Capital inflows in the post-crisis period since 2008 have tended to prove more problematic, as opposed to capital outflows, for companies based in (or with operations in) emerging markets. As a result, controls on capital inflows have been observed in countries including Brazil, South Korea and Indonesia to curb currency appreciation. Such flows, particularly short-term inflows, have been driven by an improving risk appetite in financial markets, with attractive prospects of carry-trade gains between the slow recovery in advanced economies and resilient growth in emerging markets. However a changing outlook – which includes the possibility of a rise in the US benchmark interest rate, which has been close to zero since the end of 2008 – threatens the retraction of funds from these destinations, potentially hampering growth. Consequently, in the medium term multinational companies (MNCs) are likely to face increasing challenges from controls on capital outflows in emerging markets.
For many companies coping with exchange rate volatility, inflation and trade obstacles are sufficient challenges for cross-border financial planning. Taking into consideration the sudden imposition of outbound transfer constraints is both costly and difficult to anticipate. Consideration of a country’s interventionist history, macroeconomic environment and monetary conditions are required to help gauge such a possibility. As a risk analysis firm Maplecroft developed a remittances risk index (RRI) which takes into account each of these considerations to provide a global view on the likelihood of controls being imposed on outward remittances of capital.
Developing Countries Most at Risk
As shown below in Figure 1, at the start of 2013 the RRI identified Cuba (ranked 1st) Guinea (2nd), Sudan (3rd), Belarus (4th), Ecuador (5th), Venezuela (6th), Belize (7th), DR Congo (8th), Argentina (9th) and Tajikistan (10th) as the countries most likely to impose controls on outbound capital out of a total of 177 countries evaluated.
Figure 1: Remittances Risk Index 2013
Belarus, DR Congo and Sudan have already enacted controls on outflows of foreign currency in an attempt to counter flagging economic performance, while otherssuch as Cuba, Ecuador and Venezuela have used the measure as a policy tool in the closed economic models of their governments. Because of their current use of controls, the risks that further measures will be imposed increased and the firm has advised companies operating in these countries to closely monitor developments.
Besides those with significant portfolio exposure to these countries, retail firms and those that are dependent on imported goods for production processes are particularly at risk and may struggle to ensure supply chain continuity if payments abroad are restrained. Recent controls on the transfer of currency in Argentina (ranked 9th and ‘extreme risk’ in the RRI) for instance, have seen the supply of automobiles, consumer electronics and designer apparel severely reduced, as retailers are not permitted to make sizeable foreign payments to import these goods.
Changing Conditions and Outlook
Late 2012 was a turning point for capital control policy, when the International Monetary Fund (IMF) officially consented that constraints may be suitable in some cases to calm volatile cross-border flows. This policy change broke a longstanding stance that capital controls should be avoided at all costs, which previously bound all IMF member countries. Given the new institutional position, countries are now more inclined and more justified to apply controls on outflows of capital.
Of the key markets for business with the greatest growth potential, Russia (83rd), India (98th), the Philippines (101th), Indonesia (114th), Brazil (121st), and China (127th), are classified as ‘medium risk’ in the RRI. If controls become more widely used and acceptable as policy tools, tit-for-tat restrictive measures may see an increase. Furthermore, as these economies rise, they may also gain from restricting capital outflows in order to encourage domestic investment. However, China’s increasing relaxation of capital controls as part of the internationalisation of the renminbi (RMB) may see it move into ‘low risk’ in coming years.
A major challenge for the short to medium-term outlook will be ongoing fiscal developments in the US. At present, Federal Reserve purchases of US bonds have maintained low yields, which fail to reflect mounting fiscal uncertainty. A setback in the US bond market going into 2014, prompted by a sharp fiscal contraction or a portfolio shift into stocks, would inevitably trigger a rise in US interest rates. An increase in rates would result in an increase in flows back to the US and out of emerging markets. An IMF report in 2011 estimated that the slightest rise in US policy rates could cost emerging markets between 1.5% and 2.5% of gross domestic product (GDP) through the outflow of funds.
The risk of capital controls is not confined to developing and emerging countries. The results of the RRI also identify the delicate economic situation for some eurozone member states.
Greece (ranked 58th) is categorised as ‘high risk’ due to its uncertain future in the euro. Indeed, if Greece was to leave the eurozone, the imposition of exchange controls would be highly likely in order to prevent substantial capital outflows that would undermine Greece’s banking system. Portugal (115th), Spain (129th) and Italy (128th), meanwhile, face similar conditions, although they are not considered to be quite as fragile as Greece and are categorised as ‘medium risk.’
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