Capital controls not the answer

ADRIAN CHANG 20 November 2009
The Independent

New Zealand's volatile currency woes won't be resolved by capital controls, according to a visiting central banker from a country with a history of fiddling with the dials.

Alexandre Pundek Rocha, senior adviser to the board of the Central Bank of Brazil, who was visiting New Zealand this week to promote greater business ties with Brazil, told The Independent capital controls in his region have a long history of failure.

His comments come during a period of exceptional currency volatility in New Zealand, with the kiwi increasing by about 52 per cent since March. Trade groups, economists and commentators complain unchecked capital inflows from the carry trade have hijacked the dollar.

The arguments are familiar to Pundek, who saw similar things happen in Brazil during the 1990s. He concedes countries like Brazil and New Zealand tend to attract speculative capital and have a comparative disadvantage with China, which pegs its currency at an undervalued rate.

Brazil abandoned its peg against the US dollar in January 1999 after speculative attacks on the Brazilian real caused its peg to fail. The central bank then turned to inflation targeting, much like the system in New Zealand, but has maintained much wider powers to interfere on foreign capital markets than our own Reserve Bank.

For example, it can unilaterally set a tax rate of between zero to 25 per cent on foreign capital entering the country to invest in fixed-interest bonds or shares. It exercised this power on October 20, instituting a 2 per cent tax on new money entering the country to invest in these asset classes.

Our own Reserve Bank governor, Alan Bollard, has had to restrict himself to rare and secretive forays into the currency markets and largely fruitless attempts at jawboning the dollar down.

Has Brazil's capital tax worked? It's difficult to tell, says Pundek. Capital flows have been exactly the same before and after the tax, but that doesn't mean it has failed. "You never can tell, because the flows today [without the tax] could have been even higher than they are today."

But his personal view is that imposing capital controls does nothing to address the underlying issues. He recalls in 1999 Brazil had an 8 per cent tax on incoming capital but that failed to stop a flood of speculative capital pouring into the country and driving up its currency, the real. "You delay the process, but you can never stop the process." Exactly

Senior Brazilian trade representative Mario Marconini from the Federation of Industries of Sao Paulo, says there's a growing realisation from Brazilian businesses that trying to control the exchange rate is fruitless. Yup

The long-term answer can only come from concerted international action to apply pressure on China to allow more flexibility in its exchange rate, Pundek says.

By removing China's artificially low exchange rate, the massive trade imbalances created by that rate can be corrected.

China remains the problem - KT