital controls? ›
Types of capital control include exchange controls that prevent or limit the buying and selling of a national currency at the market rate, caps on the allowed volume for the international sale or purchase of various financial assets, transaction taxes such as the proposed Tobin tax on currency exchanges, minimum stay ...
What are the three 3 main parts in capital structure? ›
The three main parts of capital structure are debt, equity, and hybrid securities. Debt represents the borrowing obligation of the firm, equity entails shares issued in the company, and hybrid securities are a combination of debt and equity securities.
What are the three main types of capital? ›
When budgeting, businesses of all kinds typically focus on three types of capital: working capital, equity capital, and debt capital. A business in the financial industry identifies trading capital as a fourth component.
What are the negatives of capital controls? ›
It may also have negative spillover effects on other countries, such as creating exchange rate volatility, currency wars, or balance of payments crises. Moreover, exchange rate policy may conflict with other policy objectives, such as monetary policy, fiscal policy, or financial regulation.
Why might a country impose capital controls? ›
The main purpose of capital controls is to reduce the volatility of currency rates in the economy and provide support and stability to it by shielding it from sharp fluctuations. Major disturbances in the flow happen from capital outflows, which lead to a rapid depreciation of the domestic currency.
What is the role of controls in capital inflows? ›
For example, controls on capital inflows are usually implemented when policymakers find a trend of high and increasing inflows. It is almost impossible to measure what would have happened in the absence of controls.
What does capital include? ›
Capital is a broad term for anything that gives its owner value or advantage, like a factory and its equipment, intellectual property like patents, or a company's or person's financial assets. Even though money itself can be called capital, the word is usually used to describe money used to make things or invest.
Control over issues of capital-(1) No company incorporated in the States shall, except with the consent of the Central Government, make an issue of capital outside the States.
What is the working capital control? ›
Working capital management requires monitoring a company's assets and liabilities to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations. Managing working capital primarily revolves around managing accounts receivable, accounts payable, inventory, and cash.
What are the benefits of capital control? ›
Short-term and Long-term Impact of Capital Controls
In the short term, capital controls can offer relief from financial crisis pressures. They can ensure monetary autonomy, allow for effective crisis management, and insulate the economy to some extent from global financial shocks.
What are exchange controls in simple words? ›
What Are Exchange Controls? Exchange controls are government-imposed limitations on the purchase and/or sale of currencies. These controls allow countries to better stabilize their economies by limiting in-flows and out-flows of currency, which can create exchange rate volatility.
Does China have capital controls? ›
China's foreign currency controls
China implements a strict system of capital controls, limiting the inflow and outflow of foreign currency.
What are the different types of capital restrictions? ›
Many countries impose restrictions on the flow of financial capital across borders. Such restrictions are referred to as capital controls. For example, a restriction can be sanctions put in place that prohibit all investment in a foreign entity. Other examples include taxes, tariffs, and volume restrictions.
What are the five types of capital in economics? ›
It is useful to differentiate between five kinds of capital: financial, natural, produced, human, and social. All are stocks that have the capacity to produce flows of economically desirable outputs. The maintenance of all five kinds of capital is essential for the sustainability of economic development.
What is capital controls or macroprudential regulation? ›
Macroprudential regulation plays the usual role of reducing the amount and riskiness of all financial liabilities, no matter whether domestic or foreign; capital controls aim to increase the aggregate net worth of the economy by reducing net inflows; they create an interest rate differential between the domestic and ...
What is the central bank capital control? ›
Capital controls are the steps of measures that the governments of the central banks of the country implement in order to control or regulate the inflow or outflow of capital. The main intention of implementing this process is to maintain economic stability in the domestic economy.
