What are Capital Controls?

Published by Thomas Herold in Banking, Investments, Laws & Regulations

'Capital Controls' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Capital Controls refer to government intervention measures that a sovereign national government undertakes either directly, through the central bank, or another regulatory agency. They institute these in an effort to reduce the outflow of foreign capital (and sometimes the inflow as well) from the domestic national economy. There are a wide range of such controls. Among these are tariffs, taxes, volume restrictions, and literal legislation. Market forces can also be a form of capital control. Such controls can have a decisive impact on a wide range of asset classes. These include foreign exchange currency trades, stocks, and bonds.

The reason a government and its agencies would go through the trouble of implementing such Capital Controls is to normalize and standardize the rates of financial inflows and outflows from its banks and capital markets. The government comes to the decision that it must stabilize the nation’s capital accounts. Such controls are not always effective on the entire economy. In fact, they can be specifically targeted towards an entire industry or even only one particular sector.

Government policies enact such controls to help ensure that the native population cannot spend their domestic currency on buying foreign assets or equities. At the same time, they impose restrictions on the abilities of foreign investors to obtain domestic securities, companies, and assets. The first example is called capital outflow controls, while the second one they refer to as capital inflow controls. The tightest of these controls often appear in nations whose economies are developing. In these states, the capital reserve base will naturally tend to be more volatile and significantly lower than in developed major economies.

There is an age-old debate still raging over capital controls. Some economists and analysts believe that they restrict and reduce economic performance and progress over time. Other economists consider them to be wise in that they provide a degree of stability to the developing economy. The majority of bigger economies pursue extremely liberal capital controls and policies. They have mostly reduced or even eliminated the stricter controls of past decades.

Despite this fact, these same liberal policy nations also maintain what they call stopgap measures. These exist to prevent a sudden and unanticipated huge capital flight in the periods of crisis or alternatively a speculative hedge fund type of attack on a national currency exchange rate. Capital controls have similarly become reduced by the twin influences of the impacts of globalization and financial market integration. Once countries choose to open their economy up to international capital this mostly permits their domestic firms and foreign firms to gain greater and simplified capital access. This can increase demand for domestic products and stocks as well.

When capital controls are deployed, this is most commonly as a direct result of economic crisis moments. A nation will make an emergency decision to stop its own citizens (as well as the guest foreign investors) from withdrawing their money from the country’s economy. On June 29th of 2015, the ECB European Central Bank made the decision to freeze all support to Greek banks because of the European debt crisis.

The response from Greece was to shutter all national banks and institute capital controls on July 7th of 2015. They engaged in this series of actions out of concern that their own citizens’ panic would lead to a “run on the banks” domestically. Such controls caused daily cash withdrawal limits from ATMs and banks. Overseas credit card payments and money transfers out of Greece simultaneously became restricted until further notice.

Approximately a year after the fact on the date of July 22nd of 2016, the Finance Minister of Greece announced that the country would ease its own capital controls in a measure designed to boost confidence in the domestic Greek banks. The easing increased the deposit base of the national banks of Greece as hoped for and expected by the national government.

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The term 'Capital Controls' is included in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.